Below are analyst updates on our twelve current high-conviction long and short ideas. We will send Hedgeye CEO Keith McCullough's refreshed levels for each in a separate email.
IDEAS UPDATES
EXAS
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On Exact Sciences (EXAS) Guidance - Guidance of 150K tests in 3Q17 and 550k for the full year implies a sequential increase of 15k tests in the third and fourth quarter for a total of 165k tests in 4Q17. Revised revenue guidance of $230 - $240M implies an increase to the low end of the ASP guidance from $415 - $436 to $418 - $436. Management guided to a cost per test in the $140s in 3Q17 due to the scale of investment in their infrastructure and personnel.
We believe cost per test will remain in the $140s as EXAS continues to invest in its infrastructure development which includes building a new lab facility in 2018 in order to expand capacity to 2 million tests per year. Eventually, we expect cost per test to moderate back into the mid $130s depending on the timing of building their new lab facility. Long-term gross margins guidance moved up from 70% to 75% which implies a long-term cost per test of $125 given management's goal of a $500 ASP. Despite the change in guidance, their timeline to profitability in 2022 remains unchanged.
TWX
Click here to read our original analysis on why we think the AT&T/Time Warner (TWX) deal will be approved.
We've explained from the day this deal was announced that the White House, despite candidate Trump's stated opposition to the deal, would have limited if any impact on the Justice Department review process and that DOJ review would likely lead to ultimate approval (Hedgeye Potomac Research, The Trump Administration and AT&T-Time Warner, Nov, 9, 2016). Avoiding FCC review (by forgoing the transfer of any FCC-regulated licenses as part of the transaction) also bolsters approval prospects and simplifies the regulatory process.
RLGY
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In the short term there is some modest downside risk to shares of Realogy (RLGY) from Hurricane Irma. This is because Realogy’s owned brokerage business, NRT – which accounts for ~60% of total company EBITDA before intercompany accounting transfers -- derives roughly 10% of its revenue from Florida. At 20.6 million people, Florida’s population is ~6.4% of the United States’ 323 million and so NRT’s 10% share suggests a slightly disproportionate exposure.
While, at the time of this writing (Friday afternoon), it is unclear what the extent of the property damage will be from Irma, it seems reasonable to assume that there’s a high probability it will be serious to severe. This seems likely to delay contract and closing activity, potentially for months, which would push revenue out of the third quarter and into the fourth quarter. While I think that ultimately the market will look through this as something clearly outside of Realogy’s control, in the short-term it could serve to pressure shares as some investors elect to move to the sidelines and wait for the dust to settle.
RRR
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Red Rock Resorts (RRR) | A SHRINKING HURDLE - CONSTRUCTION EMPLOYMENT
As we highlighted back in June during our RRR / LV Locals deep dive presentation, “RRR | UNCOILING THE SPRING,” there are a number of critical drivers that will contribute to GGR growth in the Locals market. The biggest drivers that we called out were: further acceleration in home price appreciation, homeowners finally generating positive home equity, population growth (organically and inorganically), retiree growth, and the further mix shift back towards construction employment. Most of the variables have inflected positively but GGR growth still lags. The important hurdles we highlighted were the wealth effect – evidenced by a significant number of mortgages still under water – resulting in cautious spend no matter how strong the macro factors remain, and historically low levels of construction spend.
Well, there’s good news on both hurdles. The number of mortgages in the red is decreasing at an accelerating rate. It is now probably in single digits as a percentage of total.
In the following chart we address the 2nd hurdle. Given the massive amounts of pent up construction spend, which we estimate to be in $10-$15B range over the next 5 years, we expect to see further gains in construction employment. As of July, YTD trends portend well for this mix shift, as construction payrolls continue to accelerate and make new post crisis highs every month. LV is still a ways away from its pre-GFC mix, but it is certainly on the right track, and may get there in 2019.
DE
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Deere (DE) longs we meet with are extremely confident, and that’s a 180 degree turn from just a year ago. While many believe the bottom is in for North American agricultural equipment, that view is not well supported by data. Instead we believe a cessation of underproduction, aggressive pricing from Deere Financial, and higher South American sales have been mistaken by investors for a turn in the key North American market.
We think the long case for Deere suffers from several analytical inconsistencies and off-target narratives. As these factors roll into very high FY18 profit expectations, we see the potential for 40-50% relative downside in shares of DE, just after most bears have gone into hibernation.
CERN
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Cerner (CERN) Prime Contractor for VA; Timing the Dollars - We are skeptical that Cerner is going to be the prime contractor for the entire VA EHR Modernization project in the same way Leidos is to the DoD. David Shulkin, VA Secretary, has already indicated to Congress he wants to bring on an "integrator" to assist with the project through a separate procurement.
With respect to timing the dollars, while management's comments regarding having a contract signed by year-end are consistent with the VA Secretary's communicated 3-6 month timeline, there is only $65M available in this year's budget for EHR modernization. Additionally, a formal request for EHR replacement money won't come until the FY19 budget (Sept '18) and no government funds can be committed for projects if they have not been subject to approval. Therefore, we don't expect large VA bookings contributions to begin until 2019-2020 period.
COH
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A large retail industry investment conference took place this past Wednesday and Thursday where more than 15 companies presented to investors with their unique spin on the dominant retail themes set to drive the back half of 2017. We were able to draw on numerous callouts from the conference that strengthen the Coach (COH) long thesis.
- Macy’s (M) announced strength in back to school sales during the second quarter.
- The broader retail industry has been feeling pressure of increased promotional activity which we expect will continue into the Holiday season. However, we see the handbag space avoiding this promotional intensity.
- Competitor Michael Kors has clearly stated it intends to put less product on the market and will reduce promotions.
- COH has already outlined its plans to pull back on KATE flash sales through the Holiday season as well.
We think these data points mean increased likelihood of profitable growth for the Coach brand while layering on an acquisition of Kate Spade that will be highly accretive.
HBI
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Hanesbrands (HBI) hit new 6-month highs this week, but our research is making us even more confident in this short call.
Target was on the tape this Friday with a blog post about lowering prices. At the same time, WMT is positioning itself for a very competitive and promotional 4Q believing there is too much inventory in the supply chain. These two data points signal that key suppliers will be pressured on sales, margins, and cash flow in the back half. HBI does over 1/3 of its business with these two retailers.
Management is planning for a big 2H and 4Q in order to hit its organic growth targets, while the data points from the industry are stacking up against that happening. We continue to think that the company will miss its sales and cash flow numbers for the year and that will send the stock downwards.
TSLA
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Tesla (TSLA): What About Model 3? The M3 reservation number – prospective sales for a make-or-break product – was disclosed as 500K in the M3 handover ceremony, but revised down to 455K during the earnings call. The net reservation count seems like a number the CEO of a company ought to know, but, then again, a technology company should be able to get the audio on an earnings call to work (#testing).
We really don’t know much about M3 demand trends given the higher price point offering and delay in lower priced deliveries. Tax credits may be reduced well before all current reservations receive deliveries. We would also caution that it is apparently much faster for a customer to make a deposit than receive a refund on it, so the net number may also need to be adjusted for in-process refunds. Would there be better transparency on reservations if it were good? Further, some reservation holders are hoping to sell M3 slots, not represent final demand. The lower priced M3 isn’t even scheduled for delivery in 3Q17, so filling the S&X demand growth gap may prove quite a challenge.
APD
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As noted in our June Air Products (APD) black book, an improved cyclical backdrop is helpful in the short-term relative to estimates. While there are odds and ends to be concerned about, not much approaches the likely dominant positive impact of redeploying the APD balance sheet. Once that process starts, we expect investors will look well down that path and price in much of the upside.
While one can quibble about the quarter’s non-GAAP items, the prospects for different regions, mix, and the relevance of new and evolving disclosures at PX and APD, it really isn’t relevant to our view. For APD and the industry more generally, these kinds of items aren’t where the focus should be. The impact of PX + Linde merger and APD’s capital deployment opportunities are likely to become the dominant factors, with the entanglement of those factors (divestitures) potentially evident by year-end.
SAVE
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Share gains for Ultra Low Cost Carriers (ULCC) present a significant growth opportunity currently standing at ~5% compared to European counterparts close to 25% suggestive of a 3x-5x expansion in ULCC share. Spirit Airlines (SAVE) is currently experiencing an overhang from two issues (pilot contract disruption and UAL fare battle) that we think are likely be resolved late 2017/early 2018. SAVE going after Newark to Houston infringed on two major United hubs resulting in aggressive pricing from UAL collapsing SAVE’s pricing structure. Arguably not the smartest fight to pick given that UAL has to defend its eroding share position literally at all cost, we think SAVE will likely be out of this fight over the next 6-months.
Additionally, the current headwind from labor challenges shifts to positive catalyst in 2018. In the meantime, we think these challenges represent an overhang and attractive entry opportunity. While some consider a merger between SAVE and FRNT likely, which at first glance seems to make sense, we think it’s unlikely – at least near-term. The team has built several high frequency data trackers that provide granular, quantitative perspectives on industry trends to track progress. SAVE’s P/E multiple is currently in-line with the avg. P/E of the Big 4 legacy airlines despite far more attractive growth potential.
SEMG
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Form 8-K/A’s with acquired companies’ financials usually make for interesting reads, as one can compare what the acquiring management team says about the acquired business versus its actual, audited financial results.
Last week SemGroup (SEMG) filed audited financials for Houston Fuel Oil Terminal Company (HFOTCO) for the years 2014, 2015, and 2016, and the first 6 months of 2017. SEMG acquired HFOTCO for $2.1B in July 2017.
Our take is still that HFOTCO is a solid business, though SEMG probably overpaid. HFOTCO has better margins than we expected, which makes it difficult for SEMG to extract synergy value (cut costs). We have two concerns after going through the 8-K/A: 1) HFOTCO’s revenues and EBITDA were down YoY in 1H17, and 2) Annual CapEx has run ~$60MM since 2014 with no major expansions underway in 2014 and 2015, which calls into question SEMG’s claim that HFOTCO’s “maintenance CapEx” is only ~$5MM per annum. HFOTCO’s aggregate FCF from 2014 – 1H17 is negative.
