Below are analyst updates on our seventeen current high-conviction long and short ideas. Please note we added Canadian Natural Resources (CNQ) and iAnthus Capital (ITHUF) to the long side of Investing Ideas this week. We also removed Owens Corning (OC) from the long side. We will send a separate email with Hedgeye CEO Keith McCullough's refreshed levels for each ticker.
IDEAS UPDATES
DFRG
Click here to read our analyst's original report.
We see an activist creating value through more appropriate Del Frisco's (DFRG) capital allocation, as the current management team has proven to not be great stewards of shareholder capital. Look no further than the Barteca acquisition as evidence of managements lack of discipline on capital allocation. Management leveraged the company up to 4.6x debt/EBITDA (plans to delever to <3.5x within 2-3 years) to purchase Barteca at a multiple of 2.5x sales or 15.7x TTM EV/EBITDA (10.6x FY18 run-rate adj. EBITDA of $31M) as compared to DFRG’s multiple of 8.3x TTM EV/EBITDA at the time of the deal.
The activist’s playbook 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.
GTBIF
Click here to read our analyst's original report.
When looking at multi-state operators (MSO's), it is critical to look beyond just what states they are in, and look at what there are actually executing, and most importantly who ‘they’ are. Recently we toured Green Thumb's (GTBIF) facilities in Maryland with their head of capital markets, Andy Grossman, to get a better sense of their business. We had the pleasure of seeing two dispensaries as well as their production facility, which they are adding 30k sq. ft. (including new cultivation space), in addition to their existing 6k sq. ft. (purely production space) - a truly impressive operation. After a day on the ground, not only did we gain greater confidence in their process and platform, but their extensive bench of personnel working for the company at all levels. We can’t emphasize this point on personnel enough.
A critical component to our diligence process is corporate governance and focus on shareholder value. GTI executives are focused on long-term value of their equity, not on taking huge salaries, they are for the most part seasoned executives with secure financial positions. GTI also displayed a solid understanding and respect for four-wall economics, as traditional restaurant analysts this is music to our ears.
Green Thumb is our first best idea long in the US space as we feel they are one of the best positioned MSO's to capitalize on the growing market opportunity in the US. There is line of sight to Green Thumb providing a 2-3x return over the next few years.
AMN
Click here to read our analyst's original report.
Trends in hospital employment, registered nurse unemployment, and wage inflation, among other data series, suggest we are in the midst of a late cycle acceleration in medical consumption.
One of the more obvious ways to play this theme is through AMN Healthcare (AMN), the temporary nurse staffing company. The U.S. Medical Economy has fully transitioned through the distortions created by the ACA, including the surge in insured medical consumers, followed by the subsequent #ACATaper that appears to have bottomed in 2017.
There continues to be a good long thesis with AMN despite the disappointing 4Q18 results and 1Q19 guidance. We'd be more concerned if the market dynamics mentioned above were not as strong as they are. Our model continues to forecast improvement in utilization.
Pricing improved in Nurse and Allied sequentially on a one year and two year basis in 4Q18 as the premium placement trend continues to stabilize. Net of the single client, 1Q19 guidance would have been better than consensus even with the flu comp. When comparing the guidance for Nurse and Allied before and after the problem client, the negative 600 bps swing resulted in 1Q19 revenue forecast to $333M, lower than consensus of $342M. Without the headwind management quoted a +5% growth rate (versus down 1% to 2%) in Nurse and Allied which would have driven guidance well ahead of consensus and our forecast would have been spot on.
TOL
Our Macro team remains bullish on Housing (ITB) stocks more broadly and Toll Brothers (TOL) specifically. Why?
Housing related equities are acutely interest rate sensitive. Historically, Periods of expedited rate increase = Marked Underperformance across the Housing complex. With rates up almost a full 100 bps in 2018, the underperformance has been unsurprising … but the tide has shifted alongside the markets acknowledgment and acceptance of Quad 4 fundamentals.
MHK
Mohawk Industries (MHK) Priced For Disappointment? Floor covering import growth accelerated in 4Q, even if it eased in December. While MAS results and outlook seem positive, company specific issues at MHK took out 3Q18 results and reset expectations lower. With a low multiple and expectations, 4Q weakness seems well anticipated and investors will likely look to the 1Q19 guide and 2019 commentary. Substantial investments need to start paying off for MHK for the shares to really work on the long-side.
CNQ
Below is a note written by CEO Keith McCullough on why we added Canadian Natural Resources (CNQ) to the long side of Investing Ideas earlier this week:
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Long Energy (XLE) works in Quad 3 inasmuch as Long Canadian Energy via our favorite larger cap name (Canadian Natural Resources, CNQ) should. CNQ is down -5% today on an Old Wall note so I'll take that as a buying opportunity. For those of you interested in learning more about Al Richards bullish long-term view of CNQ, he went bullish on it in our Best Ideas (Institutional Research) product back in December and here are the bullet points covered in his independent research presentation:
Buy on red, KM |
ITHUF
Below is a note written by CEO Keith McCullough on why we added iAnthus Capital (ITHUF) to the long side of Investing Ideas earlier this week:
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Our Cannabis Research Team continues to do independent and differentiated research in this growing space. One of their Best Ideas (Institutional Research product) remains iAnthus (ITHUF) and the stock is on sale today. Here's an excerpt from Shayne Laidlaw's recent Institutional Research note on the name: "Over the course of the last week we have had the pleasure of speaking with the CEO/IR as well as visit their West Palm dispensary, which is one of the better ones we have seen across the nation. 2019 has numerous catalysts for U.S. based operators that we think will provide great tailwinds for the industry. Of course, many of these center on the regulatory changes at the state (NY & NJ adult-use among others) and federal level (SAFE Act and STATES Act)." Buy on red, KM |
SGRY
Click here to read our analyst's original report.
The easiest fix for Surgery Partners (SGRY) is to buy high quality facilities and divest low quality ones. However, competition for deals continues to increase, as well as the multiples paid, and SGRY does not have the balance sheet to accelerate the pace of acquisitions after NSH. Given the high debt levels, the focus should be on deleveraging, however, doing so will come at the cost of growth and missed estimates.
AVLR
Click here to read our analyst's original report.
Our bearish view of Avalara (AVLR) is reaffirmed by, among many other things (like sales inefficiency and lack of tech prowess), the company’s M&A strategy – which sort of reveals the whole joke. On the one hand, AVLR bought an alcohol license company and claimed that many of its own customers (who by the way, are mostly won thanks to an ERP refresh cycle) are naturally demanding help with obtaining their alcohol licenses.
And its other recent acquisition of Indix, which management touted has “changed the game” – clearly has not, having been shut down as a product after once boasting to having revolutionized the state of retail… But more important is that Indix’s technology is something that AVLR should have built from the beginning, that is, if they were actually a technology company – and whose existence (in droves of similar startups) shows that the arbitrage of taking publicly available tax laws and running “multiplication” for clients will not be a high dollar draw forever.
In other words, if new generation companies can do this with automation, they will get there faster, cheaper, and a heck of a lot more efficiently than Avalara. If all else fails, at least AVLR can help customers apply for their liquor license.
CCL
Click here to read our analyst's original report.
Carnival’s (CCL) press releases showed that the company purchased ~4.4 million in Carnival plc shares in Q1, slightly higher than in Q4. However, since the share price bought in Q1 is lower than Q4, the total amount purchased is roughly equal at around US$235m. Furthermore, we’re modeling 0.5m shares bought in Carnival Corporation common stock. All-in, we’re expecting $265 million dollars of shares bought in Q1, similar to $263m in Q4. We continue to believe the amount of dollars for buybacks will slow for CCL this year and 2020 or leverage will expand, given negative FCF. CCL cash flow is under pressure and could elevate above Street expectations stemming from lower yield growth and higher capex.
TGT
Click here to read our analyst's original report.
Cornell just jammed unhittable guidance down the Target (TGT) outgoing CFO’s throat. Quarter was similar to what we expected, inline EPS, with comp slightly ahead and gross margin slightly weaker. SG&A driving the upside to hit the EPS number. In 2018 with a 5% comp, EBIT declined 3% (slight impact from 53rd week). Inventories still a problem here up 10% on a 5% comp. Better than last Q, but still high. Guidance is somewhat puzzling, as the company is guiding earnings for the year 5% higher than the street and up 9% yy, but that is with a low to mid single digit comp… the range of earnings is large on a low SD comp vs mid SD comp.
We think guidance is all about the comp. Gross margin has to be down 20-50bps in 2019 we don’t see a way around that for TGT given its investments and inventory position. The SG&A leverage needed will only happen if the company can comp 4-5%. Given the comparison set-up, our macro view of slowing US GDP and slowing consumer, and the fact that the company just made it clear that Toys and Baby growth was a big help in 2018 (our math was about 100bps of help, but company comments implying potentially more, which is not repeatable in 2019), we think 4-5% comp sales are not achievable without sacrificing margins in 2019. The CFO appeared only willing to bless 1Q, and took no ownership for the rest of the year, seemingly putting all of that on Cornell. 2Q and beyond is when growth gets very difficult.
TSLA
Click here to read our analyst's original report.
For those doubting why Tesla (TSLA) is looking as disruptive as Sears of late, our data on demand make the actions clear. The combination of the tax credit step-down, lower used prices, and an exhausted backlog have pushed the company’s back against the wall. Tesla is behaving like a distressed company, largely because we believe it is. The SEC asking the court to hold Musk in contempt for violating the “420 tweet” settlement was low on the list of things that went wrong this week. A bigger issue is that Tesla’s new strategy to sell cars makes absolutely no sense – they can’t have a Zappos-like return policy given the depreciation car values incur when driven off the lot. We see it as a least-worst solution out of a set of terrible options for Tesla.
ROL
Click here to read our analyst's original report.
Rollins (ROL) 10-K was filed on the first, and we’d note a few things. First, in addition to the debt to fund the Clark acquisition, ROL will pick up $175-$195 mil in right-of-use liabilities for consolidation of leases. In addition to the 2018 changes in revenue recognition language, we were surprised by a lack of detail on the drop in other current liabilities on higher revenue. Decreased accruals can help net income. The most noteworthy item, as we see it, was the change in the description of pricing. Since the 2010 Boston Consulting Group pricing study, which seems to have found room to increase prices for Orkin, ROL has usually reported that “less than 2.0% of the Company’s revenue increase came from pricing actions”. This year, it dropped to “Around 1% of the Company’s revenue increase is attributable to pricing actions”. A pricing deceleration in a strong economy may be due to intensifying competitive pressures and/or price increases taken too far.
DVA
Recently, the Secretary of HHS, Alex Azar gave a speech at the National Kidney Foundation and articulated a new vision for Medicare’s treatment of kidney disease. Kidney care, according to Azar, “has some of the worse incentives in American health care.” To correct those incentives, the Secretary laid out three areas of focus for policy change.
- Prevention, detection and management of kidney disease. Azar is planning to disrupt the center-based dialysis system on which FMS and DVA have thrived.
- Innovation in treatment of ESRD. The plan to do so includes new payment models that will encourage home dialysis.
- Improved access to transplants and artificial kidneys. The recent falloff in people on the transplant waiting list has raised alarm bells at CMS.
While DaVita (DVA) has talked a good deal recently about better treatment and prevention, the primary mechanism they have to execute on such a strategy is DMG, whose sale to UNH is pending. Absent the necessary expertise to provide prevention and management before the onset of ESRD, DVA will have little control over the treatment channels suggested by this new policy.
Certainly, home dialysis has better margins for DVA and FMS, which could even improve if CMS proposes increases to the in-home training add-on payment or to the per treatment reimbursement. In-home dialysis, however, faces other hurdles like state mandates and nephrology practices patterns that are going to be harder to overcome in the short run.
MCD
Click here to read our analyst's original report.
Apparently, McDonald's (MCD) distributor Martin-Brower Co. is raising delivery fees. Not a big surprise, but its also a problem for MCD and other restaurant companies. Labor inflation and other line items on the P&L are causing the industry to raise menu prices to protect margins. Any incremental inflation from here will not covered by menu prices increases.
For the last four years MCD has used price to drive same-store sales. By doing so, MCD has lost its position as the “value” brand in the restaurant industry leading to significant traffic declines and franchisee unrest. Something must give, and the stock does not reflect the current risks.
W
Click here to read our analyst's original report.
We continue to think that Wayfair (W) will never make money – as its Gross Margin structure is structurally too low to fund the SG&A costs inherent to growing this business. But let’s face it, the stock didn’t care about that at $50, it didn't care at $120, and probably cares even less post short-squeeze at $163.
What the market should care about is a change in the competitive set that is materially going against Wayfair. Its success has attracted the wrong kind of competition – as in, the folks you don’t want to compete with – ever. Combine that with more challenging Macro growth headwinds in the US and in Europe, and we’re looking at the growth trajectory being cut at least in half over a TAIL duration – which is dangerous given that there’s no earnings or cash flow to trade on here. This thing is ALL ABOUT the top line, and we’re currently sitting at an unsustainable growth rate that should begin a multi-year deceleration this year. In the ‘watch what they do not what they say’ department, keep in mind that Wayfair management is better at selling their W stock than they are at selling furniture (note: I’d challenge you to find more Form 4s for any company – ever).
AMZN
News broke this week about Amazon (AMZN) pushing more of its items onto its third party network, with less focus on selling itself directly. Third party sales are higher margin for Amazon, but this move is pressuring the supplier base and will most likely pressure sales growth for Amazon.
Since 3Q18 Amazon’s revenue has been moderating, while margins have expanded. It has made the stock “cheaper” with higher EPS, but the stock has fallen. Amazon likely sees the revenue slowdown coming is trying to appease investors with margin/EPS upside. We think the story will continue to evolve from revenue momentum to margin. For a company trading at 55x earnings, facing increased competition from big competitors (WMT/TGT), and a slowing US consumer, we’re not sure how margin over revenue can be anything but bearish for AMZN stock over the near term.
