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CMG: C NOTE

What P/E multiple would you pay for a restaurant company with the following characteristics?

 

(1)    5-yr EPS growth of 18-20% (13% unit growth, 4% SSS and some margin expansion?)

(2)    Consumer loyalty that cyclical (otherwise management would have raised menu prices)

(3)    Little pricing power (management implied that last night)

(4)    Significant margin volatility due to significant commodity exposure (read the rest of this note)

 

Pick from the following:

 

(A)   20x earnings

(B)   25x earnings

(C)   30x earnings

(D)   35x earnings

 

This brackets the valuation of CMG at some where between $120 and $210 per share, with stock having closed at $256 (and trading up at $275).  Yes, you can accuse me of having a BEARISH view of CMG, but I also feel like I’m being rational in a market that is irrational.  Right now I have CMG earning $6.00 in 2011 below the $6.66 consensus estimate.  I’m the bearish one so I’m going to use 25x as an appropriate multiple to value CMG - that puts $100+ downside to CMG. 

 

Read the balance of this note and you tell me that the current 42x multiple is justified.  

 

CMG once again beat street expectations, reporting 4Q10 earnings of $1.47 per share and 12.6% comp growth relative to the street’s $1.31 per share and 9.9% same-store sales growth estimates, respectively.  With restaurant-level margins up over 140 bps to nearly 26%, and operating margins up 240 bps YOY, it is hard to poke any holes in the company’s fourth quarter results.

 

CMG maintained its reported FY11 guidance to open 135 to 145 new restaurants and for low single-digit comp growth, but outside of that, all of management’s commentary around its outlook for this year was decidedly bearish.  In short, same-store sales comparisons, and more specifically, traffic comparisons, get increasingly more difficult as we progress through the year, inflationary headwinds will put real pressure on margins and labor costs will creep higher as a result of the recent immigration inspection in Minnesota, which could ultimately affect additional markets.

 

Same-store sales growth


 During the fourth quarter, CMG successfully lapped its first quarter of slightly positive traffic growth reported in 4Q09 after lapping five quarters of traffic declines.  The traffic comparison turns significantly more positive in 1Q11 to about 4% and jumps to double-digit growth in the second half of the year.  Given that the company is currently not planning any menu price increase for the first half of the year and menu mix has only been a minor driver of comp growth in recent quarters, the sharp uptick in traffic comparisons will likely cause comp growth to slow, particularly in the second half of the year, to closer to 3% from the double-digit growth reported in 2H10.   

 

On the earnings call, management announced a loyalty program based on rewarding “our best customers for their knowledge and understanding of Chipotle, rather than simply rewarding visits as most loyalty programs do”.  While CMG’s intentions may be admirable, to ‘educate people about “Food With Integrity”’, I am skeptical that this initiative will prove incremental to comparable sales and traffic growth when it is rolled out in April.

 

During the first quarter, a tougher comparison will not be the only hurdle; however, as management said that although comps held up well in 4Q10, “it's been pretty volatile so far in 2011 with extreme weather throughout much of the country.”  Given this volatility, I am currently modeling 6% same-store sales growth during 1Q11, which implies about a 200 bp deceleration in two-year average trends.  For the remainder of the year, I am modeling flat two-year trends with the fourth quarter because management did specify that, outside of the weather impact, there does not appear to be any change to underlying trends.  But again, flat two-year average trends imply a significant slowdown in comp trends on a one-year basis (pictured below).

 

CMG: C NOTE - cmg1

 

Inflationary headwinds

 

CMG sounded decidedly more negative today regarding its commodity cost outlook for 2011 relative to the company’s 3Q10 earnings call when it said it could face low-to mid-single digit cost inflation.  During the fourth quarter, food costs as a percentage of sales increased nearly 100 bps to 31% and that is with comps up 12.6%.  Now, management is saying that, using that 31% of sales level as a starting point, overall food cost inflation will climb to mid-single digits during the year.  This new guidance does not even include the expected 200 bps of pressure that the company could face in the coming months as a result of recent freezes in Mexico and Florida that have impacted the supply and cost of tomatoes, green peppers and tomatillos. 

 

After hearing this outlook, I assumed management’s next comment would be that it has already or will soon be implementing a price increase to offset this margin pressure.  That was not the case.  Instead, the company said it will not take any price for the next two quarters until it sees how the commodity environment pans out and how consumers react to its competitors’ price increases.  I understand management’s caution around taking price in this economic environment, particularly since traffic growth has been the primary driver of CMG’s comp growth. 

 

Increasing prices could likely be detrimental to traffic growth, but without pricing, CMG’s margins will take a hit, and likely a big hit, specifically during the first half of the year until we see how the situation in Mexico and Florida shakes out.  Rising corn prices are also a major concern.  Specifically, management stated, “reports of continuing or even worsening supply shortages of corn will only add to inflationary pressure on the meats that we serve.”  To that end, management continues to think it has pricing power and will decide whether a price increase is necessary during the second half of the year.  We could easily see food costs as a percentage of sales up 200-300 bps in the first half of the year.

 

CMG: C NOTE - cmg2

 

Labor cost pressure

 

As a result of the recent Minnesota immigration inspection, CMG has had to hire and train hundreds of new employees, which management called “disruptive.”  CMG has 50 restaurants in Minnesota and the company has had to train new employees in nearly all of them, which adds up to 20% to 30% more crew hours in those restaurants.  At the company level, these increased labor hours in Minnesota alone are expected to add 20 to 30 bps of extra costs to the labor expense line, which should then level off over the next few months.  But, this might not be the extent of the damage because the company has already received a similar notice of inspection for all of its restaurants in Virginia and Washington D.C. and I would not be surprised to see more markets added to the list.

 

During the 3Q10 conference call, management provided an insightful comment pertaining to the company’s ability to sustain margins going forward; “so long as we continue to see some comp growth – and we typically need something mid-single digit, generally with normal inflation [to hold margins]”.  Given that the inflation picture has worsened and they are now guiding to low-single digit comps, margin contraction, not expansion, seems more likely.

 

Timing the 2011 Headwinds:


1Q11: Experiencing “volatile” trends quarter-to-date, could face an additional 200 bps of commodity pressure on top of the already climbing commodity costs (would not be surprised to see food costs as a percentage of sales up 200-300 bps YOY), expecting at least 20-30 bps of incremental pressure on the labor line as a result of the immigration inspection in Minnesota, no price increases…I am expecting the biggest YOY restaurant-level margin decline in 1Q11 (down about 300 bps).

 

2Q11: Lapping a more difficult 8.7% comp relative to 4.3% in 1Q11, facing continued commodity pressure (would not be surprised to see food costs as a percentage of sales up 200-300 bps YOY) and likely additional costs associated with an expanded immigration situation, no price increases

 

2H11: Lapping double digit comp and traffic increases, commodity pressures will be an issue; though they may mitigate somewhat as the year progresses, company may implement a price increase if necessary

 

Howard Penney

Managing Director


WYNN 4Q2010 CONF CALL NOTES

Blockbuster quarter in Macau. Even after normalizing the unexpectedly high Mass hold, the beat was still huge.

 

 

CONF CALL NOTES:

  • If there was a recovery underway, it was abandoned by the addition of inventory to Vegas, but in spite of that, room rates are up a little, occupancy is ok, and convention is up a lot.  Indicators are pointing up, but it's still very lackluster and disappointing.  However, 2011 will surely be better than 2010.
    • Well, they also have less room capacity to sell given the renovations
  • The market is Macau is very robust.  Their Cotai project will be the best thing that they have ever done.
  • Had the biggest CNY in Vegas in history with $16MM in table revenues. In China they also had a record night - casino win of over $46MM.

Q&A

  • In Macau, the credit balance is outstanding with their associates. They reserve 3-4% on their own accounts for bad debt - in 40 years, they have never had exceeded their reserve. They are just as conservative with their junkets. They have never used credit as a marketing tool in Macau or in general.
  • $13MM bad debt provision - $11MM of that was in Macau and that was a function of business volume. So it was purely based on business volume.
  • On a volume basis, direct play, is always 10-15% of of VIP RC. This quarter, it was on the low end. They are adding 24 tables through 2 junket rooms which will open in 2Q.
    • By our math, direct play as a % of RC was 11%
  • The entertainment component of the Cotai project is far and away the best they have ever done
  • Corporate expense run rate level - 3Q is a better run rate - 4Q just had some development activity in the quarter
  • A little more than 50% of the cash is at the parent; rest is at Wynn Macau
  • Signing of the concession in Cotai?
    • Master plan for Cotai specifically includes Wynn's property as well as SJM's and MGM's site. However, they are still waiting for official approval.
  • Opening in Cotai - Late 2014 / early 2015 is Wynn's best guess but needs to wait on the government's approval
  • Everything is up in Macau and Las Vegas in Jan & Feb - and they are being lucky but in their range
  • They will definitely book btw 20-22% of their rooms as convention rooms in 2011 vs. 13% in 2009. Historically it was always btw 20-25%.
  • Competitor's new comping policy - doesn't really make any sense to them.  They have always been the most conservative with their comping policy.  There was a period when LVS and MGM were very aggressive with comping. Invariably, high comping policies end up picking up the "unworthy" and unprofitable customers... sort of like granting too much credit.
  • On the convention side, people relaxed about coming to Vegas
  • Infrastructure improvements to Macau -Hong Kong-Zhuhai-Macau Bridge will be huge for Macau. Left room in their plans to add more additional business that may come from this in the future
  • What was the unusual corporate development activity in the quarter?
    • No comment - would rather fill the call with deals that they have signed not spec.., don't want wild speculation on their call
  • Property growth at Wynn Macau was across the board not just attributed to the one junket added in the Q
  • Japan? No one knows about Japan yet.
  • Areas for growth in 2011:
    • Improvements in domestic business. Just remodeled the entire Vegas facility - spend $200MM in Vegas. Raising rates, and will finish renovations by April. Only 2-3% of their rooms are out of commission in the meantime.
    • First full year of Surrender and the new night club
    • Improved the cost side of F&B and should see the benefit of that
    • Full year of Encore Macau in 2011 also continued to modify their floor to accommodate the premium mass business and new VIP business. 
    • Think that they can do a lot better on the slot side as well. They restructured their slot operation - will be completed in 2 days.
  • Win per unit at the Encore casino in Wynn - 3x that of the general casino. Chinese customer base responds to intimacy.
  • $2.5BN is a comfortable budget for Wynn Cotai. Expect that the government's approval is not very far away
  •  Is credit extension too loose in the Macau market as a whole?
    • It appears that credit for a time was overextended and that some operators have more liberal credit decisions than Wynn's
  • Only holding at 1.9% in Macau in February so far... so that's why their market share dipped
  • Doesn't think that there is a current infrastructure capacity issue today
  • Impact of Galaxy Macau on the market?
    • Thinks it's a very ambitious project that will be well received and should be good for Cotai and the market given the hotel shortage on the weekends
    • Can't wait to see it next month
  • Have 9300 FTEs in Vegas and feel like that's a good number to handle any recovery- they have a pretty fixed cost structure 
  • Would consider developing something in the US in the not so distant future

Commodity Scorecard

 

We’ve been harping on commodity inflation since November – not surprisingly, so now is everyone else.  We’ll rejoin the chatter with an update on ten key commodities, their YTD price performances, their correlations with the US dollar index (over the last six weeks), and some commentary on what is driving the prices (other than correlation with the USD).  For reference, the US dollar index is down 1.06% YTD.

 

WTI Crude Oil: -5.00% YTD, +0.38 correlation w USD

  • Supply of oil at Cushing, OK (the storage hub where WTI is priced) hit an all-time high on February 2nd of 38.3MM barrels.  This glut of oil may not recede anytime soon, as the Keystone XL pipeline from Canada is expected to bring an additional 150,000 b/d into Cushing starting this month.  The result of the over-supply?  WTI has lagged other light, sweet grades that have jumped on the strife in the Middle East; the WTI-Brent differential is ~$14.

Natural Gas: -9.01% YTD, +0.14 correlation w USD

  • The blast of snow and cold across much of the US during January and early February could not resuscitate natural gas prices, which have dropped back down to $4.00/Mcf.  Associated gas production that comes with oil drilling in shale plays is keeping gas production elevated.  Furthermore, warmer-than-normal weather forecasts for the next two weeks in the eastern and central U.S. have investors worried that record inventory draws will not continue.

Coal: -10.17% YTD, +0.60 correlation w USD

  • China, the US, and India are the top three consumers of coal.  Coal consumption has a +0.94 correlation with China’s GDP and a +0.96 correlation with India’s GDP (Dhakal et al, 2007).  Growth in China and India is slowing (email us for recent reports).  Couple that with the flood waters receding in Australia (the world’s largest coal exporter), it’s not a surprise that coal prices are down 10% YTD

Gold: -4.10% YTD, +0.56 correlation w USD

  • Gold underperforms when real interest rates are positive and rising; as a result, gold had its worst January in twenty years.

Copper: +1.50% YTD, -0.49 correlation w USD

  • Dr. Copper hit an all-time high of $4.63/pound early this morning despite the fact that demand for the metal appears weak.  Inventories of copper at the London Metal Exchange are up 5% this year as orders to draw copper from stocks dropped 4% over the same time period.

Corn: +11.45% YTD, -0.87 correlation w USD

  • In yesterday’s crop report, the USDA announced that stockpiles of corn before the next harvest will be 9.4% smaller than estimated last month because of increased ethanol production.  In addition, supplies are dwindling as emerging markets increase corn imports and crop yields are weak in Argentina.  If you were short this grain, you’ve gotten corn-cobbed!

Wheat: +10.07% YTD, -0.83 correlation w USD

  • The UN warned this week that China’s northern wheat growing areas are facing an epic drought.  China is the world’s largest wheat producer and wheat noodles are a staple in the Chinese diet.  This news, on top of the Russian export ban and the cyclones ravaging Australia, powered the price of wheat to a 30-month high.

Rough Rice: +15.04% YTD, -0.87 correlation w USD

  • Yesterday Indonesia announced that it will lift its rice stockpiles by a third as it struggles to fight food inflation.  Indonesia's government met to discuss food security and chief economic minister Hatta Rajasa said it would gradually lift rice stockpiles from a current 1.5 million tonnes, underlining its fears over shortages leading to price spikes.  Rice is the number one food staple in Asia – a 15% increase in rough rice prices in six weeks has emerging markets worried.

Cotton: +29.54% YTD, -0.84 correlation w USD

  • Cotton has gone straight up in 2011 as China’s imports have reached the highest level since 2006 because adverse weather has slashed crops and Chinese producers are reportedly hoarding the crop, not selling into the market.  As a result, cotton prices are at a 140-year high and growers intend to take advantage: the American Cotton Shippers Association forecasts that global cotton output will rise 5.7% in the year starting August 1st.

Rubber: +19.21% YTD, -0.79 correlation w USD

  • Parabolic commodity prices can have some bizarre consequences.  On February 4th, 700,000 utra-thin condoms destined for Japan were stolen, and the police suspect an “inside job.”  The Sagami Rubber Industries Company said that these top-selling polyurethane condoms are reportedly worth $1.5 million – that’s 91.9% more than they were worth one year ago!

 

Kevin Kaiser

Analyst

 

Commodity Scorecard - commmooodd


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CONSUMER UNREST

Tomorrow we get the University of Michigan consumer sentiment reading for February and recent indicators, such as the ABC consumer comfort index, suggest that the consumer may be turning more UNeasy. 

 

Last month, the Thomson Reuters/University of Michigan final index of consumer sentiment decreased to 74.2 from 74.5 in December.  The median forecast calls for a reading of 73.3, up from a preliminary figure of 72.7 issued earlier this month.  As it stands now the February preliminary reading is for an increase from 75.0 up from 74.2, according to Bloomberg.  In my view, a reading below 74.0 would not be surprising.

 

The reason for our caution is premised on the following factors:

  1. Political unrest in Egypt is playing a role in consumers’ heightened concerns for political and national security issues.
  2. While the holidays are in the rear-view mirror, the holiday bills are not.
  3. On Wednesday, the ABC consumer comfort index declined from to -46 from -41.  Significantly higher gas prices were cited as the primary culprit.
  4. With average pump prices well over $3.00 per gallon, drivers are increasingly absorbing higher fuel expenses by cutting costs of other household expenses.
  5. Despite the Federal Reserve’s focus on the stock market, Main Street is still focused on making ends meet.
  6. The jobs picture is improving but needs to improve faster.  Also, with regard to the longer term picture, the prospect of higher interest rates does not bode well for job growth.
  7. The Small Business Optimism index showed an improvement, but the hesitancy to hire remains evident.
  8. The Overhand of Austerity is looming large on the American Consumer.  As more and more column inches are dedicated to the implications of cutbacks and job growth, I expect this to drag on sentiment.

At this juncture, continuing improvement in consumer confidence is critical.  Much of the inflation in input costs is expected to be passed on to consumers; if the consumer is not prepared to take on this burden, the outcome for corporate profits will likely be dire.

 

 

Howard Penney

Managing Director

 

CONSUMER UNREST - univ mich sentiment jan


CONSUMER UNREST

Tomorrow we get the University of Michigan consumer sentiment reading for February and recent indicators, such as the ABC consumer comfort index, suggest that the consumer may be turning more UNeasy. 

 

Last month, the Thomson Reuters/University of Michigan final index of consumer sentiment decreased to 74.2 from 74.5 in December.  The median forecast calls for a reading of 73.3, up from a preliminary figure of 72.7 issued earlier this month.  As it stands now the February preliminary reading is for an increase from 75.0 up from 74.2, according to Bloomberg.  In my view, a reading below 74.0 would not be surprising.

 

The reason for our caution is premised on the following factors:

  1. Political unrest in Egypt is playing a role in consumers’ heightened concerns for political and national security issues.
  2. While the holidays are in the rear-view mirror, the holiday bills are not.
  3. On Wednesday, the ABC consumer comfort index declined from to -46 from -41.  Significantly higher gas prices were cited as the primary culprit.
  4. With average pump prices well over $3.00 per gallon, drivers are increasingly absorbing higher fuel expenses by cutting costs of other household expenses.
  5. Despite the Federal Reserve’s focus on the stock market, Main Street is still focused on making ends meet.
  6. The jobs picture is improving but needs to improve faster.  Also, with regard to the longer term picture, the prospect of higher interest rates does not bode well for job growth.
  7. The Small Business Optimism index showed an improvement, but the hesitancy to hire remains evident.
  8. The Overhand of Austerity is looming large on the American Consumer.  As more and more column inches are dedicated to the implications of cutbacks and job growth, I expect this to drag on sentiment.

At this juncture, continuing improvement in consumer confidence is critical.  Much of the inflation in input costs is expected to be passed on to consumers; if the consumer is not prepared to take on this burden, the outcome for corporate profits will likely be dire.

 

 

Howard Penney

Managing Director

 

 CONSUMER UNREST - univ mich sentiment jan


Athletic Apparel Trends Stable

 

The weekly athletic apparel data reflects positive sales for the week adding to a more stable trend of positive sales observed for each of the last four weeks. The family retail channel continues to strengthen posting the only sequential improvement on the week.  It’s also worth noting that prices firmed up, with ASP’s increasing across each of the channels.  This marks a change in trend for the first time since the week before Christmas and coincides with recent anecdotes coming out of January that inventories may indeed be in healthy shape.

 

In looking at the brands, we highlight the disparity in outerwear between the growth in The North Face at up +10%, while Columbia continues to decline down -1% posting the only such loss on the week.  Lastly, the Pacific region continues to underperform all other regions for the third week in a row – a trend worth noting in our book and unfavorable for retailers over-indexed to the west coast such as BGFV. It just so happens the company cited negative comps in December as the reason for negatively preannouncing last month. A trend that may have continued so far in 2011.

 

Athletic Apparel Trends Stable - FW App App Table 2 10 11

 

Athletic Apparel Trends Stable - FW App App 1Yr 2 10 11

 

Athletic Apparel Trends Stable - App Region chrt 2 10 11

 

Casey Flavin

Director


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