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Fiscal 1Q11 earnings of $0.61 per share came in $0.13 per share better than street expectations (only about a $0.02 per share benefit from a lower tax rate), but the company slightly lowered its full-year EPS guidance to $1.40-1.65 from $1.41 to 1.68.  Despite the better-than-expected same-store sales growth of +1.5% at Jack in the Box company restaurants (versus the street’s +1.2% estimate and management’s guidance of -1 to +1%) and the fact that 1Q11 marks JACK’s first quarter of positive comp growth at Jack in the Box after six quarters of decline, investors will likely be disappointed that there is no flow through to guidance from the first quarter earnings surprise. 


Although management is likely being cautious, and maybe even practical, it will also be viewed negatively that the company did not raise the low end of its -2% to +2% full-year comp growth guidance at Jack in the Box company restaurants as a -2% result would imply a sequential slowdown in two-year average trends from 1Q11 levels.  Given the changes in guidance, higher commodity costs are the primary driver of the lower earnings guidance for the balance of the year.


Below I outline the positive and negative offsets included in the current guidance versus the company’s prior outlook.




  • Qdoba system same-store sales growth now expected to be +3-5% (from prior guidance of +2-4%)
  • Tax rate:  targeting 35-36% (versus 37-38%)
  • Anticipated refranchising gains:  $0.70 to $0.82 per share (versus prior range of $0.66 to $0.78 per share)



  • Commodity costs are expected to be up 3-4% (from prior expectation of +1-2%)
  • Restaurant operating margin expected to range from 13 to 14% (had said 14 to 14.5%)



  • Jack in the Box company same-store sales growth guidance unchanged at -2 to +2%
  • New unit development plans are mostly unchanged (only expected to open 19 company-owned Jack in the Box restaurants versus prior guidance of 25)
  • SG&A expense unchanged in the mid-10% range


We will be back with more details after the company’s earnings call tomorrow.


JACK – FIRST LOOK - jack sss


JACK – FIRST LOOK - jack quadrant



Howard Penney

Managing Director

Good Better Best

The overlay of a luxury retailer, a traditional department store, and the world’s largest off-pricer yields an interesting observation.  Inventory management relative to sales momentum is still very well controlled in the mall while the y/y improvement at TJX has been sequentially decelerating.  Being in-market buying goods at year-end is definitely a factor here, but the multi-year run of taking inventory out of the system and improving turns is going to be incrementally less impactful for TJX in 2011.


Both SKS and DDS still have room to go given both are still in mean reversion mode in their efforts to return to prior peak margins. 


Additional TJX thoughts:

  • Similar to ROST, TJX mentioned that they are taking advantage of buying opportunities in the marketplace. Specifically, a 4% increase in in-store inventory levels at year end was the direct result of “much larger available quantities of end-of-season branded products”.  We continue to believe supply disruptions, lack of clarity on pricing, and cost-induced strategy changes for branded vendors will ultimately result in further advantageous buying opportunities for the off price community.
  • Despite an expectation for a pick-up in “disruption” in the apparel space from a sales/margin perspective, we also believe we may see a pick-up in special make up product in 2011.  With units generally planned down for most first-cost retailers, it’s likely that excess factory capacity could lead to some planned buys for the off-pricers.  Even if factories are willing run production at lower margins, it still nets profit dollars against fixed costs that would otherwise go unused.  Expect to hear more about this as the year progresses.
  • Unlike M and VFC, TJX remains very conservative with its forecasting coming off of a record year of sales and profits.  In fact, TJX has reported positive comps in 32 of the last 33 months (Jan ’09 was the only negative).  As such, the outlook for 2011 calls for just a 1-2% increase.  Overall inventory per store expected to be down again for 2011.

Good Better Best - tjx sks dds

Accelerating Athletic Apparel Trends


Weekly athletic apparel sales accelerated on a sequential basis across all channels for the second straight week. Consistent with the recent trend, the greatest improvement came from both the family and discount/mass channels with athletic specialty breaking out from the +3%-4% range reported over the last 4-weeks to +7.7% this week. It’s also worth noting that ASPs decelerated in both the athletic specialty and family channel (less than 1%) driving unit volume while pricing at discount /mass retailers increased considerably last week. Our prior commentary regarding what appears to be healthy inventory positions at retail as we transition out of the holiday appear to be magnified in the discount/mass channel. Finally, sales growth was positive and improved sequentially across all regions for the first time since the first week of the 2011 lead by New England, the Mid-Atlantic, and the Midwest all of which have outperformed in the first few weeks of Q2 (good for DKS). The Pacific/Mountain regions continue to underperform though each were up +9% and +11% respectively (less good for BGFV).


Accelerating Athletic Apparel Trends - FW App App Table 2 23 11


Accelerating Athletic Apparel Trends - FW App App 1Yr 2 23 11


Accelerating Athletic Apparel Trends - FW App App 2Yr 2 23 11


Accelerating Athletic Apparel Trends - FW App Reg 2 23 11


Casey Flavin


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Japan’s Jugular Update: Just Getting Started on the Short Side of Japanese Equities

Conclusion: Though we covered our oversold short position in Japanese equities today in the Hedgeye Virtual Portfolio, we remain outwardly bearish on Japan’s intermediate-term TREND and long-term TAIL.


This morning we covered our short position in the EWJ for a gain. We’ll look to re-short Japanese equities on a bounce back up to its immediate-term TRADE line of resistance at 10,909.


Japan’s Jugular Update: Just Getting Started on the Short Side of Japanese Equities - 1


Watching how US equities trade will be critical here, as both markets have been the beneficiaries of the “flows” into relative “safe havens”. If 1,307 in the S&P 500 doesn’t hold or if it can’t close above 1,330 in the immediate term, the probability of a meaningful bounce in Japanese equities dwindles. In an environment of Global Stagflation, these “safe havens” will wind up looking like relative value traps over the intermediate-term TREND.


Japan’s Jugular Update: Just Getting Started on the Short Side of Japanese Equities - 2


Regarding Global Stagflation specifically, Japan’s January trade data revealed more of the nasty tea leaves that we’ve been harping on since early November: 

  • YoY Export growth slowed sequentially by (-1,150bps) to +1.4%, driven primarily by a sharp reduction in Asian demand (China down sequentially: +1% YoY vs. +20.1% in Dec; Shipments to Asia down sequentially: +0.4% YoY vs. +14.8% in Dec);
  • YoY Import growth accelerated sequentially by +180bps to +12.4%, driven primarily by rising commodity prices, including Brent crude oil, which was up +29% YoY in Jan;
  • Japan's Trade Balance swung into a deficit for the first time in 22 months in Jan: (¥471.4B) vs. ¥727.7B in December. 

Japan’s Jugular Update: Just Getting Started on the Short Side of Japanese Equities - 3


Of course, any bull worth his shirt at a market top will find a way to massage this data into a less-bearish mosaic:


Seiji Adachi, Senior Economist at Deutsche Securities, argues that the timing of the Lunar New Year is distorting Japanese trade data a bit, as Japanese exporters started scaling back shipments to Asia in late January to accommodate for the early Feb start to the Lunar New Year (Feb 2-8 in 2011 vs. Feb 14-20 in 2010). He argues, “It’s hard to project how much the Lunar New Year holidays will affect trade as they change every year, so we need to look at the overall trend through March.”


In rebuttal to this view, the data shows that growth in the value of Japanese exports slowed on a global basis: 

  • YoY Export growth to the US slowed (-1,050bps) to +6% in Jan; and
  • YoY Export growth to the EU slowed (-900bps) to +0.7% in Jan. 

As we’ve been forecasting since October 5th via our Consumption Cannonball thesis, US consumption growth is slowing – a trend further highlighted by WMT’s sales/inventory problem. We knew that austerity and higher interest/tax rates would weigh heavily on consumption patterns in the EU, but it appears the US consumption dominoes are at the Tipping Point, and are currently being nudged by near $100 WTI crude oil prices.


Back to Japan specifically, Japanese stocks have indeed benefitted from the overwhelmingly bullish sentiment that is commonly associated with being at/near the top of a global economic cycle. Citing lagging 4Q global growth data points, Japanese Officials, CFOs, Economists, and PMs have all taken advantage of their chance(s) in the past few weeks to upgrade their assessment of the Japanese economy: 

  • Officials: Both the BOJ and the Japanese government upgraded economic outlooks, with the BOJ specifically raising their growth projections for the year ending in March to +3.3% vs. +2.1% prior;
  • Corporations: Toshiba, Cannon, and Toyota are among a handful of large Japanese exporters who recently guided higher on “strengthening Asian demand” and “robust US consumer demand”;
  • Sell-Side: Bloomberg consensus estimates for Japan’s 1Q11 GDP advanced from +0.5% QoQ SAAR in early Jan to +1.1% QoQ SAAR today; and
  • Buy-Side: “The worst of the economic conditions are behind us… If the global economy continues to recover, that should boost Japanese stocks.” – Junichi Misawa, Head of Equity Investment at STB Asset Management, which oversees $14B AUM. 

In stark contrast to such bullish sentiment, we continue to stick with the intermediate-term call embedded in our Japan’s Jugular thesis which shows just how vulnerable the Japanese economy is in a situation of Global Stagflation. In fact, Japan is among the least defensive economies in the world in such a scenario:


Hedgeye’s current global growth outlook (decidedly bearish) does not bode well for Japanese export and manufacturing growth, which, in turn, bodes poorly for Japanese employment and wage growth:


Japan’s Jugular Update: Just Getting Started on the Short Side of Japanese Equities - 4


The current global inflation trends bode exceptionally poorly for Japanese consumption growth, as rising food and energy prices tax Japanese consumers who have been accustomed to 10-plus years of flat-to-negative nominal wage growth and prices. In fact, four out of five Japanese citizens say higher prices would be “unfavorable” in a January BOJ survey – the common reason: lack of wage growth:


Japan’s Jugular Update: Just Getting Started on the Short Side of Japanese Equities - 5


The current global inflation trends are a headwind for Japanese corporate earnings, whose deflationary mindsets will continue to force them to Take it in the Margin as COGS increases fail to be met with offsetting sell-through price hikes:


Japan’s Jugular Update: Just Getting Started on the Short Side of Japanese Equities - 6


Last but certainly not least, the current global inflation trends are an unmitigated disaster for Japanese consumption growth on a combined government and private basis. It is without question that the Japanese economy is the least equipped to deal with rising interest rates, which is one of the many reasons it has kept rates near zero for such an “extended and exceptional” period of time.


Even the slightest backup in yields confounds the Japanese government budget, where debt service accounts for 44.8% of organic revenue (tax receipts + fee collections) – up +1,320bps from 31.6% in 2001, just ten years ago.


Japan’s Jugular Update: Just Getting Started on the Short Side of Japanese Equities - 7


To this point, the nominal yields on 10Y JGBs have backed up +41bps since bottoming out on October 6th (coincidentally one day after we published our Japan’s Jugular thesis). The more interest rates continue to back up, the more resolve Prime Minister Naoto Kan will have in his fight to hike the consumption tax. Should the current massive opposition to Kan’s proposal win out, Japan will be forced to issue additional debt to fund its burgeoning fixed social security expenditures, which currently consume 31.1% of total revenue – up +990bps from 21.2% in 2001, just ten years ago.


Japan’s Jugular Update: Just Getting Started on the Short Side of Japanese Equities - 9


We continue to maintain that sovereign debt buildup past the Rubicon of 90% Debt/GDP structurally impairs economic growth – a stance supported by eight centuries of empirical data. Japan is no exception here and Pavlovian investors who flock to Japanese equities, JGBs, and the yen as “safe havens” in times of heightened risk will be surprised to the downside on both an intermediate and long-term duration.


Darius Dale



Japan’s Jugular Update: Just Getting Started on the Short Side of Japanese Equities - 8


Commodity costs continue to be a headwind for many restaurant companies.  Some relief has come around on some items but, by and large, year-over-year inflation remains an issue for all operators.


I’m beginning to sound repetitive but the pizza concepts are not getting any respite from the commodity markets of late.  The price of cheese has risen sharply over the past couple of months and, after weeks of flagging it in these posts, it seems the number of investors and analysts taking note is also increasing.  Below, I give my take on a few important points pertaining to commodity price action and the implications for individual stocks/categories.


Coffee is obviously the first item that catches one's eye in the table below.  News emerged today that demand for coffee beans from Guatemala is at a “near standstill” as roasters turn to countries with cheaper, lower-quality beans.  Brazil is also reported to have stockpiled 1.5 million bags of beans, which if released into the market “would bring some relief to a currently tight market”.   Starbucks revealed on its latest earnings call that it has effectively locked in coffee prices for the year.  GMCR, according to the most recent earnings call, had locked in six months coverage at fixed prices.  The company stated that it will “adjust our pricing as necessary”.  PEET passed along increasing costs to its customers via price increases recently.  The retail and home delivery business prices increased in the fourth quarter, the foodservice business saw an increase in January, followed by the grocery business.  The company did not disclose its current hedging strategy for 2011 (as of 3Q10, we know PEET had locked in 40% of its 2011 coffee needs), but management said it expects coffee costs to climb nearly 30% YOY.




Cheese prices have been a key concern and definitely are worth monitoring.  Dairy prices are receiving support from weather events (cyclones in Australia, for example), an increase in feed costs for dairy animals, and a lesser supply of dairy animals given the increased demand for meats that has seen protein costs go higher.   This is a concern for DPZ and PZZA and, as I mentioned in the Tales of the Tape yesterday, downgrades have begun and will likely continue as a result of this.  DPZ has been in the news a lot of late, with high-profile investors taking positions in the stock, but I believe the one-two punch of higher commodity costs and extremely difficult compares from a top line perspective do not bode well for the stock.  The latest news on DPZ is that the company is rolling out a new chicken menu.   While an increase in chicken sales would be accretive from a margin perspective due to relatively lower chicken costs, I think the increase in cheese – as shown below – will be a significant headwind.  On the most recent earnings call, management stated that its contract “still floats with the block.  But the way we’ve got it worked out, the contract kind of reduced about a third of that volatility”.




Chicken wing prices continue to provide a tailwind for BWLD earnings, declining again week-over-week.   The company’s guidance of 18% EPS growth may be revised upward if the current trend (shown below) continues, although the back half of the year will likely see less YOY favorability in chicken wing prices.






Howard Penney

Managing Director

The Gadhafi-Berlusconi Trade

With the world focused on the chaos erupting in Libya and Moammar Gadhafi’s intent to fight the uprisings until his “last drop of blood”, what’s garnering less headline attention is Italy’s outsized exposure to the North African nation. It is this exposure, especially to oil and gas vis-à-vis its partially state-owned energy concern ENI, that has helped to drag down the country’s equity market and ENI stock since late last week. We think the implications behind Italy’s exposure to Libya (and vice versa) are considerable, which we quantify below.


By the Numbers



  • Produces roughly 1.8 million barrels per day (bpd) of oil, down from peak production of 3 million bpd in 1960
  • The world’s 12th largest net exporter of oil at 1.5 million bpd. (~95% of the country’s export earnings come from the hydrocarbon industry)
  • The largest proven oil reserves in Africa at 44 Billion barrels, followed by Nigeria 37.2 bb and Algeria 12.2 bb
  • 54 Trillion cubic feet (tcf) of natural gas reserves, the 4th largest in Africa behind Nigeria (185.3 tcf); Algeria (159.0 tcf); and Egypt (58.5 tcf)


  • ENI is the largest oil consumer in Libya
  • Italy’s consumption of Libyan oil (via ENI) accounts for ~ 24% of local consumption
  • Italy is Libya’s largest export market at 365,742 bpd in 2010, or 29% of total exports, followed by France at 14%, China 13%; Germany 11%; and Spain 10% according to the EIA
  • ENI has committed $25 billion of investment in Libya over the next decade

Market Performance:

  • ENI is down -6.3% since 2/18
  • FTSE MIB (Italy’s broad equity market) is down -5.2% since 2/18
  • Etf EWI, in which ENI composes 18.3%, is down -5.3% since 2/18


Broader Implications for Italy and Berlusconi

  1. Despite calls from Italy’s Industrial Minister Paolo Romani that the country isn’t in danger of running out of natural gas we think Italy’s energy reliance on Libya is compelling.  On Tuesday ENI suspended its Greenstream pipeline that supplies ~ 10% of Italy’s natural gas needs. And while Romani cited that commercial stockpiles of 134 billion cubic feet of gas can be tapped if needed, and the country can increase import supply lines from Algeria, Norway and Russia, we take the view that a.) there’s significant probability that production will be completely severed/no one will be manning the equipment and, b.) increasing alternate supply lines is never as easy as flipping a switch, and would be expensive given this time of the year.
  2. Despite a phone call that Berlusconi gave to Gadhafi yesterday, urging him to avoid bloodshed, Berlusconi is viewed as buddy-buddy with Gadhafi, which reflects poorly on his already tarnished leadership. (Berlusconi stands trial beginning on April 6th for allegedly having sex with an underage belly dancer). Allegedly, Berlusconi shut down Rome’s largest park in June 2009 to allow Gadhafi and his entourage of all-female bodyguards to set up camp.
  3. Uncertainty abounds ENI’s footprint in Libya and conversely Libya’s investments with Italian companies, including: Fiat, UniCredit, or the Jeventus soccer club.
  4. We can’t substantiate the numbers, but just today in parliament Italy’s Foreign Minister Franco Frattini said that Italian companies stand to lose 4 Billion EUR in infrastructure projects.
  5. Italy could be one country to see a mass exodus of refugees to its shores. Officials in Brussels believe as many as 750K could attempt to cross the Mediterranean, but Libyan estimates put the figure as high as 2 Million (of a population of ~6.4 Million Libyans).  Italy already faced an influx of over 5K Tunisian refugees following the country’s regime change.  Clearly, policing an influx of these proportions would be a huge tax on the Italian state.  

Much like with the uprising in Tunisia and Egypt, we cannot solve for the unknowns that will transpire in the coming days. What’s clear is that share prices from energy companies in Libya, including companies such as Total, OMV and Repsol, will be taking a hit as these companies move to shut down production. In particular, we view Italy’s outsized energy exposure (via ENI) to Libya as a critical force weighting to the downside of its equity market, or the etf EWI with its heft ENI weighting. We’ve long been critical of the Italy’s excessive debt leverage and have been short Italy via the etf EWI at times over the last 6 months in the Hedgeye Virtual Portfolio. Now, we see even more short-term downside pressure for Italy’s FTSE MIB given the country’s exposure to the precarious state of Libya.   


As we show in the chart below, the FTSE MIB is trading between a rock and a hard place. It is trading above its TREND line of support at 21,193, but recently broke through what was its TRADE line of support, and is now resistance, at 22,709.


Matthew Hedrick

The Gadhafi-Berlusconi Trade - mib

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