“Let him that would move the world, first move himself.”


Working closely with a European over the past year has been a learning experience for me.  Europe’s history has always been fascinating, of course, but the future of Europe is now highly topical as uncertainty mounts and political turmoil seems more and more likely to cross the Mediterranean and bring tectonic shifts in the power structure of the continent.  Having a European on the team helps me to get a different perspective on events over there.  It’s been educational!


One small thing I’ve realized is that European names often sound far more grandiose than the names I grew up around.  For instance, economist and former president of the Deutsche Bundesbank, Axel Weber, does not sound like a man you’d want to mess with.  The time has come for Portugal’s travails to garner some media attention and, with it, another interesting name has been brought to my attention.  Jose Socrates.


While I have a firm interest in politics in this Republic, and therefore have a passing interest in the origins of Western philosophy, I must confess that my weekend reading list is not heavily weighted towards political philosophy.  In yesterday’s Early Look, Keith referenced the Portuguese Prime Minister Jose Socrates, and his recent decision to step down.  Relative to some of his fellow eurocrats, Socrates showed a degree of humility in tendering his resignation this week in light of the escalating sovereign debt issues in Portugal. 


His namesake that lived in Athens over 2,400 years ago was tried and killed for disrespecting the gods and corrupting the youth of Athens.  Rather than plea for his life and compromise principles he held dear, Socrates accepted the death that preceded his death as part of the social contract between himself and society.  He refused, as a matter of principle, to pursue conventional politics.  In fact, in The Apology, he is depicted as an individual that took pride in distancing himself from public office, reflecting that he was “really too honest a man to be a politician and live”.  As the quote at the head of this Early Look indicates, Socrates’ view was that people should adjust themselves, and their views, to fit the world and its realities.  Clearly this is not a tenet that has been held by many politicians, in 400 B.C. or 2011 A.D.!  It seems that Keith, in his disapproval of Professional Politicians, is in good company.


We do not see 2011 as the year opacity died in Washington D.C.  It will likely survive as long as this Union does.  However, we are aware of the increasing premium Americans are placing on transparency, accountability, and trust.  Twitter, YouTube, and the general proliferation of easy-access information – and the thirst for it – underline this trend.  As a sanity check, simply observe the steady decline of self-professed leaders stepping into the political arena.  Transparency separates the boys from the men, the principled from the corrupt, and the industrious from the idle.  We believe demand-driven transparency is coming to America in a big way.  It is no longer a choice of politicians and public figures to be forthright or not; individuals are demanding it.  That was our call when we opened the doors at Hedgeye in 2008, and it remains our call today.


Being cognizant of the fact that our role is to help our clients make money and, more importantly, not lose any, I have applied the Socratic Method in consulting some colleagues about some of their best fundamental ideas.  The Socratic Method searches for general, commonly held truths that shape opinion, and scrutinizes them to determine their consistency with other beliefs. 


This Method rhymes with our modus operandi at Hedgeye: upon gaining conviction in a fundamental thesis, each vertical filters the idea through our Macro process in order for the idea to ultimately become a call we communicate to clients of the firm.  Below, I outline some broad parameters impacting our current investment approach from a fundamental perspective:

  • Job creation is a net positive, but too slow for a real robust recovery
  • Inflation is real, despite what Bernanke and everyone who is long oil/energy tells us (bullish on oil)
  • Government support for consumer income will diminish beginning 2Q11 (short large, cumbersome consumer businesses)
  • Focus on some basic consumer services that are less discretionary (eating out and/or dental needs)
  • Think local – what can consumers do to entertain themselves while not driving too far (casual dining/regional gaming)

Here are some ideas from the research team using me as a filter, with one caveat -- Keith has not signed off on them with his quantitative models as a long or short.  The ideas would all fit in the intermediate term TREND duration:


Financials: Today at 11am we are rolling out a Hedgeye Black Book highlighting TCF Financial (TCB) as a SHORT.  Our horizon for TCB is over the next 2-3 quarters.  Our Financials team’s core thesis is that the street is underestimating credit losses in the consumer loan book at TCB.  We think there’s downside of 20% over 6-9 months.


Energy: Long SUNCOR Energy (SU). As global geo-political tensions mount, particularly in the Middle East where nearly 60% of the world’s proven reserves lie buried, oil deposits in low political risk countries as Canada are increasingly more valuable.  Our favorite among these attractive Canadian Oil Sands companies is Suncor (SU) which has no exploratory risk; price and operating leverage are strong tailwinds. We consider it cheap with more upside potential than downside risk; SU is underpriced in the market by ~20%. With Brent crude oil at ~$115/bbl and SU 87% oil weighted, price momentum is a strong tailwind, as SU has a 0.69 positive correlation with Brent.


Gaming: This was a difficult choice given the group’s recent performance.  The Gaming team has been very positive on IGT but could not go with name today given the +5.04% move yesterday.  I like the Ameristar Casino (ASCA) story.  ASCA is a best in class operator that should be able to beat the quarter.  The MACRO environment is stable relative to other gaming operators, the company has easy comparisons, and the FCF yield offers some downside protection.


Restaurants: I continue to be positive on SBUX, but I’m going with Brinker International (EAT).  I recently met with management in a market where the company has recently 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.”  Like our Gaming, Lodging and Leisure team’s view of ASCA, I think the earnings estimates are low for the current quarter.  I still like the SHORT side of MCD, and we are currently short that stock in the Hedgeye Virtual Portfolio.


Retail: One name that has been in and out of the Hedgeye Virtual Portfolio and a high-conviction SHORT is Carters (CRI).  What we see, that the street does not, is that margins will unravel by 400bps in 2011.  The retail team posted a note on 9/16/10 with the title “CRI: One of the Worst Stories in Retail.”  Now that is conviction.  Other SHORT names to consider are J.C. Penney (JCP) and Wal-Mart (WMT).


Healthcare - I’m going with DENTSPLY International (XRAY).  The Hedgeye Healthcare team has been conducting a series of calls with dentists focusing on our MACRO survey work.  The bottom line is that our demand model is forecasting rising visit volume, driven by per capita visits by age and employment status.   In FY 2011, our model suggested some improvement in US patient visits and we assumed some improvement in mix from patients signing on to “treatment plans” that dentists are selling (this is consistent with what dentists are suggesting in our calls).  EPS growth should accelerate in FY2011 as the US market improves, particularly in the second half as employment gains among younger workers accelerates.      Another long in the Healthcare space is Baxter (BAX).  BAX is insulated from much of the global macro turmoil as their IVIG business returns to price and volume growth, but it is less interesting at these levels based on our fundamental factor screens.  I would defer to Keith as to what he thinks might be a good entry point.  The fundamentals suggest the stock is in need of a catalyst or a pullback.  Lastly, their Japan exposure is not insignificant.


I apologize for the longevity of this Early Look.  I’ll leave you with some parting words from the Athenian Socrates ahead of the weekend:  “Enjoy yourself -- it’s later than you think”.


Function in disaster; finish in style,


Howard Penney

Rory Green






TODAY’S S&P 500 SET-UP - March 25, 2011

The tone coming from the European and Asian markets are leading the US futures higher.  As we look at today’s set up for the S&P 500, the range is 30 points or -1.73% downside to 1287 and 0.56% upside to 1317.




As of the close yesterday we have 4 of 9 sectors positive on TRADE and 9 of 9 sectors positive on TREND. 

  • One day: Dow +0.70%, S&P +0.93%, Nasdaq +1.41%, Russell 2000 +0.72%
  • Month-to-date: Dow (0.46%), S&P (1.32%), Nasdaq (1.65%), Russell (0.77%)
  • Quarter/Year-to-date: Dow +5.12%, S&P +4.14%, Nasdaq +3.15%, Russell +4.27%
  • Sector Performance: - Tech +1.56%, Consumer Disc +1.47%, Healthcare +1.18%, Industrials +1.04%, Consumer Spls +0.92%, Financials +0.49%, Materials +0.44%, Utilities +0.42%, Energy +0.36%


  • ADVANCE/DECLINE LINE: 937 (+634)  
  • VOLUME: NYSE 870.60 (-0.91%)
  • VIX:  18.00 -6.10% YTD PERFORMANCE: +1.41%
  • SPX PUT/CALL RATIO: 2.23 from 1.40 (+59.41%)


Treasuries were weaker for a sixth consecutive session despite significant MACRO headwinds.

  • TED SPREAD: 23.55 + 0.101 (0.432%)
  • 3-MONTH T-BILL YIELD: 0.09%
  • 10-Year: 3.42 from 3.36
  • YIELD CURVE: 2.70 from 2.66


  • 7:30 a.m.: Fed’s Fisher speaks in Brussels (also at 1 p.m.)
  • 8:30 a.m.: Fed’s Evans speaks to reporters at Chicago Fed
  • 8:30 a.m.: GDP, est. QoQ 3.0%, prior 2.8%
  • 9:15 a.m.: Fed’s Lockhart speaks on economy in Fla.
  • 9:55 a.m.: UMich Confidence
  • 12 noon: Annual revisions: Industrial Production
  • 12:15 p.m.: Fed’s Plosser speaks on monetary policy


  • Reactor core may be breached at damaged Fukushima power plant
  • NATO to take command of no-fly zone in Libya
  • Oracle rises in late trading after forecasting fourth- quarter earnings that beat estimates
  • Quarterly estimate of hog inventories from Department of Agriculture
  • RIM falls 13% in late trading after forecasting first- quarter earnings that missed estimates
  • VIX has dropped for six straight days


  • CRB: 358.48 +0.41% YTD: +7.72%  
  • Oil: 105.60 -0.14%; YTD: +13.03% (trading +0.15% in the AM)
  • COPPER: 442.45 -0.09%; YTD: -0.36% (trading -0.01% in the AM)  
  • GOLD: 1,433.60 -0.29%; YTD: +1.03% (trading +0.05% in the AM)  


  • Pork Rally Fails to Spur Expansion at U.S. Hog Farms After Feed Costs Gain
  • Cows in Japan Barred From Grazing as Radiation Leaks From Fukushima Plant
  • Russia Says Won’t Lift Grain Export Embargo Until After Harvest is Reaped
  • Wheat Climbs on ‘Surprise’ Purchases From China, Concern Over Dry Weather
  • Pan Pacific Copper Will Restart Hitachi Refinery Hurt by Quake Next Month
  • Oil Trades Near Two-Day High on Libya Conflict; JPMorgan Raises Forecast
  • Beef Imports by Japan Set to Climb as Food Radiation Risk Roils Consumers
  • Palm Oil Set for Weekly Decline as Malaysian Exports Drop, Inventory Gains
  • Gold May Climb to Record for Second Day as Silver Trades Near 31-Year High
  • Coffee Exports From Vietnam Pegged at 150,000 Tons in March, Agency Says
  • Copper May Drop, Paring Weekly Advance, on Concern About Recovery's Pace
  • Coal May Advance on Rising Trend Channel, Fibonacci: Technical Analysis
  • Rice Exports From Vietnam Forecast at 650,000 Tons in March, Agency Says
  • Gold May Advance Next Week on Libya, Europe Debt Concern, Survey Shows


  • EURO: 1.4188 +0.45% (trading -0.11%% in the AM)
  • DOLLAR: 75.656 -0.18% (trading +0.21% in the AM) 


European markets continue to trade higher; EU leaders agreeing the EuroZone bailout fund needed to throw more good money after bad.  Today’s notable stand outs are Greece trading up over 2% and Italy slightly lower.  The Ifo institute said its  business climate index declined to 111.1 from 111.3 in February, which was the highest reading since records for a reunified Germany began in 1991.


MACRO: France Q4 GDP +0.4% vs preliminary +0.3%; Germany Feb Import Prices +11.9% vs consensus +11.7% and prior +11.8% and France Mar Consumer Confidence 83 vs consensus 84 and prior 85

  • United Kingdom: +0.63%
  • Germany: +0.68%
  • France: +0.36%
  • Spain: +0.28%
  • Greece +2.13%
  • Italy: -0.07%


Most Asian market traded higher, with the exception of Vietnam and Indonesia down -0.78% and -0.13%, respectively. 


MACRO: Japan February core CPI (0.3%) y/y, matching expectations; Tokyo March core CPI (0.3%) vs (0.4%) consensus and February corporate services price index (1.0%) y/y vs consensus (1.2%).

  • Japan: +1.07%
  • Hang Seng: +1.06%
  • Australia +0.91%
  • China: +1.06%
  • India: +2.53%
  • Taiwan: +0.40%
  • South Korea +0.85%

Howard Penney

Managing Director




The Macau Metro Monitor, March 25, 2011



MBS's 1st gambling debt lawsuit against Singaporean Lester Ong Boon Lin may be headed for trial after the High Court ruled Ong can argue his case.  MBS first filed its writ of summons against Ong in October 2010.  Ong allegedly owes MBS more than S$240,800.  Ong claims the debt is null and void because he wasn't a premium player when the casino extended credit to him.  But MBS argues that under Singapore gaming laws, Mr Ong remains qualified as a premium player for one year until April 30, or until MBS closes his deposit account.  Media reports say Ong's father, the owner of a famous nasi lemak business, had lost S$1.8MM in gambling.



Stanley Ho's 4th wife, Angela Leong, has increased her stake in SJM Holdings Ltd. from 8% to 11%.  This is part of the settlement ending the Ho dispute.

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CHART OF THE DAY: Professional Politicians - Inspiring Distrust



CHART OF THE DAY: Professional Politicians - Inspiring Distrust -  chart


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

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