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BWLD put together a rare quarter for the restaurant industry, with food costs declining and same-store sales accelerating.  From a ROI perspective, management continues to alter the store base to improve performance by closing underperforming stores.  It was very difficult to poke holes in this quarter.


Buffalo Wild Wings announced earnings of $0.81 versus the street at $0.73.  Company same-store sales came in at +3.9%, which implies an 80 basis point sequential acceleration in two-year average trends.   Franchise same-store sales grew +1.6% in the first quarter which implies a sequential acceleration in two-year average trends of 70 basis points.  Consensus was expecting comps at 3.4% and 1.8% for company and franchise restaurants, respectively.  Net earnings grew by 40% year-over-year, far in excess of the annual guidance  of 18%.


Same-store sales


BWLD – HOT QUARTER - bwld pod 1


As discussed above, comps were impressive for the first quarter of the year and I would expect same-store sales to remain strong in 2Q.  As the chart above shows, 2Q is a relatively easy comparison on a year-over-year basis.  For 1Q, the company stated that there was 2.4% of price on the menu during the first quarter.  Management stated on the earnings call that same-store sales for company restaurants during the first four weeks of April were tracking at +5.3% versus -3.7% during the same period of 2010.  While this is encouraging, it is important to remember that the early part of 2Q10 was a low point, and the intra-quarter comparisons become more difficult as we begin to lap the World Cup.  On a year-over-year basis, April comparable restaurant sales growth included 1.9% of price. 


The limited-time offers, including burgers, that the company promoted during the quarter proved popular with customers.  A new menu, rolled out during the quarter, also helped drive sales as management noted increased popularity for several new products and sauces recently released.    


Management engaged NFL fans as the “NFL Pick ‘Em” promotion winners received a trip to the Rose Bowl.  Another initiative that helped to capture attention for BWLD was the petition the company formed to encourage owners and players to reach an agreement and save the fall football season.  Basketball fans were also engaged with heightened media presence during the NCAA basketball season.  BWLD occupied T.V. spots during every NCAA men’s championship game on CBS including the championship game on April 4th. 


Average weekly sales growth for 1Q11 grew by 7.8% year-over-year at company restaurants versus same-store sales of 3.9%.  150 basis points of that outperformance was attributed to the closure of lower-volume restaurants while the remaining 240 basis points, according to management, was due to “quality operations” in the new 2010 and 2011 company owned units. 


Operating Margins


BWLD – HOT QUARTER - bwld pod2


From an operating margin perspective, BWLD had a fantastic quarter.  As the chart above illustrates, restaurant operating margins two-year trends improved 120 basis points.  Much of this was due to the deflation in chicken wing prices as well as moderate year-over-year gains (in percent-of-sales terms) in Operating and Occupancy expenses.  Chicken wing prices for the quarter were $1.22 per pound, down 36% from the average price of $1.91 during 1Q10.  From a cost-of-sales perspective, the outlook for chicken wing prices appears favorable for – in all probability – the remainder of the years.  The boneless wing contract has been extended through March 2012.


BWLD – HOT QUARTER - chicken wing prices 426


The new menu boosted sales but, of course, came at a cost in terms of training expense.  However, despite this training expense and added investment in hourly labor to drive improve guest service during lunch and happy-hour, leveraging sales growth and management wages enabled the company to keep labor expenses as a percentage of sales flat year-over-year.  



Management struck a confident tone on the call and, given the performance in 1Q and the favorable post-market reaction in the stock, it is no surprise.  Clearly, the prospect of losing any of the NFL season is a threat to BWLD’s profitability.  However, management emphasized that the 18% growth is achievable even if part of the NFL season is lost.  New markets, most notably California, are performing well and there seems to be ample runway for unit growth to continue.   The company’s cash balance is currently at $91.3 million versus $71.2 million but the company remains conservative on the topic of returning capital to shareholders.  Capex spending in the first quarter was a mere $18.7 million.  For the year, capex is due to total $120-125 million ($100m new company restaurants, $17m remodels, and $6m maintenance capex).   Lastly, the company is guiding to a 34% tax rate for 2011. 



Howard Penney

Managing Director


MCD was covered yesterday in the Hedgeye Virtual Portfolio.  Although, I still remain bearish on the name for 2011.


In 1Q11, MCD continued to post industry-leading same-store sales in the U.S. (above my estimate), but now below the rate of inflation the company is experiencing.  While the company has raised prices to absorb some of the commodity inflation, there is a strong possibility this could dampen sales trends given that MCD’s U.S. comps are largely guest-count driven (influenced by significant discounting). 


Compound this scenario with the difficult year-over-year compares MCD U.S. is facing over the summer months and there is heightened risk of sales trends missing consensus in 2Q and 3Q11.  Keith covered the stock today in the Hedgeye Virtual Portfolio and the quantitative risk management set up is illustrated in the chart below.


MCD: MCD VS. YUM - mcd levls chart



One pair-trade that could be of interest if you do not agree with my fundamental thesis on MCD would be short YUM and long MCD.  The valuation spread between the two stocks is the widest it has been for some time on an EV/NTM EBITDA basis.  Additionally, it is typically MCD that has been awarded a higher cash flow multiple by the street.  As the chart below indicates, YUM is currently trading at significant premium to MCD.


YUM's premium multiple is being driven by strong trends in YUM's China division.  To the degree that YUM's +13% same-store sales in China for 1Q is not sustainable, the valuation disparity between the two name could correct.


MCD: MCD VS. YUM - mcd yum spread chart



Howard Penney

Managing Director

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“WMS’ fiscal third quarter results reflect lower-than-expected global new unit demand, unit shipments expected to be fulfilled in the March quarter not shipping until early April, and delays in the commercialization of certain new products. We’ve already begun to implement the appropriate solutions to address the root causes for the fulfillment issues and we are revising our processes for regulatory submissions to try to shorten the time frames from-concept-to-launch for our advanced technology-based new products."

- Brian R. Gamache, Chairman and Chief Executive Officer




  • “Despite the continued impact of customers’ constrained capital budgets, our strategic direction remains laser focused. We made progress on several fronts in the third quarter including further increases in sales of new units into international markets, a year-over-year increase in average selling prices and progress towards lowering the cost structure and improving the profit margin for our popular Bluebird xD™ units. We also successfully introduced several new games for our participation business that are improving the average revenue per day performance of our installed base."
  • Product sales:
    • New  units sold: 6,058
      • New units to NA: 3,720 (replacements: 3,000)
      • International: 2,338
      • "Growth in Mexico and Australia, and modest growth in Asia and Latin America more than offset lower shipments to Europe. Mechanical reel products were 21% of global new unit shipments in the March 2011 quarter"
    • ASP: $16,492
      • ASPs "rose 3%... , primarily reflecting a product sales mix that benefited from Bluebird2 and Bluebird xD premium-featured units representing 92% of total global new unit sales in the March 2011 quarter, compared to 89% in the March 2010 quarter and 96% in the December 2010 quarter. The average selling price was essentially flat on a quarterly sequential basis, representing a slightly more favorable mix of premium products offset by a greater portion of international shipments of original, lower-priced Bluebird cabinets in the March 2011 quarter."
    • Used machine sales: 2,500 (vs. 2,200 in March 2010)
    • Hardware & conversion kit sales: 2,200 (vs. 3,000 in March 2010)
      • "Other product sales revenues rose ... 12%... driven by higher revenues from low-margin used gaming machines sales, while revenues from higher-margin hardware and game conversion kit sales declined modestly year over year."
    • GM: 48.6%
      • "Reflecting the impact from the introduction this year of the Bluebird xD cabinet, more low-margin used gaming machine revenues and a declining margin achieved on the sale of such units, lower new unit sales revenue, added costs associated with customer changes to existing orders and new orders received late in the quarter, and lower revenues from high-margin conversion kit sales."
      • "Additional cost structure reductions and supply chain improvements are expected to drive higher Bluebird xD and overall product sales gross margins in the June 2011 quarter."
  • Game ops:
    • Install Base (End of period): 10,002 (average: 10,021)
      • Coin in: 3,829
      • % net win:  3,107
      • Daily lease: 3,066
      • "Installed base ... reflects a greater-than-anticipated number of conversions of existing games to newly launched participation games, which reduced the opportunity to grow the installed base. In the March 2011 quarter, WMS launched the new video THE PRICE IS RIGHT- The Ultimate Show, YAHTZEE and Attack from Mars/Revenge from Mars games, and continued the rollout of THE GODFATHER and THE WIZARD OF OZ™- THE GREAT AND POWERFUL OZ games that launched in the December 2010 quarter."
    • Average win per day: $76.14
      • Sequential 2% increase "reflecting the successful introduction of new participation games and historical seasonal influences"
    • "Other gaming operations revenues increased modestly, reflecting revenues from the start-up of the Company’s UK-based online gaming site, partially offset by a decline in royalty income as a result of WMS’ direct entry into markets previously addressed through content licenses to third parties"
    • GM: 60.7%


  • Fulfillment issues: The $8MM delay in fulfillment was due to orders received in the quarter after the cut off date as well as changes to orders late in the quarter. 
  • Believe that customers do not have the increased confidence to increase their budgets to spend on slots
  • Growth in used machine sales continues to depress their margins. 50% of these sales were WMS games. Sales of used gaming machines reduced their margins by 180 bps in the quarter.
  • Deployed 700 new units to their install base, however, most of these games replaced their existing install base games rather than grow the base, but did contribute growth in daily win per day.
  • Invested $30MM in stock repurchases
  • Collection rates remain high and default rates were 1/2 of 1%. Only 2.3% of total receivables were aged more than 90 days - more favorable than their competitors
  • Will provide more color on their F2012 on their next call
  • Portal apps were delayed from original guidance of October to April
  • Adoption of enhanced technologies can experience an extended adoption period - and so they expect the same for portal applications. Plan to maintain pricing flexibility with their earlier adopters.
  • During the last 90 days they have launched multiple games in their G+ Deluxe series - which are amongst their best performing games
  • 400,000 unique log ins have been created to date in Players Life
    • vs 250,000 on their last call 
  • Will continue to opportunistically repurchase WMS shares
  • Began marketing efforts for their UK online site


  • Sense of NA ship share?
    • 26-28% range in the quarter but wallet share was more like 30% given their higher ASP. Expect to get back to 30% ship share with their new product launches. Assume high 20s-30ish% ship share in their FY2012 guidance
      • Based on IGT's and Konami's NA units, we estimate that WMS's ship share was closer to 20%- however this is a preliminary #
  • Haven't bought any more stock since April since they have been in a quiet period
  • Pricing didn't enter into their issues in F3Q
  • Their 2012 guidance includes no new markets aside from some Italy units
  • Not giving up on their 30% operating margin goal - they just need more volume
  • Have 107k BB1's out in the field today
  • xD was just over 20% this quarter and it is still at a bit of a lower margin than the BB2 product although they closed the gap a lot. Expect to reach parity in FQ1.
  • Italy - made their initial submissions and hoping for field trial in June, which once completed will allow them to begin sales
  • R&D- they are just below the 15% mark of revenues. They are trying to manage expenses with their revenues.
  • D&A looked a little higher because they have been investing more in their install base to BB2 from BB1. So D&A will continue to be at that higher level going forward.
  • Felt that they were punished for keeping their game ops games out there too long which is why many of the new games are just replacing old games in their base. Expect a nice uptick in win per day over the next two quarters as well as some uptick in their install base.
  • Have an industry leading delivery time of just 2 weeks - which is part of the reason that they had some issues this quarter - which lead to them taking orders too late in the quarter
  • Expect growth to come from game operations, higher ship share penetration - especially internationally, and new business like portal applications and UK casino
  • Is the deployment of the Italy units contingent on a successful trial? - Yes
  • 700 new NA units include shipments to a Ocean Downs, Grand Falls, and a variety of expansions in Canada and the US
  • 25% of their game operations install base is BB2 or xD and plan to change out the rest over the next few years
  • Did not recognize Galaxy Macau in the quarter
  • Had an obsolescence plan for BB1's out there for the next few quarter. Other than that no new marketing initiatives.
  • Great and Power Oz - is doing very well for them - #s close to the original peaks they reached
  • Doesn't believe that their pricing had anything to do with what happened in the quarter

Skinning Growth’s Cat

"There's more than one way to skin a cat.”

-Mark Twain, A Connecticut Yankee, 1889


Conclusion: Though earnings season is off to a fairly healthy start, we urge substantial caution to anyone buying equities right now in hopes economic growth will rebound enough to reach the $96.92 target consensus has forecasted for 2011 S&P 500 EPS. Aided by an ailing consumer, our call for slowing US GDP growth looks firmer by the day.


Current Virtual Portfolio Positions: Growth Slows (Short: SPY, XLI, NKE, and SAM; Long: FLAT) as Inflation Accelerates (Short: ELD; Long: FXC, FXB, SU, PBR, Gold, Crude Oil, and the Chinese Yuan).


At the beginning of the year, the delta between Hedgeye estimates for the slope of domestic growth and inflation and consensus’ overly bullish forecasts for GDP and CPI were as wide as they’ve been since early 2008. Nearly four months into the year, that spread has narrowed quite substantially as the sell side has begun to capitulate on both fronts in the last several weeks.


While normally we’d look to fade sell side capitulation (i.e. get longer of risk assets), careful analysis of their collective behavior reveals that they haven’t really “capitulated” at all. In fact, the Bloomberg Consensus Real GDP Forecast has increased on a YTD basis for each of the four quarters of 2011. That’s remarkable, considering the peak-to-trough decline of the 1Q11E estimate of (-90bps)! Interestingly enough, the 4Q11E estimate has been ratcheted up alongside the 1Q11E estimate’s last leg down. Sell side forecasts for all-time high S&P 500 earnings have to be achieved somehow…


Skinning Growth’s Cat - 1


As Daryl Jones penned in a note yesterday titled: “Consensus Meets The Hedgeye: Q1 GDP Estimates In Freefall”, our conviction in the simple theme we introdued six months ago remains unshaken. That message remains: Growth Slows as Inflation Accelerates.


At the start of the year, the biggest risk to our bearish bias for US GDP growth was, in fact, improvement in employment statistics – which was to be expected, given the confluence of their traditionally lagging nature and 4Q10’s robust growth figures. As such, we’ve seen the Unemployment Rate tick down in recent months alongside recent strength in Nonfarm and Private Payrolls growth. The go-forward outlook is certainly less bullish, however, with Rolling Initial Jobless Claims now trending sideways for the eighth week in a row.


Skinning Growth’s Cat - 2


It doesn’t come as a conceptual surprise to us that employers aren’t opening up their coffers and taking on additional labor expenses as The Bernank’s Inflation continues to make higher highs in the form of some of the most expedited rallies we’ve seen across commodity markets in many years. Simply put, as input prices increase, producers are forced into pulling various operating levers to protect profit margins – an effect compounded by the certain companies’ public status (gotta meet the street’s earnings estimates somehow…).


The net result of their collective choices has been to slow hiring plans and limit wage growth; the latter is doubly affected by the former as a slack labor market limits the bargaining power of current employees for wage increases. Average Hourly Earnings growth has slowed to a +1.7% YoY growth rate in the last two months from +1.9% YoY in January.


On the hiring side, we’ve seen a similar slowdown. NFIB’s Small Business Plans To Hire Index slowed to 2 in March from 5 in February; on a 3-month moving average basis, the index slowed to 3.3 vs. 4.7 in the prior month. The ISM data points to a similar slowdown in hiring plans. Using a weighted average of the Employment subcomponents within the Manufacturing (30%) and Non-Manufacturing (70%) Reports on Business Surveys, we’ve created an index that accurately tracks Private Payrolls growth on a concurrent basis. It’s interesting to note that this index just backed off its all-time high of 58.3 in February ’11 to 56.5 in March. While, in theory, the index could continue to make higher all-time highs from here, we know that ISM readings above 60 are typically not sustained – especially when they are 1.6 standard deviations above the long run average. Thus, reversion to the mean seems likely for this series, just as slowing jobs and wage growth seems likely for the US economy.


Skinning Growth’s Cat - 3


Skinning Growth’s Cat - 4


So why is US economic growth slowing? Well, aside from Housing Headwinds, a potential currency crisis, burgeoning sovereign debt, and depressed consumer confidence stemming from natural hazards and geopolitical risk (alongside the centrally-planned fear mongering associated with crisis ZIRP), the most tangible thing we can all agree on is accelerating inflation. Whether you agree with our thesis that the uptick in inflation that continues to be reported on a global basis is a function of Burning the Buck is beside the point. Both market prices and government statistics are pointing to higher prices for global consumers.


Skinning Growth’s Cat - 5


Skinning Growth’s Cat - 6


What does that mean to consensus’ “resilient” US consumer? It means that the consumer will increasingly fill the pinch of higher prices and depressed wage growth. While members of the Keynesian Kingdom will continue to tell you that there’s no inflation if wages aren’t appreciating, we market practitioners realize the glaring lack of common sense associated with this academic fallacy. As such, we’ve taken the liberty to create alternative measures of inflation for a more useful gauge of consumer prices.


Along these lines, we’ve introduced our original Hedgeye Inflation Index last year, which simply attempts to measure the spread between what consumers buy and they earn. Since we’ve introduced the project back in early 2010, we’ve made a few additions to make it more robust, given the natural limitations associated with using the CRB Index as a proxy for consumer prices. As such, we are now equipped with the following measures of inflation:


Hedgeye Inflation Index (Original): YoY % change in CRB Index less the YoY % change in Average Hourly Earnings. We use the CRB Index as a proxy for prices here because its daily price quotation allows for a real-time, up-to-the-minute gauge of inflation.


Skinning Growth’s Cat - 7


Hedgeye Inflation CPI Index: YoY % change in Headline CPI less the YoY % change in Average Hourly Earnings. We use Headline CPI here because of its encompassing nature, particularly relative to the market prices of commodities. While the series has been repeatedly adjusted throughout history to limit COLA expenses for the federal government, we cannot deny its appeal as a broad-based, official statistic.


Skinning Growth’s Cat - 8


Hedgeye Inflation Chinese Import Prices Index: YoY % change in Chinese Import Prices less the YoY % change in Average Hourly Earnings. While the series may appear out-of-place to the naked eye, careful analysis of the products the US imports from China lend credence to this selection (ranked in order of largest to smallest): electrical machinery and equipment; power generation equipment; apparel; toys, games, and sports equipment; furniture; footwear; plastics; iron and steel; leather and travel goods; and optics and medical equipment.


Skinning Growth’s Cat - 9


Hedgeye Inflation Expectations Index: University of Michigan 1Y ahead Inflation Expectations Index less the YoY % change in Average Hourly Earnings. This derivative is designed specifically to capture the consumer’s own expectations of the spread between his income and expenses. It’s worth pointing out that the +2.9% spread (or +290bps) is the highest ever reading in this data series (starting in March ’07). The consumer knows he’s getting squeezed on the P&L.


Skinning Growth’s Cat - 10


No matter how you skin this cat, the net result is that inflation is up and to the right.


What does this all mean for consumption growth (~70% of the US economy)? Net-net, it means that the consumer has less discretionary income to spend after nondiscretionary purchases are made. As such, we’ve seen a measured slowdown in discretionary spending over the last few months as The Bernank’s Inflation started to show up measurably at the pump. We’ve taken the liberty to create an index to track consumer discretionary spending trends. Interestingly enough, growth in the Hedgeye Consumer Discretionary Spending Index has inflected in a fairly meaningful way, slowing to +1.3% YoY in February vs. its cyclical peak of +5.2% YoY in December ’10. As we receive more up-to-date data points in the coming weeks, it’s important to keep in mind that growth decelerating to below +1% YoY has proceeded the last two recessions.


Skinning Growth’s Cat - 11


All told, we maintain our bearish outlook for the slope of US growth over the intermediate-term TREND, largely due to the Consumption Cannonball, which looks to gain steam in the coming months. We underestimated the consumer’s resiliency in 4Q10 when we introduced this thesis. We don’t anticipate we’ll be making the same mistake of being too early this time around.


Darius Dale


Early Look

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