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

Investing Ideas Newsletter - 01.03.2019 Indiana Jones bull cartoon

Below are analyst updates on our nine current high-conviction long and short ideas. Please note we added Canopy Growth (CGC) to the short side of Investing Ideas this week. We also removed Altria Group (MO) from the long side. 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.

3Q18 Recap: Adjusted EPS in the quarter was $0.26 vs. expectations of $0.19. Production of 2.27 Bcfe/d equated to 14% growth YoY and 3% QoQ. The production profile was heavily weighted to the SW PA acreage position where production growth of ~30% YoY offset production declines in NE PA and N. Louisiana.  Cash OpEx, including net marketing expense, increased from $1.61/Mcfe to $1.67/Mcfe QoQ due to higher midstream costs. Unhedged EBITDAX per Mcfe of $1.67 increased 38% YoY on a 19% increase in realized prices. The most important metric from our perspective is the ~$80MM the company generated in FCF ex. hedge losses and before changes in working capital. FY2018 CapEx guidance of $941MM was kept flat for the year.

Bottom Line: There wasn’t a whole lot of new information in RRC’s 3rd quarter print. But with short interest still hovering at ~15% of the float, boring prints are good prints for RRC. We continue to believe that Range offers one of the best risk/rewards in all of E&P, given the relative valuation for an asset base that has produced best in class recycle ratios and full-cycle margins for years. The balance sheet is in much better shape with leverage on 3Q18 EBITDA annualized at 3.0x; 2.8x pro forma the $300MM asset sale.

We estimate Fair Value for RRC to be $25 /share, significant upside from the current price of ~$10.

(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.)

DFRG

Click here to read the long Del Frisco's (DFRG) stock report Restaurants analyst Howard Penney sent Investing Ideas subscribers earlier this week.

SGRY

Click here to read our analyst's original report.

We are more bearish on Surgery Partners (SGRY) after the prelim 3Q18 release and news of incremental capital raise (which was successful). High-beta, high-leverage, no cash flow makes for a great Quad 4 (i.e. U.S. growth and inflation slowing) short, and the stock remains significantly overvalued.

We think what’s really fascinating about Surgery Partners pre-announcement is that in the press release the company said Same Store Revenues were 9-11%. That’s significant same store growth particularly with where the company has been trending, in the low single digits. At the same time the company isn’t generating any type of operating leverage or free cash flow so their margins are continuing to come under pressure.

If Same Store growth was going to save the day this would have been the quarter we were going to see it. That’s part of the reason why the stock has traded down since the announcement.

MCHP

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

Microchip Technology (MCHP) isn’t Microchip anymore. You can’t own MCHP for industrial HPA like performance with organic growth, singular focus on share gains in large markets, and innovation curves that continue to prove out.

The organic share gains are done, the second biggest revenue category is a creation of Analog Frankenstein that doesn’t grow much, and Microsemi Corp (MSCC), now at ~30% of revenue, will be dilutive to the growth rate of the entire entity. The long game of fixing vertical analog product inside a general purpose company is not a no-brainer fix and maybe hasn’t really been done successfully in the past. Investing, healing, and re-growing individual product lines wrapped up in the MSCC mess will take some time. In addition, capital intensity and taxes seem to remain as surprise factors.

The nose dive implied here is a shift of investors who used to own MCHP as a proxy for LLTC, knowing that cash flow would come their way in increasing ways (via dividend) and that they could confidently buy short term inventory led equity value contractions. But they can’t own MCHP for those things anymore as MCHP downshifts growth rate, mix of businesses, balance sheet, and strategy into a ‘tier 2’ type category more exemplary of ON Semiconductor Corp (ON), STMicroelectronics (STM), and NXP Semiconductors (NXP).

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.

Looking more long-term, while the valuation of GWW bakes in ongoing favorable growth and performance, data continues to support views that the Industrial Distributor market is being disrupted from many different directions. 

From resilient independent distributors, to pricing transparency, to competitive entrants, we doubt that the legacy distributor model will prove relevant in coming years. The traditional industry moats are drying-up as customers see an opportunity to switch to competitors. In short, structural pressures are intensifying competition from all sides, while longs cling to the myth of under-penetration.

We believe that persistent gross margin pressure will preclude equity outperformance, and that recent share price outperformance is an opportunity to enter a well-supported structural short. We expect GWW shares to give back their recent gains and resume long-term underperformance as structural pressures leave the company ‘stuck in the middle’ as margin is wrung from Industrial Supply.

Investing Ideas Newsletter - gww

AVLR

Click here to read our analyst's original report.

Avalara (AVLR) isn’t such a young company, originally founded in 1999, and then in its current form in 2004.

Employees had been promised an exit for several years prior to the IPO (including a full IPO prep in 2015). Based on our reviews of employee comments, we expect a fair bit of pent up selling.

Employees see that the company has struggled with efficiency historically, and now must pivot towards profit and cash flow at a time that the growth rate is likely to deflate; for investors this may mean that middle of the road software EV/S rates of 5-6x may be a shallow trough with real bedrock value only when the company can transition fully to FCF.

We reiterate our short call on AVLR.

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.

(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.)

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SPLK

Click here to read the short Splunk (SPLK) stock report Technology analyst Ami Joseph sent Investing Ideas subscribers earlier this week.

CGC

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

I guess the mo mo move in Cannabis stocks is back #on, for a day...

While Shayne Laidlaw remains The Bull on CRON, he and Howard Penney also remain The Bears on Canopy Growth (CGC).

Personally, I like being short most things "growth" during Quad 4, so adding another word makes it all that much more inviting, especially with the stock +8% here today.

Yours in selling on green since 2008,
KM