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Takeaway: UNFI, SGRY, TSLA, DE, DRI, FL, MCHP, KSS

Investing Ideas Newsletter - 10.23.2018 bear on a bike cartoon

Below are analyst updates on our eight current high-conviction long and short ideas. Please note we removed United Continental (UAL) from the short side of Investing Ideas this week. We will send a separate email with Hedgeye CEO Keith McCullough's refreshed levels for each ticker.

IDEAS UPDATES

UNFI

Click here to read our analyst's original report.

United Natural Foods (UNFI) is falling like a knife. We are staying short given the operational challenges we still believe they will have. We continue to think UNFI's business, along with their acquisition of SVU, will be challenged. We're also bearish on Food Distribution as a sub-sector. 

Here's the deal. How do you make a low and declining margin distribution business even worse? Buy an even lower margin distribution business strangled by debt, mounting pension liabilities, and add in a small dying retail presence!

Overall, we view the SVU acquisition as very troubling, that could cause problems for the company going forward. We believe this could be the beginning of an even greater downfall in the stock as the potential for missing targets and complications with integration mount.

SGRY

Click here to read our analyst's original report.

No update on our Surgery Partners (SGRY) short thesis this week. Below is our post-earnings recap note.

The company pre-announced adjusted EBITDA range that bracketed consensus (the number that matters). "Modest" same unit volume growth on an easier compare from hurricane impact last year... still suggests structural issues persist. Big increase in revenue per case to get to 9-11% same store growth. Will have to wait for the Q to get more clarity on that, whether it was one time payment or mix that drove strength. Note that the base comparison on 2017 is really messy due to acquisition and hurricane impact, so I am reluctant to read to much into it. That said, we do expect a better utilization environment into 2H18, which we will discuss on Monday and this announcement is somewhat consistent with my comments on morning call yesterday. 

However, the pre announcement comes because they have to raise additional capital! That was one of the major points we made in our black book in July. SGRY is a cash burning machine and there is nothing for equity holders. So taking on additional variable rate interest debt to feed a roll up strategy in order to hit consensus numbers when you are already 9x levered and have looming debt payments is not a good thing. Q4 is the big ramp in EBITDA and they are clearly feeling pressure to hit numbers and need to raise capital and buy stuff to do so. More capital will have to be raised next year.

TSLA

Click here to read our analyst's original stock report.

Tesla (TSLA) reported results that are…well…unlikely. We suggested that they might be getting into the business of manufacturing results, but this appears truly disruptive. An earnings call that gives scant details on how such exceptional results were achieved?

Relative to our model, Tesla came in with a much, much lower SG&A line than expected.  We based our estimate on SG&A per delivery, and we can benchmark the company against, say, a dealer and an auto OEM, since Tesla is basically a combo of both. Take AutoNation, which has about $2.5 billion in annual SG&A and deliveries of about 563,000 new and used vehicles. That comes out to about $4,500 per new and used vehicle sale.

Ford, a well-established car maker with a much lower average selling price and over 6.5 million annual units, comes in with SG&A/unit at about $1,750/unit. That combines for a scale, low ASP dealer + OEM SG&A of about $6,250/unit. 

Tesla, with a high service store model, high ASP, and much lower scale operation should be well higher than F + AN unit SG&A. Historically, Tesla has been about 3x-4x higher.  3Q18 was an anomaly, with SG&A per unit falling from ~$25,000/unit in 3Q17 and $18,500/unit in 2Q18, to a stunning $8,700 this quarter.  And that includes OpEx for all Tesla’s businesses.

Does Tesla expect investors to believe that they have leveraged OpEx all the way to the level of a low ASP, higher volume competitor?  It seems they think investors aren’t “smartish” enough to notice.

Investing Ideas Newsletter - tsla sg a

DE

Click here to read the short Deere (DE) stock report Industrials analyst Jay Van Sciver sent Investing Ideas subscribers earlier this week.

DRI

Click here to read our analyst's original stock report.

Labor is a problem for Darden Restaurants (DRI) and other players in the industry. What happens to margins when sales slow into the middle of the fiscal year? There's no evidence that independent operators are gaining share. According to DRI, chains have a distinct advantage in the current labor environment.

Off-premise grew 13%, and is now 13% of sales, and the management team has a problem with the delivery proposition.  The comments on delivery are very telling not only for DRI, but for the rest of the industry:

  • “We're not sure that it enhances our brands.”
  • “We're concerned about how it's executed.”
  • “We're concerned if it can create incremental growth at scale.”
  • “We're not happy with the economics.”
  • “We still have the issue of the data.”
  • “We have to get our arms around how we protect the profitability of our large and growing current off-business premise, which would be difficult to deal with.” 

Cheddar’s is a problem!  This is an example of the issues the company faces as the CEO said on the call “Dave George, our Chief Operating Officer, will continue to dedicate a significant amount of his time working side-by-side with the Cheddar's team to improve the performance of the business.”  Is it a great use of the COO’s time to spend that much time on a small part of the business?

FL

Click here to read our analyst's original stock report.

Nike suffered a blow last night that could have implications for Foot Locker (FL). One of Nike’s chief supply chain partners – Flextronics – missed, fired its CEO, and wrote off its Nike facility. The partnership was a way for Nike to expand its DTC footprint, providing customizable footwear solutions to consumers and significantly increasing speed to market using the cutting edge technology provided by Flextronics. The fallout will hinder the rate at which Nike is able to meet its internal projections for DTC penetration and margins.

This could go one of two ways for FL: Either a) Nike steps up its other initiatives to drive e-commerce at the expense of traditional wholesale channels, or b) it doubles down on the #oldretail FL model for distribution.

We’d be floored to see the latter. We remain committed to the short FL call and believe Nike will continue to pull product from traditional wholesale in substitution for its own DTC channels. The news however is a near term net positive for FL as the Nike-Flextronics breakup likely delays a negative for FL.  

MCHP

A new lawsuit was filed by the former CEO of MSCC, which Microchip Technology (MCHP) acquired earlier this year. The key here is the lawsuit that Jimmy P and the former MSCC executives filed against MCHP and its CEO (see filing HERE). Details of spurious distributor programs, channel stuffing, and a failure by MCHP execs to access major sections of information in the data room during the due diligence process that creates an open invitation for lawsuits against MCHP (if true).

Essentially, the plaintiff is claiming that the surprises that MCHP have been discussing in earnings calls, were all there in plain sight, if only MCHP had actually performed normal due diligence.

The June quarter was the first negative y/y volume growth print in a long time after a healthy cycle suggesting a classic post cycle peak is now in the rearview. Management is now tempering outlook expectations, which typically takes 2-3 quarters to sort through to lower EPS with gross margin compression inevitably realized last.

KSS

Click here to read our analyst's original stock report.

A big part of the Kohl's (KSS) bull case today is the opportunity to capture sales from door closings of competitors like Bon-Ton, Sears and JC Penney.

Some analysts have said KSS can potentially get 25-50% of lost sales from these competitors.  We think that is way too aggressive.

We got a notable data point on “recapture rates” from WMT last week.

At the Wal-Mart investor day the Sam’s club CEO noted about half of the 2Q comp was from transferred sales of closed stores.  We found this data point to be very interesting given that a wholesale club is a store where the customer pays to be able to shop there.  One would think you can’t find a better sales transfer rate than that.  So we ran the math.

The punchline is, depending on what productivity you think the closed stores were relative to the average Sam’s store, you get probably about 45%-55% transfer rate of sales from the closed stores.

We’ll call that a retail best case scenario.  So if you are talking 25%-50% recapture rates from competitor store closures in categories that can be shopped many places (JCP, SHLD), good luck if that is your bull case.  Any transfer sales to KSS would be significantly lower than expected.

We’d also note that there was another time JCP was shedding sales, it was when Ron Johnson was trying to reshape the company. JCP lost over $5bn in sales, yet KSS couldn’t find a way to grow sales.

Investing Ideas Newsletter - kss