• run with the bulls

    get your first month

    of hedgeye free



Street too low, FCF yield too high



ASCA reported a blockbuster quarter this week, beating our EPS estimate by 9 cents and consensus by 12 cents.  Margins were particularly strong and management’s outlook was favorable.  But we don’t want to rehash the quarter.  To quote Larry Kudlow “the mother’s milk of stocks is earnings” and we think strong earnings going forward and an attractive free cash flow yield will propel ASCA still higher. 


We turned positive on ASCA with our 3/24/11 post “ASCA: FCF AND EARNINGS” (3/24/2011) where we stressed its attractive free cash flow yield and potential for higher than expected earnings.  While the stock has risen over 30% since then, the good news is that we’re essentially in the same situation.  Thanks to an incredibly accretive (earnings and free cash flow) refinancing and stock buyback, ASCA’s free cash flow yield remains over 20% and earnings estimates still need to go higher.  As we’ve pointed out, for ASCA that combination has historically resulted in significant share appreciation. 


Street estimates on Q2 and FY 2011 and 2012 are still too low.  We’re 10% and 23% above consensus Q2 EBITDA and EPS, respectively.  For fiscal year 2011, we’re 8% and 31% higher than consensus.  The Street seems to be underestimating the accretion from the refinancing and buyback and more importantly, continued margin improvement and revenue growth.  Remember, ASCA’s number one competitor in virtually all of its markets is Harrah’s (Caesar’s).  Have you seen a Harrah’s property lately?  When every nickel is going to pay down debt rather than buying slot machines from the current decade, it becomes tough to maintain share.


On any valuation metric, ASCA looks very cheap – yes even P/E!  On 2012, ASCA trades at 6.3x EV/EBITDA, 8.5x earnings, and carries a FCF yield of 21%.

TBL: Textbook Lesson For All

If you want a textbook example in when to buy and sell retail names, check out TBL. Sometimes the best call is to do nothing.



The Timberland quarter is such a great lesson for anyone who cares about any company touching the retail supply chain. While we love to dig into the nitty gritty details more than anyone, sometimes you simply need to look at the calendar, a stock chart, and understand the motivational drivers behind what makes the company tick.  This is one of those instances.


Specifically, recall that on the company’s 2Q conference call, CEO Schwartz altered the revenue strategy for the company. After years of pulling distribution (voluntary and involuntary) of its classic ‘yellow boot’ business, and then restricting distribution further as it tiered product to build demand under Gene McCarthy (who now heads UnderArmour’s footwear business), he said something to the tune of “our consumer wants our product, so we’re going to give them the product!!!” The triple exclaimation point there is to try to capture his tone, which was more cocky than it was aggressive.  The market liked it, and the stock popped 20% in a week.


Then when TBL printed 4Q results, it blew away  growth expectations. The stock was up another 25% in just 2 sessions.


But today’s results resulted not only in a miss, but in a flat-out horrible earnings/cash flow algorithm. Revenue growth of 10% was de-levered to operating profit decline of -29% with receivables and inventories up 13% and 37% (!), respectively. We won’t debate the company’s assertion that this is needed to hit their growth plans, but we will question the margins that will be realized to achieve such growth.


Simply put, this is just a great case of management behaving badly.


I’ll be the first to admit how I kicked myself for missing that positive move in the stock on that mid-February day. But I’d have kicked myself harder for participating in the “capital destruction gong show” that was TBL’s 1Q.  


Yes, we want to be right all the time. Every quarter, every month, and every day. But sometimes the best strategy is to sit back, stick to your guns, and do nothing.



This is the gnarliest looking SIGMA we've seen all year.Let us know if you need help interpreting.

TBL: Textbook Lesson For All - tbtb


TBL: Textbook Lesson For All - tbsshgma


1Q11 is proving to be a strong quarter for the pizza category.  DPZ reported $0.42 versus consensus $0.34.  Domestic comparable restaurant sales slowed -1.4% versus street expectations for a -4% print versus last year’s blowout first quarter.   Domestic company and franchise comparable sales slowed -2.3% and -1.3% versus consensus at -4.3% and -3.9%, respectively.   International comparable restaurant sales grew 8.3% versus consensus 6.5%. 


Management shirked away from providing guidance, reverting back to their normal practice after providing sales commentary on 1Q during the 4Q10 Earnings Call.  Management’s discussion, if a little light on forward-looking details, certainly seemed positive in tone.  The domestic and international businesses are performing well and management is “comfortable” with the +3-5% commodity cost outlook.  Given that inflation in 1Q11 was 5%, the higher end of the range seems more conservative.



Comparable-restaurant sales growth


The chart of company-operated domestic same-store sales below shows clearly that DPZ’s domestic business is trending very well.  Despite a negative comparable-restaurant sales number for the first quarter, the two-year average trend is encouraging.  On a sequential basis, from 4Q10, two-year average trends accelerated by 350 basis points.  Media spending in the quarter was in line with the one year ago and the last few quarters, and management stressed that media spend should remain at a fairly constant level for the foreseeable future. 


International markets are providing robust returns for the company with Turkey (promotions and TV) and Malaysia (new menu items) two of the standout markets.  The company began its recap of the quarter with commentary on international markets so that, according to management, it might be highlighted that Domino’s is an international company that derives one-third of its profit from international operations. 


By way of an explanation for the upside surprise in the company’s top-line performance, management reiterated its comments from a quarter ago; the company views its brand and equity as having been enhanced far past where it was pre-2010.  The U.S. business continues to perform well as the company added pizza and chicken promotions to the menu during 1Q11.  While management wouldn’t give specific numbers on the impact of chicken on average check, or what average check was during the quarter, it was explained that chicken was ordered with high frequency as an add-on, and did not cannibalize pizza sales, so we can infer, from a traffic and average check perspective, that the chicken promotion was a net positive.   Chicken was only rolled out for the last 5 weeks of the quarter so the impact on the current quarter may be more significant. 





Restaurant Operating Margins


Food costs are certainly rising for every company in the restaurant business, with the exception of BWLD, but DPZ is managing the challenge well.  The structure of the company, being 90% franchised, is a great help in this regard but DPZ feels that inflation has been managed and the company’s supply chain system has put the company in a good position in terms of negotiating contacts.  Commodities, according to the company, have been in line with their expectations.  As I wrote in my note titled “DPZ – 1Q11 INFLATION COMMENTARY”, DPZ has been maintaining a far more realistic inflation outlook than many of its peers.


Cheese prices were a huge concern for DPZ at the time of the past earnings call on March 1st.  Ten days later, cheese prices fell off a cliff and for the quarter, DPZ paid an average price of $1.60 per pound versus $1.44 last year.  Considering that cheese was trading at $2.00 before its precipitous decline in mid-March, investors are far more at east at the present time than one quarter ago.





From here, I think this name has plenty of momentum.  Some of the key reasons for my stance include: robust sales growth, a heavily franchised system, a supply chain business that benefits from higher commodity costs, and a management team that is managing investor expectations, as well as the business, very well.


Howard Penney

Managing Director

the macro show

what smart investors watch to win

Hosted by Hedgeye CEO Keith McCullough at 9:00am ET, this special online broadcast offers smart investors and traders of all stripes the sharpest insights and clearest market analysis available on Wall Street.

The Correlation Risk: SP500 Levels, Refreshed



If they didn’t know there was a surreal amount of The Correlation Risk associated with The Bernank’s Burning Buck, now they know…


Whether it’s Euros, Gold, Oil, or the SPYs, it’s one giant correlation suck. With the US Currency Crash finally stopping, abruptly, for a day, you can now see the crashing expectations of everything that’s priced relative to those crashing Dollars (remember Q208).


The good news here for US stocks is that the SP500’s inverse correlation to the USD is lower than that of say the Euro and Silver (-0.95 and -0.99, respectively on our intermediate-term TREND duration). The bad news is that it’s still very high at -0.82.


The rotational mechanism within the SP500 is healthy to observe. US Dollar UP = Deflating The Inflation (our Q2 Macro Theme), and that’s bad for the big beta TRADE (oil, basic materials, financials), but really good for the rest of America trade (consumers, savers, transports).


As a result, I’m still mapping a correction in the SP500 of -2.7-4.3% from the April month end high. No, that’s not calling for a crash – although beta can indeed feel that way.


Putting some prose with a picture (see chart below), here are some risk management lines to consider: 

  1. Immediate-term TRADE support of 1352 is now immediate-term TRADE resistance.
  2. Immediate-term TRADE support drops to 1332 (making the new immediate-term range = 1)
  3. Intermediate-term TREND support remains 1310 

Out on the long-term TAIL, as long as the manic media is still debating trivial levels like “Dow 13,000”, as professional Risk Managers you should be quite happy to know that using that consensus as your backboard will simply help you manage your gross and net exposures proactively ahead of their predictable behavior.


On the way down today (the SP500 is down every day this week), I’m expanding both my gross and net through the two Hedgeye products that I can best express that in (the Hedgeye Asset Allocation Model and the Hedgeye Portfolio).


Right now I have 16 LONGS and 7 SHORTS (versus Monday where I tightened up my net exposure to 15 LONGS and 12 shorts). I think I’m too long.



Keith R. McCullough
Chief Executive Officer


The Correlation Risk: SP500 Levels, Refreshed - 1

Retail: Showing Some Crack


We’re seeing the first of the big apparel retailers showing inability to pass through the cost increases that they otherwise planned. The industry needs this to prove aberrational, otherwise the 2H set-up will not be a pleasant one.  Our thesis is, and has been, banking on the latter.


The phrase “planning cautiously” appears to capture the tone coming out of Sales Day from more than a few companies. While there was still an exceptionally high number of beats relative to (company-set) expectations (17 of 23), we are beginning to see what may be the early signs of the meaningful roll in retail we expect in the 2H with margin pressure ratcheting both higher and sooner than anticipated.


Let’s recall for a moment that strong sales across the board were already baked into April numbers due to the holiday shift so of course the yy compares look solid, but in looking at the underlying 2-year comp trends that eliminate the shifts and noise, it just cracked for the first time since last July. That matters. We also had several retailers taking down numbers despite posting better than expected April comps (SSI and GPS) with at least Gap, Inc.  highlighting insufficient price increases resulting in more significant margin pressure than originally planned. If this unfolds as we suspect, the old adage “Sell in May and go away” may never be more true – particularly in retail. Remember that we don’t need to see everybody make Gap-ish comments, but simply need a few heavy hitters (like Gap, which accounts for a whopping 4-5% of US apparel retail sales) to put pressure on others who have otherwise planned more appropriately.


(clients that have not yet flipped through our industry overview outlining our scenario for a 4.5pt decline in industry margins this year, please contact sales at for a copy – we’d be happy to run through it with you).



SSS Callouts:

  • In a sign that higher product costs are proving more disruptive than some retailers have expected, not only did ARO announce lower sales and earnings, but both GPS and SSI took earnings expectations down despite better than expected sales. Our suspicion is that we are in the early stages of this trend.
  • The strongest performing categories were food/grocery (TGT, COST), women’s apparel particularly dresses (JCP, ROST, TJX), home/housewear (TGT, KSS, COST), and footwear particularly kid’s due to the holiday shift after several retailers highlighted it as a drag last month (ROST, KSS, JWN). Both COST and TGT highlighted electronics as a particularly weak category driven by persistent deflation.
  • TGT came in below expectations and at low end of their April comp guidance. This has been one of our favorite shorts this year for many reasons (see our 8/23 note “TGT: Multiple Targets”). The company’s May outlook of L-MSD implies a rollover in the 2yr trend – the company would have to post a +6% comp just to remain flat. That said, grocery posted a substantial improvement in April suggesting that P-Fresh remodels may finally be gaining traction. As the driver of an expected +200-400bps in incremental comp, the sustainability of such improvement will be one of the more scrutinized line items in next month’s release.
  • Consistent with recent results, ROST highlighted that pack-a-way counts for an even  higher percentage of total inventory to 48% up +1% from last month and compared to 33% yy driven by lower consolidated inventories up 29% down from 35% in March. The ability to offset higher costs with prior pack-a-way inventory is starting to become visible in results with stronger gross margins driving earnings upside.
  • JCP confirmed that it’s still comfortable with the level of inventory, but notably dropped the verbiage that it’s “in-line with sales trends” mentioned last month. While highlighting several outperforming brands including Sephora, American Living, and Liz Claiborne, internet sales contribution appears to be slowing up only ‘slightly’ compared to LSD-MSD increases of late. The company also highlighted that traffic at off-mall stores continues to outperform mall-based locations.
  • COST further confirmed our view on inflation with food and sundries up ~3% (from LSD) and fresh food across all departments now up MSD-to-HSD (from LSD). In addition, gas contributed +3.5% and +4.6% to SSS for both COST and BJ respectively.
  • As expected, weather received frequent mention including from JCP and FRED both of which missed expectations. By and large performance was strongest in the Southeast and West (JCP, ROST, TGT, GPS, JWN, KSS, COST)
  • Weekly trends were strongest in Week 3 in advance of Easter with Week 4 commonly cited as the weakest due simply to the loss of a sales day – JCP was the only retailer to note Week 2. COST was the only retailer to highlight Easter as a negative event during the month impacting comps by -1.5%-2%.

Retail: Showing Some Crack - TGT MoGrid 5 11


Retail: Showing Some Crack - SSS Total 5 11


Retail: Showing Some Crack - SSS YR1 5 11


Retail: Showing Some Crack - SSS 2 YR 5 11


Casey Flavin


Where's the Jobs Growth?: Prep For Tomorrow's Employment Report

Conclusion: We expect tomorrow’s employment report to affirm our call that Jobless Stagflation will continue to percolate domestically. We don’t see the growing bifurcation between the equity market and the direction of the economy as one that will exist in perpetuity – particularly given a Global Macro backdrop infused with Fed-sponsored Correlation Risk, Housing Headwinds, and the Sovereign Debt Dichotomy.


Position: Short US Equities (SPY).


Without question, this morning’s Jobless Claims number was a bomb. Josh Steiner, the Managing Director of our Financials Team, had this to say in his weekly analysis of this data series:


“The headline initial claims number rose 45k WoW to 474k (43k after a 2k upward revision to last week’s data).  Rolling claims rose 22k to 431k.  A Labor Department spokesman said that the increase was due to temporary layoffs in the auto sector, and also noted an effect from some New York school employees, who can claim unemployment during spring break.  On a non-seasonally-adjusted basis, reported claims rose 27k WoW, an atypical seasonal move… Big picture, regardless of whether this week's number was artificially higher due to one-time events, the takeaway from this morning's data is that rolling jobless claims are now up for the past 9 weeks, and even more importantly we're now at the YTD high in rolling claims.”


Where's the Jobs Growth?: Prep For Tomorrow's Employment Report - 1


Where's the Jobs Growth?: Prep For Tomorrow's Employment Report - 2


Where's the Jobs Growth?: Prep For Tomorrow's Employment Report - 3


Irrespective of whether or not this week’s huge miss is a statistical anomaly, the larger takeaway here is that rolling claims have been trending higher for nine consecutive weeks and are now at their YTD high of 431k. That doesn’t bode well for continued improvement in the overall employment picture. To this point, Steiner writes:


“We have been looking for claims in the 375-400k range as the level that can begin to bring unemployment down.  If claims return to this level, we expect to see unemployment improve. We consider unemployment to be ~200 bps higher than the headline rate due to decreases in the labor force participation rate. In other words, if the labor force participation rate were at the long-term average level of the last decade, unemployment rate would be 10.8% rather than 8.8%. So when we say that claims of 375-400k will start to bring down the unemployment rate, we are actually referring to the 10.8% actual rate.”


The takeaway from this deteriorating trend is that the bulls are running out of bullets. At the start of the year, “employment growth” was among the major factors supporting what we called out at the time as overly optimistic GDP growth forecasts. The others, including “continued strength in manufacturing” and a “pickup in exports”, have yet to have a meaningful impact on the overall economy, as evidenced by 1Q11 Real GDP growth coming in around half of what consensus expectations were in early February (+1.8% QoQ SAAR vs. +3.5%).


As the market braces for tomorrow’s employment report, we think it’s important to widen the analytical lens by which we contextualize this data series. We’re coming off a +230k MoM gain in Private Payrolls, which slowed from +240k MoM in February. Interestingly, February’s Private Payroll number was the highest rate of MoM growth this country has seen since March 2006 – roughly halfway through the largest consumer leverage buildup in economic history.


For many reasons, don’t expect the April 2011 Private Payrolls report to show a reacceleration to the upside. In addition to Initial Unemployment Claims consistently highlighting a developing trend of weakness in this sector, our proprietary Hedgeye ISM Employment Index lends credence to our thesis.


Using a GDP-weighted average of the Employment subcomponents within the ISM Manufacturing and Non-Manufacturing 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 has backed off its current-cycle high of 56.6 in February ’11 to 54.8 in March and now down to 53.2 in April. While, in theory, the index could continue to make higher-lows and higher-highs from here, the balance of risks remain skewed to the downside given that February’s high was 1.3 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 slowing US economy.


Where's the Jobs Growth?: Prep For Tomorrow's Employment Report - 4


A linear regression analysis of these two series produces a predicted value of +128k for tomorrow’s Private Payrolls series – which would be a noteworthy sequential deceleration and not supportive of current consensus expectations for +3.2% GDP growth in 2Q11. While +128k appears aggressive at face value considering that it would be a rather large miss relative to consensus expectations of +200k, we do believe the risks to Private Payrolls growth is skewed to the downside given the persistent weakness in Jobless Claims and increased corporate visibility on how the run-up in raw materials and energy prices over the last 7-8 months will negatively impact margins from a COGS standpoint. As such, we’ve done our best to define probable downside risk using 1x and 2x standard deviation bands as outlined on the chart below.


Where's the Jobs Growth?: Prep For Tomorrow's Employment Report - 5


As also depicted in the chart, we’ve attempted to define the potential upside risk to our model’s +128k output. Supporting the case for upside risks is April’s +4% gain in the DJIA, which helped boost US CEO sentiment to the second highest level (64.1) since the Young Presidents’ Organization survey began back in 2Q09. In addition, 42% of those surveyed said they intend to increase hiring throughout the year while only 3.7% expected to reduce employee head count. While our process flags survey results like these as contra-indicators and indicative of the tops of economic cycles, we cannot strongly argue any bullish spin as it relates to very near-term job growth.


All told, tomorrow’s jobs report should be a pretty telling gauge as to whether or not the US economy is, in fact, on firmer footing and whether or not we will see calls for additional stimulus ahead of QE2’s end-of-June expiration. With the US Dollar trading up over a full percent today, it will be interesting to see whether or not this is a leading indicator for a beat relative to expectations for tomorrow’s employment report (suggesting a pull-back in market expectations for QE3). On the contrary, falling US Treasury yields are not confirming this theory behind today’s dollar strength. In fact, yields on the short end of the curve are trading in what our models define as the quantitative equivalent of calls for additional easing.


Where's the Jobs Growth?: Prep For Tomorrow's Employment Report - 6


Tomorrow we'll get more clues as to whether market participants will call on The Bernank to try to inflate his way into more job creation via additional support for the equity market. For now, enjoy what's left of your Cinco de Mayo.


Darius Dale


Early Look

daily macro intelligence

Relied upon by big institutional and individual investors across the world, this granular morning newsletter distills the latest and most vital market developments and insures that you are always in the know.