The EU’s Extend and Pretend Summit Lean

Positions in Europe: Long Germany (EWG); Short Spain (EWP)


The initial report of results from the EU Summit on Competitiveness on Friday and into the weekend suggests that: (1) far more was agreed upon at the Summit than advertised, and (2) in aggregate, most of the agreements leaned dovish, meaning leaders elected to throw more monies and more generous loan terms at the region’s sovereign debt issues. Again, we contend that over the intermediate to long-term, policy that facilitates piling more debt-upon-debt only increases the inevitability of another crash.


The main Summit agreements include:


On Temporary vs Permanent Bailout Structures


-The temporary European Financial Stability Facility (EFSF) will be able to access its full funding (from the member states) of €440 Billion, versus the approximately €250 Billion previously available.


-Agreement was reached to let the EFSF buy bonds directly from governments; however, the EFSF is not authorized to buy bonds in the secondary market or finance debt buybacks by governments. Ahead of the Summit, the EFSF was only authorized to loan funds to governments. Therefore, under this agreement, credit risk for primary bond purchases will move onto the EFSF (taxpayer) balance sheet.


-Funding for the permanent bailout fund, the European Stability Mechanism, starting mid-2013, is pegged at €500 Billion.


On Existing Loans


-European leaders agreed to lower Greece’s bailout interest rates of about 5% by 100 bps, and extend the repayment period of the loans to 7 1/2 years from 3 years.  (Greek PM George Papandreou estimates the moves would save about €6 billion over the life of the loans.)


-Ireland did not receive its request to have the interest rate on its bailout loan (~5.8%) reduced by 100bps, as Irish PM Enda Kenny refused to raise the country’s 12.5% company tax rate, which compares to the EU corporate tax rate average of 23%, or Germany at 30% and France at 34%.



Overall, the agreements reached at the Summit far exceeded the syllabus, with the gravitas expected to come at the EU Summit for a Comprehensive Package on March 24-5. In particular, the more hawkish stance of Germany (via Chancellor Merkel) going into the Summit was lost over the weekend, namely that government bonds could not be bought directly by the EFSF and that funding for the facility would not be increased.  The only point that Merkel (and Sarkozy) stood strong on was maintaining that Ireland could not receive more favorable loan terms unless it raised the country’s corporate tax rate, an issue that’s very contentious and one that the Irish refuse to budge on.


In any case, the market response to the weekend is clear: bond yields from the PIIGS have come in, notably the Greek 10YR yield was down as much as -50bps d/d and the equity market (Athex) closed up a monster +5.2% today (see first chart below). The results of the weekend also alleviate the pressure that major compromise has to be met at the second Summit, which should tone down the recent return of sovereign debt fears.


We are by no means of the camp that this news is positive for the health of the region. On the contrary, we see Europe’s action as confirmation that it will choose to kick the can of debt further down the road.  In this light, the European Commission forecasts Greek public debt will reach 159% of GDP in 2012!


And while the expansion of the EFSF and talk of funding for the European Stability Mechanism will instill a level of confidence in the market and common currency, the underlying issue is not if there exists adequate funds to bail out the next overly indebted country, but should be enacting policy measures to more properly incentivize or punish countries that exceed debt and deficit levels. This will better direct the region’s future economic growth. Further, simply loosening debt payback terms sends the wrong message to countries, namely that mismanagement is permissible and the union will always be around as a backstop/crutch.


And to the point of more favorable loan terms for Ireland, we believe the island nation is going to have to play ball: it’s not going to be able to have its cake (an extremely low corporate tax rate) and eat it too (have its bailout loan more generously restructured).


What’s also clear from this weekend is that the ECB will continue to play a role as buyer of government bonds in the secondary market, currently at €77 Billion since May 2010.


We’ll get the final approval for the agreements reached this weekend at the March 24-5 Summit. While we could very well see stability in European markets and the common currency over the short run as optimism surrounds the Summit meetings, over the longer term our concern remains grounded that Europe is simply pushing its sovereign debt imbalances further out on the curve.  At the very least, we’d expect the PIIGS, some of the best equity market performers year-to-date, to mean revert over the coming weeks (see second chart below). We’ll continue to manage risk on a day-by-day basis.


Matthew Hedrick



The EU’s Extend and Pretend Summit Lean - wohl1


The EU’s Extend and Pretend Summit Lean - wohl2


The following companies are currently enjoying positive same-store sales and margin growth as of the most recently reported quarter: CMG, BJRI, PNRA, SBUX, YUM (US), DPZ, MCD, DIN, PFCB, DRI, RT, MRT, KONA.  All of these companies, with the exception of DPZ and KONA, were operating with positive same-store sales and expanding margins during their most recently reported quarter.  Also, as one can see in the chart at the bottom of this post, these stocks saw significant price gains during the fourth calendar quarter.  It is important to note that, since the end of the fourth quarter, MCD, MRT, and RT have all slowed from a price performance perspective.


Last time around, I highlighted YUM China, TXRH, MRT, CAKE, and RT as five names that I believed were “moonlighting in Nirvana”.  As it happened, YUM China, TXRH, and CAKE dropped out of the quadrant into “Trouble Brewing”, the lower-right quadrant where same-store sales remain positive but margins are contracting on a year-over-year basis.  


RT posted a strong quarter for 2QFY11 and seems well-poised for the remainder of the fiscal year.  In the immediate term, 3QFY11 could show some weather-related top-line softness.  From here, I still believe that MRT faces significant headwinds from a margin perspective and could well drop out of Nirvana.


YUM China will likely face continuing labor, food, and paper inflation throughout 2011.  On the last earnings call, management guided to 5% food and paper inflation in China with wage inflation running in the mid-teens.   As of February 2nd, the date of the most recent earnings call, management expected the modest price increase taken by the company just before Chinese New Year to cover the majority of the company’s inflation expectations (at the time) for the year.  I would expect that inflation expectations may  have changed somewhat given that many foodstuffs have increased markedly over the last five weeks.  Clearly, given the record margins YUM enjoyed last year, driven by commodity deflation, some year-over-year margin contraction is to be expected.  It will be interesting to see if comps slow in China during this year as compares step up in difficulty.


As a side note to trends in China, MCD has reported that January/February (combined) same store sales in China were up mid-to-high single digits.


MRT is not contracted on any beef prices for 2011 and that commodity has risen sharply in 2011.  Management has expressed confidence in its ability to take price as business traffic has been increasing at their restaurants.  The company has indicated its willingness to take price if necessary to offset inflation.  Obviously, margins may come under pressure as beef costs are absorbed and top-line trends may weaken if price is passed on to the customer. 


CMG is a notable constituent of Nirvana at this juncture.  The top-line growth has been nothing short of spectacular but there are definite negative factors impacting the outlook for the company.  Commodity headwinds are impacting Chipotle at least as much as any other restaurant chain given their sourcing of food ingredients from the spot market in order to abide by their “Food with Integrity” mantra.  Labor costs are also a question mark from here; federal investigations of 50 Chipotle restaurants in Minnesota resulted in the firing of 450 workers for not possessing the appropriate paperwork.  An internal review of hiring practices in Washington, D.C., has resulted in a further 40 jobs becoming vacant. 



The Deep Hole quadrant has been vacated by a large number of names over the past two quarters.  SONC, JACK, and CPKI are still languishing down there, however, as same-store sales are negative and margins are contracting on a year-over-year basis. 


SONC is a name that has received a boost recently on the back of a sell-side upgrade and a preannouncement of 2QFY11 sales of between +1% and +1.5%.  While this will mean that SONC is due out of the bottom-left quadrant when 2QFY11 results are reported a week from Tuesday.   However, as I wrote on March 8th, compares are stepping up materially from here and the preannounced same-store sales range for 2QFY11 actually implies a slowdown in two-year average trends.  Interestingly, following a strong showing in 4Q, SONC is down almost 14% year-to-date.



The lower-right quadrant, “Trouble brewing” , is where YUM China, TXRH, CAKE, and WEN are operating at present.  With the exception of WEN, which is in the midst of a turnaround, each of these names has dropped from the upper-right quadrant as a result of declining margins in 4Q10.  WEN is a name that I have a bullish outlook on; the sale of Arby’s and simplification of the menu will lead – in my view – to continued top-line growth and leverage over costs as well as labor efficiencies.  WEN’s stock gains in 4Q were somewhat muted but, for the reason I mentioned above, the stock has performed strongly since mid-January.



The upper-left quadrant, “Life-line” is currently inhabited by EAT and BWLD.  BWLD is a unique company in the restaurant industry; continuing commodity cost favorability due to declining chicken wing prices is greatly boosting margins.  The company is vulnerable to an NFL strike and, as that situation seems to be worsening, it could definitely effect traffic at BWLD if the points of contention between the players and owners is not resolved in time to save the 2011 season.   The company’s stock price declined in 4Q10 but has outperformed year-to-date, gaining over 20%.


EAT is a name I have been positive on for some time.  Operational improvements and sales-driving initiatives are greatly improving Chili’s performance.  Sell-side sentiment is only just beginning to change on this name and I believe there is significant outperformance left for this name in 2011.  Following a gain of 11% in 4Q, year-to-date the stock has risen an additional 17%.  I believe it is likely that, as EAT reports 3QFY11 results, the company will be operating in “Nirvana”, with positive same-store sales and margins.





Howard Penney

Managing Director

Drawdown: SP500 Levels, Refreshed

POSITION: no position in SPY


All 3 factors (PRICE, VOLUME, and VOLATILITY) in my core immediate-term risk management model continue to flash bearish for US Equities: 

  1. Immediate-term TRADE resistance of 1311 wasn’t overcome on Friday
  2. Immediate-term VOLUME signals continue to flash very bearish (3/11’s DOWN day = +31% VOLUME study)
  3. Immediate-term VOLATILITY (VIX) for the SP500 continues to build upward momentum > 18.52 support 

Since we’re Duration Agnostic, it’s important to expand this view to our intermediate-term duration (TREND): 

  1. Intermediate-term TREND resistance for the SP500 remains overhead at 1343
  2. Intermediate-term TREND support for the SP500 remains lower at 1271
  3. Intermediate-term VOLUME and VOLATILITY studies support a heightening probability of a 1271 test 

On a downside test of 1271, I’ll probably get longer of US Equities. I’m in a good position to do that because I’ve proactively cut my US Equity exposure (Hedgeye Asset Allocation Model) from 9% last week to 3% this morning (sold Healthcare on the open – XLV).


No one said managing drawdown risk of -5.4% is going to be easy (1). No one here was saying you should chase US Equities into their February 18th top either. Waiting and watching for risks, ranges, and spreads will be critical in the coming days.


The crowd is still too long,



Keith R. McCullough
Chief Executive Officer


Drawdown: SP500 Levels, Refreshed - 1

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Still on a pace for mid to high 30s% growth.



Through March 13th, table revenues were HK$7.3 billion month to date.  We’ve seen a slowdown compared to the last few weeks but we believe it is primarily hold related.  Nevertheless, we are now projecting full month March revenue of $17.5-18.5 billion, +33-40% YoY.  Based on just the first week’s data we had been estimating HK$1 billion higher.


In terms of market shares, SJM and LVS gained from week 1 at the expense of Galaxy.  Relative to their 3 month market share averages, LVS and WYNN remain below trend while MPEL and Galaxy are above.  We still see MPEL as delivering the most upside relative to consensus near term EBITDA estimates.




Conclusion: Knapp Track comparable restaurant sales in February indicate that the casual dining recovery is slowly progressing.  However, a sizeable downside revision of January’s number from +0.6% to -0.1% is concerning.  Another factor that has been receiving a lot of attention is highlighted by Knapp in his report; gas prices have advanced to over $3.50 per gallon at a brisk pace.


Knapp Track preliminary results for February suggest that the casual dining recover, which took a pause of sorts in the fourth quarter, may be back in place.  February comparable restaurant sales of +1.6% signifies a sequential uptick in two-year average trends of 95 basis points.  The revision in January’s trends means that the sequential uptick in two-year average trends in January was 80 basis points.  Q4 saw a sequential slowdown in comparable restaurant sales to +0.6% from +0.8% in 3Q10.  At present, 1Q to-date is tracking at +0.8%, almost 100 basis points above those seen in 4Q on a two-year average basis.


Comparable guest counts in the casual dining space saw a sequential gain from a revised -2.2% result in January.  February’s preliminary decline of -0.4% shows that the recovery is far from secure, especially as gas prices continue to gain and discourage discretionary travel by automobile.   Additionally, an inevitable raising of prices from here could slow any further acceleration in comps.  On a two-year basis, February’s result implies a sequential acceleration in guest counts of approximately 60 basis points.  


We continue to favor EAT and PFCB.



Howard Penney

Managing Director

R3: HIBB, ANN, Russell, PERY



March 14, 2011






  • Hibbett Sports noted that the shift in “rapid refund checks” or RAL’s had a negative impact on the company’s sales of urban lifestyle products during 4Q.  Overall, this contributed to the company’s low single digit decrease in footwear comps.  However, the trend has changed notably since 4Q closed, with comps-to-date increasing 8% against a difficult 17% comparison.
  • Ann Taylor reported one of the most substantial increases in e-commerce revenues in all of retail during 4Q.  Ann Taylor increased by 74% while LOFT increased by 77%.  As a result of the recent success, ANN will be investing in the re-platforming of both sites to offer international commerce, improve checkout, personalization, and add mobile commerce.
  • In an embarrassing corporate moment, Russell Corp – makers of Russell Athletic, recently lost a copyright infringement lawsuit against actor Russell Brand. In 2008, the actor registered his name as a trademark for apparel and footwear products in the UK – a move that will enable him to sell his collection under his entire name while Russell Corp. can only use the “Russell” label.



Perry Ellis Purchases Anchor Blue IP - Perry Ellis International Inc. said Friday it has closed on its $500,000 purchase of all intellectual property assets of Anchor Blue Inc. The assets were purchased in a Delaware bankruptcy court proceeding, due to Anchor Blue’s voluntary Chapter 11 petition for bankruptcy court protection on Jan. 11. Anchor Blue, a Corona, Calif.-based teen specialty retailer operating primarily on the West Coast with 115 stores, is undergoing an orderly liquidation of its operations. Included in the IP assets Perry Ellis purchased are the Anchor Blue and Miller’s Outpost trademarks. A Delaware bankruptcy court approved the purchase on March 11. <WWD>

Hedgeye Retail’s Take:   With the purchase of Anchor Blue’s IP secured,  it’s likely we’ll see a wholesale line emerge in the not so distant future.


VF Corp.'s Growth Plan - VF Corp. is aiming to add $5 billion in revenue to its topline and $5 in earnings per share over the next five years. The Greensboro, N.C.-based company will focus its efforts on the outdoor and actions sports categories, expanding its direct-to-consumer channels and increasing sales in international markets. If successful, VF’s sales will reach $12.7 billion by 2015 and EPS will hit $11.50. The company expects to generate $6 billion in cash over the next five years and will direct that arsenal toward acquisitions, particularly in the outdoor and action sports arena, as well as dividends and potential stock buybacks. <WWD>

Hedgeye Retail’s Take:  Despite nearer-term cost pressures, management remains confident that the outdoor/lifestyle group can continue to be the company’s growth engine over the next five years growing to greater than 50% of total sales in the process.


Borders Scrambles to Be Lean - Borders Group Inc. hopes to exit bankruptcy-court protection by summer's end after getting a head-start on its restructuring by targeting 200 superstores for closure, Borders President Mike Edwards said in his first interview since the bookstore chain filed for Chapter 11 protection. Borders president Mike Edwards said the bookseller is receiving new titles from major publishers on a cash basis, thanks to its recent financing. Borders is exploring closing as many as 75 additional stores and hopes to present a formal business plan to publishers and other creditors in early April. The ultimate goal: exit bankruptcy in August or September, ready to ramp up business for the key holiday selling season, Mr. Edwards said. "You've got a window, and you have to move decisively," he said. The companies that have failed in Chapter 11, he added, held onto their money-losing stores too long. <WallstreetJournal>

Hedgeye Retail’s Take:  While emerging from Bankruptcy is a step in the right direction for restoring confidence with suppliers, we believe this just the beginning of the end for the struggling specialty retailer. 


Neiman’s Sees Ready-to-Wear Rebound - Shoes and handbags have led the luxury rebound, but ready-to-wear is showing signs of life, according to Neiman Marcus Group president and chief executive officer Karen Katz. “The big change between fall and resort was that the ready-to-wear business picked up pretty significantly. Trends for spring are selling very, very well,” Katz said, citing bohemian influences, corals, flat sandals and floral prints. A lack of color and fabrics that were too heavy dragged down the fall rtw season. “The minute we started receiving early spring and resort, the business in ready-to-wear started lifting,” Katz said. <WWD>

Hedgeye Retail’s Take: While non-apparel has largely been the reason behind luxury’s strength, these comments are notable coming from THE country’s leading luxury department store.


Gilt Groupe Sells Big Ticket Item on iPad - Score a big one for iPad commerce: The most expensive item sold on Gilt Groupe so far, a $24,000 vintage watch, was purchased by a shopper using the less than year-old tablet computer from Apple Inc., according to Chris Maliwat, vice president of product development for the private-sale e-retailer. He was speaking this week about iPad shopping trends at the Innovate 2011 conference in San Francisco. The conference was organized by the National Retail Federation, a trade group. Gilt Groupe, one of the leading companies in the growing online private-sale industry, launched its iPad app in April. The retailer, which has some 4 million members and sells products from more than 1,000 brands, says 177,000 consumers have downloaded its iPad app. As of January, about 100,000 consumers a month actively use the iPad app, he says, compared with about 300,000 a month for the flash-sale site’s iPhone app. <InternetRetailer>

Hedgeye Retail’s Take:  Not sure why this is newsworthy given the 14+ million consumers that have embraced the iPad as a new way access the internet.  Big ticket selling online is nothing new although flash sales selling $24,000 watches certainly is.


Cost Crisis Impacts Shoe Firms - For months, footwear manufacturers worried about the prospect of rising expenses for producing shoes. Now, thanks to big bumps in raw materials and labor costs, those fears are the new economic reality for the fall season. “Everything is going up like crazy,” said designer Stuart Weitzman. “It’s really the biggest story of the season, more so than whether a platform [heel] is important or not.” As previously reported in Footwear News, sourcing costs across the board, for labor, raw materials and shipping are slated to rise sharply in 2011. “The material costs are up and the labor cost also is significantly up this season, at least 10 percent, and some are higher than that,” said Maxwell Harrel, president of Corso Como. <WWD>

Hedgeye Retail’s Take:  Perhaps this shouldn’t be so surprising given the sharp increases we’ve seen in raw material, labor, and freight across the board in the apparel sector.  Leather remains a key culprit in y/y increases.


Quake Disrupts Key Supply Chains - The earthquake that struck northeast Japan Friday forced shutdowns across a broad spectrum of the country's industries, but the bigger impact for companies could come in the weeks ahead as the disruptions make their way through the global supply chain. The 8.9-magnitude earth quake, one of the largest on record, has crippled activity for now in a country that is a critical source of parts for consumer electronics, as well as a key producer of automobiles, auto parts, steel and other goods.  Plants don't appear to have suffered widespread, catastrophic damage, but production delays could be enough to affect some tightly calibrated industries. The earthquake affected operations at dozens of semiconductor factories, raising fears of shortages or price increases for a number of widely used components—particularly the chips known as flash memory that store data in hit products like smartphones and tablet PCs. <WallstreetJournal>

Hedgeye Retail’s Take:  This is likely to become a bigger story as time passes and existing inventories in key categories begin to diminish.


Pakistan: Tanners Association Urges for Reliable Supply of Utility - The leather industry in Pakistan is facing a decline in exports of up to 30%, partly due to a lack of basic facilities such as gas and electricity, said Khurshid Alam, chairman of the Pakistan Tanners Association (PTA). The Association has recently demanded the government to ensure uninterrupted supply of gas and electricity to tanners in the province of Punjab. He stressed that despite previous efforts to bring these issues to the attention of ministers, there has been no change. <FashionNetAsia>

Hedgeye Retail’s Take: With reliability of the country’s supply chain clearly in question, it seems highly unlikely that Pakistan will ever emerge as a leading global leather supplier.




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