SONC reported fiscal 2Q11 earnings after the close yesterday.  The company had already preannounced comp results of +2.2% at company-owned drive-ins, which was the first quarter of positive same-store sales growth after 11 quarters of declines.  Earnings of $0.02 per share fell short of the street’s $0.03 per share estimate and despite the positive comp growth, restaurant-level margins still declined about 260 bps prior to non-controlling interest and 170 bps including the change to the company’s partner compensation structure, which includes non-controlling interest.   Even with positive comp growth, the company was not able to get any leverage during the quarter.


Higher commodity costs were a big factor for SONC during the quarter with food and packaging costs as a percentage of sales up 110 bps YOY due to higher beef and dairy costs and continued product quality investments.  The company had guided to a 25 to 75 bp increase in food and packaging costs for both the second and third quarters during its first quarter earnings call.  The company is locked in on most of its commodity needs, outside of beef and ice cream mix, and now expects third quarter commodity pressures to worsen with food and packaging costs as a percentage of sales up about 150 to 200 bps.  Although SONC management expects costs to mitigate somewhat during the fourth quarter as result of improved sales and the lapping of product quality investments from the prior year, food and packaging costs as a percentage of sales are still expected to increase 50 to 100 bps YOY.  As a result of these higher-than-anticipated food costs, management is now guiding to a decline in full-year restaurant-level margins relative to its prior guidance for flat fiscal FY11 margins.


The company now also plans to take a menu price increase during the fiscal third quarter, which will result in a 1.0 to 1.5% cumulative price increase (fully implemented in fiscal 4Q11) to help offset the increased commodity pressure.  As of the first quarter earnings call, the company had planned a less than 0.5% cumulative price increase for the third quarter.  Although management stated that this price increase has been tested and has not impacted traffic trends, I think a price increase of this magnitude is risky in this environment, particularly for a company that has underperformed its competitors and posted its first quarter of positive comp growth after about two and a half years, and will likely be detrimental to traffic trends.


The focus of yesterday’s earnings call was on management’s guidance for “continued improvement in same-store sales trends throughout the fiscal year.”  Although same-store sales improved during fiscal 2Q11 to +2.2% at company-owned drive-ins from -1.9% during 1Q11, two-year average trends decelerated about 85 bps.  The year-ago comparisons get increasingly more difficult with the company lapping a -6.3% comp from fiscal 3Q10 versus the -14.9% comp in fiscal 2Q10.  The guidance for sequentially improving same-store sales growth seems so unbelievable that about four different analysts questioned whether management was referring to better two-year trends rather than the implied 1-year trend.  Management finally just said that the guidance did, indeed, assume positive comp growth in both the third and fourth quarters as they layer on various initiatives and build on current momentum.


Given that two-year average trends continued to decelerate during the second quarter and only maintaining the same +2.2% level of comp growth in fiscal 3Q11 (rather than sequentially improving) implies a 430 bp improvement in two-year average trends, I think analysts and investors, alike, are right to be cautious.  This comp guidance is definitely aggressive.  With the stock trading up today, however, it seems that some investors are drinking the Kool-Aid.


It is important to remember that the company’s current margin guidance, particularly as it relates to the food and packaging expense line, takes into account this aggressive comp guidance so margins could come in much worse than current expectations should same-store sales trends fall short of management’s targets.  The company also guided to leverage on the labor and operating expense lines during the back half of the year as it laps the implementation of its new partner compensation structure in April of the third quarter and more importantly, as a result of the assumed continued momentum in top-line growth.  Time will tell.









Howard Penney

Managing Director


Wheat and corn lead the way as commodity prices, in general, rebound from last week’s slowdown.


If last week bucked the trends in the commodities we follow in our weekly monitor, this week reestablished them.  Wheat and corn were highly notable last week as the grains saw price declines of 7.2% and 8.5%, respectively.  Corn, in particular, is highly important for the broader food and restaurant industries as a feed for livestock.  While the week-over-week gain in live cattle prices was tame, at +0.7%, if corn prices can remain elevated I expect beef prices to follow suit. 


As the chart below shows, corn prices have rebounded sharply over the past week and remain significantly above the levels of 2010.  In terms of news flow, it seems that the grain is set to continue on its upward trajectory, supported by an expected increase in global demand.  In particular, China, which only last year became a net importer of corn, is expected to increase imports of the grain over the next couple of years.  For restaurant companies with high exposure to protein costs, increasing corn prices are a concern.  Below is some commentary from management teams on corn prices:


CMG, 4Q10 Earnings Transcript, 2/10/11:

“Though we have contracted for most of our corn for our salsa for the year, reports of continuing or even worsening supply shortages of corn will only add to inflationary pressure on the meats that we serve.”


JACK, 1Q11 Earnings Transcript, 2/24/11:

“There are some Act of God provisions that will get us north of our contract bands, but at a reduced rate from what the current market pricing is ... And then also grain, corn, wheat and soybean impact, and there are input costs for a number of the proteins. And that's really what's driving up beef at this point.”





Wheat prices rose in step with corn over the last week, supported by dry weather in the plains of the United States and on signs that demand from Japan may be unaffected by the March 11 earthquake.  For companies like Panera, which does have wheat costs largely locked in for 2011 roughly flat versus 2010, prices remaining this elevated could result in a price increase in the back half of this year.





Cheese prices declined 9.3%, week-over-week.  As the chart below shows, cheese prices have come down significantly over the last two weeks (~10% and 9%, respectively).  Below, I again provide some commentary from management teams from their most recent earnings calls with their views on cheese prices and the implications for their businesses. 



"Yeah, so the forward curve and kind of looking at about three different sources right now have cheese actually easing a little bit through the rest of the year. We're at almost $2 right now. And so, our expectation is that we're going to see a little bit of easing, to give you on cheese. We've talked about this in the past, we've got a contract in place that basically reduces the volatility on cheese moves by about a third. So about two thirds of increases or decreases in cheese are passed through to our system.


I think the kind of consensus forecast out there right now for cheese are in the $1.70 to $1.75 range. And – you know so what you're looking at is kind of a $0.25 to $0.30 move and I think we've said in the past a $0.40 move in cheese is equal to a point at the store level P&L."



We expect the favorable impact of early year sales results to substantially mitigate the unfavorable impact of currently projected commodity cost increases, most notably cheese, throughout the remainder of the year.


DPZ is 95% franchised and, as such, management claims a degree of insulation from commodity costs.  Of course, to the extent that price needs to be taken and royalties slow, the company is not immune from inflation.  The downward move of cheese over the past week will raise hopes that a price increase can be avoided. 


Looking at the chart below, the trend in cheese prices seems to be leveling out.  Nevertheless, even if cheese prices were to trend horizontally throughout the rest of the year, inflation over the first half of the year, at least, would remain a significant headwind for restaurant companies with exposure.







Howard Penney

Managing Director


Notable news items and price action from the past twenty-four hours.

  • SONC reported $0.02 adjusted versus $0.03 expectations.  Revenues also came in a little light, $113.5m versus $114.5m despite comps turning positive, as preannounced, and management guiding to positive comps in the back half of the fiscal year despite increasing difficulty in year-over-year compares.
  • BWLD, not surprisingly, is kicking off a “grass roots” movement to “save our season” so that the fans can enjoy the football season from which BWLD derives so much of its traffic.
  • SBUX has lost some of its “buzz”, apparently.  Market research firm, YouGov BrandIndex, are not clear on the cause of the recent swoons in public perception but suspect that news around higher packaged coffee prices may be impacting consumer view.
  • COSI traded up, on strong volume, after trading poorly for much of the last month.
  • RRGB traded up 2.4% on accelerating volume.  MRT, PFCB, and RT traded down on accelerating volume.




Howard Penney

Managing Director

Daily Trading Ranges

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Instrument of Plunder

“It would be impossible, therefore, to introduce into society a greater change and a greater evil than this – the conversion of the law into an instrument of plunder.”

-Frederic Bastiat


Bastiat wrote that in his treatise on individual liberties titled “The Law” in 1850. If you are in the business of having an open mind and teaching yourself alternative economic frameworks to the Keynesian Kingdom of thought, I highly recommend taking the time to read it.


I certainly don’t agree with everything Bastiat wrote. Nor do I disagree with everything Keynes wrote. What I’ve tasked myself with in writing to you each morning is exploring my interests in markets out loud while maintaining some sense of a moral compass. My Mom inspired me to do that.


Anytime one uses the words “moral” and “interest” together in writing something to Washington/Wall Street, one must tread carefully. When one considers America’s Declaration of Independence and the principles embedded in the Constitution however, one must not contradict our high society’s self-interested group-think with the underpinnings of our citizenry’s morality.


It’s only fitting to ask this question today, because on this day in 1775 an American patriot by the name of Patrick Henry delivered a famous speech in defense of liberty to the Virginia Convention when he proclaimed, “Give me liberty or give me death.”


I’m too self-centered to ask for death over liberty this morning, but I will remind those who are begging for bailouts in order to get themselves paid that this country’s new Transparency & Accountability Tools (YouTube, Twitter, etc.) will most likely smoke you out of your hole of contradiction.


If only because he was born early enough to say it first, Bastiat nailed this fundamental point down early in “The Law” when he wrote:


“When the law and morality are in contradiction to each other, the citizen finds himself in the cruel alternative of either losing his moral sense, or of losing his respect for the law.” (Bastiat, “The Law”, page 7)


When I think about that quote and the timing of revolutionary event risk in this world, I just can’t stop thinking. I do not profess to have the answers to all of this, but I can definitely tell these Government People what not to do. Stop compromising the “fairness” and “free-ness” of market systems by making new laws that implicitly choose winners and losers.


Back to the grind…


As always, this morning’s Global Macro news-flow is multi-factor and multi-duration. In summary, I think the points I am about to rattle off speak pointedly to the Instruments of Plunder being used by Big Government Interventionists who fundamentally believe issuing Fiat Fool paper is the best path to prosperity:

  1. USA: The US Dollar Index continues to hit fresh YTD lows – down again for the week-to-date, and down for 10 of the last 13 weeks
  2. JAPAN: Japan announced that the damage is going to cost at least 25 TRILLION Yen – 25,000,000,000,000 – that’s a lot of Yens
  3. EUROPE: Portugal’s government is on the brink as Eurostat questions the credibility of their numbers and Portugal’s PM may resign

Of course, there is both causality and correlation being imputed into market prices on these factors across durations:

  1. USA: The bond market smells The Bernank considering QG3 (Treasuries up) and the stock market sees GDP Growth Slowing
  2. JAPAN: The stock market failed to overcome our immediate-term TRADE line of resistance (9,719), closing down -1.7% overnight
  3. EUROPE: British bonds continue to be the recipient of sobriety (implementing austerity with credibility) while Portugal earns a P for PIG

Then you have countries with pseudo-conservative fiscal and monetary policy getting less confident in US, Japanese, and European stock markets as Price Volatility ramps (so they invest more at home):

  1. CHINA: Continues to see capital pour into the Chinese Yuan (making new highs at 6.55) and flow-through to Chinese stocks (we’re long CAF)
  2. CANADA: Continues to benefit from low-geopolitical risks and high resource exposures to oil and precious metals (we’re long FXC and GLD)
  3. NORWAY: Continues to see its stock market trade in the green for the YTD as raising interest rates and long-exposure to Petro-Dollars helps

Finally, you have SP500 and WTI Crude Oil futures whipping around like Pac-Man attempting to absorb all of this and stay ahead of what some Central Planner With Tan Socks at the Fed is going to do next.


What I’m going to do this morning is at least consistent. That usually starts with what I am not going to do – and one of those things is not cheering on Big Government Intervention and using the US Dollar as an Instrument of Plunder. All that does is drive The Inflation and The Price Volatility higher. After seeing the globally interconnected “Black Swans” that were born out of the early 2008 US Dollar destruction, I’ve seen enough of that.


From an asset allocation perspective, this week I’ve sold all of my US Equity exposure (Energy and Healthcare – XLE and XLV), ramped up my allocation to Fixed Income to 9% (bought long term US Treasuries yesterday), and have taken my CASH position back up to 55%.


If you are a Central Planner looking to protect the liberties and properties of The People, Bastiat said “it is absolutely necessary that this question of legal plunder should be determined, and there are only three solutions of it:”

  1. When the few plunder the many.
  2. When everybody plunders everybody else.
  3. When nobody plunders anybody.

My solution remains. For starters, just stop. Stop what you are doing with The Inflation policy to enrich the few. The money isn’t worth it to me.


My immediate-term support and resistance levels for WTI crude oil are now $101.32 and $105.98, respectively. My immediate-term support and resistance levels for the SP500 are 1293 and 1310, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Instrument of Plunder - Chart of the Day


Instrument of Plunder - Virtual Portfolio


The Macau Metro Monitor, March 23, 2011




US consul general for HK and Macau, Stephen Young, said that the claim made by the US Department of State of illegal side-betting in Macau being 10x higher than GGR is "just speculation or a guess".  “I’m not an expert. I can’t give you any more [information] on this idea that there is a lot of side-betting. I also read that a lot of this side-betting is maybe done off-shore, not in Macau,” he added.


Regarding junkets, Young commented, “I still find the whole junkets business a little puzzling. I don’t quite understand how they manage to bring Renminbi here. If the gamblers win, everything’s fine. If they lose, I wonder how they pay off that debt.”


Total visitor arrivals increased by 5.2% YoY to 2,164,249 in February 2011.  Visitors from Mainland China rose by 5.1% YoY to 1,204,301.  Those traveling to Macau under the Individual Visit Scheme totaled 580,415, up 0.2% YoY.  Visitors from Hong Kong (657,355), Republic of Korea (39,332) and Japan (32,081) increased by 7.3%, 42.5% and 13.3% respectively, while those from Taiwan (86,293) decreased by 13.8%.





Spore's February CPI rose by 5%, versus market expectations for a rise of 5.4%.  Core inflation measure, which is tracked by the Monetary Authority of Singapore (MAS) rose 1.8% YoY, versus 2.0% in January.  Costs of transport, housing and food rose slower than expected.



In January 2011, the total number of non-resident workers in Macau stood at 77,900, an increase of almost 2,100 workers in just one month.



According to Vincent Studer, executive assistant manager of the Grand Lapa hotel, the Grand Lapa will undergo a major renovation project, including a face lift of the Tung Yee Heen restaurant.  Grand Lapa is part of Sociedade de Turismo e Diversões de Macau and is managed by the Mandarin Oriental group.

CHART OF THE DAY: Is the Keynesian Kingdom Running Out of Steam?



CHART OF THE DAY: Is the Keynesian Kingdom Running Out of Steam? -  chart

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 80.46%
  • SHORT SIGNALS 78.35%