• Global ‘Black Hole’ Risk Rising: A Discussion With Danielle DiMartino Booth

    Former Fed advisor Danielle DiMartino Booth discusses key economic developments and the outlook for Fed rate cuts with Hedgeye CEO Keith McCullough.

Takeaway: RRC, DFRG, SGRY, MCHP, AVLR, SPLK, CGC, DPZ

Investing Ideas Newsletter - 01.14.2019 bear mob cartoon

Below are analyst updates on our eight current high-conviction long and short ideas. Please note that we added Domino's Pizza (DPZ) 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.

The EIA released its Short Term Energy Outlook on Tuesday, January 15th calling for an incremental increase in dry natural gas production of ~7 Bcf/d. That’s off a base of 83.3 Bcf/d in 2018. 2020 dry natural gas production is forecasted to be 92.2 Bcf/d in 2020. Dry natural gas production exited Dec-2018 at 88.6 Bcf/d, meaning that 2019 production is forecasted to grow ~1% from the current production base. The market has absorbed the 2018 production build as evidenced by the depleted inventory base. Taken in concert with added LNG export capacity, we continue to be relatively positive on the commodity.

The question is, where will the incremental supply come from. With WTI at ~$50/bbl, associated gas growth will likely underdeliver in 2019 from original expectations. And, with natural gas levered equities not being rewarded for growth, we expect more companies to prioritize capital discipline at the expense of growth. GPOR and AR have already been the first movers in that respect in the first few weeks of 2019. That would stand to benefit Range Resources (RRC), which we think has a best in class acreage position and efficiency metrics.

DFRG

Click here to read our analyst's original report.

The activist’s playbook on Del Frisco's (DFRG) should focus more on stronger capital allocation to concentrate on eliminating the massive economic risk inherent in the company’s financials. We agree that the stock is intrinsically undervalued.

Our sum-of-the-parts analysis suggest buying the stock today in the $6-$7 range and you are essentially getting Del Frisco's Double Eagle for free!  The Double Eagle is a highly prized asset in the restaurant space with strong margins and some growth potential.

We think DFRG stock has the potential to double over the next 12-18 months.

SGRY

Click here to read our analyst's original report.

We think margin expansion is going to be very difficult for Surgery Partners (SGRY).

But the core of any balance sheet short is that this company is not earning it’s cost of capital. It continues to burn cash which means that they’re going to have to raise capital at a time where they’re already significantly levered. This company is about 9X levered.

One of the points we made is that they just don’t have enough liquidity given that cash flow is already negative. Leverage is so high it’s going to be difficult for the company to fuel the roll-up strategy and hit consensus numbers. Sources of cash are being drawn down so it’s going to be difficult for the company to do enough acquisitions to close on the pipeline and hit numbers. They need to spend about $150-$200 million in acquisitions to hit 2019 estimates. At the end of 1Q19, at the current pace, they would only have $122 million so there’s a gap that’s emerging.

We are more bearish on 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.

The company pre-announced saying that they’re going to raise additional capital to fund acquisitions going forward. This is really not what you want to see as an equity holder when they probably should be deleveraging, since there is so much risk to this model.

We think what’s really fascinating about the 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.

Investing Ideas Newsletter - sgry

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?

Investing Ideas Newsletter - mchp

AVLR

Click here to read our analyst's original report.

The lack of addressable market is real in many ways: Avalara (AVLR) is selling an expensive version of something that is available at cheaper price points with better pricing transparency, and into a market that has a mixed opportunity set of open and closed doors.

Investing Ideas Newsletter - avlr

SPLK

Click here to read our analyst's original report.

Splunk (SPLK) is still priced on go-go growth but multiple recent tailwinds begin to fade on a forward basis. Accelerations that drove the stock higher will not repeat next year including ~600-700bps benefit from the shift to ASC606, a big data center spending bump, plus the Machine Learning and Analytics splurge in the last year.

Investing Ideas Newsletter - splk

CGC

Click here to read our analyst's original report.

Canopy Growth (CGC) is a 4 year-old roll-up story, who is the dominate global player in Cannabis. Cannabis is a heavily regulated industry and the largest potential market in the world, the USA, is still federally illegal to operate in and there is no line of sight on it becoming legal.

While CGC has a leadership position in supply agreements and production facilities, it also has the highest cost of production. This will become a problem for CGC when/if wholesale prices begin to decline. If we look at wholesale prices across other regions that have gone recreational, prices have collapsed. The three states in the USA that have been recreational in the USA the longest, wholesale prices are $1.30 to $2.00 per gram versus the current $4.50 in Canada. When Canada becomes oversupplied in 2019/2020, how will the Canadian government respond?

DPZ

Below is a note written by CEO Keith McCullough on why we added Domino's Pizza (DPZ) to the short side of Investing Ideas earlier this week:

Still looking to make sales in "Consumer" shorts that get hit in both Quad 4 and Quad 3? Howard Penney still likes Domino's Pizza (DPZ) on the short side.

It's signaling immediate-term TRADE overbought today within a Bearish @Hedgeye TREND.

Here's what Howard had to say in a recent Institutional Research note about the company's latest strategy:

"DPZ is officially on the defensive in trying to justify why cannibalization/splits/fortification is a smart business strategy.  It might be the right thing for DPZ, but that strategy has never worked."

Sell on green.

KM