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A common theme for this earnings season is that top line sales trends remain strong, but nearly every management team has underestimated the impact of inflation on margins and earnings.


Here is a look at what DPZ was saying about their most important commodity during the company conference call on 03/01/11.  Keep in mind that cheese prices went up 20.86% during the first quarter of 2011.  DPZ has a contract that effectively eliminates one third of the price volatility of cheese in its commodity basket.


The average cheese block price in the fourth quarter was $1.61 per pound versus $1.48 last year, an 8.8% increase.  DPZ seems to be more in tune with inflation expectations in their guidance of 3-4%.  Compared to other companies maintaining a 2-3% range for inflation, DPZ is far more realistic.



Question: Okay, and then just one more. Just in the 3% to 4% food cost inflation, what are your cheese expectations and how covered are you on your cheese needs for 2011 at this point?


Answer: Yeah, so the forward curve and kind of looking at about three different sources right now have cheese actually easing a little bit through the rest of the year. We're at almost $2 right now. And so, our expectation is that we're going to see a little bit of easing, to give you on cheese. We've talked about this in the past, we've got a contract in place that basically reduces the volatility on cheese moves by about a third. So about two thirds of increases or decreases in cheese are passed through to our system. About one third of that volatility is – does not come to us and does not come to our stores. So that has not changed on the cheese in terms of how that's kind of fixed and locked in. Other commodities we do have more locked in.



Question: Okay, and the assumption for the cheese is that prices ease as we move through the year. And then the meats you said other than chicken that you're not locked on that either or – ?


Answer: That is correct. Meat prices, which are primarily toppings for us, are not locked. But chicken is. 

[Interestingly, management was correct in its statement that prices would ease going forward; ten days later cheese prices fell off a cliff and are currently ~20% off the 03/11/11 peak]



Question:  What spot price are you assuming for cheese in fiscal '11 given the fact there we're at $2 now. I know you said lower, but how much lower is it?


Answer:  I think the consensus forecast out there right now for cheese are in the $1.70 to $1.75 range. And – you know so what you're looking at is kind of a $0.25 to $0.30 move and I think we've said in the past a $0.40 move in cheese is equal to a point at the store level P&L…so what you're looking at is – best guess is about a 0.5 point of easing from where we are today. But obviously there is – it's been a moving picture out there the last 4 to 6 weeks. But order of magnitude, if 3% or 4% up on total commodities is around a point, if cheese stayed right where it is you'd be looking at about another 0.5 point is the way to think about it. So if the consensus is wrong and it stays where it is as opposed to backing off that's about a 0.5 point.


Now just as a reminder though, while that's very important to us, it's very important to our franchisees and to our overall system. Remember we're over 90% franchised domestically, we're 100% franchised internationally. And I would point out I've been assuming that all the questions we're getting are domestically focused. And that's the way we've been answering them. But remember we're quickly approaching being 50-50 on this.






Howard Penney

Managing Director



A common theme for this earnings season is that top line sales trends remain strong, but nearly every management team has underestimated the impact of inflation on margins and earnings.


Here is a look at what PZZA was saying about their most important commodity during the company conference call on 2/23/11.  Keep in mind that cheese prices went up 20.86% during the first quarter of 2011.



Confirming guidance (but they need to maintain sales trends)- We are reaffirming our 2011 earnings per diluted share guidance range of $2 to $2.12, as we expect the favorable impact of early year sales results to substantially mitigate the unfavorable impact of currently projected commodity cost increases, most notably cheese, throughout the remainder of the year.


Change in accounting this quarter - As Jude will discuss in more detail, we reached an agreement with our domestic system regarding the national marketing fund contribution rate for 2011 through 2013.  In connection with this agreement, we eliminated the year-end BIBP deficit of approximately $14.2 million and substantially all franchisees have executed a cheese purchase agreement.   As a result, future differences in cheese costs and prices paid by franchisees will be reported as changes in a payable to or receivable from franchisees as opposed to income or expense in our financial statements. And accordingly, we intend to eliminate pro forma reporting for the impact of BIBP beginning in Q1 of 2011.



Question - Going back and doing the math, it looks like it's around a three to four basis point change in operating margin for every $0.01 change in the price of cheese.  What I'm wondering is, in this environment is that still relevant to think that a $0.01 increase in cheese prices equates to a certain dollar amount of operating margin? And if so, I was wondering if you could possibly quantify for us the comparable sales level that would be required to make up, say a 40 basis point decrease in margin, operating margin resulting from a $0.10 to $0.12 increase in cheese prices in '11, if that were to be the case?


Answer - John H. Schnatter: Yeah, it correlates exactly, mathematically the way that you described it, if you lived in a linear world. Fortunately we do not live in a vacuum. Fortunately we do not live in a vacuum. So, with inflationary pressures on all the restaurant chain while cheese is going up and we don't like it, so are our other commodities and we see price increases in the restaurant segment that should offset these costs, or at least to your point, mitigate it along with the great top-line sales we're having.  And David, I don't think we'll be any more specific than that relative to how the year has started off since it is the current quarter that we're in.



Question - Can you kind of give us an outlook on where you guys think the competitive environment is going here with cheese costs? Do you see the other guys backing off of these deep, deep discounts and that's a benefit to you, or do you think that you're still going to be competing on very, very discounted pizzas out there for the foreseeable future even with cheese where it's at? 


Answer - John H. Schnatter: I've been doing this for 26 years. We've seen a lot, if not everything. We've learned that if we just run our business the way it's supposed to be run, we do quite well with our brand and our positioning and the quality of our product. With that being said, I think 2010 was unprecedented in that I've never seen two of the bigger competitors change their whole product and spend the kind of marketing dollars they spent and run the kind of discounting they run and us still have positive traffic. So 2010 in our eyes was a litmus test, for the brand is very solid.





Howard Penney

Managing Director

Brazil: All Bark & Little Bite

Conclusion: Our proprietary Global Macro research process continues to point to more Stagflation in Brazil.


Position: Bearish on Brazilian equities for the intermediate-term TREND; Bearish on Brazilian real-denominated debt for the intermediate-term TREND.


“Guaranteeing purchasing power means playing tough on inflation. This is one of the fundamentals of our political economy, and one we’ll never let up on.”

-Brazilian President Dilma Rousseff, May 1, 2011


Judging by the quote above, one would expect Brazilian policymakers to be more proactive in combating inflation, rather than reactively waiting and watching for more surprises to the upside. Alas, we continue to see more “bark” than “bite” with regard to Brazil’s inflation-fighting efforts. For instance, just as Rousseff was uttering these vigilant words, it was reported that her administration intends to launch a new program to reduce extreme poverty. The initiative – which will initially expand upon Brazil’s Bolsa Familia program – will emphasize cash transfers, a general expansion of public services and Brazil’s social safety net, and specialized job training.


It appears that as Rousseff & Co. lean hawkish with their political rhetoric, their actions tell an entirely different tale of dovishness, populism, and fiscal laxity. While we certainly applaud the overwhelming success of Bolsa Familia in delivering millions of Brazilians from the clutches of poverty, we do question the timing of the decision to expand upon it here and now – particularly with regard to inflation, which is running at a 28-month high on an official basis. Simply put, the last thing the Brazilian economy needs at this juncture is increased government spending for socialist projects.


Brazil: All Bark & Little Bite - 1


In an earlier report titled: “Brazil: One Step Forward; Three Steps Back”, we’ve shown that Rouseff’s R$50B in proposed spending cuts for this fiscal year are little more than smoke and  mirrors when analyzed with a careful lens (email us if you’d like a copy of the report). Importantly, it means that the increase in government spending via this latest initiative is not likely to be funded with savings from other areas of the budget. As we outlined in a recent post titled: “Oh, Brazil…”, Rousseff is likely to miss her central government budget target of a primary surplus of R$117.9B reis and initiatives like the one introduced this weekend certainly do not help her cause.


Be it Greece in March or the US in January, it’s important to remember that sovereigns can and do miss numbers. Net-net, we remain bearish on Brazilian real-denominated debt over the intermediate-term TREND as Brazil’s deficit and debt burden is likely to surprise to the upside alongside Brazilian inflation in the coming quarters.


Shifting gears, we remain bearish on the slope of Brazilian growth through 2Q11 and on a full year basis, we think Real GDP could surprise to the downside of consensus expectations of +4.05% YoY – expectations that have dropped like a rock in recent weeks as the sell-side once again proves how useless after-the-fact estimate revisions are. Economists now find conviction in their bearish forecasts on recent weak economic data – something we contend they should have saw coming in early November. 


Brazil: All Bark & Little Bite - 2


Brazil: All Bark & Little Bite - 3


Brazil: All Bark & Little Bite - 4


In the meantime where risk is managed on a proactive basis, we’ll stick to our process which continues to point to the conclusion that Growth Slows as Inflation Accelerates in Brazil. As inflation ramps up in the coming months, we expect Brazil’s consumption growth to deflate, Brazil’s GDP Deflator to inflate, and the central bank to resume hiking interest rates in an aggressive manner. These primary factors continue to have us bearish on Brazil’s equity market and we will look to short Brazilian equities on strength up to the Bovepa’s TREND line of resistance of 68,333.


Darius Dale



Brazil: All Bark & Little Bite - 5


Notable news items and price action from the past twenty-four hours as well as our fundamental view on select names.

  • SONC gained 4% on accelerating volume after reporting an acceleration in system-wide comps for the first two months of the company’s third fiscal quarter ending May 31st.  The company cited hotdogs as a major driver of sales for the company in the quarter. 
  • DIN reported 1Q11 EPS of $1.46 versus $1.16 consensus this morning.  Applebee’s domestic system-wide same-restaurants sales increased +3.9% versus consensus of 2.1%.
  • TXRH reported 1Q11 EPS of $0.27 versus $0.29 consensus.  Company-owned same-restaurant sales came in at +4.6% versus consensus at +3.7% but operating margin was 10.6% versus consensus 11.4%.  Inflation is proving a problem for the steak chain.  The company guided to EPS growth of 5-10% versus prior 10%, implying $0.84-$0.88 versus prior $0.88 and consensus of $0.90.  Sales accelerated in the early stages of 2Q, according to management.
  • MSSR reported 1Q11 earnings yesterday.  EPS came in at -$0.04 versus expectations of $0.00.  Comparable restaurant sales decreased 3.2%.  The company reaffirmed its prior earnings forecast of annual 2011 fully diluted earnings per share to be between $0.35 and $0.40 excluding the remodeling project.
  • KKD was initiated neutral at Janney.
  • CBRL declined yesterday on strong volume.  I continue to believe that CBRL will be a net market share loser in the current environment.
  • PNRA is breaking down finally on strong volume.  The trade line of resistance, according to the Hedgeye Quantitative setup, is $123.33.
  • JACK continues to show signs of weakness.
  • DPZ Is telling U.S. regulators a health-law mandate requiring chain restaurants to post calorie contents of fare is unworkable because the company offers 34 million combinations of toppings, crusts and sauces.



Howard Penney

Managing Director


The Macau Metro Monitor, May 3, 2011



GAINING MASS Inside Asian Gaming

The two latest gaming initiatives at CoD are the 'Red Hot Tables' concept for baccarat players and the 'New Game Zone' for slot players.  As the world's first baccarat trend indicator, Red Hot Tables technology allows incoming players to spot winning streaks at baccarat tables at a distance. MPEL's Co-COO of Gaming Ted Chan explains that this would help new mass market customers find a table they may want to bet at. He added, "It sounds very simple, but unfortunately, nobody in the world is doing it except for us. We are the only ones because we know that is what the customer would like to do." 

The 'New Game Zone' helps players find the latest new electronic gaming machines.  "Setting up the 'New Game Zone' took months of negotiation, and it enables us to leverage the market developments this year, with suppliers having difficulty selling their products in other markets around the world. So now we are just launching that concept with new Aristocrat products, and probably we will be able to work with other suppliers in the future."  MPEL also plans to boost its jackpot appeal by linking the floorwide jackpots at CoD and Mocha Clubs. 


Chan says, "I cannot give you a timeline for when mass would be overtaking VIP, but I foresee very positive growth over the next say five years time frame."


Macau April gross gaming revenues hit MOP20.51 BN (HKD19.91 BN, US$2.56 BN), up 44.6% YoY.


Occupancy rate of some hotels reached 100% before and on Labor Day and then fell back to 80%‐90% the following day.  Room rates were up 15-20% YoY. 3-star/4-star ADR ranged between MOP 2,500 and MOP 3,500.



During the three-day May Day holiday from April 30 to May 2, Macau’s three border checkpoints--Gongbei, Hengqin, and Wanzai--recorded 900,000 times of border crossing, of which 420,000 were mainland visitors.  Travelers crossing via the Gongbei border totaled over 840,000, up 10% compared with the same period last year. The figures at Hengqin and Wanzai exceeded 42,000 and 16,000 respectively.

Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.46%
  • SHORT SIGNALS 78.35%