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The theme coming out a recent visit to the Oklahoma City market (the first remodeled market) with senior management: money motivates!


Earlier this week, I visited EAT’s Oklahoma City market with senior management.  This is the first market in which the company has remodeled its stores, reflecting its enhanced image.  They have currently reimaged 16 stores and they appear to be hitting the company’s hurdle rates for return on investment.  The best way to describe how the company is thinking about the remodels is that they don’t want to simply “preserve the status quo.” 


The upgrades are designed to make the brand more contemporary and relevant, while maintaining the Chili’s flavor profile.  The reimaged look fits with where the concept is going with its menus and new lunch combo program.  As management stated to me, they are losing some “clown” aspects of the old look.  They are going to remodel the Florida and California markets next.  If they can prove out the recent success in Oklahoma City in both of those markets, the company will likely aggressively roll out this remodel program to additional markets, and therefore, we should begin to see a benefit to overall company results as we exit fiscal 2011 and head into fiscal 2012.


After meeting with both senior management and store-level managers, I would say the most prevalent theme coming out of the trip was money motivates.  Saying that money motivates is not a big surprise, but it is more surprising that margins are the motivating force of the Brinker turnaround story.  Momentum begets momentum and I get the sense that we are only in the beginning stages of that at Chili’s.


While margin improvements are obviously important for the “stock” and company profitability, driving these improvements is also having a motivating force on the Chili’s employee base.  For the past two quarters, store managers are seeing bigger pay checks from improved margins and are now starting to see the benefits of the company’s initiatives.  The store managers with whom we met now want more and are looking forward to keeping the momentum going.


I understand that there are critics of the EAT margin improvement story.  Margin improvement stories are rarely sustainable and can compromise the guest experience.  The changes that EAT is making, however, will actually enhance the guest experience once completed.  The company has already reported increased guest satisfaction scores, largely in response to its Team Service initiative implemented nearly eight months ago.  At the same time, this initiative has resulted in lower labor costs while enabling servers to earn more money per hour and has already delivered 100 bps of margin growth.


There are not many companies that have used the economic downturn as motivation to get better or make changes that are sustainable and will allow them to be better competitors.  Listening to the Starbucks annual meeting yesterday, it was evident that they used their internal and external challenges to change how the customer uses the brand. 


Right now, EAT is playing from a position strength, as operational changes are improving profitability right when the company needs it most.  The margin improvement and cost savings initiatives are allowing the company to take a wait and see approach to pricing.  EAT can hold off on raising pricing, while the competition is forced to raise prices in an uncertain time for the consumer.  The news reported earlier of a customer pulling an air gun on a Taco bell employee over the price increase of a burrito is an example, though extreme, of how price-sensitive the consumer really is.


As I see it now, the EAT turnaround plan is progressing slightly better than management talked about at its analyst meeting last year; though the comprehensive program is rolling out quite differently than initially anticipated.  The remodels are taking, on average, three weeks to complete, while the kitchen makeover can be done overnight. 

  1. Team service is fully implemented and is benefiting margins and employee morale
  2. The food prep portion of the kitchen retrofit program was rolled out earlier than initially expected at the end of fiscal 2Q11 and is now fully implemented, but fiscal 4Q11 will be the first quarter to report the full margin benefit
  3. The benefit of the kitchen technology is showing a real improvement to margins, but the rollout is slower due to some changes in specs and recipes to allow the food to be cooked properly in the ovens. 

My sense is that the new lunch menu is having a significant impact on the lunch business, which was one of the hardest hit dayparts over the past three years.  While at lunch at Chili’s earlier this week, I did notice many tables of women that ordered the soup and a half sandwich.  If you order off the lunch combo menu, you can get lunch at Chili’s (including tip) for around $8. 


My main takeaway after the day of visiting remodeled stores is that the momentum is just getting started at Chili’s.  As I wrote in the Chili’s Black Book of April 2010 “Beyond the next two quarters, it seems margins will go higher even without Chili’s gaining meaningful market share.  We expect that, as consumers adjust to the changes made at Chili’s and as industry sales continue to improve, comps will turn positive at Chili’s.  Same-store sales seem to be on track to recover at the same time margins are headed higher – beginning in FY11. Again, I think the margin story will materialize without a significant tick up in trends.  I am modeling a nearly 1% comp increase at Chili’s for FY11, with all of the growth coming in the back half of the year.  That being said, as better sale sand margin trends both become clear to the market, the stock should be trading closer to $24.”


While there were a few bumps in the road relative to the timing around a sales recovery, the company has made significant progress in improving profitability in a very difficult environment.  To that end, I would expect the company to continue to report improved margins in fiscal 2H11, along with the beginning signs of a real turnaround in comp growth at Chili’s.  The lapping of last year’s 3C promotion early in fiscal 3Q11, combined with the company’s new expanded daypart initiatives at lunch and happy hour, should translate into positive same-store sales growth at Chili’s during the third and fourth quarters (after 10 quarters of reported declines).  With the momentum I’m seeing now, the company could get close to earnings of $2.00 per share (or close to it) in fiscal 2012, which implies a mid $30’s stock in the next 12-18 months.



Howard Penney

Managing Director





Europe: Data Slows and Uncertainty Compounds

Positions in Europe: Long the British Pound (FXB); Short Italy (EWI), Short Spain (EWP)


High Frequency PMI Data Inflects


An initial March reading today of Manufacturing and Services PMI data for Germany, France, and the Eurozone average showed a market inflection to the downside in manufacturing in Germany and the Eurozone versus the previous month. The move is indicative of the uncertainty in global demand following the earthquake and tsunami in Japan earlier in the month, but also the mean reversion trade. As we’ve mentioned over the last three months, European PMI figures were white hot, in particular for German manufacturing, which was bumping up against and through the 60 line, a heavy resistance level on a historical basis (see charts below).


Europe: Data Slows and Uncertainty Compounds - 1


Europe: Data Slows and Uncertainty Compounds - 2


While we continue to like Germany longer term from a fundamental basis, our models show that the fiscally sober nations of Europe (think Germany, Sweden, and the Netherlands) are all broken on immediate term TRADE and intermediate term TREND durations. Therefore, we’re not invested in them in the Hedgeye Virtual Portfolio. Perversely, some of Europe’s most indebted nations are leading global equity performance YTD (think Greece +13.9%, Italy +8.5%, Spain +8.4%), while Germany underperformed strongly in the days following Japan’s earthquake on March 11th and is flat year-to-date.


However, German fundamentals and business trends continue to look positive. Exports are expanding, employment has improved, and factory orders and business confidence have come in strong over recent months.  GDP is expected to grow 2.5% this year. We continue to believe that Germany will be the region’s growth engine and given the country’s fiscal conservatism Germany can also be a defensive play as the region remains mired in a sovereign debt contagion. 


Here are a few recent news stories to keep in mind regarding Germany: 

  • Last week Chancellor Merkel ruled to shut down 7 of the country’s oldest nuclear plants for a 3 month moratorium.
  • On Wednesday, Germany refused to participate in the enforcement of an arms embargo on Libya that the UN authorized and has abstained in the Security Council on the resolution authorizing military action to protect Libyan civilians. Germany is therefore diverging from its European allies Britain and France, who have supported the UN action.
  • Support for Merkel’s CDU party has waned in state elections this year (already in Hamburg and Sachsen-Anhalt). This Sunday, the CDU could well lose its stronghold in elections in Baden-Wuerttemberg and Rheinland-Pfalz. As support for the CDU at the state level wanes, expect Merkel to face increased opposition in the upper and lower houses of parliament which will weaken her broader authority.


Socrates Takes a Bow


Late yesterday Portugal’s parliament voted down the newest austerity bill backed by PM Jose Socrates and his minority Socialist party. While the outcome wasn’t a great surprise, Socrates had made it clear going into the vote that if the package didn’t pass he’d step down.  Now with his resignation tendered, there’s increased noise that Portugal will asks for a bailout from the EU and IMF worth €50-100 Billion in the coming days. [The risk premium to own Portuguese debt has jumped, reflected by Portuguese CDS trading up 37bps since Monday (3/21) to 533 bps.]


Under these circumstances, and the decision by Fitch today to cutting Portugal’s debt rating, today begins the first of a two-day EU Summit to decide on the structure of the region's temporary and permanent bailout funds. The most recent kink in the armor comes with Finland’s firm stance that it won’t approve increasing its loan guarantees to the temporary bailout fund (the European Financial Stability Facility, or EFSF) in order to raise its full capacity to €440 Billion versus the current ~ €250 Billion. It also appears Ireland will not get a concession on the interest rate of its bailout loan (~5.8%) as the country is unwilling to hike its corporate tax rate (at 12.5% vs EU average of 23%). All in, it appears friction may well divide the Summit and prevent a unified decision. We believe this would weaken the common currency.


This EUR-USD has held up well this month despite sovereign debt contagion fears coming back into the market spotlight over recent weeks. We primarily attribute this to the USD’s weakness. However, we believe the market has largely priced in that the Summit would go off without a hitch, meaning that both the increase in funding for the temporary bailout fund (EFSF) would pass as would a permanent fund, or the European Stability Mechanism worth €500 Billion beginning in mid-2013. Should this not be the case, we’d expect the EUR-USD to pull back from its recent steady level of $1.41.



We bought the British Pound via the etf FXB in the Hedgeye Virtual Portfolio yesterday (see levels below). We’ll have a post out on our outlook on the UK economy, including the implications of Chancellor of the Exchequer Osborne’s 2011 Budget, in the coming days. We remain short Italy (EWI) and Spain (EWP) over the intermediate term TREND.


Matthew Hedrick



Europe: Data Slows and Uncertainty Compounds - 3

Brazilian Tug-of-War

Conclusion: Is it time to buy Brazilian equities? We think not, though we are certainly much less bearish on them than we have been in recent months.


When we when we initially turned bearish on Brazilian equities in November (alongside most other emerging markets), we were making the call within the context of our contrarian intermediate-term TREND thesis of Global Growth Slowing as Global Inflation Accelerates. Understanding full well history’s lessons of inflation eroding EM growth and asset returns augmented our conviction then.


Fast-forward nearly five months, and we have no less conviction with our fundamental call – if anything, $115 crude oil is incrementally supportive. We do, however, have less conviction in being bearish on Brazilian equities, as a lot of the scenarios we initially forecasted have already played out. Simply put, we’re running out of catalysts on the short side, so, naturally, we’re reining in our bearishness: 

  • Slowing Growth: YoY GDP growth slowed sequentially by (-170bps) in 4Q and both the Brazilian government and the sell-side have been taking down their 2011 GDP forecasts recently, currently at +4.5% YoY and +4.1% YoY, respectively.
  • Accelerating Inflation: Since bottoming in August, Brazilian CPI has crept up +150bps to the current +6% YoY reading (Feb). Consensus estimates for Brazil’s 2011 CPI are now at +5.5% YoY - up from +4.7% YoY when we initially called out Brazil’s inflationary headwinds.
  • Rate Hikes: Since our initial forecast for Brazil to resume raising interest rates (late October), the Selic Rate has been hiked +100bps and we expect an additional +50bps hike at the central bank’s next meeting (April 19-20). After that, we expect Tombini to go on hold and await more data, particularly given his dovish comments following Japan’s crisis and his reiteration that recent fiscal and monetary tightening will slow CPI to the target range by 2012. Further, the Finance Ministry recently revised down their 2011 CPI forecast (-50bps) to 4.5% – a sign that declining inflation expectations are spreading throughout the policy-making spectrum.
  • Prices: Since the start of November, the Bovespa is down (-5.7%) and are underperforming the S&P 500 and the MSCI EM Index by (-1,605bps) and (-598bps), respectively. 

Brazilian Tug-of-War - 1


Brazilian Tug-of-War - 2


Brazilian Tug-of-War - 3


Given that we’re inclined to be less bearish on Brazilian equities at current prices (relative to our entry point), the next risk management question to ask is, “Is it time to get long?”


For now, our answer is “no”, for two reasons: 

  1. The Bovespa is broken from an intermediate-term TREND perspective; and
  2. The sell-side is increasingly bullish. 

Addressing the latter point specifically, Morgan Stanley and Citigroup have come out recently recommending buying Brazilian call options (MS) and overweighting Brazilian equities (Citi). While we don’t want to dismiss their recommendations just for the sake of being contrarian, both history and our own anecdotal experience has shown sell-side recommendations tend to be lagging, if not outright contrarian, indicators.


Combining this idiosyncrasy with our quantitative context gives us a more cautious outlook. For now we’re content to wait, watch, and trade the rage. We’d need to see a sustained breakout above the TREND line or breakdown below the TRADE line before we are willing to make a new call from here, given that much of our current call has likely been priced in.


Brazilian Tug-of-War - 4


What would be incrementally bearish for Brazilian equities relative to our November forecast is if crude oil prices continue to make higher-highs over the intermediate term (incrementally accelerating inflation) and if the real weakens over the intermediate term due to (potential) Japanese repatriation, which gives Tombini more headroom to hike interest rates and escape the accompanying currency appreciation. Currently, Japan is the largest holder of real-denominated debt according to PIMCO and has some $34.3B in Japanese deposits according to HSBC.


What’s next for Brazilian equities and her currency? Stay tuned to find out.


Darius Dale


Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.

WMT: Does Someone Think They Know Something?


Keith shorted WMT this morning in the Hedgeye Virtual Portfolio at $52.90, as he continues to trade around one of our core intermediate-term ideas. 


"l assume someone thinks they have inside information somewhere in this name this morning. US Consumption will remain lower as Oil climbs higher.” -KM


Our WMT view is based on our bullish view on inflation on top of the internal challenges that the company faces to drive its domestic same store sales back into positive territory.  


The situation surrounding Wal-Mart’s internal execution in areas such as apparel and overall category management is nothing new.  Too much selection? Not enough selection?  Brands? Basics?  Management is hyper focused on turning things around, yet numerous strategy changes over the past year have yielded little in the way of tangible results. We do not see a meaningful and credible plan at this current time that suggest domestic sales can outperform an increasingly challenging backdrop for the company’s core consumer.  In fact, the company entered 2011 with total inventories up 11% against a 2.5% increase in sales.  Clearly not the “clean” start that instills confidence in the wake of rising costs and substantial volatility at the gas pump. 


We remain concerned with the following near-term challenges:

  •  Management’s message now says the US goal of positive same store sales will “take time”.  The CEO acknowledged that issues facing sales (and their customers) were bigger than they “initially expected”.  Traffic is still a drag and likely to remain so given the law of large numbers that puts 1 in 3 Americans at a Wal-Mart each week.
  • Inventories are high no matter how you slice it heading into this year.  Total inventories up 11%, total sales up 2.4% at year end.  With a negative comp headwind, inventory pressure is likely to persist through the first half of the year leaving little chance for margin expansion.  From a timing perspective, this then rolls into the second half of the year which is the most uncertain time from an inflation and price elasticity standpoint.
  • The current four point plan aimed at fixing the US business is centered on price leadership, broad assortments, improved remodels, and focus on multi-channel.  None of this is revolutionary, but rather basic blocking and tackling.  Details surrounding these plans are also scant, at least as of 4Q reporting.  The first point of the plan is most telling however.  In order to maintain price leadership in a the wake of rising costs, we suspect WMT will be as aggressive as ever to protect its market share.  At best, this caps margin improvement in the near to intermediate term.
  • The company's $1bn cut in capex is a fcf positive for the year. But a company with this magnitude of challenges on the top line and margin equation banking on to cost cutting and financial engineering to drive cash flow is a concern for us.  



The Bloomberg Weekly Consumer Comfort Index has just hit the tape and reveals some interesting takeaways on the state of the consumer for the week ended March 20.


The Bloomberg Consumer Comfort Index is not a metric that I have written about at length in the past but the granular nature in which the findings of the survey is presented allows us to gain some valuable insights into sub-trends in the economy. 


Overall, the Index declined to -48.9 for the week ended 3/20 versus -48.5 for the week prior.  Hardly a momentous decline, but a decline nonetheless.  More narrowly, respondents’ view on the state of the economy went from -80.3 to -86 week-over-week.   Personal Finances and Buying Climate were two topics that drew sequential improvements in respondents’ perception of each subject; however, both have deteriorated significantly from five weeks ago.


Segmenting the data by age, as expected, 18-34 year-olds showed the worst week-over-week decline in sentiment on the state of the nation’s economy.   Additionally, it is worth noting that over the past five weeks, 18-34 year-olds’ sentiment has declined rapidly, from -35.7 for the week ended 2/13 to -57.3 for the week ended 3/20. 


Filtering the findings of the survey by income, the only brackets that saw a week-over-week improvement in the index were the $15k to $24.9k and the $40k to $49.9k groups.  All other groups saw a decline, with the $75k to $99k seeing the sharpest decline at -35.6 versus -27.6 for the week prior.


By region, the MidWest was the only area of the country that saw a sequential improvement in the CCI on a week-over-week basis.  The NorthEast saw the steepest decline from 3/13 to 3/20, coming in at -50.5 from -45.6.


The Polarization Index, which represents the difference between Democrats and Republicans, expanded to -7.9 from -3.9 for the week prior.  The larger the absolute figure, the greater the divergence in confidence.  For Republicans and Independents, the most recent week saw a sequential improvement in the CCI, while Democrats’ reading declined.


A summary of the key takeaways from the Bloomberg Weekly Consumer Comfort Index is as follows:

  • 18-34 year olds have become far less optimistic, relative to other age groups, of late.  Joblessness continues to be an issue for this age cohort and compounding stress factors such as high personal debt levels and the general societal malaise in the United States today further drag on sentiment among young adults.
  • Overall, political sentiment has declined for GOP, Democrat, and Independent voters over the last five weeks.  Heightened concerns about government balance sheets, foreign policy, and a dearth of leaders stepping up to the plate for the GOP presidential nominations may be contributing to this trend.
  • Lastly, if you are single or divorced, you registered as being more positive for the week ended 3/20 than you did the week prior.  The married among us, however, saw their sentiment decline week-over-week!

Howard Penney

Managing Director


CONSUMER UPDATE - weekly cons comf

Range Rover: SP500 Levels, Refreshed



I should have covered my SP500 short position on yesterday’s test of the 1 range. Should-haves are a poor hockey player’s excuse for staring down at the puck. I should not have had my head down when in Big Alberta’s trolley tracks…


With month and quarter end coming up (next week), there’s no reason why the bulls won’t do their best to defend the bottom end of this market’s newly established trading range. For both our TRADE and TREND durations, I see those ranges as follows: 

  1. Immediate-term TRADE = 1
  2. Intermediate-term TREND = 1 

One of the key reasons for the sustainability of this one-week rally from immediate-term TRADE oversold lows is that the VIX has backed off its long-term TAIL line of 22.03. The inverse relationship between the VIX and SP500 remains critical to respect. Currently, intermediate-term TREND support for the VIX holding around the 18 level keeps the intermediate-term TREND of lower-highs for the SP500 intact.


On a breakout above 1308, I’ll wait and watch to short the SP500 again at 1315-ish. Otherwise, I’m waiting for another Short Covering Opportunity at 1281. Manage your risk around the ranges.



Keith R. McCullough
Chief Executive Officer


Range Rover: SP500 Levels, Refreshed - 1

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