Takeaway: RRC, MO, DFRG, SGRY, MCHP, GWW, AVLR, TGE, SPLK

Investing Ideas Newsletter - 12.27.2018 at least you are not long bitcoin cartoon

Below are analyst updates on our nine current high-conviction long and short ideas. Please note we added Del Frisco's (DFRG) to the long side and Splunk (SPLK) to 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

RRC

Click here to read our analyst's original report.

Below are three key updates to our Range Resources (RRC) long thesis:

Bullish Near Term: Natural gas storage inventories are ~20% lower than the 5yr average. The last time inventories were this low was pre-shale. Near term price support has been overshadowed by the consensus supply story.

Top Quintile Operator: On a trailing 3-year basis, RRC is one of only 10 companies of the 60 we analyzed with an organic Recycle Ratio in excess of 1.5x. This metric is a proxy for ROIC and it looks only at changes in Proved Developed reserves as it more properly reflects the returns generated on capital employed.

RRC Is Efficient With The Drill Bit: Range Resources is extremely efficient with the drill bit. Trailing 3-year F&D cost is best in class which is largely a function of rock quality. Other premium operators trade a significant premium to RRC.

(In case you missed it and for more detail on our long call on Range Resources, click here to watch Energy analyst Alec Richards' appearance on The Macro Show recently. Richards' updated commentary on RRC begins at 4:27.)

Investing Ideas Newsletter - RRC

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MO

Altria Group (MO) officially announced recently (press release HERE) that it will invest $12.8B for a 35% stake in JUUL Labs (values the company at $38B), a U.S. producer of e-vapor products. The driving force for the acquisition as MO put it, is to “accelerate harm reduction and drive growth.” We think the “drive growth” portion of that statement has a lot to do with cannabis! In the release MO went on to say: “Building on Altria's previously announced growth investment in Cronos Group Inc. (Cronos Group), Altria believes its investment in JUUL strengthens its financial profile and enhances future growth prospects.

While MO is not without controversy, we like the LONG set-up for the stock but need to do some more work:

  1. Since 2000, the stock has had three down years on an absolute basis 2002, 2008 and 2018.  So far in 2018, the stock is down 24%, underperforming the S&P by 22%
  2. The company continues to shift priorities to focus on the emerging segments of the industry, including cannabis.
  3. The proposed FDA ban on Menthol cigarettes is now discounted by the market.  Over the years, management’s track record of delivering strong results despite a challenging regulatory environment is one of the hallmark attributes of MO. 

DFRG

Below is a note written by CEO Keith McCullough on why we added Del Frisco's (DFRG) to the long side of Investing Ideas earlier this week:

During a stock market crash, under-performing fund managers will sell pretty much everything in the emotional moment... 

They aren’t selling because they want to. They’re selling because they didn’t sell higher (and now they have to).

That presents the patient investor with opportunities. There's a reason why I haven't had you buying a bunch of small and mid-cap stocks for the last 3 months!

On Del Frisco's (DFRG) we had news last week - here's the opportunity from Howard Penney's perspective:

"The management team of DFRG officially put the company up for sale.  The best asset the company has (and a very attractive PE asset) is Del Frisco’s Double Eagle Steak House.  Depending on how you want to value the Double Eagle we think that asset is worth between $7-$10 per share alone."

Buy on red,
KM

SGRY

Click here to read our analyst's original report.

Below is a 2-minute video with Healthcare analyst Andrew Freedman outlining the short thesis on Surgery Partners (SGRY).

Investing Ideas Newsletter - Healthcare SGRY AF

MCHP

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

Microchip Technology (MCHP) just ended a long happy cycle streak of volume growth. The question for forward thinking semis analysts and PMs today; will this downturn be a shallow one like June 2015 and then back to the races, or is the long period of awesomeness since ~2012 coming to an end implying a steeper unit trough (or shallow recovery) and lower GM% across that forward horizon as utilizations come down?

The company is fixing MSCC operationally but the ongoing evidence of excess inventory (over 8 months for high-reliability products) only buttresses our view that real growth for MSCC was even worse organically than the feeble numbers we had scrubbed to. In other words, the point of buying MSCC…is to hurry up and buy another semi company. Steve even noted that his strategy is to buy underperforming semiconductor assets, which is a fine strategy, but does not come with a premium or high performance analog multiple.

Investing Ideas Newsletter - mchp

GWW

Click here to read our analyst's original report.

While growth in the industrial economy is slowing, we don’t see a similar trend in our sample of Grainger's (GWW) web traffic. This is a problem – disconfirming evidence – for our bearish view.  We are working on ways to dismiss the offending data but may be looking at a decent quarter if the data continues to be positive for GWW.

Investing Ideas Newsletter - gww

AVLR

Click here to read our analyst's original report.

With Avalara's (AVLR) adoption curve much slower than go-go SaaS companies, and valuation in-line or better on EV/S, a mixed opportunity set, deflationary competitive elements, a company with a lot of baggage, and a host of pent-up potential sellers on the lockup in December, we think this stock still hasn’t found the right valuation center.

At its core, AVLR is still a growth company. But they may not be a tech company. Consider

  • The various parts of their engine were nearly all built via acquisition.
  • The company (allegedly) re-architected everything after meeting a tiny competitor who is now suing them for appropriating his architecture despite having an NDA with the company.

Then you stack additional items, such as:

  • Disaffected sales force
  • A ‘sales-oriented’ company
  • A litany of problems inside the corporate culture
  • Revolving door at the leadership role on the tech side
  • A large platform reseller sitting on its best market opportunity
  • A large software vendor totally deflating the value proposition at the mid-low end of the market
  • States not necessarily able to enforce compliance (today) and who tolerate best effort

We reiterate our short call on Avalara.

TGE

Click here to read our analyst's original report.

Despite improvements in the operating environment and simplified corporate structure, we value Tallgrass Energy (TGE) between $12.00 – $17.00 per share, 30% - 50% lower than current market prices. We’ve increased our valuation marginally from our last update, largely reflecting new project contributions and a more constructive crude oil price environment. However, at this juncture, we see no evidence to support walking away from the short.

Here's a key update...

TGE's Growth Projects Are Not Accretive: TGE needs to recontract its core assets: Pony Express and Rockies Express. Or it needs to find accretive growth to fund its distribution. Growth project economics don’t add up.

(In case you missed it and for more detail on our short call on Tallgrass, click here to watch Energy analyst Alec Richards' appearance on The Macro Show this week. Richards' updated commentary on TGE begins at 13:07.)

Investing Ideas Newsletter - tge

SPLK

Below is a note written by CEO Keith McCullough on why we added Splunk (SPLK) to the short side of Investing Ideas earlier this week:

You didn’t think I was going bullish, did you?

Still looking for Tech stocks to short during the Quad 4 Tech Crash? We are. How about selling some Splunk (SPLK)? Here's a core tenet of Technology analyst Ami Joseph's short thesis:

"Splunk is at a point similar to other large software companies when they hit similar revenue run rates who pivoted towards M&A. In this case, that’ll be the primary use for newly growing FCF. We think the pivot from go-go growth EV/S ratios to slower rates of growth, acquisitions, and EV/FCF ratios usually doesn’t sort out so smoothly."

Sell the bounce,
KM