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Takeaway: KSU, BEN, WMT, CFG, PNRA, TRIP, LMT, TWX, FXB, UUP, WFM, HBI, XLU, CRI, MIC

Investing Ideas Newsletter - 03.07  X

Below are analyst updates on our fifteen current high-conviction long and short ideas along with Hedgeye CEO Keith McCullough's refreshed levels for each.

Please note that we removed the Canadian dollar (FXC) from the long side of Investing Ideas this week and removed Mednax (MD), iShares MSCI Turkey ETF (TUR), and Mexican Stocks (EWW) from the short side. We also added Wal-Mart (WMT), Franklin Resources (BEN) and Kansas City Southern (KSU) to the long side.

LEVELS

Investing Ideas Newsletter - levels 3 10 17

Trade :: Trend :: Tail Process - These are three durations over which we analyze investment ideas and themes. Hedgeye has created a process as a way of characterizing our investment ideas and their risk profiles, to fit the investing strategies and preferences of our subscribers.

  • "Trade" is a duration of 3 weeks or less
  • "Trend" is a duration of 3 months or more
  • "Tail" is a duration of 3 years or less

IDEAS UPDATES

FXB | UUP | XLU

Below is an excerpt from an institutional research note written by Hedgeye Senior Macro analyst Darius Dale entitled "Global Growth Is Rocking And Rolling!":

Our analysis suggests that global growth is unequivocally accelerating on a trending basis. This is the underlying factor perpetuating the broad-based recovery in both domestic and global corporate profit growth. Moreover, this conclusion holds true from the perspective of both the “soft” data and the “hard” data.

With respect to the former, here's the breakdown of global PMI readings which are trending higher on a sequential and quarterly average basis. 

  • Of the 32 countries and economic blocks that release monthly Manufacturing PMI data, all but five of them are accelerating on a trending basis.
  • Of the 19 countries and economic blocks that release monthly Services PMI data, all but two of them (India and Mexico) are accelerating on a trending basis.
  • Of the 19 countries and economic blocks that release monthly Composite PMI data, all but one of them (India) is accelerating on a trending basis.
  • The mean reading for each of the aforementioned 70 indicators is in the third quartile on a trailing twelve month percentile basis, which would imply not only are most PMI readings tracking higher, but also that they are elevated in an absolute sense with ample room to run.

Investing Ideas Newsletter - 03.08.17 Chart of the Day 

With respect to the latter, we’ve developed proprietary indicators to track global growth on a high-frequency basis across various segments of the global economy.

Specifically, we’ve calculated the weighted average growth rate of Nominal Retail Sales, Exports and Industrial Production for the world’s 10 largest economies, which in total represent just shy of 80% of global Nominal GDP. Moreover, we can look to IMF data to track global export growth, as well as inflation. The punchline is that each of the aforementioned indicators is accelerating on a trending basis.

All told, when analyzing the data from either a top-down or bottom-up perspective, it’s easy to see that global growth momentum is currently as strong as it’s been at any point in the last ~2.5 years. 

Investing Ideas Newsletter - World Industrial Production

Investing Ideas Newsletter - World Nominal Retail Sales

Investing Ideas Newsletter - World Exports

TWX

Click here to read our analysis on why we think the AT&T/Time Warner (TWX) deal will be approved. 

Earlier this week, Hedgeye Telecom & Media Policy analyst Paul Glenchur wrote an institutional research note updating his thinking on the AT&T-Time Warner deal:

Under former Chairman Tom Wheeler, an FCC Democratic majority adopted new requirements that force cable operators and telecom carriers to obtain affirmative consent (opt in) from subscribers before using web browsing or app usage data for targeted advertising purposes. 

This was a departure from FTC requirements, putting heavier burdens on broadband ISPs under the FCC regime while leaving edge providers like Facebook (FB) and Alphabet-Google (GOOGL) lightly regulated under FTC enforcement policies.  Such policies do not require opt-in as a condition for third party marketing.  Studies suggest affirmative opt-in mandates discourage a large majority of consumers from accepting targeted ads.

The FCC rules involving data security have been stayed, in part, by the new FCC under Republican Chairman Ajit Pai.  The more onerous rules are working their way through the administrative clearance process but a congressional resolution of disapproval under the Congressional Review Act will prevent implementation of the regulations and prohibit the Commission from adopting similar rules in the future. 

Democrats cannot filibuster a CRA resolution of disapproval.  A simple majority in the House and Senate is all that is required to pass it.  We assume President Trump will sign it.

With increasing competition and market saturation in traditional subscription services, expanding digital ad revenues has become a priority with cable operators, telecom carriers and wireless service providers.  To a large extent, efforts to diversify into customized innovative content/marketing offerings represent a critical driver for the pending merger of AT&T (T) and Time Warner (TWX). 

Although major events, like the Super Bowl, draw massive audiences in real time, video consumers increasingly tap video-on-demand over mobile devices, fragmenting the market and forcing reliance on targeted ads to monetize niche content.

WFM

Click here to read our analyst's original report. 

One of the key metrics we like to use when analyzing a company is ROIIC (return on incremental invested capital). As you can see in the visual below, Whole Foods Market's (WFM) ROIIC has seen a precipitous decline, and one way to rectify this issue would be to re-evaluate the Company’s CAPEX growth.

Consequently, slowing unit growth is a part of WFM’s new way forward, and as we stated in our February Black Book, Mackey is devoted to making sure every dollar spent going forward will benefit the Company in some way. 

Investing Ideas Newsletter - wfm image

LMT 

Despite being the punching bag for tweets and headlines on the costs of its major programs, the company continues to kill it on the Hill. This week the House advanced the FY 2017 Appropriations Bill and it is clear that defense procurement programs in general and Lockheed Martin (LMT) in particular are going to do much better than planned.  

The House added $877M to the F35 program, increasing Obama Administration planned Lot XI (FY17) orders by 11 jets to a total of 74, 6 more than the FY 2016 authorization of 68.  

Almost as significantly, the bill takes the Joint Program Office to task for tardiness in putting Congressionally- authorized aircraft on contract and demands a remediation plan within 45 days.  LMT has been clear and everyone agrees that protracted annual negotiations have hurt cost reduction efforts.

There have been improvements on that front.  The Lot IX (FY15) contract took 18 months to negotiate and then ended up with a governmental Unilateral Contract Action after the 34 aircraft were already 75% complete. The Lot X (FY16) contract was at handshake level this past January after only 45 days of negotiation and coincidentally (?) after President-elect Trump's tweet storm.  Now there are clear indications that the Lot XI (FY17) contract may be agreed soon after final passage of the appropriations bill by Congress NLT 28 April and actually before the fiscal year expires in September, a program first.

Other LMT major programs also did well with Congress adding $438M (+39%) to the controversial Littoral Combat Ship (LCS) program, $331M (41%) to the Army’s UH-60 program and $110M (8%) to the C130J program. When all is said and done USG procurement spending on LMT major programs in FY17 will approximately equal spending appropriated in FY16 whereas it had been forecast to be reduced by about 10%.  

Note that the FY17 Appropriations bill discussed here does not include the $20-30B supplemental spending request headed for Congress later this month. An outline of the FY18 budget plan will be released March 16 with details coming in June.

MIC

Click here to read our analyst's original report. 

Investing Ideas Newsletter - mic image

In a recent institutional research call on Macquarie Infrastructure Corporation (MIC) Hedgeye Energy analyst Kevin Kaiser said: “It doesn’t take a lot to go wrong for this to get really ugly." He continued: "I think probably a key tenet of the bull case is betting on management and the company’s capital allocation strategy. I think that’s poorly thought out.”

Here’s why:

  1. The existing businesses are clearly mature—there’s not much growth.
  2. The company relies mostly on acquisitions to grow.
  3. MIC has an aggressive dividend payout, over 150% of their earnings and free cash flow.

In other words, the stock is highly-sensitive to changes in U.S. economic cycles since they’re largely acquiring growth by tapping capital markets. Kaiser has seen this before. He explains how he thinks this plays out.

“So with this capital asset allocation strategy, like any other company that does this, what tends to happen is you buy when times are good. You buy when your stock price is high. You buy when asset valuations are high; when profit margins are near peak.

 

And then when capital market cycles roll over, you have to hunker down because your stock price has gone down, your leverage is high and you had to cut your dividend.”

Many investors are long MIC because they believe management can create value simply by deploying capital. As Kaiser says, “I’m not so sure about that.” 

HBI | CRI

Click here to read our analyst's original report on Carter's and here to read Hanesbrands.

Both Hanesbrands (HBI) and Carter's (CRI) are highly exposed to cotton prices. As cotton prices fell from the peak in 2011, HBI and CRI saw big gross margin expansion. CRI saw about 350bps, while HBI saw about 700bps of expansion. Low product costs (cotton) played a material role in the expansion for both. Now that 4-year margin tailwind is inflecting to a headwind.

Investing Ideas Newsletter - 3 10 2017 HBI CRI 2

For HBI specifically, a 10% move in cotton is about 45-65bps of gross margin risk. Or about 4% EPS hit. Cotton is up about 36% from the bottom we saw about a year ago.

It takes about 9-12 months for these costs to flow through to the P&L, so we should now see product costs pressuring margins. Additionally, given that the brands are over-earning their wholesale partners, it is highly unlikely that the retailers will be willing to consume that higher cotton cost or pass it along to the consumer. Both Target and Wal-Mart are on the record indicating they actually plan to lower prices and pressure their vendors like CRI and HBI.

We think margins are headed lower for both of these companies in 2017.

Investing Ideas Newsletter - 3 10 2017 HBI CRI 1

CFG

No update on Citizens Financial Group (CFG) but Hedgeye Financials analyst Josh Steiner will send out a detailed stock report next week.

PNRA

Click here to read our analyst's original report. 

As has been our mantra for the better part of four months now, delivery is the next frontier for the restaurants space. Despite the aggressive entrance into the delivery space by many restaurant brands and aggregators, it is still a relatively underpenetrated segment of the market.

This is great news for Panera Bread Company (PNRA) as the company has gone all-in on delivery, and is devoted to owning the whole delivery process from order inception to order delivery. As seen by the CivicScience results below, there is still very much white space to cover in the delivery space, as odds are that many consumers would utilize a delivery service, if available. 

Investing Ideas Newsletter - pnra image

TRIP

Click here to read our analyst's original report.

Despite the shot in the arm this week for shares of TripAdvisor (TRIP), largely driven by M&A rumors, we continue to stress the long term opportunity and business transformation that TRIP is undergoing.  We're putting together a presentation of our up-to-date thoughts on the company as well as the general health of the OTA landscape.  

All in all, we continue like TRIP as one of the top risk/reward opportunities in the travel space. 

KSU

Below is a note from Hedgeye CEO Keith McCullough on why we added Kansas City Southern (KSU) to the long side of Investing Ideas:

"I'm still looking to signal BUY in our Best Ideas (Institutional Research Product) on pullbacks. Let's add KSU here.

On Election Day, shares of Kansas City Southern (KSU) fell as much as -12% intraday. About 48% of the railroad operator’s revenue comes from Mexico.

The company’s executives acknowledged the irony of posting results on the day of Trump’s inauguration following the share price drop:

 

"Obviously the political and economic uncertainty is probably first and foremost on most of our minds, and the irony of us reporting earnings on the inauguration day of the 45th President is not entirely lost on us," Chief Executive Patrick Ottensmeyer said.

Our Industrials Analyst, Managing Director, Jay Van Sciver explains why he thinks Trump uncertainty is already priced-in, but skittish investors are missing the positives: 

  • Kansas City Southern’s multiple is cheaper than usual.
  • Van Sciver sees robust growth ahead (cost savings and favorable profit outlook).
  • Van Sciver thinks M&A speculation will heat up again and close the gap between where it is trading now and its historically premium valuation."

BEN

Below is a note from Hedgeye CEO Keith McCullough on why we added Franklin Resources (BEN) to the long side of Investing Ideas:

"Looking to get longer of The Financials, on red? I am.

 Earlier this week, Jonathan Casteleyn hosted a bullish Best Ideas (Institutional Research product) call on asset manager Franklin Resources (BEN). Our presentation outlined the subtle turn up in BEN's core performance and flow metrics: 

Performance is improving: We think the asset managers generally understate current performance metrics and in this case, Franklin is putting up a solid recovery in its core mutual fund products. Morningstar ratings have almost improved by 1 full star which has already started a rate of change improvement in its investment flow."

WMT

Click here to read our analyst's original report.

Here's an excerpt from Hedgeye Retail analyst Brian McGough's Institutional Research note on Wal-Mart Stores (WMT) (after they reported the recent quarter):

  1. #GrowthAccelerating.  Keith and our Macro team are looking for another y/y GDP acceleration by 2Q. WMT just put up its best US comp in nearly five years. Check.
  2. Traffic was up 1.4%, accelerating from 0.7% last quarter. That’s now nine quarters of positive traffic for WMT. E-comm up 36% -- off an admittedly low base of 3% of sales. But growth is growth.
  3. I still think that McMillon will be CEO of the year. He took up investment spending in stores, in both online and in-store content, and bought an e-comm infrastructure WMT failed to build over the course of a decade. Expectations – over TREND and TAIL duration – are in-check and very doable (even with the AMZN grocery call). Check.
  4. Speaking of AMZN, WMT just accelerated 4Q growth in the US while AMZN slowed on the margin. I know I’m nit picking here giving the parabolic 21% growth at AMZN. But numbers are numbers, yes AMZN added $4.5bn in 4Q US revs, but WMT was not too far behind at $2.3bn. That spread is narrowing. That’s a #fact that matters with WMT trading at 8x EBITDA and 16x EPS, with AMZN at 32x EBITDA and ‘infinity’ times earnings.
  5. Don’t extrapolate this to Target. WMT ‘out-trafficked’ (that’s now a word, fyi) TGT last quarter by 350bps. It’s gonna happen again, imo, with limited growth in AUR/basket at TGT. As good as McMillon is – that’s how bad Cornell is. He’s done the opposite. Underinvesting in the core (check out the SG&A per ft analysis below – WMT accelerated again this quarter #investing. TGT likely to decel -- again), buying stock at the peak, with literally no levers to pull to grow this business. I don’t think he’ll be living in Minny on the last day of 4Q.
  6. This is a very bad read for HBI.
  7. WMT SIGMA looks stellar. Great 4Q Gross Margin setup."