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WEN – 1Q11 THOUGHTS AND INFLATION COMMENTARY

WEN is set to report EPS before the market opens tomorrow.  I expect management to strike a careful but confident tone on the earnings call when discussing its outlook for 2011.  2011 is still a “transitional year” for Wendy’s and the entire enterprise.  We don’t expect much news on the previously announced sale of Arby’s but ultimately expect the sale to be a positive catalyst for the stock. 

 

I continue to think WEN is solid long-term play in the QSR space.  The company’s renewed focus on revitalizing, not complicating, the menu in 2011 will benefit the company for years.  The company’s focus on selling burgers and cokes will, in my view, yield significant results in terms of sales, labor efficiency, and – ultimately – earnings. 

 

As with every company that has reported so far, food inflation is center-stage.  For WEN, beef costs inflation (in a sluggish sales environment) is one thing that could hinder the turnaround in the short term. 

 

Here is what the company had to say on the topic during the most recent earnings call on March 3rd.

 

WEN has all of its ingredients with the exception of fresh beef, which cannot be hedged.  As a result, it is likely that WEN will raise its FY11 inflation target, which is currently 2-3% at Wendy’s.  Since March 3rd, beef costs are actually down approximately 5%.  However, given the persistent inflation in grain prices it seems likely that beef costs may remain elevated – and perhaps even increase further – for the next couple of quarters at least.  Chicken is obviously one foodstuff that is trending down year-over-year, and therefore could provide some relief, but WEN is “pretty much locked in” on that item.

 

Below are some quotes from WEN management on beef prices and commodity inflation in general, provided during the March 3rd earnings call:

 

“For 2011, we expect Wendy's same-store sales to grow between 1% and 3%. We expect improvement of 30 to 60 basis points in Wendy's company-operated restaurant margin. This margin assumption factors in a 2% to 3% increase in total commodities for the year.”

 

“With beef costs going up significantly this year, you'll see Wendy's food costs, I think, reach a higher level in Q2 and Q3 because of the timing of when we'll recognize those market increases. Arby's will also be facing very high beef prices, we think, through this year, 15% or more increase year-over-year.”

 

“The offset that we have to it right now is favorable prices on chicken for the most part for the year that we're pretty much locked in on. So that will help mitigate, I think, some of the overall commodity costs. But I think we're like everyone else, I think we're nervous overall about the pressures we're seeing on commodity costs and we're working very hard from a menu and a pricing strategy to help offset that, so we can achieve the kinds of margin increases that we talked about.”

 

WEN – 1Q11 THOUGHTS AND INFLATION COMMENTARY - live cattle

 

 

Howard Penney

Managing Director


European Risk Monitor: Greek Exit Scares Doused

Positions in Europe: Long British Pound (FXB); Germany (EWG)

 

As we discussed in a note on Friday titled “Greece Leaving the EURO, Not so Fast”, fears swirled on Friday afternoon that Greece had plans to leave the Eurozone based on unconfirmed sources reported by the German publication Spiegel Online.  As we expected, and as was confirmed over the weekend, this claim was a complete fabrication. However, the abruptly called meeting of finance minister on Friday in Luxembourg did focus on Greece’s persistent public debt imbalances. Of the few remarks we’ve received out of the meeting, it appears that a modification of Greek debt (either through lower interest rates on outstanding debt or more favorable maturities) could be in the cards in the near term. One issue outstanding, and oft pressed by fiscally stronger peers, is increased collateral on Greece's existing debt and future issuance.

 

Is all the Greek news baked into the cake? The short answer is no, however Greek equities and bonds have seen a significant plunge after an eerie rise in the beginning of the year. The Greek Athex (equity) is down -21.3% since a high on February 18th (and hitting ytd lows today, trading down -1.5%) and the yield on the Greek 10YR bond has gained steadily ytd, trading at 15.6% today!   

 

While the EUR-USD corrected -3.4% last week, the common currency has remained resilient in the face of glaring risks over the last weeks. We attribute a fair amount of this strength to the weakness in the USD, which we expect to persist as the US government wrestles with the debt ceiling debate (decision scheduled for August 2nd).  We still expect to see volatility in the EUR-USD over the coming weeks, but within a tight trading range. 

 

As Keith signaled to clients this morning, “the Euro has a ton of support at our immediate-term TRADE line of $1.43 and immediate-term upside to $1.47. Commodity markets (oil in particular is holding our TREND line of $98.63 like a champ) are betting USD down and EUR up from here in the very immediate term.”  As the EU continues to throw its weight (both in terms of capital and in principle) behind maintaining the Eurozone, we expect the EUR to continue to largely shake off sovereign debt contagion fears across the region.

 

Catalysts to keep in minds are Eurozone Q1 GDP reports this week and next week’s meeting of Finance Ministers on May 16th.

 

As is typical for Mondays, below we show our European Risk Monitor charts. The first chart of sovereign cds shows that risk premiums continue to heighten in the periphery, especially from Greece, Ireland, and Portugal. With Portugal receiving a €78 billion bailout early last week, Ireland is taking the opportunity to once again plea for more favorable terms on its bailout funds, a development we don’t think the European community will acquiesce to, but is worth monitoring.  

 

European Risk Monitor: Greek Exit Scares Doused - ch1

 

Our European Financials CDS Monitor shows that bank swaps in Europe were mostly wider week-over-week, widening for 31 of the 39 reference entities and tightening for 8. This shows a reversion from last week’s tightening, and is a reflection of the ever-present (but fluctuating) risk trade as debt contagion looms.

 

European Risk Monitor: Greek Exit Scares Doused - ch2

European Risk Monitor: Greek Exit Scares Doused - ch3

 

Today we bought back our position in Germany via the eft EWG in the Hedgeye Virtual Portfolio. We continue to see confirmation of Germany’s fundamental strength, including impressive export numbers of 7.3% in March month-over-month (vs 2.8% in February) reported today. Germany’s GDP is expect to grow around 2.6% this year, a healthy premium over many of its peers, while the country’s fiscal conservatism leaves it in a strong defensive position as sovereign debt contagion within the region persists.

 

Our levels on the DAX are immediate term TRADE support at 7,297 and intermediate term TREND support at 7,138 (see chart below).

 

European Risk Monitor: Greek Exit Scares Doused - ch4

 

Matthew Hedrick

Analyst


JNY: Virtual Portfolio Update

 

Keith shorted JNY putting one of our favorite shorts back in the in the Hedgeye virtual portfolio today. Consensus is still too optimistic with numbers shaking out at $1.25 in EPS for ’11 and nearly $1.50 for ’12 following the quarter.

 

As we look out over the balance of the year, revenue compares get increasingly more difficult and margin risk escalates meaningfully as the company banks on consumer confidence in the 2H (we have gross margins down -200bps vs. management’s outlook for -50-100bps). Yes, the stock’s down 11% since the quarter, but at $13.15 and no visibility or confidence in seeing earnings north of $1.00 in the company’s near future, we see further downside from here.

 

JNY: Virtual Portfolio Update - JNY Levels 5 9 11

 

JNY: Virtual Portfolio Update - JNY S 4 11

 

 


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“MCD – SAYING UNCLE (FOR NOW)”

Today, McDonald’s reported global SSS of 6.0% in April, vs. 4.0% consensus estimate.  The US, Europe, and APMEA were up 4.0%, 6.5%, & 6.5%, respectively.  Every region was ahead of consensus of 3.3%, 5.1%, and 2.7%, respectively.  This month’s sales were helped by a 1% calendar shift and 1-2% of pricing taken in the first quarter. 

 

Our bearish thesis on MCD has been predicated on a slowing in the U.S. business which has not – as yet – materialized.  The strength in the USA comes on the heels of a strong year in 2010 and no new product momentum.  While MCD is not out of the woods yet, the momentum going into summer is far stronger than we had modeled.  However, the summer is the period where the validity of my bearish thesis will ultimately be determined. 

 

The U.S. business, on a calendar-adjusted basis, saw a slight deterioration in two-year average trends from March.  However, the level of sales growth has now been in excess of what we were modeling for two consecutive months.  Management highlighted the popularity of the McCafe beverage line-up, including the recently introduced McCafe shakes, the breakfast menu, and core products including the Big Mac and Quarter Pounder with Cheese as key drivers of the U.S. growth.

 

Europe’s print was ahead of consensus and implied a sequential acceleration in two-year average trends of 50 basis points.  In spite of concerns over unemployment levels and austerity measures in Europe, MCD’s business there is continuing its robust growth rate in 2011.  Beef and chicken options, dessert offerings, and the ongoing benefit of restaurant reimaging were highlighted as key drivers of the business’ growth.

 

APMEA offered the  most substantial upside surprise versus consensus.  Management cited strong consumer appetite for locally-relevant menu options and compelling value as two key factors.  Many countries in the developing world are seeing food costs spiral out of control.  To the extent that MCD continues to offer compelling value by leveraging their system, the robust top-line should continue in APMEA.

 

MCD and its franchisees are seeking to reimage the vast majority of its U.S. stores by 2015.  We will have additional thoughts on this, and the company’s broader U.S. business, following our trip to Tampa on Thursday where we will be joining the MCD Restaurant Reimaging Tour. 

 

“MCD – SAYING UNCLE (FOR NOW)” - MCD US

 

“MCD – SAYING UNCLE (FOR NOW)” - MCD Europe

 

“MCD – SAYING UNCLE (FOR NOW)” - MCD APMEA

 

 

Howard Penney

Managing Director


R3: Adi/Titleist, GILT, Cotton, Amazon

 

R3: REQUIRED RETAIL READING

May 9, 2011

 

 

 

 

RESEARCH ANECDOTES

  • According to Millward Brown’s annual Brandz study that incorporates both economic factors and competitive dynamics to assess brand value, retail/apparel companies took 11 of the Top 100 in 2011. Amazon (formally categorized under tech) and Wal-Mart led the pack coming in at #14 and #15 respectively with all but Wal-Mart (-5%) growing in value year-over-year. Interestingly, Luxury was the third fastest growing sector in 2011 led by LVMH while Nike, H&M, and Zara rounded out the Top 3 in apparel, which landed at fifth. (here’s a copy of Millward Brown’s report).
  • The first third of the K-Swiss management’s prepared commentary on Friday’s call was spent on the company’s recent marketing efforts – most notably its initiative featuring Jillian Michaels which kicked off in January and for good reason. This was the first quarter that Performance product (i.e. new innovation such as running etc.) overtook Lifestyle (includes legacy tennis white shoes) accounting for 43% compared to 33% of total sales respectively. In addition, not only has Tubes became a top seller at Lady Foot Locker, but the effort also includes an apparel line designed by Michaels, which presents substantial opportunity for the company with less than 8% of sales generated by apparel currently.

OUR TAKE ON OVERNIGHT NEWS

 

Gilt Groupe Raises $138 Million from Softbank and Others for Growth, Acquisitions -Gilt Groupe, the New York-based flash-sales site that offers discounts on apparel, travel, home decor and other categories, has raised a whopping $138 million in capital. Participants in the fifth round include Softbank Group, the Japanese-based telecom conglomerate, as well as Gilt’s previous investors, General Atlantic and Matrix Partners. Other new investors include: Goldman Sachs, New Enterprise Associates, Draper Fisher Jurvetson Growth, Pinnacle Ventures, Triple Point Capital and Eastward Capital. Softbank’s involvement is two-fold. Not only will it be contributing $62.5 million of the round, which will all be going towards Gilt’s U.S. operations, it will also invest a smaller undisclosed amount into Gilt Groupe Japan. The two companies will each own 50 percent of the joint venture. In all, Gilt has raised $240 million. The fifth round values the company at roughly $1 billion before the round is taken into account. The round was first reported in a regulatory filing last week.  <Emoney>

Hedgeye Retail’s Take: Interesting…. A 5th round of financing is pretty big, and we’re definitely talking about some bigger numbers. Goldman is not buying into Gilt to own it in perpetuity. There will be a monetization event. But keep in mind that this business is not easily scalable – which is why it has ventured into so many categories. The Japan angle is interesting, as geographic expansion might be the meal ticket here given the absence of an opportunity to go deep in a category. 

 

Online Retailer Amazon Repays Indiana Sales Tax Policy - Amazon.com is planning to open a third large distribution center with hundreds of jobs in tax-friendly Indiana, finding refuge from other states that have attempted to force the online retail giant to collect sales tax. Seattle-based Amazon is announcing today that it plans to open a 900,000-square-foot Internet order fulfillment center in Indianapolis this summer but gave few other details. It declined to disclose the facility's precise location. Company officials said the facility will create hundreds of jobs. That figure could go higher, considering that an existing Amazon fulfillment center in Whitestown has 1,200 full-time workers. Another in Plainfield opened with 350. Like the existing centers, the new Indianapolis facility is expected to hire hundreds of additional seasonal workers, particularly around the busy Christmas season. <Indystar>

Hedgeye Retail’s Take: The latest move in Amazon’s online tax charade, the retailer has found a shelter state after closing its DC in Texas back in February. Either way you look at it’s political. In this instance, its about jobs and a greater local presence by Amazon. That trumps internet sales tax in this instance.

 

Adidas Among Final Bidders for Acushnet Co. - Adidas AG and Blackstone Group LP are among the companies vying for Acushnet Co., Fortune Brands Inc.'s golf division that includes Titleist and FootJoy, sources told Bloomberg News. Offers are due May 9, and Fortune Brands may negotiate with multiple parties in the coming weeks, one source said. Sumitomo Rubber Industries Ltd., the owner of the Srixon golf ball line, also may submit a bid, one of the sources told Bloomberg. Fortune's sporting-goods business generated more than $1.2 billion in sales last year. <SportsOneSource>

Hedgeye Retail’s Take: This comes down to whether Adidas ‘could’ versus ‘should’ buy Acuschnet. They want it, as it would make them a force to be reckoned with in US golf when combined with Taylor Made. The price tag here is likely in the $800mm to $1Bn range (using EBITDA and Sales multiples). There will be other suitors, though the strong euro will help here.  Most importantly, this would help Nike and UnderArmour, as it would tie up capital that Adidas would otherwise spend on growing its US business (and on sports market assets).

 

BCBG Looks to Refinance Debt - BCBG Max Azria Group Inc. is working to secure a new $230 million term loan to refinance a portion of its debt. Standard & Poor’s Friday gave the proposed senior secured first-lien term loan a rating of “B-minus.” The debt watchdog also raised BCBG’s corporate credit rating to “B-minus” from “CCC-plus.” The company’s current rating suggests that it has capacity to meet its obligations, but that adverse economic conditions might change that. BCBG has a $110 million first-lien term loan coming due in August that, if not refinanced, could impair the firm’s liquidity. The refinancing would extend repayment on the debt until 2015. “The ratings on BCBG reflect our belief that liquidity will improve to ‘less than adequate’ from ‘weak’ after the completion of the refinancing, with an extended maturity profile and adequate covenant headroom,” said S&P. <WWD>

Hedgeye Retail’s Take: Waiting a little late to refi debt due in August, huh?  Anyone who might be interested in owning this brand should be sitting back and watching how this plays out. This might be an opportunistic buy. 

 

Hampshire Sells Women's Business - Hampshire Group is getting out of the women’s business, freeing up resources for both acquisitions and its men’s wear operations in a bid to return to profitability. The New York-based firm, headed by chief executive officer Heath Golden, sold its Designers Originals, Mercer Street Studio and Hampshire Studio businesses to the LF USA division of Li & Fung and inked an agreement to sell its Item Eyes unit to KBL Group. The terms of the deals were not disclosed. “The plan is to get to profitability, and our women’s businesses were good businesses but difficult for us with our cost structure to really grow and do very well in,” Golden told WWD. “We had an opportunity to monetize them for good value and bring significant money back onto our balance sheet.”Hampshire’s losses from continuing operations widened last year to $9.7 million from $6 million in 2009, as sales fell 18.6 percent to $134.5 million. The company last turned a profit in 2007, when net income from continuing operations was $2.8 million. The company ended last year with cash and short-term investments of $33.7 million.<WWD>

Hedgeye Retail’s Take:  If you can’t make money, then get out! These guys get it… Too bad they account for 0.0001% of the industry. 

 

Barnes & Noble Plans to Launch a New e-reader - Barnes & Noble Inc. plans to launch a new e-book reader May 24, the company disclosed in a U.S. Securities and Exchange Commission filing this week. The bookseller already has two devices, the Nook and Nook Color. The Nook Color has a 7-inch touchscreen and retails at $249. The Nook, with a grayscale display, starts at $149. The retailer did not disclose whether this new device will be an additional e-reader or a replacement. A Barnes & Noble spokeswoman says the company will not comment beyond the single sentence announcing the planned launch in the filing.  <InternetRetailer>

Hedgeye Retail’s Take: This product category might go down in history as one of the most rapidly commoditized categories. 

 

Cotton Price Squeeze Goes On -  The price of cotton per pound is at levels not seen since the Civil War and it doesn’t look like things will abate anytime soon. That was the message from Mark Messura, senior vice president of global marketing supply chain at Cotton Incorporated, who presented a cotton market analysis Wednesday at The Union League Club to industry executives. The event was sponsored by The Intimate Apparel Council, a division of the American Apparel and Footwear Association.   “What’s going on in the cotton market is unprecedented,” said Messura. “A fundamental balance has tightened with exported crops nearly sold out worldwide, exported crops in China [the world’s largest cotton producer] close to sold out.…Ninety eight percent of U.S. cotton exports are already sold out on paper.…World production [of cotton] has dropped dramatically, by 40 percent, because farmers are planting more corn and soy crops. The real culprit is ethanol.” <WWD>

Hedgeye Retail’s Take: While Messura’s agenda is clearly biased, the argument is a fair one. 

 

Getting Consumers to Buy In to Geolocation Apps - Many marketers find location-based services exciting because of the possibilities for local and loyalty-based initiatives, and the tech media lighted on check-in apps as a shiny new game. But the average consumer still has not found a real reason to check in—especially not one that overcomes their concerns about mobile privacy and security. Even knowledge of the apps has not reached many smartphone owners yet, according to digital marketing agency White Horse. A February 2011 survey of US smartphone users ages 14 and older found that fewer than three in five knew about location-based mobile apps, and just 39% used them. Even that level of awareness has likely risen significantly due to Facebook’s entrance into the market. Earlier market entrants foursquare and Gowalla have been quickly passed in usage by Facebook Places, which can be credited with introducing check-ins to the masses, if not leading to mass adoption.<eMarketer>

Hedgeye Retail’s Take:  This is a really interesting call-out. We’re not sure what to make of it, other than mobile shopping has yet to catch on in a meaningful way. The companies who are investing in this today (and have been for years) will be the winners. We’ve got more work to do on that one.

 

R3: Adi/Titleist, GILT, Cotton, Amazon - R3 5 9 11

 

 

 


WEEKLY RISK MONITOR FOR FINANCIALS: TED SPREAD HITS A NEW YTD HIGH

This week's notable callouts include a new high in the TED spread and a sharp decline in the JOC commodity index. 


Financial Risk Monitor Summary (Across 3 Durations):

  • Short-term (WoW): Neutral / 3 of 11 improved / 3 out of 11 worsened / 5 of 11 unchanged
  • Intermediate-term (MoM): Positive / 2 of 11 improved / 6 of 11 worsened / 3 of 11 unchanged
  • Long-term (150 DMA): Neutral / 4 of 11 improved / 4 of 11 worsened / 3 of 11 unchanged

 

WEEKLY RISK MONITOR FOR FINANCIALS: TED SPREAD HITS A NEW YTD HIGH  - summary

 

1. US Financials CDS Monitor – Swaps widened across domestic financials, widening for 25 of the 28 reference entities and tightening for 3. 

Widened the most vs last week: GS, PMI, MBI

Tightened the most vs last week: MS, ACE, AON

Widened the most vs last month: JPM, PMI, MTG

Tightened the most vs last month: ACE, ALL, AGO

 

WEEKLY RISK MONITOR FOR FINANCIALS: TED SPREAD HITS A NEW YTD HIGH  - us cds

 

2. European Financials CDS Monitor – Banks swaps in Europe were mostly wider, widening for 31 of the 39 reference entities and tightening for 8.

 

WEEKLY RISK MONITOR FOR FINANCIALS: TED SPREAD HITS A NEW YTD HIGH  - euro cd

 

3. European Sovereign CDS –  After taking a breather the prior week, European sovereign swaps increased late last week, rising 5 bps on average.  Greek CDS rose on speculation that Greece would leave the Eurozone.  Our Europe analyst, Matt Hedrick, commented in a piece on Friday, “It seems far more likely that these meetings are being called to discuss the back and forth over recent days about the prospect of Greece restructuring its debt, a position Greeks deny the need for, while select European voices continue to press.  Greece’s equity market (Athex) had a tough week, closing down 4.5% w/w as sovereign cds and government yields remain elevated, with the Greek 10yr yield at 15.5%. That said, we’re not seeing a freak-out in risk intraday that would confirm the validity of the likelihood that Greece leaves the union.  If anything, a serious talk about Greece’s public debt and the prospect for restructuring was probably in order, and the weekend will help shield some of the downside risk to the meeting’s announcement.”

 

WEEKLY RISK MONITOR FOR FINANCIALS: TED SPREAD HITS A NEW YTD HIGH  - sov cds

 

4. High Yield (YTM) Monitor – High Yield rates fell last week, ending at 7.12 versus 7.66 the prior week. A data error or methodology change appears to be the cause of the step function in the Bloomberg series.  We are awaiting clarification on this shift.  

 

WEEKLY RISK MONITOR FOR FINANCIALS: TED SPREAD HITS A NEW YTD HIGH  - high yield

 

5. Leveraged Loan Index Monitor – The Leveraged Loan Index remained flat last week at 1621. 

 

WEEKLY RISK MONITOR FOR FINANCIALS: TED SPREAD HITS A NEW YTD HIGH  - leveraged loan

 

6. TED Spread Monitor – The TED spread rose last week to a new YTD high, ending the week at 26.2 versus 23.8 the prior week.

 

WEEKLY RISK MONITOR FOR FINANCIALS: TED SPREAD HITS A NEW YTD HIGH  - ted

 

7. Journal of Commerce Commodity Price Index – Last week, the JOC index dove with the rest of the commodity market, ending the week at 21.0, 7.3 points lower than the prior week.  This fall brings the JOC to its year-to-date low.

 

WEEKLY RISK MONITOR FOR FINANCIALS: TED SPREAD HITS A NEW YTD HIGH  - JOC

 

8. Greek Bond Yields Monitor – We chart the 10-year yield on Greek bonds.  Last week yields fell 15 bps versus the prior Friday.

 

WEEKLY RISK MONITOR FOR FINANCIALS: TED SPREAD HITS A NEW YTD HIGH  - greek bonds

 

9. Markit MCDX Index Monitor – The Markit MCDX is a measure of municipal credit default swaps.  We believe this index is a useful indicator of pressure in state and local governments.  Markit publishes index values daily on six 5-year tenor baskets including 50 reference entities each. Each basket includes a diversified pool of revenue and GO bonds from a broad array of states. We track the 14-V1.  Last week spreads fell to 99 from 112.

 

WEEKLY RISK MONITOR FOR FINANCIALS: TED SPREAD HITS A NEW YTD HIGH  - mcds

 

10. Baltic Dry Index – The Baltic Dry Index measures international shipping rates of dry bulk cargo, mostly commodities used for industrial production.  Higher demand for such goods, as manifested in higher shipping rates, indicates economic expansion.  Early in the year, Australian floods and oversupply pressured the Index, driving it down 30% before bouncing off the lows.  Last week it rose 71 points to 1340.

 

WEEKLY RISK MONITOR FOR FINANCIALS: TED SPREAD HITS A NEW YTD HIGH  - bdi

 

11. 2-10 Spread – We track the 2-10 spread as a proxy for bank margins.  Last week the 2-10 spread tightened 8 bps to 260 bps. 

 

WEEKLY RISK MONITOR FOR FINANCIALS: TED SPREAD HITS A NEW YTD HIGH  - 2 10

 

12. XLF Macro Quantitative Setup – Our Macro team sees the setup in the XLF as follows:  2.3% upside to TRADE resistance, 0.6% downside to TRADE support.

 

WEEKLY RISK MONITOR FOR FINANCIALS: TED SPREAD HITS A NEW YTD HIGH  - xlf

 

 

Joshua Steiner, CFA

 

Allison Kaptur


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