Below are analyst updates on our nine current high-conviction long and short ideas. We will send Hedgeye CEO Keith McCullough's refreshed levels for each in a seperate email.
Please note that we added Mexico (EWW) and Mednax (MD) to the short side of Investing Ideas this week. We removed Micron Technology (MU) from the long side and Carter's (CRI) from the short side.
IDEAS UPDATES
FXB | UUP | TUR | EWW
As macro analyst Christian Drake wrote on Thursday morning in Hedgeye’s Early Look:
“While the ‘Trump Trade unwind’ has increasingly garnered headlines, most haven’t, in fact, unwound.”
While performance spreads are generally past peak, relative performance across reflation and Trump policy levered assets remain almost universally positive. As Drake continued in Thursday's Early Look, the stock market bear's line of thinking goes like this:
"Trump Trades should unwind and the market should correct in the progressive abandonment of that narrative as investors rationalize that over-exuberance and reprice the reality of geopolitical risk and uncertainty, lagged and slower-to-materialize stimulative policy. Moreover, Peak Complacency prevailing currently in the face of conspicuously elevated uncertainty must represent a build of latent risk that will invariably manifest in an acute increase in volatility."
We would draw attention to two things with regard to the equity market rally:
- The excerpt above from Drake's Early Look is not an irrational line of thinking and, for the most part, the empirical evidence supports it as multi-year lows in cross-equity correlations and VIX <11 is typically followed by VIX >11 and rising equity correlations. 30 and 60 day realized volatility in the Dow, SP500, and Nasdaq just hit their lowest levels since 2007. Even though we’re not calling for a correction just yet, that’s not typically something to get excited about – it's kind of a one way street from here.
- The second is a potential growth pivot in Q1 into QUAD 3 (Growth Slowing, Inflation Accelerating, which is better for the currency than equities). We’re currently at -0.76% for Q1 GDP on a quarter-over-quarter annualized basis (on a year-over-year basis, our preferred measure, it would actually imply +1.5%, still a deceleration from 1.9% in Q4). That's obviously a negative catalyst. Old Wall Media won't understand why it’s “negative”. Furthermore, the media is literally begging for any data point to disconfirm that Trump has impacted the economy
Don’t forget, our model suggests we're in QUAD1 (Growth Accelerating, Inflation Decelerating) for Q2-Q4. We talk all the time about how positively inflecting data is good for the currency, and we have it overwhelmingly despite a comp effect in Q1. Below we show two slides that support the growth narrative full-circle.
As KM likes to say, “the data will set you free”.
Cheers.
Below is a note from Hedgeye CEO Keith McCullough on why we added Mexico (EWW) to the short side of Investing Ideas:
With both US and Global Equity Beta now signaling immediate-term TRADE overbought, the time and price is right to add one of our favorite EM shorts (Mexico, EWW)
Per Darius Dale's latest thoughts speaking with Institutional Investors in Texas we're citing its balance of payments risks arising from a #StrongDollar. Specifically, the Mexican economy and financial system screen very poorly relative to our EM sample median on a number of key BoP metrics:
- Current Account Balance: -3.3% (Mexico) vs. -1.7% (sample median)
- Short Term External Debt as a % of FX Reserves: 29% vs. 19%
- Total Inbound Portfolio Investment as a % of Total Nonfinancial Sector Credit: 40% vs. 16%
- Total U.S. Dollar Debt as a % of FX Reserves: 141% vs. 97%
Moreover, its credit gap and debt service ratio gap metrics screen very poorly at +2.3 and +2.7 standard deviations relative to their respective trailing 10Y means. All of this implies Mexico is facing acute risk of a nasty deleveraging cycle to the extent we continue to be right on the longer-term TAIL side of the USD.
Click here to read Hedgeye Senior Macro analyst Darius Dale's institutional research note on Turkey that we sent Investing Ideas subscribers earlier this week.
TWX
Click here to read our analysis on why we think the AT&T/Time Warner (TWX) deal will be approved.
WFM
Click here to read our analyst's original report.
Our timing was very early on this Whole Foods Market (WFM) call and that was our mistake. We had previously thought that the plans in place would have bore fruit earlier. That was clearly not the case, as the company continued to struggle with decelerating comps as competition intensified. Why is this time different? Why should you believe us now?
In our opinion the number one determinant for the success of a company that rises above the rest is allocation of capital and therefore the return on each incremental dollar spent. As Whole Foods has continued to grow units outside of their comfort zone into a slowing environment, ROIIC has declined, as depicted in the chart below.
We stated in our Black Book back in September 2016 that, “if they were to cut their capex by roughly 50% we would view that as a positive for the stock as they would be more focused on refining their business.” We stand by that statement and although they are only reducing capex by roughly 11%, or $78M (from 4.6% of sales to 4.0%), that is a fair number given the number of projects they already have under way.
This reduction in growth going forward will allow WFM to shift their focus to providing the best customer experience at core locations and not be distracted by sub-par unit returns in weak markets. John Mackey said it best on the call last night, "ending square footage growth will result in a healthier bottom line, increased free cash flow and high returns as we minimize the impact of cannibalization and redirect our energy and capital on improving comps, EBITDA and ROIC.”
And this is our vision, but to fill the void of new stores, Instacart will expand coverage zones of existing Whole Foods allowing them to reach more of the population without necessarily squeezing a store in.
To quickly draw a parallel to the restaurant industry, cutting capex is what Chipotle (CMG) needs to do, but they don’t have the guts or humility to cut growth and lose that aspect of their story. As soon as CMG admits they are just like any other restaurant company and they need to cut capex substantially, that is the moment it would no longer be a short for us.
But back to Whole Foods. The sub-title of our Black Book in September of 2016 was, “The search for revitalization in an ever-changing landscape.” That search has been longer then we have hoped. But we believe they have found the correct tools and are now ready to dig in. The exact inflection point is difficult to determine, given the lead times of some of these initiatives, but we are looking to the 3rd and 4th fiscal quarters as key dates at which we need to see improvements in trends.
LMT
Lockheed Martin (LMT), like all defense industry companies and in fact Congress itself, are eagerly awaiting the Pentagon supplemental request to its still outstanding FY 2017 budget. SecDef Mattis is expected to make decisions on the size, shape and priorities of the supplemental request by February 24th and forward to the OMB by March 1st which should send it to the Hill shortly thereafter. The Congress will act on it one way or the other by April 28.
As a reminder, the Pentagon is currently operating on a Continuing Resolution (CR) due to expire on April 28. The CR maintains Pentagon total current spending at the same level as FY 2016, which is about $11B less than President Obama had requested for FY 2017 ($591B vs. $580B). Note that Obama’s FY 2017 request conformed to the base spending cap prescribed by the amended Budget Control Act. The Trump Administration has been clear that it wants to remove the Budget Control Act caps and increase defense spending within the current fiscal year.
The supplemental request will be based on the four military services “Unfunded Priority Lists” provided to Congress last spring. The House attempted last summer to mostly fulfill those lists by adding $15B to its mark of Obama’s FY17 request. The Senate did not go along and so we ended up with the CR. Given the new atmospherics, the Services are now updating their list of requests (read: increasing).
We expect the range of the total supplemental requests to be the in the range of $25 to $35B. While there is a keen focus on readiness, I.e., maintenance and training, there is only so much Operations and Maintenance money that can be responsibly spent in the five remaining months of the fiscal year and so there will considerable increases in Procurement Budget Authority.
LMT can expect at least the following increases to its programs: +11 F-35 ($1.5B), +8 C130J ($724M), 24 H-60 ($440M).
MIC
No update on Macquarie Infrastructure Corporation (MIC) this week but Hedgeye Energy analyst Kevin Kaiser reiterates his short call on the company. We will send subscribers a full stock report on the company next week.
MD
"Hedgeye Healthcare analyst Tom Tobin is reiterating his SELL call on Mednax (MD) post their recent quarterly report," wrote Hedgeye CEO Keith McCullough earlier this week.
Here are the key takeaways from a recent institutional research note written by our Healthcare team:
"In terms of metrics, our Maternity Tracker continues to trend negative which resulted in -1.8% decline in NICU days for the quarter. The vRad narrative continues to disappoint, which we believe is now spearheading a quality dilution in the MD physician portfolio as they turn to brick and mortar radiology acquisitions. Radiology may present a green field opportunity for cheaper acquisition multiples compared to Anesthesiology (which remain elevated), but they are cheap for a reason."
4Q16 TAKEAWAYS
- Missed 4Q16 and guided below consensus for 1Q17 with much of the Q&A spent on radiology
- MD currently has 411 radiologists under vRad according to our data analysis which compares to "over 400 reading" and "500 contracted" according to management commentary on their earnings call
- Last quarter management said they had "nearly 400" reading radiologists and were on track for 500 contracted by year end
- With same unit volume down -0.7% overall, we estimate the non-maternity volume trend was +0.6%, a weak result
- As management highlighted, matching volume and staffing, particularly in radiology, is "hard"
- NICU margins are also impacted by weak volume high "fixed costs" in terms of staffing
- We assume acquisiton multiples remain high given management's comment that multiples remain "unchanged"
- On the 3Q16 earnings call vRad problems "...we hope will go away by the end of the year..."
- New on the 4Q16 earning call was that vRad, due to poor performance lost business, but is no longer "losing contracts"
Click here to watch the most recent edition of Sector Spotlight with Tobin and Healthcare analyst Andrew Freedman. In it they discuss their investment process, fourth quarter earnings season, healthcare employment and why Mednax (MD) is one of their favorite short ideas.
