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CMG – HOW GOOD IS GOOD?

Conclusion:  We are short CMG in the Hedgeye Virtual Portfolio.

 

CMG is now the sixth largest publically traded restaurant company having just come public in 2006.  It has the captivation of the growth crowd, as there are few other alternatives in which to invest as part of a growth-oriented strategy.  For the past three quarters, the company has crushed it, beyond my expectations.  I don’t like to “chase” stocks so I have missed the doubling in the stock this year.

 

With just two short months left in the calendar year, if you own CMG you probably want to hang on for the balance of the year in order to show everybody how you have done and so as to not incur the significant tax liability that comes with selling it.

 

Certainly the financial performance has been nothing short of amazing in FY10 with restaurant-level margins that are about 1200 bps above comparable companies on average (please refer to the charts below for more details).  The company’s new A-model sites are pushing the envelope on growth, allowing growth investors to become even more captivated by the company’s potential.  Ah yes, and there is the potential to take over the world…I get it - comps, margins and the unit growth potential are mesmerizing. 

 

CMG – HOW GOOD IS GOOD? - CMG margin analysis

 

CMG – HOW GOOD IS GOOD? - CMG margin gap

 

We all know nothing happens in a straight line, but CMG’s current market capitalization values each store at nearly $7 million.

 

How can we forget Howard Schultz telling the investment community that SBUX was going to have 40,000 stores when that stock was trading at $40 and 40x EPS?  Or the potential for PFCB’s Bistro when the stock was at $65 and trading at 40x EPS.  We can’t forget CAKE and its smaller unit, which was going to accelerate the potential number of units (not to mention the potential for Grand Lux) when that stock was at $39 and 35x EPS.  As the following chart shows, however, the multiples of SBUX, CAKE and PFCB have all come down over time.

 

CMG – HOW GOOD IS GOOD? - EVEBITDA historical

 

Yes, history is repeating itself and the “food with integrity” mantra produced an unprecedented 27.7% restaurant-level margin last quarter.

 

So what is the market discounting?  Perhaps, perfection for the next five years.  In 2016, based on my preliminary estimates, I have the company operating 1,916 stores and generating about $615 million in EBITDA or a 17% EBITDA margin; down slightly from my 19.4% EBITDA margin estimate for 2010.   

 

While the growth in stores and EBITDA could possibly be some of the best in the industry, what you can’t fight is the ultimate multiple assigned to a more mature business in 2016.  If we assume the stock trades at 10x our 2016 EBITDA estimate (which is a strong multiple given the potential issues outlined below), we get a market capitalization that is down about 7.5% from where we are today. 

 

CMG – HOW GOOD IS GOOD? - CMG good

 

All of this assumes the company can maintain the same “integrity” across a nearly 2000-unit store base as it has with a 1000-unit store base.   Below is a list of issues that the company will likely face over the next 5 years: 

 

(1)    Increased competition

(2)    Increased labor

(3)    Increased food costs

(4)    A challenging consumer environment

(5)    An aging store base

(6)    A compromised site selection strategy

(7)    Slowing same-store sales

(8)    Declining margins

 

Lastly, the biggest issue CMG will likely face relates to the company’s announcement after the close today that it is working on an Asian restaurant concept that will follow the Chipotle model.  The company plans to open one Asian inspired restaurant in 2011.  Unfortunately, I have seen this movie before and it does not typically end well as the company will begin to throw shareholder capital at a concept that will earn less of a return than CMG’s current business model.

 

 

Howard Penney

Managing Director

 


Professional Politicians Beware

This note was originally published at 8am this morning, November 03, 2010. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

"We must all strive to find common ground to support the middle class, create jobs, reduce the deficit and move our nation forward."

-Nancy Pelosi, November 2nd, 2010

 

While it will take many days for the final tallies to come in, it looks like our prediction will hold and that massive Republican turnout has driven a net gain in House seats of 65+ for Republicans.  According to Nate Silver over at the FiveThirtyEight blog (one of the more accurate electoral statisticians we follow):

 

“Our current projection is that Republicans will finish with a total of 243 house seats: this would reflect a net gain of 65 from Democrats. The range of plausible outcomes is fairly small: our model thinks there is roughly a 90 percent chance that the G.O.P.’s total will eventually be somewhere between 64 seats and 66.”

 

As it relates to our prediction in the Senate, we were off slightly as a number of major Democratic candidates did marginally better than expected, in particular Harry Reid in Nevada.  Currently, Alaska, Colorado, and Washington are still too close to call, but even if these States all go Republican the Democrats will still retain at least 51 seats in the Senate.  Nonetheless, the Democrats should lose a net 7 seats.

 

Since it seemed statistically unlikely that the Republicans could take the Senate, the story of the night is really the massive seat losses in the House.  To put it in historical context, this will likely be the largest seat loss in a midterm election for any party since 1938 under President Roosevelt, when the Democrats lost 72 House seats and 7 seats in the Senate.  Clearly, the electoral results today are indicative of a strong statement being made by the American people.

 

The obvious conclusion from these results is that this is a repudiation of the Obama agenda.  While we would be naïve to not agree at least partially with that, more broadly this looks to be a referendum on politicians themselves.   To wit, given a historical incumbency advantage of almost 90%, the last three congressional elections of 2006, 2008 and 2010 have shown accelerated volatility of incumbent losses.  Specifically, in 2006 the Democrats gained 30 seats in the House, in 2008 the Democrats gained 22 seats, and in 2010 the Republicans will likely gain back 65 seats.  In a span of four years, we have seen massive volatility between the parties and the relative support from the electorate.

 

The chart of the day, which is posted below, underscores the key reason why this occurring.  This chart highlights broad congressional approval.  Currently, 73.8% of voters disapprove of Congress!   If you were a professional politician yesterday and didn’t understand the implications of that yesterday, today you do in spades. 

 

We’ve used a quote from Nancy Pelosi at the top of the note today to further emphasize our point regarding the popularity of professional politicians.  While Pelosi retained her seat, her approval rating across the country as Speaker of the House was 29% heading into yesterday’s election.  Her brief statement last night, assuming it is not just rhetoric, is actually what politicians collectively need to work towards for this nation.  More broadly, the message this morning is clear from Americans, they are tired of rhetoric. 

 

While the Republicans will take a few victory laps over the next few days, the gauntlet is now thrown to them.  They have been given at least a nominal agenda and the next two years will be a test as to whether they can work with the President to move the country forward.  The questions we would ask are: what is next for monetary policy, what can be done about the burgeoning budget deficit, and how can we address the escalating sovereign debt situation of the federal government?  As Paul Rand stated in his victory speech last night:

 

“When I arrive in Washington, I will ask them, respectfully, to deliberate upon this. We are in the midst of a debt crisis and the people want to know why we have to balance our budget - and they don't.”

 

To take a deeper dive on some of these questions and to test the mettle of the rhetoric we will be hearing over the coming weeks, Keith and I will be hosting a call next Wednesday November 10th at 1PM with Peter Orszag, former Director of the Office of the Management and Budget.  This call will be a similar format to the one we held with our friend Karl Rove in September.  Peter will present for 20 – 25 minutes and he will then take questions for the duration of the call. 

 

If there is anyone in the nation who understands what can and cannot be done to reduce the budget deficit, it is Peter Orszag.  If you would like to join this call and are an institutional subscriber, or would like to trial our institutional service for the call, please email Jen Kane at sales@hedgeye.com.  The budget deficit is one of the most pressing economic issues facing the United States; therefore we think this call will be a valuable use of your time.

 

To Rand’s point in his victory speech last night, the people of America are asking a lot of questions.  The next two years will be a test as to whether the professional politicians are finally ready to answer the people with more than rhetoric. Needless to say, our Hedgeyes will be watching.

 

Yours in risk management,

 

Daryl G. Jones

Managing Director

 

Professional Politicians Beware - DJ EL


DEEP DIVE INTO MACAU'S OCTOBER NUMBERS

Wynn and MGM were the standouts 

 

 

Despite missing the HK$20BN mark, October was another very strong month for Macau.  Total revenues came in at $2.25BN, growing 50% YoY.  VIP revenues grew 57% while Mass grew 31% and slots grew 47% YoY.  VIP still comprises more than 76% of the table revenues.  Direct VIP play was only up 10bps YoY to 7.2%.  Adjusted for direct play, junket hold percentage was 2.7%, similar to last year.  November will have a difficult hold comparison of roughly 3.1%.

 

In terms of winners and losers for the month, MGM took the top spot with 97% total rev growth, increasing its share to 10.7%. Wynn clawed back 150bps of its losses from last month, ending with total market share of 13.8% and revenue growth of 66%.  SJM also increased market share by 2%.

 

Despite 77% YoY growth, MPEL was the largest share donor, losing 2.2%, followed by Galaxy, who lost 180bps of share.  LVS also lost share by having the lowest revenue growth at 19% YoY.

 

 

YoY Table Revenue Observations

 

LVS table revenues increased 17.5% with growth coming from a 13.6% increase in VIP revenues and a 26% increase in Mass revenues.

  • Sands decreased 4.6%
    • VIP revenues declined 11% despite flat Junket RC volume
    • 11% increase in Mass revenues
    • Assuming 14% direct VIP play (same as 2Q & 3Q2010), we estimate that hold for October was 3.1%. However, last October, assuming 9% direct play (inline with 4Q09), hold was even higher at 3.5%.
  • Venetian was up 25%
    • VIP revenues increased 20% despite a 1.6% decrease in Junket RC due to a very easy hold comparison
    • Mass revenues increased 35%
    • Assuming 23% direct VIP play volume, we estimate that hold for October was 3.2% compared to 2.6% last October if we assume that direct play was 17% (in-line with 4Q09 levels).
  • Four Seasons grew 56%
    • Mass revenues grew 25%
    • VIP revenues increased 64% on a 93% increase in Junket VIP RC volume
    • Assuming $750MM of direct VIP play or 43% in October, implied hold is 2.6% compared to 2.3% in October 2009 assuming direct play was 28% (consistent with 4Q09)

Wynn Macau/Encore table revenues were up 70%, driven by an 80% increase in VIP revenues and a 40% increase in Mass revenues

  • Junket RC volume increased 94%. Assuming 13% direct VIP play, October hold would only have been 2.3% even worse than the 2.5% hold experienced in October 2009 (assuming 12% direct play)

MPEL table revenues grew 76% with the growth fueled by a 232% leap in Mass and 35% growth in VIP

  • Altira was up 42%, due to a 15% increase in VIP revenues and a 105% increase in Mass revenues
    • VIP revenue growth was partly driven by very easy YoY hold comparisons, since RC grew only 14%
    • We estimate that hold in October was 2.6% vs. 2.1% in October 2009
  • CoD table revenue increased 106.5% YoY, driven by 93% growth in Mass and 110.5% growth in VIP revenues
    • Mass revenues hit a record $42MM
    • Junket VIP RC increased 68%
    • While hold looks normal in October at 2.8%, assuming 15% direct VIP play, last's October's hold was only 2.2% assuming 18% direct play

SJM table revenues grew 58%

  • Mass was up 18.4% and VIP was up 81.6%
  • Junket RC volumes increased 70%
  • SJM's hold was 2.72%, compared to 2.55% in October 2009.  November will have an difficult hold comparison since last October's hold rate was 3.25%.

Galaxy table revenue only increased 18.5%, driven by a 20% increase in VIP win and a 7% increase in Mass

  • Starworld's table revenue soared 103%, driven by 112% growth in VIP revenues and 30% growth in Mass
  • The Group RC volumes were up 40% while Starworld RC volumes increased 49%.  VIP revenues for the Group and Starworld were negatively impacted by low hold in October.  October hold for the Group and Starworld was 2.5% and 2.44%, respectively, compared to normal hold of 2.9% and 2.8% last year.  November 2009 hold rates were a bit high at 3% for the Group and 3.1% for Starworld.

MGM reported the strongest growth in the month of October, with growth of 97%

  • Mass revenue growth was 67%, while VIP revenues grew 106%
  • VIP RC grew 111%
  • Hold appears to have been normal in October at roughly 2.75%

 

Table Market Share

 

LVS table share dropped 50bps sequentially to 18.6%

  • LVS's share of VIP revenues decreased 50 bps in October, along with a 80 bps decrease in LVS's share of Junket RC to 11.6% - its lowest share since we've been getting data (March 2007)
  • Mass share was flat at 26.3%
  • Sands market share decreased by 80bps due to losses in both Mass and VIP share
  • Venetian gained 130bps to 10.7% sequentially, driven mostly by gains in VIP share which were driven by favorable hold comparisons
  • FS share dropped 100bps to 2.5% due to a 140bps loss in VIP share

WYNN's table share increased 150bps to 13.5%, a little below the TTM average pre-Encore opening market share of 13.8%.

  • Mass market increased 120bps to 11.4%
  • VIP revenue share increased 1.5% to 14.1% sequentially
  • Wynn's VIP share increased to 4th place behind SJM, MPEL, and LVS

Crown's market share fell 2.3% sequentially to 14% in October, driven by a 310bps drop in VIP share

  • CoD's share decreased 30bps
  • Altira's share fell 2%, driven by a 270bps drop in VIP share

SJM's share increased by 2.3% to 33.3%

  • SJM's share gain was driven by a 70bs gain in Mass share and a 3.4% increase in VIP share

Galaxy's share slipped 2% to 10.1%, its lowest share since August 2009

  • The Groups share loss was driven by a 260bps decrease in VIP share and a 50bps decrease in Mass share
  • Starworld's market share decreased 240bps sequentially to 8.1%, due to a 330bps decrease in VIP share
  • Junket RC share only decreased 60bps to 12% for Starworld and decreased 70bps for the Group

MGM's share increased by 100bps to 10.6% - MGM's best share month since August 2009

  • MGM's share gain can be attributed to a 130bps increase in VIP
  • RC share increased 70bps

 

October Slot Revenue Observations

 

Slot revenue grew 47% YoY in October reaching a record $111MM and accounting for 5% of total revenues

  • Galaxy experienced the largest growth of 115% to $4MM
  • MGM's slot revenue increased 102% to $16MM
  • MPEL slot revenue increased 80% to $21MM
  • LVS, having the largest base, grew 37% to $34MM
  • Wynn's slot revenue increased 27% to $22MM
  • SJM's slot revenue had the slowest growth at 16% to $13MM

 

DEEP DIVE INTO MACAU'S OCTOBER NUMBERS - macau table

 

DEEP DIVE INTO MACAU'S OCTOBER NUMBERS - macau RC

 

DEEP DIVE INTO MACAU'S OCTOBER NUMBERS - macau mass


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THE FED MEETING - MORE DELUSIONAL COMMENTARY

No matter what happens, all eyes should be on the Dollar following the FED meeting and we covered our short on the Dollar ahead of the meeting. 

 

Before the FED announcement this is what the set up looked liked at 12pm EST:

  1. The Dollar was up +0.10%
  2. Oil was up +1.23%
  3. Euro was down -0.05%
  4. Gold was down -0.23%
  5. Copper was down -0.57%
  6. The S&P 500 was trading flat
  7. Treasury prices are higher
  8. XLB XLY and XLE were trading lower
  9. XLI, XLF and XLU were trading higher

Out of the FED today we get:

  1. The FED intends to purchase a further $600 billion of longer-term Treasury securities by the end of the second quarter of 2011, a pace of about $75 billion per month.
  2. No acknowledgment of inflation - he is as delusional now as he was in 2008 when oil was at $145
  3. Hoenig dissents once again
  4. More confirmation that the US economy is weak

The facts have changed about the effectiveness of the FED program and they have not TIME IS RUNNING OUT.  The Republicans are unlikely to provide any “silver bullet” for the country's serious problems and from an economic perspective the new QE will get us very little bang for a lot of bucks.  The “recovery” is behind us and the current policy will not bring back the consumer spending to the level of the last 30 years.  So what’s the point?  Where is the job creation that is so badly needed and how is QE going to provide jobs?

 

As we can now get back the grind, there three things that matter most in global MACRO today:

  1. Global growth slowing
  2. Inflation accelerating
  3. Interconnected risk compounding

The initial reaction of the dollar to weaken only slightly stock rally the EURO improves and treasuries get hit hard.  All that matter is we are seeing the bottoming process for the Dollar and this is BAD for equities.  As the buck stops burning, our first level of support to the S&P 500 is 1167 or 2% down side from here.

 

 

Howard Penney

Managing Director

 

THE FED MEETING - MORE DELUSIONAL COMMENTARY - BERNANKE RUNNING OUT OF TIME


WMS: ADDRESSING THE ISSUES

Replacement demand is what it is but WMS margins and gaming ops revenue were both lower than expected.

 

 

WMS has probably “over-earned” on market share the last two quarters and replacement demand has been sluggish.  Outside of replacement demand accelerating, we’re not exactly sure what the next positive catalyst will be, but we would like to address a couple of concerns that emerged from the FQ1:  Gaming Ops revenues and Gaming Equipment margins.

 

Gaming operations were clearly a little disappointing in the quarter and the change in the presentation makes things even more confusing to draw insight

  • They missed our revenue number here by $3MM and gross margin by $2MM
  • The difference vs our number was driven by both a lower install base and average win per day
  • There were no new WAP games launched in the Q and Lord of the Rings generates a fee close to the participation average so that explains the slightly lower yields
  • Gaming Ops margins were good and should continue to benefit from Lord of the Rings, paying like a WAP game without the associated jackpot expense – assuming base grows
  • Under the old method, sequentially, we think that standalone units would have increased by ~100 units, LAPs would have been flat, and WAPs would have decreased by 175 units
  • In the next few quarters, they have several WAP games coming,  a new LAP (Godfather), and several standalones.  The December and March quarters will be very active from a release standpoint and should generate increases across the board in the install base

The margin issue… disappointing but we believe it is temporary

  • Lower xD margins and a higher mix of used/parts revenues meant margins were 3.6% lower than we estimated so gross margin was only $1.2MM better than our number
  • We shouldn’t really ding them for lower xD margins because that’s a temporary issue that will resolve itself by the YE
  •  xD was a much higher % of the mix than they estimated - this was partly magnified by the fact that there were many units shipped in the quarter and that xD just launched.  For the rest of the year, the mix will be less than 35%, aside from perhaps the very end of the year.  
  • While Bluebird (BB) margins were the same, there were less total units, so fixed costs were spread over a smaller base, further impacting margins
  • Used games and parts have much lower margins than conversion kits (which are around 90+%) so the mix of non-gaming dampened margins.  It seems like used games and parts should continue to be strong this year as they are getting lots of trade-ins of BB1’s for BB2’s – which isn’t a bad thing – but this is a lower margin income stream and it almost doubled YoY.

SENTIMENT WATCH - MAXIMUM BULLISHNESS IS BAD

Conclusion: Sentiment is at maximum levels.  This is another indicator to watch carefully as this market continues to echo the mania of 2007.

 

With much of Wall Street focused on the election and upcoming Federal Reserve Policy Announcement, it is interesting to look at the sentiment that has bolstered this recent stock market rally.  Clearly it is not news that sentiment is high among investors but the chart below paints an alarming picture of just rose-tinted the Street’s glasses are.  As LBO rumors and guesstimates of how sizeable QE2 might be have driven the market, the underlying economic climate has remained fragile.  The clear and lucid picture of GDP growth propped up by government spending and inventory build is a stark reminder not to follow the herd.  I discussed this point in greater detail in the Early Look yesterday, titled, “VERSIONS OF THE TRUTH”.

 

Looking past the Federal Reserve announcement today, the next ball to catch is the Retail Sales numbers that are due to be released tomorrow.  Eric Levine, Director of Retail at Hedgeye, had the following insights ahead of tomorrow’s releases.  The question is, does the market – and the elevated level of bullishness – bake in the significant downside risk suggested by the commentary below.  As Eric told me, the preponderance of the commentary around the building products companies of late suggests slowing within 3Q.

 

Levine:

  • With cold weather comparisons at their toughest for the month of October, we believe solid Halloween sell-throughs will be mitigated by weak overall demand for seasonal apparel.
  • With the next major catalyst being Christmas (kicked off by Black Friday), it’s unlikely that any tangible improvement in sales momentum materializes over the next few weeks.  We fully anticipate that holiday sales will materialize, although in a manner in which it will be difficult to guage in real time.  Recall that holiday sales generally occur later and later each year as well as even after 12/25. 

 

Howard Penney

Managing Director

 

SENTIMENT WATCH - MAXIMUM BULLISHNESS IS BAD - bullbear


Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.65%
  • SHORT SIGNALS 78.64%
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