Casual Dining results have been fairly mixed so far this earnings season.  Knapp Track data shows that 4Q saw a period of sequentially slowing monthly same store sales trends.  From 3Q to 4Q also, comparable restaurant trends slowed by 30 basis points.  By contrast, a simple average of casual dining comparable restaurant sales reported for 4Q thus far shows a marginal improvement from 3Q.   It will be interesting to see if 4Q results reported from here follow more of a negative sequential direction from 3Q.


In October, during the 3Q10 earnings call, CEO Bert Vivian effectively threw in the towel on the target of $2 in EPS for 2010.  The more likely scenario, according to Vivian, is EPS of $0.57, which would imply EPS for the year approximately “a nickel less” than the prior $2 guidance.   The Street is expecting $0.57 cents and while some casual dining companies have surprised to the upside, I think there is some downside risk to forward guidance given the drastic changes in the commodity markets since the last quarter.  See my note, “THEY SEE INFLATION”, from last night for more details.  Below I offer a quick run through of forward-looking statements from the October earnings call:


“We believe that both concepts are well positioned for the fourth quarter and we have our fingers crossed that the holiday season will be a good one.”


“We've been paddling pretty hard since our less than stellar first quarter to achieve our annual earnings goal of $2. While $2 is still possible, I would not assign a high probability to that outcome. The more likely scenario is about a nickel less.”


“New unit development will be very modest at the Bistro. We would like to allocate more capital to that brand. However the development landscape has only provided about three to five opportunities for next year. At Pei Wei, we expect to open 25 to 30 new restaurants over the next two years, roughly 10 to 12 next year with the balance in 2012.”

“EPS growth should be around 10% as a result of slightly better restaurant margins, improved profitability at our global brands division and a smaller share count.”


“Right now, we have 200 domestic Bistros and we continue to play with a target number of about 250. And now again, we won't be exactly correct with that. It may be a little bit more, may be a little bit less.”


“Having Christmas on Saturday at the margin is probably not helpful to us. However, I will say that the last two weeks of the year in particular the last 10 days or so, every day is busy, almost regardless of when Christmas falls. So to a degree the calendar shift is negative, but I don't think it's that big of an impact.”


“As we look forward into next year, we do think there's going to be a little bit of cost pressure.”


“From then on, I think it's going to be a little bit of a battle for us. We do intend to take a little bit of price in the first part of next year to help offset increases where we think we'll see increases in labor as well as a slight increase in our cost of goods sold basket. As we push forward into some of the non-operating lines, we are anticipating as much as $0.10 of additional pressure related to our equity incentive comp program. So that's holding it back just a little bit in terms of where I would guide you today.”


“We thought about the back half of the year this year, we felt like we would see positive traffic and positive comps at the Bistro. We're early on in the fourth quarter, we remain positive. I think as we move into the holiday season, I think that strength will continue to grow.”


“The biggest wildcard unknown that we had last time we talked to you was on beef. We began to lock some of that into 2011 now. That's coming in a little bit higher than 2010. So obviously our overall commodity basket will probably be up slightly next year.” [see beef chart below]


“Our thoughts with respect to pricing, I'm estimating and guestimating that it's going to be similar to what we did this year, which means roughly 1% to 2% at both concepts.”


“We expect to see higher utilities that's been running a little bit higher for us, property taxes and so forth, which just brings it slightly lower than we saw in 2009.”


“We shifted the spend to October, primarily along the lines of Bert's thought that September is not necessarily the best month in the restaurant industry that we might get a greater impact by shifting the spend to October, which is traditionally a better month”


“So with that learning, we will craft our next LTO launch, which will happen sometime in the middle to the end of the first quarter next year.”




Howard Penney

Managing Director

Japan: Setting Up to Collapse?

Japan: Setting Up to Collapse?


Conclusion: In the report below, we contextualize how recent economic data combined with price and policy action have Japanese equities looking like an incredible short opportunity over the intermediate-term. Moreover, we detail the cyclical and structural risks to both Japanese and US growth in 2011 – a must read regardless of industry focus. Lastly, we detail how near-term catalysts accelerate Japan’s long-term march toward the Keynesian endgame and how the credit and currency markets could start to significantly price this in over the intermediate term.


Position: Bearish on Japanese Equities for the intermediate-term TREND. Bearish on the Japanese yen and bullish on Japanese CDS for the long-term TAIL.


Pulling up the top-ten YTD performers among world’s equity markets, we see that it’s littered with countries with bad balance sheets and even worse political leadership:

  • #2: Greece up +16.2%
  • #3: Ukraine up +14.7%
  • #4: Italy up +12.2%
  • #5: Hungary up +9.5%
  • #6: Spain up +9.3%
  • #8: Romania up +7.4%
  • #9: Iceland up +7.4%

Not surprisingly, we see that Japan too has benefited from the global mean reversion junk rally, though to a lesser extent (lower beta): +4.9% YTD. In fact, since the dollar bottomed on November 4, the Nikkei 225 is up +14.6% - second only in Asia to the hyper-beta Sri Lanka Colombo All Shares (up +17.3%).


The (-3.1%) decline in the Japanese yen drove the strength and recent outperformance of Japanese equities. While there is a great deal of merit to a weaker yen benefitting this manufacturing and export-heavy economy, we continue to urge severe caution to investors looking to “buy the cyclical bottom” in Japanese growth.


As we outlined in our Japan’s Jugular presentation on October 5th (email us for an updated copy), the benefits of a weak yen for Japanese exporters are VASTLY overplayed by the manic media. Consider the following breakdown of Japanese GDP (CY10): 

  • Private Consumption: 56.9%
  • Gross Fixed Capital Formation: 19.4%
  • Government Consumption: 18.9%
  • Net Exports: 4.9% 

While 4.9% on $5.39 trillion dollars is nothing to scoff at (~$265B), the lion’s share of the economy is leveraged to consumer spending, and consumers don’t welcome rising prices perpetuated by a weak currency when their wages are falling:


Japan: Setting Up to Collapse? - 1


Backtracking a bit, it’s important to understand that Japan imports ~60% of its domestic food needs and over 100% of its crude oil needs. The YoY growth in global food prices and Brent crude oil will continue to act as a tax on Japanese consumers and corporations over the intermediate term.


Japan: Setting Up to Collapse? - 2


In addition, analysis of producer prices on both the input and output level suggest the weak yen is doing significantly more damage than perceived by the media. Recent trends in the Bank of Japan’s Corporate Goods Producer Price Indexes underscore this reality.


Japan: Setting Up to Collapse? - 3


Costs are going up and selling prices are on the decline for Japanese exporters – a margin squeeze that can only be remedied by growing unit demand. To some extent, we’re seeing that with recent positive revisions in earnings guidance by Toyota, Nissan, and Honda, all of which cited strong demand from Asia and upward surprises of sales in North America.


While it would certainly be easy to take corporations’ word for it, it wouldn’t be prudent risk management to assume steady state or an acceleration of Asian growth – or global growth for that matter. In fact, rising inflation and tighter monetary policy are two key reasons why we expect growth to slow in the region over the intermediate term. Other key emerging markets, particularly in Latin America, are tightening as well, so we continue to be outwardly bearish on the slope of global growth in 1H11.


Going Forward: The Outlook for US and Japanese Growth in 2011


For Japanese equities to continue work, global growth has to accelerate from here. The Nikkei’s fantastic run-up into and through today’s reported economic contraction (-1.1% QoQ SAAR) suggests Japan is getting the benefit of the “accelerating US growth” story. As we’ve mentioned in our previous work, US growth is setup to slow from here (though the gov’t is likely to continue fudging the numbers): 

  • Corporations will find it hard to pass through rising COGS inflation to US consumers (70% of the economy) who have been used to 20-plus years of merchandise deflation;
  • Rising COGS inflation will make it tough for companies to increase their labor expenses and add any meaningful dent to the government’s currently understated unemployment rate of 9% (do you think SYY, F, or PEP plan to go on a hiring spree after their recent margin guidance?);
  • Spending cuts at the Federal, State, and local level of government will further depress Non-Farm Payroll growth;
  • Housing Headwinds Part II (yes, housing still exists, and yes, it’s mired in a secular decline) will further crimp consumer spending and have a negative wealth effect significantly greater than the positive effect felt by the recent paper-thin run-up in US equities (housing is more broadly owned);
  • Rising interest rates will weigh on capital investment and the budgets at every level of the economy from the Federal budget to corporations to households across the country; and
  • The five-quarter streak of positive inventory adjustments contributing to US GDP growth came crashing to a halt in 4Q10, detracting (-5.3%) from the sequential change in growth. The question all US management teams need to answer: do you load up on inventory here with many commodity prices at/near all-time highs, or do you delay those purchases and HOPE for lower input prices and a strengthening recovery? If the answer is the latter, inventory adjustments will continue to weigh on US GDP growth over the intermediate term, as we see no structural reason for commodities to retreat meaningfully absent a significantly stronger US dollar. US “S&P 500 earnings” bulls better hope and pray The Ber-nank doesn’t load his global monetary policy gun with QE3 bullets… 

Moving back to Japan specifically, we don’t buy the bullish commentary offered recently by a few economists: 

  • “The economy’s pretty much past its temporary slump.” – Noriaki Matsuoka, Daiwa Asset Management
  • “Japan bottomed out in the fourth quarter.” – Yuichi Kodama, Meiji Yasuda Life Insurance Co.
  • “This was just a temporary contraction and growth may accelerate more than investors anticipate this quarter and next.” – Kyohei Morita, Barclays Capital 

As mentioned before, the Nikkei 225 is up nearly 15% in just over three months, so it would be reckless to assume it hasn’t already been pricing in a bottoming of Japanese growth. To some extent, much of the economic data appears to have put in a bottom: Japan’s Export growth, Consumer Confidence, and PMI all appear to have inflected in Dec/Jan. Japan’s Unemployment Rate continues to trend down, albeit on a shrinking base (the Labor Force Participation Rate is contracted for the third straight month in December and is down -110bps from peaking in September at 60.2%).


One of the keys to getting the big trades right in global macro is determining whether or not inflection points are the start of new trends or whether or not they are temporary headfakes for Rookie Traders to succumb to. As mentioned before, we don’t see global growth accelerating enough for Japanese exporters to grow unit demand fast enough to overcome their rising input costs.


Domestically speaking, a combination of waning consumer demand and an exporting of investment abroad will weight on Japanese growth over both the near and long term. After contributing 2 percentage points to GDP in 3Q10 ahead of expiring stimulus and a tobacco tax hike, Consumer Spending subtracted (1.7) points from growth in 4Q10 (SAAR). Gross Fixed Capital Formation subtracted (0.1) points after contributing 0.6 points in 3Q10.


Japan: Setting Up to Collapse? - 4


As mentioned before, declining wage growth and higher prices will squeeze Japanese consumer spending over the intermediate term. Moreover, we continue to see major Japanese corporations detail and execute on plans to export production abroad to partially escape the negative impact of a stronger yen on profits. Late last week, Japan Tobacco (the world’s third-largest publicly traded cigarette maker) joined Honda, Nissan, and Toyota as the latest major Japanese employer to unveil plans to export jobs and increase production overseas.


Accelerating Towards the Keynesian Endgame


Of course, the chaos theorists in us can’t resist pointing to the rapidly-deteriorating regulatory environment and an accelerated erosion of public finances as additional reasons for declining domestic investment. Japan’s Diet risks dissolution as early as June as a result legislative gridlock surrounding Prime Minister Naoto Kan’s record ¥92.4 TRILLION budget proposal and his refusal to force Ichiro Ozawa to testify regarding his recent indictment of violating campaign finance laws.


Kan’s budget, which is seeking to increase the consumption tax beyond the current 5% is being met with major contention from the Liberal Democratic Party opposition, who cite the 1997 recession as a reason to refrain from increasing the levy. Currently the DPJ does not have enough voting support to pass the legislation (required: approval of the LDP-controlled Upper House or 2/3rds majority in the Lower House), which suggests Kan will be forced to seek a public mandate in order to potentially ratify the bill.


Recent polls and election trends suggest the DPJ will perform unfavorably in the event of dissolution: Kan’s approval rating dropped to a low of 27% in February and DPJ candidates lost races for mayorships of Nagoya, Japan’s fourth-largest city, and Aichi on February 6th. The Japanese fiscal year starts on April 1st, which suggests Kan could be headed for a major political showdown as late as March whereby Kan could potentially be forced to resign as Prime Minister.


Should Kan resign and become the fifth consecutive Japanese premier to last less than one year, it would further destabilize Japan’s already unstable political situation, making its sovereign debt ripe for more ratings downgrades. Both Moody’s and the S&P have recently stated that Japan’s lack of a credible solution to reign in its public debt and deficit spending put the country at risk for further downgrades.


While we could care less about the warnings of analytically incompetent US rating agencies, we do recognize the impact that further downgrades will have on Japanese interest rates and public perception of the island economy going forward. A couple of steps down the rating scale could potentially erode any marginal global demand for Japanese government bonds due to persistent deflation. As our earlier work shows, domestic demand for JGBs is currently coming unglued as well and that looks to accelerate substantially in the latter half of this decade.


Perhaps the credit market is starting to bake all this into the cake (see chart below). Recent CDS moves in the face of bullish global growth storytelling suggests Japan is indeed accelerating its pace toward the Keynesian endgame of bankrupt pensions, hyperinflation, negative investment, declining consumer and business confidence and structurally impaired growth.


Darius Dale



Japan: Setting Up to Collapse? - 5


Japan: Setting Up to Collapse? - 6


In preparation for HST’s Q4 earnings release tomorrow, we’ve put together the pertinent forward looking commentary from HST’s Q3 earnings call.




  • “RevPAR growth in our portfolio has been consistently strong since April of this year. As we have transitioned more fully into a recovery, the composition of that RevPAR growth has turned more favorable as the improvement has been increasingly driven by increases in average rate. We are also continuing to benefit from a shift in business mix towards higher rated segments and these improving demand trends allow us to be less reliant on just booking discounted business.”
  • “We would expect to see additional strengthening on the rate side as our business mix continues to shift more towards the higher rated segments and as the impact of last year’s special corporate rates, which were determined during a weak environment, diminish and are replaced by higher price contracts.”
  • “On the group side, the strengthening demand trends we have been enjoying all year carried into the third quarter, as group revenues improved by more than 9%. The bulk of this improvement was caused by an almost 8% increase in room nights although it still benefited from a 1.3% increase in average rate, which was our first average rate increase in the group sector since the fourth quarter of 2008. The demand growth was led by association business, which grew by more than 11%, and our luxury corporate segment, which increased by 27%.”
  • “Our booking cycle continues to be very short-term. Bookings in the quarter, for the quarter exceeded last year’s strong pace, and were well above levels we experienced in 2007. Group booking activity for the fourth quarter is up nearly 6% compared to 2009, with the improvement occurring over the last 90 days as our fourth quarter room night pace was negative at the start of the third quarter. As we look out to 2011, our booking pace for the combined first three quarters is up slightly and we would expect that surplus to strengthen as we progress into the year.”
  • 2010 Guidance:
    • Capital expenditure: $300 to $320MM
    • RevPAR: 5.5%-6.5% (increase offset by “more cautious outlook with respect to food and beverage and ancillary revenue.”)
    • “We expect comparable hotel adjusted operating profit margins to be up 15 basis points at the high end of the RevPAR range and flat at the low end of the range. These amounts have been reduced by 70 basis points for the year-over-year difference in cancellation and attrition fees and 30 basis points for incremental property level bonus expense.”
    • Adjusted EBITDA: $815 to $830MM
    • FFO: $0.67-$0.69
  • “As we look to next year, we believe that the positive trends we are seeing now will continue, resulting in improvements in RevPAR margins and EBITDA.”
  • Regional 4Q outlook:
    • New Orleans: “We expect the property to underperform the rest of the portfolio due to less city-wide business.”
    • Orlando: ”We expect the hotel to underperform the portfolio… due to lower levels of group business and the start of a rooms renovation at the hotel.”
    • “We expect our Chicago hotels to perform in-line with the portfolio.”
    • “We expect the Boston market to underperform the portfolio… due to fewer citywide room nights and the ballroom renovation at the Sheraton Boston.”
    • “We expect New York City to have a very good fourth quarter, even with rooms renovations at the New York Marriott Marquis and the Sheraton New York Hotel & Towers.”
    • Hawaii: “While both of our hotels will have some of their rooms out of service due to renovations, we still expect them to continue to outperform the portfolio.”
    • “We expect Denver to continue to outperform the portfolio, as we expect both group and transient demand to remain strong.”
    • “We expect our San Francisco hotels to perform in-line with the portfolio”
    • “We expect our San Antonio hotels to rebound …and outperform the portfolio due to a substantial increase in group and city-wide demand.”
    • “We expect our Phoenix hotels to continue to underperform the portfolio as the renovation and construction projects at the Westin Kierland continue.”
    • “Our San Diego hotels started to rebound in the third quarter and we expect them to significantly outperform the portfolio."
  • “As we look out towards the end of the year, we’re expecting that roughly a third of our hotels will be paying incentive management fees.”
  • Customers “were probably being a bit more cautious about what they spent on food and beverage. Specifically on breaks, that seemed to be the area, as we talked to the operators, where we were feeling the most impact. It’s just coffee and water and soda instead of more elaborate food displays. And so the net effect is that group spending per customer, is down just a little bit.”
  • “We’re not seeing quite as much spending in spas and golf as we might have anticipated. With the strong increase in occupancy that we’ve had, we would have normally expected those revenues to trend up a little bit more aggressively. If you look at where ended up, I think we’re probably up – probably about a 4% increase in occupancy, yet our ancillary revenues were only up about 1%.”
  • “I still suspect that on general the majority of the acquisitions that we complete will be domestic.”
  • “As you look into 2011, you’ll probably find that wage increases will trend slightly above inflation, kind of consistent with the long-term average.”
  • “I think that the [RevPAR] comp gets slightly more difficult in Q4… we do have some renovations happening at some of our larger hotels that are going to hit in November and December of this year.”
  • “Booking pace continues to follow the same pattern of being about in-line a quarter out and then getting very strong during that quarter preceding the actual quarter that happens and then bookings in the quarter continue to be good. We’re also comforted by the fact that as demand has continued to improve, we’re finding better ability to both stop the limit providing discounts to customers to solicit business and at the same time to begin to move rate.”

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UA: Endorsement Cadence Continues With Cam


According to reports out this morning from CNBC’s Darren Rovell, Under Amour is adding another high profile endorsement to its portfolio with the signing of Cam Newton just weeks ahead of the NFL draft. The deal would not only secure one of the top players in the draft, but also suggests that UA’s endorsement strategy is the ‘new reality’ with related costs here to stay and most likely to increase at an accelerated rate. Here are a few of our key takeaways from the deal:


1) UA remains aggressive…big time. This is a big deal for them. It shows that they are not afraid of getting in bed with controversial players. Keep in mind that Nike is still reeling from Tiger. If they wanted Cam, they’d have gotten him. They probably played the conservative card here and did not submit an all-out bid – especially given that fact that they’re about to digest the NFL deal.

2) P&L item to watch…front-loaded SG&A associated with this deal. Keep in mind that they just endorsed Tom Brady as well. Could pressure margins in 2H.

3) We’ve got to consider the implications to the balance sheet. The same way a retailer is required to provide off balance sheet lease obligations, the athletic brands need to show their duration of endorsements, which can be used as a key lever to impact reported earnings. Take a look at our updated analysis of both UA’s and NKE’s commitments below.


Nike’s deals are still spread rather consistently over the next 5-years. Under Armour’s on the other hand are considerably more front-end loaded with 81% of its obligations due in 3-years or less. As suggested when we posted on these schedules nearly a year ago in “Sunny D, Blind Side, and UA” on 3/29/10, this figure shrank over the past 12-months down from 86% reflecting the company’s latest additions (e.g. Michael Phelps et al.). We expect this trend to continue with the addition of Tom Brady and Cam Newton both of which are/will be long-term contracts, which is a change from the usual approach for UA.  What’s likely to happen here is UA’s duration will continue to elongate as longer-term deals come on board.  While we tend to feel uncomfortable with durations beyond 5-years, let’s consider that the endorsement/sales ratio for UA still only sits at 8%. This compares to Nike’s 21%. UA will definitely close that gap. Our sense is that if this is done at a measured pace, it can actually help the P&L before the balance sheet sheet comes into question. We’re not justifying a more aggressive approach…but this is simply the reality of where things are headed.       


UA: Endorsement Cadence Continues With Cam - UA NKE Endorsement Liab Chart 2 11



Bullish Breakout . . . In the U.S. Deficit

Conclusion:  The Federal Government released their budget numbers for January, and we continue to see expansion towards an all time high in the U.S. budget deficit.  The federal budget deficit is now expected to be $1.65 trillion for fiscal year 2011.


Position: Short Municipal Bonds via the etf MUB


The Treasury Department released its budget statement for the first four months of the fiscal year late last week and the results were indicative of a widening U.S. budget deficit.  In conjunction with this release, the White House took up its deficit estimates for fiscal year 2011 to ~-$1.65 trillion.  This puts the federal deficit squarely in the red zone of budget deficit-to-GDP of -10%.  In fact, based on our math and using the White House’s deficit projection for fiscal year 2011, budget deficit-to-GDP should be ~-10.9%, which is the highest level we’ve seen since World War II.


In the table below, we’ve compared key line items for the first four months of this fiscal year and the first four months of last fiscal year.  As always, we have normalized for TARP and 1-time payments.   There are a few year-over-year trends to highlight, which include:

  • On the outlays (or expenditures) side, Medicaid was up +7.9% and Net Interest on Public Debt was up +9.6%.  The latter point will be even more critical as debt expands to fund future deficits and interest rates continues to climb; 
  • The key positive for expenditures was  the decline in unemployment insurance payments, which declined (18.2%) year-over-year (albeit the savings was small relative to the entire deficit); and 
  • The primary positive change on the revenue side of the ledger was a +23.2% increase year-over-year on individual income tax revenue, which amounted to a net positive contribution of $72 billion for the period. 

Bullish Breakout . . . In the U.S. Deficit - 2


In aggregate, government outlays continue to accelerate, as they were up +6.6% on a year-over-year basis.  While revenues also expanded (up a healthy +9.4%, driven primarily by individual income tax receipts), it was not large enough growth from the smaller revenue base to narrow the year-over year budget deficit, which was up +1.9% to -$422 billion for the first four months of the fiscal year.


As we outlined in our conference call last week,Mayhem in Muni Bond Land,” one of our key short ideas as it relates to the burgeoning U.S. federal budget deficit are municipal bonds as an asset class.  The key implication of a larger-than-expected federal budget deficit is that there is less money available to offset state and local level budget deficits, which will require state and local governments to issue more debt to fund their operating budgets and capital expenditures.


The other key issue to consider is that as the federal budget deficit increases, the future supply of U.S. Treasuries will increase as well.  Naturally, a larger supply of Treasuries to be issued should demand a higher interest rate.  Since municipal debt, as outlined in the chart below, tracks the yields of U.S. Treasuries very closely, increasing supply in the Treasury market (and likely increasing yields) will be negative for the municipal debt market as well.


The last interesting point we wanted to highlight from the budget report relates to foreign aid.  According to the CBO:


“Those increases were partially offset by several large decreases, including a reduction of $2.4 billion in outlays for international security assistance, reflecting a delay in making most of the $3 billion in annual payments to Egypt and Israel for military aid.”


It is interesting to note the scale of these security payments, as well as the actual levers that the U.S. government can pull by delaying these payments.


Daryl G. Jones

Managing Director


Bullish Breakout . . . In the U.S. Deficit - 1

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 80.47%
  • SHORT SIGNALS 78.68%