Corn Planting Progress Remains Sluggish

Written April 22nd, 2014 by

As of Sunday, 6% of the U.S. corn crop had been planted versus a five year average of 14% – a slow start to be sure.  Significant progress was made across more Southern locations (Louisiana was virtually completed, for example) while the heart of the Corn Belt has seen little to no progress.

While initial progress has been slow, plantings should accelerate this week as weather appears favorable across much of the Midwest and soil temperatures have begun to creep higher (need to be above 50º for seeds to germinate, at a minimum).  It would be a mistake to bet against the U.S. farmer, crop genetics and modern farming technology full stop, but even more so with the weather as a tailwind.  We expect that the corn plantings make significant progress this week toward the historical averages.

Having said that, our bias on corn is still bullish as demand remains brisk:

  • Weekly corn inspections for export continue to trend higher (Exhibit 1);
  • Ethanol production for both domestic consumption and export remains solid (Exhibit 2)

Agricultural commodities broadly started the week lower as we saw non-commercial (hedge fund) positions come down across the complex.  We note that corn remains one of the least popular positions across soft commodities.

As stated above, our bias is to be long corn based on what we expect will be continued robust demand given U.S. corn’s global position as an inexpensive input and the risk that usage poses to corn stocks given a stocks to use that remains low by historical standards.  We would balance a long position in corn with a short position in beans, and also see an emerging opportunity to be short wheat, perhaps more in 2H.

Quick Thoughts – Another Challenging Quarter for MCD

Written April 22nd, 2014 by

We suspect that expectations were modest for MCD’s Q1 results given the weather in the U.S., recent trends ex-weather and the company’s cautious commentary on margins contained in its last sales release.  We believe that the stock’s recent move higher was more a function of sector rotation dynamics, rather than any optimism surrounding the company’s near-term business momentum.

Given this setup, Q1 results were appropriately underwhelming, with the company delivering below consensus results on both EPS ($0.03) and revenue (~$30 million).  Sluggish U.S. results (certainly related in part to the weather, but a challenging competitive environment that appears to be getting more difficult on the margin likely played no small role) weighed on global comparable sales (+0.5%, -1.7% in the U.S.).  Constant currency revenue growth was +3%, with constant currency EBIT increasing +1%, so we saw negative leverage as we move through the income statement.

Currency weakened EPS results by $0.03 in the quarter, but even on adjusted basis EPS declined year over year against a fairly easier comparison (+2%) – EPS comparisons stiffen in Q2 and Q3 (+5% and +6%), calling into question the forecasted EPS growth contemplated by consensus (+6% in Q2 and +7% in Q3).  With consensus estimates still too high in our view, we see little reason to be involved in the name at current levels.

While the stock was indicated lower initially, we suspect the commentary surrounding (modestly) positive global comparable sales in April may have helped buoy shares in early trading. 

With the U.S. operations a bit of albatross due to consumer frugality and incremental competition, it is difficult at this point to build a fundamental investment case.  Having said that, the risk to being short may lie in the company levering up to repurchase shares in a much more aggressive fashion or some other corporate action (incremental cost savings, for example).  We see any opportunity along these lines as likely more weighted to the second half, just as we could potentially see more aggressive input cost inflation impact operating results.  Bottom line for us is that we continue to see MCD as a source of funds, and with the share price over $100, a less than compelling risk/reward profile over the next 6-9 months.

Quick Thoughts: Netflix Fiddles while Traditional TV Begins to Burn

Written April 21st, 2014 by

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-          NFLX beat on EPS ($0.86 vs. $0.81 consensus) and new subs (4M net adds vs. 3.85M guidance), as its original content strategy is beating on-line and traditional rivals alike.

-          With the rapid expansion NFLX subs and streaming hours, the contention that traditional TV viewing remains unaffected is not credible, an omen of future pressure on TV advertising.

-          Investors cheered the decision to raise prices for new subs, one of many unused monetization levers available NFLX – the $ will fund more original programs, new markets and higher margins

-          Despite cutting a well-publicized deal with Comcast for better interconnection, NFLX was explicit in its criticism of the proposed merger with TWC and of the market power of ISPs in general.

Netflix handily delivered another great quarter, maintaining momentum and delivering strong subscriber growth globally. US streaming subscriber additions were 2.25M, in line with management guidance, while international net adds beat the 1.6M guidance by nearly 10%, bringing total subscribers to more than 48M worldwide, up more than 25% YoY. The user growth drove sales in line with consensus expectations, while EPS of $0.86 easily topped the $0.81 forecast. While the results were unequivocally strong, the nearly 7% after hours pop came from CEO Reed Hastings’ abrupt about face on raising prices. After delivering upside to margins in this quarter, perhaps Netflix is starting to care about its profitability.

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DuPont – Sifting Through The Noise We Saw What We Wanted to See

Written April 21st, 2014 by

Our positive stance on DuPont has been driven by two factors; valuation, and the belief that there is a real growth story in the core business.  Valuation support remains but it is much less of a factor today than it was a year ago as the stock is only 5-6% below our measure of fair value – we estimate that “normal relative value” for DD is around $71 per share.   However, our measure of fair value is based on DD continuing to operate and behave in the same way it has for years and clearly that is not the story that the company is telling today.

The exit of the Performance Chemicals business, according to the company, should leave a large core portfolio of differentiated platforms with very strong growth – driven by R&D advancements and leading to premium pricing.  This is the third quarter in a row where we have seen evidence of that, with most of the core segments (excluding Agriculture this quarter) showing operating earnings gains versus the prior year.  Ag was weaker because of the Latin American pull through of demand into Q4 2013 – across the two quarters Ag was positive.

The investment controversy here is whether DuPont is on either of the return on capital paths shown in the first Exhibit.  The more muted recovery is what is driving our earnings/valuation model and creates our current fair value of $71 per share.  We struggle to get more positive if this is indeed the right path, because even though returns are growing, there will be a negative step change in this chart when the performance chemicals business is divested as it has a higher return on capital than the company as a whole.


Upside in the stock will only likely come from a demonstration of faster and more consistent growth and a return on capital trend that approaches the more aggressive arrow in the Exhibit.  In other words, the 12% return on capital generated by forward 12 month consensus earnings is on trend or close to trend rather than 200 basis points above trend.  Even with a step down, post divestment, a growth trend like this would likely result in a multiple expansion possibly along the lines of what we have seen for PPG – shown in the second Exhibit.  PPG’s relative multiple has doubled from 2008 to today.   DuPont’s relative multiple was not as discounted as PPG’s historically – third Exhibit – but is around 20% lower than PPG’s today.  Note that the analysis is based on “normalized earnings” and while PPG is expected to earn around 20% above our view of normal in 2014, DD is expected to earn 30% above normal so the comparison is not unreasonable.  Forward estimates do not have PPG growing earnings significantly faster than DD for the next three years; the higher multiple is an indication that investors have more confidence in PPG’s trajectory today than they do in DuPont’s.

A 20% jump in relative multiple for DD would put a value of around $85 per share on the stock today.




SSR Index of Current-Quarter Healthcare Demand Growth: Final 1Q14 Estimates

Written April 21st, 2014 by

We expect 3.5% (nominal) y/y growth in US health services demand during 1Q14, the product of 2.5% growth in demand intensity and 1.0% growth in price. Intensity growth reflects a 20bp improvement over actual 4Q13 growth of 2.3%, and a 10bp increase from our prior 1Q14 forecast. Price growth reflects a very large 30bp drop from 4Q13, but is unchanged from our prior 1Q14 forecast

Independent of our quarterly growth rate models, we handicap the odds of a trend break, i.e. a significant acceleration or deceleration in demand. The trend-break model indicates that sequential acceleration in demand during 1Q14 is likely (89%)

Pricing growth remains at historically low levels, and is negative (+/- (0.4%) – 0.0%) in real terms. As Medicare pricing growth slowly recovers from the year ago +/- 2% Medicare ‘sequester’ cuts, commercial pricing is weakening

Sequential hiring within hospitals in March drove the very modest 10bp increase in our intensity estimate; however the longer-term trend of declining hospital employment remains intact. Fundamentally, we believe falling hospital employment reflects decisions by hospital administrators to reduce capacity in the wake of poor ACA enrollment, rather than any weakening of the sequential demand trend

This year’s weaker flu season reduces YoY intensity growth by roughly 40bp in 1Q14; thus ‘true’ underlying growth in intensity is closer to 2.9%. As context, bear in mind that demographics alone currently drive 1.5% intensity growth (80bp from population growth and 70bp from aging); and, that per-capita age-adjusted intensity has historically exceeded this baseline level of demographic demand by an additional 2.2%. Thus a reasonable estimate of ‘normal’ intensity growth is roughly 3.7%

We believe intensity of demand will continue to grow as employment improves, as this serves to move a larger percentage of the population into the most generous form (employer sponsored) of health insurance. For this reason, we favor healthcare sub-sectors that are: 1) positively levered to gains in US per-capita intensity; and 2) have stable pricing, such as Non-Rx Consumables (e.g. BDX, BCR, COV, CFN, OMI)

For our full research notes, please visit our published research site.

Quick Thoughts – CMG Q1 EPS

Written April 17th, 2014 by

There is very little not to like in CMG’s earnings release this morning (unless you care about margins or EPS results) – but we recognize that it is a growth stock and that top line growth is pretty much all that matters to some subset of investors and to CMG stock this morning.

  • +24.4% revenue growth year over year bested consensus by approximately $30 million;
  • Comparable restaurant sales increased an impressive 13.4% (we had heard whispers that were 10%+, but this result surely exceeds those expectations); one additional day in the quarter didn’t hurt either.
  • Restaurant level operating margins declined 40 bps, driven by 150 bps of higher food costs related to inflationary pressures in a number of commodities (we have discussed some of this in our work on agriculture);
  • EPS missed consensus in dramatic fashion, growing just 7.8% in the quarter, but is apparently an afterthought against the backdrop of sustained top line momentum.

Perversely, it seems that the more dramatic the impact of inflation, the more engaged investors become as the talk of CMG pulling the pricing lever moves to the forefront.

  • Acknowledging the traffic trends, it is abundantly clear that CMG is on point with respect to its offering to consumers, and we don’t doubt that the brand has sufficient equity to take pricing on a reasonable basis, even in an uncertain consumer spending environment.
  • On the other hand, if it ain’t broke don’t fix it can be applied to a large number of situations, this one included – we would not be buyers of CMG solely on the basis of an anticipated price increase because, even with substantial brand equity, there is an inherent riskiness to all price changes in terms of consumer response.

Ultimately, while we acknowledge the significant, positive momentum, likely on a multi-duration basis, behind the CMG brand, we can’t reasonably frame the risk/reward for investors and therefore can’t suggest being buyers of the name, particularly in light of our thematic work surrounding growth and value in the market.

Finally, there are a number of restaurant concepts whose positioning is far less fortunate than that of CMG in terms of brand equity and pricing flexibility and who are facing the same inflationary pressures (maybe not with respect to avocados) as CMG – beef and cheese sounds a lot like a hamburger, for example.  The restaurant sector remains one of our least preferred across consumer as we add concerns about inflation to our already existing concerns on valuation and consumer spending.

Quick Thoughts – PM Q1 EPS

Written April 17th, 2014 by

This morning, PM reported Q1 ’14 EPS of $1.19 per share, besting consensus estimates by $0.03 – we would characterize the quality as somewhat mixed (certainly not as strong as Q4 ‘13), but our view on PM is unchanged given what we see as one of the best risk/reward profiles in consumer staples, well-supported by a dividend yield of 4.4% and robust FCF.

  • Importantly, PM broke the recent cycle of negative EPS revisions, maintaining expectations for adjusted (excluding currency and charges) EPS growth of 6-8% for 2014.  Guidance on reported EPS improved by $0.07 per share ($0.10 more favorable currency, $0.03 in charges).  We tend not to get too bent out of shape on currency (in either direction), but it appears as if some of the pressure that we saw on reported EPS in ’13 is abating.
  • Currency drove most, if not all, of the ’13 negative EPS revisions even as the underlying business continued to deliver against plan – with currency moving to more of a tailwind (less of a headwind is technically more correct) in ’14, it would strike us as very odd for investors to now say, “It’s just currency”.
  • We continue to see sentiment as mixed, at best (just based on conversations we would tend more toward decidedly negative, but we don’t talk to everyone) and this quarter almost certainly isn’t the catalyst for investors to climb over the wall of worry.

The company’s reported 4.4% volume decline (against the easiest volume comparison of the year) may drive the stock reaction today.  The volume weakness was across multiple regions, but the company did suggest that the unfavorable timing of inventory movements in the quarter represented 2.4% of the volume decline.  Our main concerns with respect to volume weakness are Russia and Indonesia, but we are encouraged by the commentary suggesting early signs of improvement in the operating environment in Europe.  Our expectation is that volume trends will strengthen as we move through the balance of ’14.

Driven by the volume decline, constant currency organic revenue growth of -1.6% was disappointing, but the company was against the most difficult comparison of the year as pricing was nearly +10% in the first quarter of ’13.  Comparisons ease as we move through the balance of ’14.  Constant currency EBIT declined in the quarter as well (-3.1%), a contrast to the excellent currency neutral operating leverage that we saw in Q4.

We expect some small, positive adjustments to consensus estimates based on these results driven primarily by currency and continue to see PM as one of the better ideas in consumer staples across multiple durations.  The company is poised to deliver 6-8% currency neutral EPS growth in an investment year and while we appreciate the concerns investors may have regarding the company’s ability to return to its prior 10-12% EPS growth algorithm, we would argue that the current dividend yield and FCF profile make for an engaging investment case even if long-term growth is impaired, with investors essentially getting an inexpensive option on a return to prior growth rates.

Quick Thoughts: Another Annoying Google Quarter

Written April 17th, 2014 by

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-          While GOOG’s 1Q14 miss is disappointing, it is not particularly unusual in its history of focusing on the long term. To that end, 19% sales growth is a healthy indicator for the future.

-          Network ad sales grew just 4% as GOOG is capturing more ad dollars on its own sites through programmatic ad buying. TAC is now at a record 3 year low of 23.3%

-          The bottom line miss was exacerbated by a 400bp boost to OPEX, mostly due to unusual legal expenses and costs associated with integrating Nest that will be resolved by next quarter.

-          The miss had GOOG off over 3% after hours. We do not see the results as alarming, and would use weakness as an opportunity to add what we see as the best positioned player in the sector.

Earnings happen. Google, like its archrivals Amazon and Facebook, maintains a blasé attitude toward its short term results. This long-term approach, while ostensibly to be applauded, has an annoying tendency to periodically bite investors in the portfolio. Google’s first quarter report is an example of this habit. The numbers were short on both the top and bottom lines, and the stock tumbled after hours, eventually recovering to just 3.15% down. In its past 4 misses, Motorola’s hardware business was the prime culprit, but this time it seems to be a bit of over exuberance in sales estimates combined unusual items that drove OPEX up 400bp. Legal fees likely stemming from the recent stock split drove G&A up, while Nest’s heavy R&D flowed through the P&L taking the company from a historic R&D rate of 12% of revenue to 14%. Despite this little speed bump, things look more than alright in Mountain View.

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Medicaid HMOs: Growth Prospects Undervalued

Written April 16th, 2014 by

The outlook for commercial premium growth is sluggish; modest enrollment gains from the Affordable Care Act (ACA) and rising employment are offset by the rising tendency of beneficiaries to either buy cheaper policies, or forego coverage altogether

On top of this, the large ‘national account oriented’ commercial HMOs (e.g. CI, AET, WLP, UNH) stand to lose share of commercial beneficiaries, as employer sponsored beneficiaries move to the ACA’s exchanges or (more frequently) to private exchanges

Conversely, Medicaid is expanding; enrollment losses from rising employment are more than offset by more generous eligibility standards under the ACA; and by rising enrollment as states that have not participated in the expansion eventually choose to participate. Medicaid HMOs are gaining share of this growing population; and, average contract values stand to rise as dually eligible Medicare / Medicaid beneficiaries eventually enter HMOs

Importantly, we believe many of the Medicaid hold-out states would have expanded their programs to 100 percent of the federal poverty level (100 FPL) if Health and Human Services had agreed to pay the enhanced federal match on enrollees in these smaller expansions

Former Secretary Sebelius’ decision not to provide enhanced matching to partial expansions presumably was meant to encourage full expansions in most states, but this has not worked; more than 9 million Medicaid beneficiaries at or below 100 FPL remain on the sidelines in states that have not expanded. Former Secretary Sebelius’ policy was set to expire at the end of 2016, however we see some chance that the new Secretary nominee may choose to retire the policy sooner, bringing these additional 9 million beneficiaries into the program more quickly

We believe the relatively narrow difference between commercial and Medicaid HMOs’ valuations fails to reflect the broad differences in these subsectors’ growth prospects, and we conclude that the Medicaid HMOs are undervalued

For our full research notes, please visit our published research site.

April 15, 2014 – TMT: Don’t Rain on My IPO

Written April 15th, 2014 by

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TMT: Don’t Rain on My IPO

2013 was the biggest year for TMT IPOs since 2007, with 54 companies hitting the market, led by TWTR, but otherwise dominated by enterprise cloud software. 2014 began with a big backlog of 590 venture funded companies in the pipeline, up from 426 a year ago, representative of years of public market angst. 19 IPOs have issued YTD, with several high profile acquisitions as well. This year, the mix includes more consumer names, including 50%+of the IPOs YTD, and with Chinese e-commerce giant Alibaba expected to top FB’s 2012 offering as the biggest debut in history. For investors, we see 2014’s likely IPOs as a mixed bag. To date, intriguing plays like GRUB and OPWR have had strong launches, while riskier issues like KING have foundered. Looking ahead, we are more optimistic for enterprise cloud application plays like Palantir, New Relic and AppDynamics, than for the sub-scale infrastructure plays like Box and platform vulnerable consumer businesses like Dropbox and Evernote. Overall, we are bullish that paradigm shifts in advertising, retail, enterprise IT, entertainment, and telecom are opening huge new addressable markets to new paradigm TMT players, and that most valuations remain reasonable given this growth potential. Given this, strong cash flows and balance sheet liquidity, we believe talk of a new tech bubble is misplaced. On a side note, the IPO market may raise prices and slow the pace of sector M&A. We are adjusting our model portfolio – over the past 4 months, the large cap underperformed by 3200bp, driven by the recent pull back, while the small cap outperformed by 4600bp. FB and DATA are joining the large cap list, replacing CRM and CTXS, while OPWR and GRUB are added to the small cap portfolio, replacing GTAT and TYPE.

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