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Takeaway: TWX, RRR, HST, MLCO, TWTR, ORLY, COST, CERN, VIRT, HCA, DPZ, TSLA, MC, HBI, UAL, SBUX

Investing Ideas Newsletter - 03.07.2018 macro tourist cartoon

Below are analyst updates on our sixteen current high-conviction long and short ideas. Please note we removed Mednax (MD) and Kroger (KR) from the long side of Investing Ideas this week. We also added Costco (COST) to the long side. We will send a separate email with Hedgeye CEO Keith McCullough's refreshed levels for each ticker.

IDEAS UPDATES

TWX

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

Several forces seem to be working against a potential merger between AT&T and Time Warner, but a deal between the two media giants is still likely to get done.

Antitrust violation has been a concern of democratic legislators, but Telecom & Media analyst Paul Glenchur says: “The burden of proof remains with the DOJ to demonstrate the transaction would impose significant harm on consumers.” Adding another wrinkle to this complicated story is President Trump’s ongoing grudge against Time Warner-owned CNN.

The Justice Department's challenge threatens AT&T's acquisition of Time Warner and disrupts the deal making environment for other big media transactions. The outcome could even trigger a possible reexamination of the Comcast-NBCU merger conditions. An AT&T victory, however, could unleash a wave of consolidation scenarios, including vertical transactions beyond the media space. 

Click here to watch a 10-minute video of Glenchur explaining why we still think this deal gets done.

RRR 

Click here to read our analyst's original report.

Up until 2008, the 2000s were boom times for the Las Vegas locals market, marked by high flow through on strong SSS. Population/retiree growth combined with terrific macro (especially housing) environment to drive the top line at STN (the previous incarnation of Red Rock Resorts (RRR). Post Great Recession, GGR growth lagged macro – wealth effect and lack of construction/infrastructure spend.

Historically, home prices are the critical macro driver – multi-year strength mitigated by a still high % of mortgages under water (the wealth effect) – until now. Without a negative wealth effect impediment, GGR well exceeds GDP growth in the Las Vegas locals market when housing prices are climbing.

Is this the beginning of a bull market? Same store growth (ex Palms/Palace Station) was already flashing positive and then accelerated in 2H 2017. Why have we been focused on the SSS inflection. Incremental flow through on GGR can be as high as 80% (management conservatively guided to the 50% to 70% ranges). Are we back to circa 2000, the beginning of an 8-year bull cycle when STN (the previous incarnation of RRR) climbed 500%?

HST

Click here to read our analyst's original report.

Latest data is in for our weekend vs. weekday RevPAR analysis.  Note, we remove Sunday from the equation, which makes for a much cleaner look at true leisure (weekend) demand and corporate (weekday) demand.  Due to monthly swings in the data, we prefer to look at this dataset on TTM basis.  As shown below, the divergence that we’ve seen take place since early 2016 had finally reversed this past month, and in February we saw considerable follow through.  Given that we haven’t entered the seasonally strong business travel period just yet, (typically picks up mid-March – October), we can’t get too excited just yet, however, trends seem to be pointing in the right direction. 

If the midweek period does continue to improve, this would disproportionately favor the full service REITs, who tend to be more corporate transient/group focused (like our favorite name in the space right now, Host Hotels (HST).  We think that a degree of conservatism that was baked into REIT guidance will likely be reversed when the companies report 1Q results in late April/early May.  If RevPAR continues to chug along at its current pace or accelerates, we expect earnings beats and guidance raises.

Investing Ideas Newsletter - mlco1

MLCO

Click here to read our analyst's original report.

Q4 was a strong one in Macau and we were particularly impressed with the performance of the mass segment.  Mass growth surged in Q4 and if March can sustain the combined growth of Jan/Feb, Q1 earnings should exceed expectations for most of the Macau operators.  We’re bullish on Macau’s near and long term outlook and Melco Resorts (MLCO) is among our favorite stock picks. While February GGR fell a little short of consensus expectations, we would buy these stocks on any weakness.  February faced a tough comp and an unfavorable Chinese calendar and volatility with this seasonally up and down period is difficult to forecast.  We see a nice bounce back in March which should round out a strong quarter of revenues and earnings.  A closer look at the visitation statistics suggest surging 1st time visitation and faster growth from underpenetrated provinces.  These are nice trends and suggest a long tail of growth for Macau, not necessarily reliant on the macro.

TWTR

Click here to read our analyst's original report.

Twitter's (TWTR) prior monetization strategy was unsustainable since its two growth drivers were working against each other (user growth & ad load), and the model failed in 2Q16. TWTR has since used the restructuring to right-size its model in terms of ad load while also prioritizing Autoplay, which reduces its dependence on ad load and takes pressure off its MAU growth.

We suspect TWTR could return to double-digit revenue growth by as early as 1H18. But everything we’ve discussed above relates to ad inventory (supply), which we previously viewed as TWTR's major structural impediment. The two factors that could be a concern are user growth and advertiser demand, but we suspect there is a common driver b/w the two in 2018 (events) that should support growth on both those fronts.

ORLY

Click here to read our analyst's original report.

The Auto Parts Retail sub-sector has among the highest returns and most defendable competitive moats in the broader retail sector.

Since the suppliers manufacture what are basically commodities the retailers have considerable power over them. The suppliers generally lack distribution capabilities to the consumer and have little brand recognition. This lack of channel power has enabled the auto parts retailers to gain better payment terms and margins.

The auto parts retailers have built a considerable distribution network that is capable of shipping car parts to a repair shop within an hour. This is seemingly impossible to replicate without a multi-billion investment over several years. We think O'Reilly Auto Parts (ORLY) has built the best distribution network for both the Do-It-Yourself and Do-It-For-Me customer.

Investing Ideas Newsletter - orly

COST

Below is a brief explanation of why we added Costco (COST) to the long side of Investing Ideas earlier this week:

HEDGEYE OPINION FROM ANALYST HOWARD PENNEY

Robust sales figures should prove that this is a retailer in a class of its own, yet many prefer to point to an uncertain future.

Given COST’s limited SKU count of roughly 3,800 items per warehouse and strong volumes, they have the ability to negotiate for the best possible price with producers, and they pass most of those savings onto the consumer, creating a value equation that can’t be beat.

Despite a competitive price environment, COST was able to achieve a relatively flat gross margin YoY at 10.98%, down just 2bps YoY. Equally as impressive was the 22bps improvement in SG&A as a percent of sales, despite investments in ecommerce, as a result of strong sales performance. Before getting into the quarter we also want to highlight the improvement in renewal trends, which ticked up 10bps sequentially to 90.1% in the U.S. and Canada and 87.3% worldwide, up from 90.0% and 87.2%, respectively at 2Q end.

It is clear to us that COST has plenty of levers to pull to improve the business.

CERN

Click here to read our analyst's original report.

Cerner (CERN) is the #2 EHR vendor in the U.S. and #1 Healthcare IT vendor in the world. While we don't believe this will change anytime soon, we also don't believe they are immune to the challenges of a saturated market with limited replacement opportunity. Simply put, Cerner is a nice house in the bad neighborhood, that is, the EHR industry.

VIRT

Click here to read our analyst's original report.

A Brief Note on Virtu Financial (VIRT): While most investors translate the elevated volatility environment as always being beneficial to the market structure sector, we highlight the empirical evidence that even the agency exchange sector and especially the principally driven brokerage sector can also be a source of funds in market drawdowns. Looking at the iShares Broker/Dealer and Exchanges ETF (the IAI), the trading community's equities historically experience losses in ultra-high vol environments, so we think that the trading opportunity set in the current environment for the company is now overstated.

We also highlight that the $1.4 billion in trading capital at the firm (targeted to be taken down to just $750-850 million over time per management's guidance) is dangerously low compared to the multiples of that level at other market making firms. Virtu runs its trading operations on just $1.4 billion in total capital on just over $300 million in tangible equity. This compares to Goldman Sachs with daily trading capital of over $540 billion supported by tangible book value of $82 billion. Simply said, the current high vol environment is also a detriment to principal traders, and Virtu sits on very thin levels of capital.

HCA

Click here to read our analyst's original report.

HCA Healthcare (HCA) is now our Healthcare team's TOP SHORT. 4Q tailwinds are fleeting and we continue to believe 2018 will be worse than 2017.

Maternity continued to trend poorly in 4Q17 as it has for several years. HCA Healthcare (HCA) management commented that, consistent with our Maternity Tracker and recent results, births declined -2.5% while NICU volume was +0.6%.  Despite the current strength of the 2017-2018 influenza season, flu was only a modest positive according to management.  Guidance net of the Oklahoma divestiture and the loss of "$180M" in EBITDA looks particularly positive in relation to 2018 EBITDA guidance of $8.45B to $8.75B.  While the volume and cost metrics continue to follow our models for volume by payer, the critical upside driver in the quarter was surprisingly strong acuity and the positive impact on pricing, particularly within the Managed Care payer segment.

We continue to find it highly unlikely that 4Q17 will continue through 2018.  While it may be hard to remember, it was not such a long time ago when 2017 consensus EBITDA peaked at $8.8B, versus the final $8.2B reported.  2018 expectations were once $9.5B, versus the current midpoint of 2018 guidance of $8.6B.  While 4Q17 held operational positives, HCA's future commitments appear excessive in comparison by committing to a $0.35 quarterly dividend and continued share repurchases, accelerating capital spending, and adding $300M in new employee training and retention costs. We believe the embedded risk for this high debt high fixed cost business has increased as a result.

DPZ

Click here to read our analyst's original report.

Looking at our Domino’s Pizza (DPZ) delivery vs. carryout figures below, the DPZ delivery business has slowed, especially as DPZ franchisees have gone through (and continue to go through) an aggressive re-imaging campaign and a media campaign both geared at driving the carryout business. Despite a recent uptick in delivery percent growth, it is being significantly outpaced by carryout and carryout has surpassed delivery as a percentage of the business.

Investing Ideas Newsletter - dpz

TSLA

Click here to read our analyst's original report.

A Brief Note on Tesla (TSLA): Competitors are now writing the script for this story stock, with huge PR budgets and a steady stream of hyped up products.  With iPace sales imminent it is worth considering just how of Tesla’s news feed is dominated by a *competitor’s* car. This is still a story stock, and the story is all about demand, demand, demand – ‘people want these cars’.  Well, that is now unwinding. 

Our thesis has three legs that matter right now – Tesla is a poor manufacturer that will struggle with quality and schedules as it tries to shift to mass production, damaging the brand. Second is expiration of the tax credit, and we can already read customers complaints that their delivery will occur after tax credit reductions. The final piece is competitive entry by competent manufacturers. 

Oddly, interest in the TSLA short case has died down in recent weeks, even though we think the case is just getting stronger. 

MC

Click here to read our analyst's original report.

For the pending 1Q18 period, our Boutique Activity Tracker (BAT) indicates that the M&A sub-industry is running below pace from a year-over-year standpoint, with first quarter activity in 2018 falling below 1Q17 production levels. While the boutique advisory stocks are pricing in an acceleration in activity due to the new, more favorable corporate tax regime in the United States, simply put, announced M&A activity hasn't responded yet.

Moelis (MC) is again lagging most at this point in the quarter, a status that our tracker picked up in 4Q17 which outlined the biggest year-over-year decline in recent 4Q17 earnings. Thus far in 1Q18, the firm has been involved in just 16 assignments worth $32.3 billion, an absolute decline from the 36 deals worth $38.7 billion last quarter. The first quarter of 2017 for MC was associated with 38 transactions worth $44.3 billion. 

Hence, our tracker outlines again that MC is running behind most on a year-over-year comp basis of all the boutique advisors.

HBI

Click here to read our analyst's original report.

Some clear read-thrus for Hanesbrands (HBI) and the mass channel from the Gildan Analyst Day last week. Great transparency by the company.  I we could sum up the feedback (and CEO’s comments) in one sentence it would be that a lessened focus on management to beat HBI bc [HBI is paving its own path to destruction. It doesn’t need our help as much anymore].  

Mass will shift more selling space to private label, bad for HBI (proven by cutting Just My Size)

  • The loss of Walmart for the Just My Size brand is not an overly significant loss for Hanesbrands in itself. What matters is that Walmart decided to replace it with its own private label brand. Gildan sees a world evolving with the mass merchants looking to insulate themselves from Amazon by featuring more proprietary brands. Walmart has changed strategies in the past. It’s hard to say how far it will take the strategic change, but it has already started. Traditionally Walmart is a very sticky distribution partner, in the last 18-24 months, that stickiness has diminished in basic apparel, check out HBI’s sales at WMT & TGT during this cycle (chart below).
  • Also, note the marketing campaign started by Wal-Mart in conjunction with its “The Walmart Box” video campaign and the Oscars this weekend.  The campaign features Wal-Mart private label brands like Time and Tru, Wonder Nation, and George (image below) with the tagline “Quality and style you won’t believe.”  
    Walmart replaced Iconix’s Starter brand with Russell Performance, a brand exclusive to Walmart and sourced by Walmart.
  • Wal-Mart's recent announcement of brands like Just My Size (that really aren’t brands) are among the first to be replaced. Target not too long ago announced it was replacing several private label brands like Cherokee and Mossimo with new private label brands it would market by psychographics and customer profiles. Target has launched JoyLab, a women’s activewear private label brand that has overlap with C9, a Hanesbrands exclusive brand for Target.
  • Gildan admitted it has been very difficult to replace incumbent brands at mass. That is something Hanesbrands has been saying all along. Now Wal-mart and Target are looking to replace these brands with its own private labels. Gildan sees an opportunity for it to source the appropriate private label business when the retailer replaces brands with private label.
  • What was difficult to do on its own in branded, the mass merchants may bring to Gildan instead in private label. For example a branded activewear program at Wal-mart looks likely to be soon replaced by its own private label brands like George.  For brands like Hanesbrands and Fruit of the Loom pursuing private label business is unattractive since neither have a cost advantage in manufacturing (GIL does).  
  • For Hanesbrands the future looks to be business being consolidated in the mass channel.

It's going to be VERY tough for HBI to grow organically.

UAL

United Continental (UAL) is a high cost airline that has struggled to generate positive free cash flow in a stable fuel price environment.

The road ahead looks increasingly rough for UAL. Our pricing data suggests pressure on domestic economy fares. UAL is ceding market share to competitors. And despite years of integration efforts and cost plans, little has improved in the carriers relative cost position.

Question: If UAL can’t generate cash, what is it worth, anyway? Is this company well positioned for a more adverse pricing environment, or an eventual economic slowdown?

SBUX

Click here to read our analyst's original report.

Wow…the Starbucks (SBUX) management must know much more about the health of the business than they are leading on. From what we can see, to leave global SSS store guidance unchanged is aggressive, especially when there is no actual growth in the business! With consolidated transactions at 0% ticket is providing all of the comp, which is a clear indication that the SBUX business is struggling. EPS guidance was elevated on the back of the new tax reform benefit, which the Street was already expecting, so nothing new there!

When pressed on what would be the Company’s growth drivers going forward and what gives the management team the confidence that they can meet the guidance laid out, technology innovation was the main staple. In addition to technology, management is hanging its hat on what they are doing around waste management, labor savings, and the continued growth in the China business. 

We reiterate our short call on Starbucks.