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Sonic is trading higher today on preannounced comps from yesterday and a sell-side upgrade this morning.


Yesterday, Sonic management indicated that sales for both company-owned drive-ins and the system were positive for the second fiscal quarter ended February 28, 2011.  The company estimates that system-wide sales for the quarter (2QFY11) increased by between 1% and 1.5% (company-operated stores up 2.2%).  While this is encouraging in that it is a positive number – the first since 2QFY08 – I would think it imprudent to chase this stock today. 


I struck a fairly positive tone when penning my last note on SONC titled, “SONC: LESS BAD IS GOOD”, on January 5th.  While I did state that the company was “not out of the woods” from a top line perspective, I was certainly becoming more positive on the margin.  The Street’s bearish sentiment on the name also made the name more attractive.  The system-wide comp for this quarter, assuming it falls at the midpoint of the estimate range provided by management, will imply deterioration in two-year average trends from 1QFY11 of 150 basis points. 


The reality is that over two months have passed since my aforementioned post on Sonic and much has transpired since then.   Coincident and lagging indicators, like employment and personal consumption, have shown some improvement and/or stabilization.  Commodities have increased greatly in the last two months, however, and I believe greater sales growth than +1%-+1.5% (versus a -13.2% year prior) will be required to absorb such cost inflation.


Guidance provided following results in January for FY11 top-line trends was suitably vague; management stated that “sequentially improving same-store sales throughout the fiscal year” would be based on “sales-building initiatives”.  While 2Q’s preannouncement certainly meets guidance from a one-year standpoint, the two year number is concerning because clearly the compare was easy and they become more difficult going forward, but also because commodity costs – as shown in the charts below – are through the roof.   For reference, to simply maintain, not improve, the 2QFY11 level of comp growth in 3QFY11 on a one-year basis, it would imply about a 350 basis point acceleration in two-year average system-wide comp trends.  To me, this seems aggressive.


Like a lot of restaurant companies, I feel that SONC is understating the real inflation numbers it is going to see.  The company previously guided to between 1% and 2% commodity inflation for the year and, while the majority of their basket items are hedged for the year, the company is purchasing beef on a short term basis. 


Regarding beef prices management stated that it expects, following mid-single digit gains in 1QFY11, “to see kind of a comparable year-over-year increase, maybe even flattening out in the third [fiscal] quarter”.   Beef prices have, although volatile, made higher highs and lower lows since early January.  Since the earnings call, beef prices are up 4%.




Of course, commodity costs impact SONC’s operations in more ways than one.  Gasoline prices are up over 14% since the earnings call for 1QFY11 earnings was held.   This is obviously relevant for all QSR chains but given that SONC’s system is exclusively drive-in, the company is particularly exposed to gas price inflation.  The company will have approximately 0.5% of price on their menu in 2Q and 3Q; considering the cost of gasoline as part of the cost of a trip to SONC, I am confident that additional price won’t be well-received by the Sonic customer.   I think it is unlikely traffic will come to the rescue either – 2QFY11 comps flattered to deceive.



Howard Penney

Managing Director

Greek 10YR Hits All-time High!

Positions In Europe: Long Germany (EWG); short Italy (EWI)


In continuation of a note published yesterday titled “European Sovereign Debt Concerns Have Not Gone Away: Red Flags from Greece and Portugal”, today the yield on Greece’s 10YR bond hit an all-time high of 12.9%, rising 51bps d/d, and Greece's Athex Composite (equity index) slid -3.8% . As borrowing costs push up following yesterday’s credit downgrade of Greece by Moody’s, investors are rightfully shaking in their boots. 


Today the country auctioned 6-month bills worth €1.625 Billion at a yield of 4.75% versus a previous auction of similar maturity of 4.64% in February. Foreign buyers represented 31% of the auction, in line with the average, and the bid-cover ratio was 3.59.


However, the increase in yield bucks a trend we were seeing in auctions from peripheral countries year-to-date in which yields came in lower than previous auctions, a reflection of confidence in foreign buyers (namely China and Japan) and that the EU’s comprehensive package to bailout the periphery would be favorable to countries like Greece.


That tide however has turned in last days, as uncertainty mounts over the specifics of a bailout package for the region, especially as the all-important German voice has become marginally more assertive on its notion of bailout and crisis management terms. This includes firm opposition to the rescue fund directly purchasing Eurozone member government bonds and a stricter stance on debt and deficit levels and fiscal consolidation mandates.


Now, given Moody’s decision yesterday to downgraded Greece credit rating by three steps on rising default risk (Ba1 to B1), investors are shaking as Greek bond yields rise. 


This month, Greece is bumping up against a hefty €12.41 Billion in Debt maturities (€10.56 Billion in Principal, and €1.85 in Interest), of the some €53.07 Billion due this year. With the country's fiscal state severely imbalanced [the country's debt as a percentage of GDP stands at 144% and its deficit is -15.4% of GDP], we'd expect to see Greek markets underperform as Europe lacks a unified voice on the conditions for a comprehensive bailout package to be decided at the EU Summit on March 24-5. 


Matthew Hedrick


Greek 10YR Hits All-time High! - mh4

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Lower-Highs: SP500 Levels, Refreshed

POSITION: No position in SPY


Consolidation or correction? Well the correction part has been solved for – at least the first 3% of one. Since the hyped-up highs that we established in the SP500 on February 18th, the US stock market looks a lot like Japan’s – struggling to convince itself that this time is different.


The best way to answer how something isn’t different is to look at what is actually happening: 

  1. Inflation is slowing global economic growth – that’s happened many times before , across many economic cycles
  2. The US Dollar Debauchery and correlation risk associated with it isn’t any different than France, Britain or Japan trying the same
  3. Asset Prices, whether they be US Homes or US Stocks, are making lower long-term highs in terms of prices 

Obviously between all of the correlation risk and storytelling about growth, no matter where you stand on the “fundamentals”, you’ll have to agree with one major birth child of all this US Government Intervention and Central Planning – volatility. Price volatility is back – and the VIX has moved back to a bullish position on both our TRADE and TREND durations with considerable support around the 18 level.


Getting above the 1316 line this morning in the SP500 has been inspirational, but we think this low-volume rally associated with dollar UP/oil DOWN will run out of steam at another lower immediate-term high of 1333.


In the immediate-term, the best way to play price volatility is to trade it. Use 1 as your intermediate-term risk management range. In the Hedgeye Portfolio, I am leaning long (15 LONGS, 9 SHORTS), but I’ll keep that exposure on a short leash.



Keith R. McCullough
Chief Executive Officer


Lower-Highs: SP500 Levels, Refreshed - 1


How will Starbucks enter the single-serve brewing market?  People continue to offer their theories on who would be the best partner for Starbucks.  Just a few weeks ago, I said that I thought Tassimo, a brand with global penetration, would be a more suitable partner than the more U.S.-centric Keurig brand.  I still don’t think Starbucks will partner with GMCR, but according to the following update on Starbucks, which is being provided on Tassimo’s website, Tassimo is an unlikely partner as well.


“As you may have read, the strategic partnership between Kraft Foods and the Starbucks Coffee Company will end on March 1. As a result, we will be unable to offer Starbucks and Seattle’s Best Coffee products for Tassimo once existing inventories of coffee are depleted. While supplies last, availability of all varieties of Starbucks and Seattle’s Best Coffee for Tassimo will vary, depending on local inventory and demand.”

SBUX’s not partnering with Tassimo makes sense, however, given the recent comments made by CEO Howard Schultz in his memo to Starbucks partners.  As I wrote in a February 17th post titled “SBUX – MY TAKE ON THE STARBUCKS MEMO FROM TODAY…”, I interpreted Mr. Schultz’s comments to say, among other things, that Starbucks is completely capable of internally developing its own innovative products to dominate every segment of the coffee market, including the single-serve brewing segment and none of the single-serve brewing systems currently available to the market are good enough to be tied to the Starbucks name.



Howard Penney

Managing Director


The U.S. shortfall is overshadowing the stronger-than-expected results in Europe and APMEA.


For the second consecutive month, MCD’s same-store sales results fell short of street expectations in the U.S. while exceeding consensus estimates in Europe and APMEA.  The company’s comps came in up 2.7% in the U.S. relative to the street’s 3.6% estimate, up 5.1% in Europe versus the street at +3.6% and up 4.0% in APMEA, much better than the street’s +1.8% estimate.


Trends in Europe have remained solid for the second consecutive month after decelerating sharply in December.  Although two-year average trends decelerated nearly 70 bps in February on a calendar-adjusted basis, this was expected after the more than 400 bp sequential improvement in January. 


MCD’s APMEA segment posted its third consecutive month of accelerating two-year average trends in February.  The company’s +4.0% comp growth was particularly impressive given the fact it was lapping a+10.5% comp from February 2010.


Despite these strong results internationally, MCD overall results are being overshadowed today by the lower-than-expected U.S. numbers.  Although MCD is a global company, MCD’s U.S. segment still accounts for about 45% of the company’s total operating income and investor sentiment still seems to be driven largely by the U.S. story.


Two-year average trends in the U.S. moved slightly higher in February, up nearly 20 bps to about 1.7% (on a calendar-adjusted basis).  Although some investors may be encouraged by this sequential improvement, I continue to think people are too bullish about MCD’s momentum in the U.S. as evidenced by the company’s posting another monthly comp result below expectations.


I continue to believe MCD’s comp trends will slow as we progress through the year and the reported March same-store sales result will likely turn negative as the company faces its first difficult monthly comparison of the year.  In March 2010, MCD reported a +4.2% comp relative to -0.7% in January and +0.6% in February of 2010.  Even if the company can maintain its two-year average trend from February, it would imply a -1.6% comp in March.  For reference, MCD has not posted a decline in monthly same-store sales growth since January 2010.


The comparisons will remain difficult for the balance of the year, particularly in the summer months when the company laps its initial smoothie/frappe rollout.  MCD has said that 2-3% comp growth is necessary in the U.S. to maintain margins in 2011 as a result of commodity inflation.  If the company can maintain two-year average trends for the remainder of the year, it implies a 0.5% decline in FY11 same-store sales growth in the U.S. and I would not be surprised to see two-year average trends decelerate from current levels.  Either way, I would expect MCD’s U.S. comp results to fall short of investor expectations in FY11.








Howard Penney

Managing Director



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