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KONA - GAIN ALPHA ON THE KONAVORE DIET

The last time I visited the KONA story, management was involved in a proxy fight with one of their largest shareholders, creating a big distraction for the entire enterprise.  While the shareholder is still one of the top holders of the stock, the dispute has, by and large, dissipated and management is now freed up to dedicate 100% of its attention on executing its business plan and generating shareholder value.  With the stock having treaded water for much of the past twelve months and the future looking brighter, I decided it is time to revisit this name once again.

 

Our bullish thesis on the KONA is rests on four pillars:

 

  1. KONA is relatively well-positioned at this juncture because, as a higher-end concept, its core customer is demonstrating a propensity to spend over the past few quarters as our High-Low society sustains itself.
  2. We estimate that comparable restaurant sales are trending at approximately 4% in 1Q11, bringing the two-year average trend to 0.8% for the quarter.  We expect acceleration in two-year average trends for the balance of 2011.
  3. Operational improvements, coupled with improving top-line trends, will allow for significant margin improvements over the next two years.
  4. In 2011, KONA will print its first profitable quarter since it became a public company.

 

I expect operational improvements implemented in 2010 to begin to flow through in 2011, along with the benefit of additional efficiency-orientated measures taken during the year.   These initiatives include phase four of the menu evolution and the benefit of five new remodels.  In addition, reduced litigation expenses will provide a $0.04-$0.05 tailwind for the company in 2011.

 

Longer-term , over the next two years, KONA will see a significant step up in profitability and also be re-accelerating unit growth, leading to improved shareholder confidence and a higher valuation.  Based on our 2011 EBITDA estimate of $7.2 million, KONA is trading at 6.0x EV/EBITDA, as compared to the average casual dining company trading at 7.0x.  Over the next two years, we estimate that KONA will grow EBITDA over 100% and potentially earn as much as $0.25 in 2012.  Based on the price of the stock today, assuming a 7x multiple on our 2012 EBITDA estimate, KONA is worth between $7.50 and $8.00, up over 55% from current levels.

 

SAME-STORE SALES TRENDS

 

KONA entered 2011 with some strong top-line momentum; posting a 6.4% increase in same-store sales in 4Q10, up 6.4% sequentially (4Q was the fourth consecutive quarter of positive traffic trends).   The top-line story for KONA has breadth and depth.  While the company does not report monthly comparable restaurant sales comps for all three months of the quarter, management stated in the transcript that approximately 75% of the comparable base of restaurants is expected to report positive comparable restaurant sales growth this quarter, with many reporting double-digit growth.

 

The increased momentum toward the end of 2010 was driven by menu improvement and new marketing initiatives driving awareness, increasing guest frequency and marginally boosting average check.  Currently, they are running 1.7% menu pricing, and will see an uptick in menu prices when the new sushi menu is rolled out in 2Q11.  We expect that KONA can maintain 4% same-store sales in 1Q11 and produce mid-single digit same-store sales for the balance of 2011.

 

MARGIN TRENDS

 

As with most restaurant companies today, food inflation is the most concerning issue.  In 4Q11, cost of sales increased to 28.4% (up from 26.2% last year) and will be at that same level for 1Q11, according to current guidance.  KONA is experiencing significant year-over-year increases for beef, chicken and seafood.  Half of the 220 basis point increase was due to higher commodity prices and the other half was driven by upgrading the quality of ingredients.  In early January, KONA began to contract for certain commodities for 2011, but no contracts are available for certain seafood products. 

Off-setting the some of the food inflation in 4Q10 was lower labor costs.  In 4Q10, labor expenses decreased to 34.8%, as a percentage of sales, from 36.9% last year.  The lower labor cost is attributable to the leveraging of fixed management wages, hourly labor and benefit costs from the 6.4% increase in comp sales.   Going forward, labor costs should continue to improve incrementally as the company gains leverage from improving comparable-restaurant sales.

 

Restaurant operating expenses decreased to 16.7%, as a percentage of sales, in 4Q11 from 17.9% last year; lower operating expense is primarily due to lower repair and maintenance expenses and leverage over higher volumes. Looking out to 2011, KONA will see restaurant operating expenses around 15% of sales, down from 16% in 2010.  Occupancy expenses decreased to 8.0%, as a percentage of sales, during the fourth quarter from 8.7% last year.  KONA continues to try to squeeze landlords for abatements and rent reductions at certain lower volume restaurants.  All in, restaurant operating profit margin was 12.0% in 4Q10 compared to 10.3% last and for the full year.

 

The G&A line is an area KONA can continue to target for improvements in 2011.  In 4Q10, G&A declined $446,000 year-over-year, primarily due to a reduction in severance and legal fees partially offset by an increase in bonuses.  As a percentage of sales, G&A decreased 300 basis points to 7.3% of sales versus 10.3% last year.   In 2011 G&A should be roughly $7-$8m, or around 7% of sales.

 

KONA’s balance sheet is in great condition and the company around $2.0 million in free cash flow in 2011.  Unhampered by shareholder issues or balance sheet concerns, the focus is now on store-level execution and returning to profitability.  On this count, the company has initiated a plan of action that will allow for a significant improvement in profitability.  A theme that runs through all of the stocks we like on the long side is the active engagement, by management, in margin enhancement efforts despite the difficult commodity environment.  KONA is a good example of this and, we believe, represents an opportunity on the long side for investors.

 

 

KONA - GAIN ALPHA ON THE KONAVORE DIET - KONA POD

 

KONA - GAIN ALPHA ON THE KONAVORE DIET - KONA POD 2

 

KONA - GAIN ALPHA ON THE KONAVORE DIET - kona food vs alcohol

 

Howard Penney

Managing Director


Europe’s Mania Returns

Positions in Europe: Long British Pound (FXB); Short Spain (EWP)

 

What a difference a day makes!  Yesterday, European equity markets closed up between +40 to 150bps; today they’ve given back all of this gain (and more) as headline risk continues to govern market performance. Today’s European headline is very much a continuation of the discussions had over the weekend by European finance ministers, namely the prospect that Greece may need a significant restructuring of its government debt to stay “afloat”; however new statements today have sent Greek (and Portuguese) bond yields and the cost of insuring debt (sovereign CDS) to all-time highs.

 

The Greek 10YR bond yield jumped a full 30bps day-over-day to 13.2% and the yield spread over German bunds reached 984bps, a new all-time high – eclipsing even the spread in early May 2010 when the country received its €110B bailout.  Equally, Greek CDS rose 45bps d/d to an all-time high of 1105bps. The Portuguese 10YR yield continued its expedient upshot today, rising 11bps d/d to rival Ireland at 9.0%, as a bailout package (~80B EUR) for Portugal remains imminent on the backdrop of an interim government that has called new elections for June (see charts below).

 

Europe’s Mania Returns - na1

 

Europe’s Mania Returns - na2

 

The news today included interview statements made by German finance minister Wolfgang Schaeuble to the German newspaper Die Welt that investors holding Greek bonds could face losses after 2013, when the temporary bailout fund that includes Greece’s rescue package expires. Further, Greek finance minister George Papaconstantinou said Greece may be unable to return to financial markets next years. These statements come ahead of potential announcements this Friday by Greece on alternative fiscal solutions to calm investors. Looking further out, June remains an important catalyst date when both the IMF and European authorities will review Greece’s “debt sustainability”. 

 

As always, Greece remains squarely mired between debt as a % of GDP that is expected to ramp to 159% in 2012, and a target from PM Papandreou and Co. to reduce the country’s deficit from a high of 15.4% of GDP in 2009 to 3% by 2014 – which we’ll think they’ll come short of.  The government is working against €13.1 Billion in debt (principal and interest) due in the months of April and May, of the some €42.5B due this year.

 

For us, the Greek “news” comes as no surprise: we’ve long said that the Keynesian Endgame that comprises European and IMF funding and subsidization of member states through more relaxed lending requirements in order to preserve the Eurozone as an entity will not end well. In fact, these bailouts are mere band-aids to calm shorter term market fears, and ultimately fail to instill (or address) the necessary response from country leaders to tackle and set longer-term plans for fiscal and economic health. In any case, the strong equity market moves made by the peripheral countries in the beginning part of 2011 are now seeing significant mean reversion.  

 

Conclusion:  European markets will continue to be volatile as the sovereign debt contagion runs its course, which we think could take at least 3-5 years. Managing risk will be an exercise based on duration. We’re comfortable largely being out of the way of this contagion risk, though we’re presently short Spain via the etf EWP. In Europe we like countries with sober fiscal standing (Germany, Sweden, Netherlands), which we think offer an attractive growth profile coupled with a defensive stance among sovereign debt contagion across the region.

 

Matthew Hedrick

Analyst


R3: Drought, JCG, Mango, and Ferragamo

 

R3: REQUIRED RETAIL READING

April 14, 2011

  

 

OUR TAKE ON OVERNIGHT NEWS

 

Drought A Big Worry as Cotton Planting Begins - How many acres of cotton will be planted in 2011 when all is said and done? Analysts say economics and weather will play a big role. Tight supplies in old crop cotton are a bullish for new crop cotton. Fundamentals can change in a hurry. Producers should consider putting a floor under cotton prices at between $1.30 and $1.40 a pound. Cotton acreage estimates may push the markets up and down as planting season nears, but lingering dry weather across the Cotton Belt could have a much bigger impact on the market in the longer term, according to Texas A&M Extension economist John Robinson, speaking at the Ag Market Network’s April 12 teleconference.  USDA’s March 31 Prospective Plantings report was a surprise to many, projecting cotton plantings at 12.56 million acres of upland and Pima. The market reacted fairly strongly with new crop cotton prices moving to just under $1.40 per pound. Robinson thinks cotton acreage may end up a couple of percentage points higher than March projections. <DeltafarmPress>

Hedgeye Retail’s Take: Prepare for speculation about what ‘next year’s crop will be.’ Investors are absolutely fed up with the inflation debate. Actually, they view it as a fact – not a debate. But quantifying the benefit to margins if we have a bumper crop is clearly more interesting, and potentially profitable.  KEEP IN MIND, however, that changes to the crop discussed today will not impact retail margins until 2013.

 

Ferragamo Aiming for July IPO - Good things come in threes. After Prada and Moncler, speculation is mounting here that Salvatore Ferragamo is the latest Italian brand to be looking at an initial public offering by July. Prada plans to list in Hong Kong in the first half, while Moncler is expected to hold its IPO slightly earlier in Milan. A source said Ferragamo’s IPO could value the company at around 1.5 billion euros, or $2.1 billion at current exchange, compared with the larger Prada’s estimated valuation in Hong Kong of up to $9 billion. Italy’s merchant bank Mediobanca has been tapped, together with J.P. Morgan, as coordinator of Ferragamo’s global offer, joint book runner and joint lead manager, a well-placed source told WWD. These are the same two banks chosen in 2008 by the Florence-based firm, which had plans to go public that year.  <WWD>

Hedgeye Retail’s Take: Given the resilience of the luxury market in the face of such ugly Macro cross-currents over the past few years, luxury IPOs have several relatively strong legs to stand on. Sell while the going’s good…

 

A Brit in London - Burberry has brought its Burberry Brit concept onto home turf. On Friday, it will unveil a sprawling, 10,000-square-foot Burberry Brit store located in London’s bustling Covent Garden area. The store is Burberry’s seventh Brit store globally and its first in the U.K., following recent Brit openings on Bleecker Street in New York and Corso Venezia in Milan.  Christopher Bailey, chief creative officer at Burberry, described Burberry Brit as “the casual expression of the Burberry guy and girl.” To wit, although the store, which Bailey designed, is done out with Burberry’s signature dark wood floors and sleek, polished black chrome fittings, it’s filled with colorful, casual merchandise. The brand’s April Showers collection, which includes pieces such as red Perspex trenchcoats and yellow mini capes, stands near the store’s entrance, placed amid Perspex blocks in primary colors. The two-story store also has areas devoted to accessories and denim, while a room on the basement floor is given over to the label’s trenchcoats and outerwear. <WWD>

Hedgeye Retail’s Take: These mega stores have traditionally been marginally profitable at best. But for the luxury brands, they’ve actually been profit centers (note comment re Ferragamo and luxury market). We’re seeing – for the most part – rational growth in these stores, as well as rational closures when warranted (i.e. NikeTown Denver closing).

 

J Crew to Launch UK Online BusinessJ Crew, the “preppy” US retailer bought out in a $3bn private equity deal last year, is planning to launch an online business in the UK’s high-end fashion market this summer, its chief executive has said. Mickey Drexler, J Crew’s head and one of the most renowned personalities in US fashion retail, said the group would use its online business to spearhead its overseas expansion ahead of opening more bricks-and-mortar stores. Mr Drexler successfully repositioned J Crew as an up-market brand, but until now he has maintained a narrow focus on the US market. He will join a growing band of fashion retailers using the internet to lead expansion outside their home markets. “We just have huge demand overseas,” Mr Drexler told Bloomberg TV. “We’re walking, we’re studying right now. But we launch in the UK . . . in August or September. That’s kind of our official online international.” <FinancialTimes>

Hedgeye Retail’s Take:  The interesting angle is that J Crew is rolling into a new market without having legacy infrastructure as baggage. Do not underestimate the importance of this! Growth into new markets without the hassle of an antiquated operating asset base is extremely high return.  We think this will come at a premium going forward.

 

Retail Restructuring Seen Ahead - Retail will be a primary source of restructuring activity for the next 18 months, if not longer.  That’s the conclusion of Durc Savini, managing director and head of the restructuring and recapitalization group at investment bank Peter J. Solomon Co., which held a company presentation Wednesday on “2011 Retail Restructurings: Watch Hemlines, Hardlines and Waistlines” at New York’s Princeton Club. Other presenters included Kenneth Berliner, president and head of the mergers and acquisitions group, and managing directors Jeffrey Derman and Jeffrey Hornstein. Savini told attendees that the largest segment of firms with risky credit ratings — 18 percent — are apparel and retail companies. Those limited by lack of financial strength or low pricing power are the ones that will be facing tough headwinds, he said.  <WWD>

Hedgeye Retail’s Take: Hmmm… The head of a retail restructuring Firm talking up that restructurings will pick up meaningfully over the next 18-months. Do you think that just MAYBE he’s a little biased? Nonetheless, given the 400+bp margin compression we expect to see this year – and specifically in 2H – he’s probably right.

 

Mango Planning Large-Scale Global Expansion - Coming off a 10.9 percent sales increase in 2010, Mango is planning to add another 550 stores to its global portfolio this year, including entries in six new markets that will give it a presence in 109 countries.  Through its own network and those of franchisees, the Barcelona-based retail and wholesale firm added 380 stores last year, lifting its total to more than 2,000. Included in the total store count are 113 units under its H.E. by Mango men’s wear banner, 39 of which are in Spain. Among the 550 stores to be added this year are 20 men’s stores. The company said that it eventually expects to have 500 H.E. by Mango stores.  In 2010, Mango’s revenues grew to 1.27 billion euros, or $1.68 billion, from 1.15 billion euros, or $1.6 billion, in 2009. These figures, converted from the euro at average exchange for their respective periods, represent both wholesale revenues and sales of company-owned stores, excluding value-added taxes.  <WWD>

Hedgeye Retail’s Take: Check these guys out. When people are hitting the conference circuit and doing their super-duper-double-secret one-on-ones, they’re focused on the typical US (used to be) growth companies.  

 

R3: Drought, JCG, Mango, and Ferragamo - R3 4 14 11

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 


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THE MGM ROLLERCOASTER

It’s up, it’s down, it’s up again.  Here’s a playbook for what promises to be a volatile month of trading.

 

 

What do you get when you mix high short interest, high leverage (operating and financial), transactions, depressed earnings, and a big valuation?  If you guessed stability, you lose! 

 

MGM will likely report earnings the first week of May.  We think it will be just ok.  Expectations seem to be pretty high though, particularly given the Street’s rate surveys and management’s RevPAR commentary.  We have little doubt that strong YoY convention activity drove rates meaningfully higher in Q1 but our concern is more on the casino side.  Street projections of mid-single digit growth in MGM’s Las Vegas casino revenue looks aggressive to us. 

 

Having said that, we are not too much below the Street for wholly owned Las Vegas EBITDA.  Our Q1 estimate is $225 million versus the Street around $235 million.  Whisper expectations may be higher and that is why we are concerned.  We will have a more detailed earnings preview out soon.

 

So stock is going down right?  Not so fast.  MGM Macau is humming and yesterday’s IPO announcement and deal with Pansy Ho is an overall positive.  Operating control should be good for MGM and good for the property.  Moreover, WYNN should report before MGM and we are expecting a huge quarter out of Wynn/Encore Las Vegas.  That should get investors juiced for MGM, given its significant Strip exposure.  However, we think WYNN will be the Vegas anomaly and MGM’s results may disappoint.


QE2 ENDING WILL RIPPLE THROUGH BOTH CLAIMS AND THE MARKET

QE, Claims, and the Market

Inspired by a chart our macro team published last week showing Fed Treasury purchases and commodity prices, we show the impact of the Fed's Treasury and MBS purchases on the S&P and on claims.  We observe in the charts below that the three series move in tandem.  We see two plausible interpretations of this data.

 

1) Quantitative Easing drives claims down, which fuels an increase in the market.

2) Quantitative Easing drives the market higher, which decreases claims.

 

Regardless of which interpretation of this data you subscribe to, the reality is that QE2 ends in June, which cuts off this process at the source. The data suggests that in the absence of Fed purchases, the market and claims tread water or deteriorate. For this reason primarily, we are cautious on the Financials space overall heading into the summer months.

 

QE2 ENDING WILL RIPPLE THROUGH BOTH CLAIMS AND THE MARKET - Fed

 

QE2 ENDING WILL RIPPLE THROUGH BOTH CLAIMS AND THE MARKET - S P

 

QE2 ENDING WILL RIPPLE THROUGH BOTH CLAIMS AND THE MARKET - S P and Fed 

 

Initial claims rose 30k last week (27k after the upward revision to last week's preliminary report).  This pushes claims back above the threshold of 400k that we watch as the trigger level for unemployment to fall.  Rolling claims rose 6.25k to 395.75k. 

 

QE2 ENDING WILL RIPPLE THROUGH BOTH CLAIMS AND THE MARKET - raw claims

 

QE2 ENDING WILL RIPPLE THROUGH BOTH CLAIMS AND THE MARKET - raw raw

 

The Bureau of Labor Statistics noted that the week following the end of a quarter usually sees an increase in claims.  The week after the end of each quarter is marked with a white arrow in the chart below.  Clearly, there is a seasonal pattern here.  Last week, claims increased by more than the typical seasonal amount, which flowed through into the seasonally adjusted numbers and drove the 30k increase.

 

QE2 ENDING WILL RIPPLE THROUGH BOTH CLAIMS AND THE MARKET - NSA

 

Yield Curve Remains Wide

We chart the 2-10 spread as a proxy for NIM. Thus far the spread in 2Q is tracking 4 bps tighter than 1Q.  The current level of 273 bps is slightly tighter than last week (276 bps).

 

QE2 ENDING WILL RIPPLE THROUGH BOTH CLAIMS AND THE MARKET - 2 10

 

QE2 ENDING WILL RIPPLE THROUGH BOTH CLAIMS AND THE MARKET - 2 10 QoQ

 

Financial Subsector Performance

The table below shows the stock performance of each Financial subsector over four durations. 

 

QE2 ENDING WILL RIPPLE THROUGH BOTH CLAIMS AND THE MARKET - subsector perf

 

 

 

Joshua Steiner, CFA

 

Allison Kaptur


THE M3: 1Q S'PORE GDP; CAP ON LABOUR GROWTH; SMOKING BILL; TOUR/HOTEL STATS; NORTH KOREA CASINO

The Macau Metro Monitor, April 14, 2011

 

 

S'PORE ECONOMY CONTINUES TO GROW Channel News Asia, Strait Times

Singapore 1Q GDP rose 8.5% YoY, beating estimates of 5.7% growth. On a seasonally-adjusted, annualized basis, the economy grew by 23.5% QoQ.  The Ministry of Trade and Industry said the strong growth was driven by the manufacturing sector, particularly in the electronics and precision engineering clusters, which benefited from a pick up in business investment in the region.  Meanwhile, the Monetary Authority of Singapore (MAS) said that economic activity is likely to be sustained at a high level for the rest of the year even with inflation concerns.  To combat inflation, MAS said the exchange rate policy band will be re-centered below the prevailing level of the SGD/USD, which suggests a higher S'pore $.

 

LABOUR FORCE TO GROW BELOW 10 PERCENT YEARLY: GOVT macaubusiness.com

According to Secretary Tam, the overall total labour force (including imported labour) must not increase by more than 10% per year.  The restrictions are needed due to “concerns over the use of social resources”.  Macau’s current unemployment rate is below 3%, with the Monetary Authority saying that the territory has already achieved full employment.
 

INDOOR SMOKING BILL PREPARED FOR FINAL VOTE Macau Daily TImes

The smoking bill is ready for final reading even though the issue of whether to exempt casinos from the smoking ban is still not fully resolved.  Nonetheless, it’s likely the law will be approved.  There is no date set for the vote.


PACKAGE TOURS AND HOTEL OCCUPANCY RATE FOR FEBRUARY 2011 DSEC

Visitor arrivals in package tours increased slightly by 0.5% YoY to 466,843 in February 2011. Visitors from Mainland China (332,349), Hong Kong (19,880), Japan (19,453) and Malaysia (9,191) decreased by 1.2%, 1.5%, 11.4% and 9.0%, respectively.  Visitors from Republic of Korea (25,596); Taiwan (24,895) and India (8,374) increased by 85.0%; 16.0% and 61.2% respectively.

 

Total number of available guest rooms of the hotels and guest-houses increased by 1,146 (+6.1%) YoY to 20,083 rooms.  Hotels and guest-houses received 600,248 guests in February 2011, +3.7% YoY, with the majority coming from Mainland China (55.1% of total) and Hong Kong (18.8%).

 

MOUNT KUMGANG MULLS OPENING CASINO TO LURE MAINLAND TOURISTS Macau Daily News

After the exclusive operation right of a casino granted to Hyundai Corporation in Mount Kumgang was terminated, North Korea plans to set up a casino to lure Chinese tourists. Currently, there is only one casino in the country located in Rason, which is exclusively open to foreigners.  The Chinese government has previously banned residents from going to Rason’s casino.  The feasibility of a casino in Mount Kumgang remains uncertain.


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