The Economic Data calendar for the week of the 27th of June through the 1st of July is full of critical releases and events. Attached below is a snapshot of some (though far from all) of the headline numbers that we will be focused on.
POSITION: Short SPY
In the Hedgeye Portfolio, I shorted the SP500 on Tuesday at 3:14PM at 1297. We maintain that short position as 1297 remains immediate-term TRADE resistance. Across durations, within the framework of our TRADE/TREND/TAIL Risk Management Process, here’s the setup:
That’s what we call a Bearish Formation – when all 3 of our core risk management durations are bearish.
Is consensus Bearish Enough on growth yet? I’m not sure – but consensus may be too bullish on earnings expectations. Micron and Oracle certainly didn’t bode well for Tech earnings today – and I don’t think the Financials are baking upside surprises to the 1st week of earnings season in mid-July either. At least not yet.
All that said, I’m not a blind bear. Short-and-hold isn’t what I do. So I just tightened up my net exposure in the Hedgeye Portfolio (LONGS minus SHORTS) back to neutral (10 LONGS, 10 SHORTS) from net short on today’s US market open.
Enjoy your weekend,
Keith R. McCullough
Chief Executive Officer
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Positions in Europe: Long Germany (EWG); Short Spain (EWP)
In sizing up our macro position in Germany, which we’re long in the Hedgeye Virtual Portfolio via the etf EWG, we want to emphasize that the high frequency data has slowed in recent months. While Germany continues to reflect a strong growth profile for 2011, especially when compared to many of its neighbors handcuffed by gross fiscal imbalances, high unemployment, government indecision and unruly populous’ over austerity measures, the charts below show that German consumer and business confidence have waned over the last four months, as forward-looking Services and Manufacturing PMI surveys have also tailed off—Manufacturing has declined for the last two months as Services has been mixed and off ytd highs established in Q1 (see charts below).
While we still like Germany’s fiscal discipline and ability to find demand for its goods and services, the risk that Germany does not meet its growth forecasts given the pressing macro climate makes us more cautious on the position. GDP forecasts include:
German Government: 2.6% in 2011. (Chancellor Merkel indicated in late May that GDP will probably be above 3% in 2011)
German-based Institute for the World Economy: 3.6% in 2011; 1.6% in 2012
Bundesbank: 3.1% in 2011; 1.8% in 2012
Contagion from the periphery remains a glaring threat. While the Troika (EU, IMF, ECB) appears poised to step in to save Greece at every step with additional funds and more favorable terms on its debt, great uncertainty exists on how long the Greek state will be subsidized by Big Brother, and the impact of similar issues for larger countries like Spain and Italy. The obvious spill-over risk could dent not only the German equity market, but also the common currency. Certainly while a weaker EUR is to Germany’s advantage, we’re certain that if a real currency crisis emerged, the advantage of “cheap” German exports wouldn’t be of note.
For now we’re managing our exposure to Germany real-time. The DAX is trading just above its intermediate term TREND support line of 7,106 (third chart below). Stay tuned.
The trends at JACK are getting better “on the margin” but the company is not in the clear just yet. As I see it, the current risk/reward is favorable. JACK is the last QSR company with a market capitalization over a billion that is trading below 6.0x EV/EBITDA. By comparison, the average multiple for the QSR sector is now at 9.8X EV/EBITDA. However, excluding CMG and GMCR, the QSR average multiple drops to 8.6X EV/EBITDA.
If JACK’s fundamental were to continue improving “on the margin” and the street were to reward the company with a higher multiple, I believe there could be over $10 of upside in the stock, or +40% from current levels.
The case for investors to revalue the stock over the next twelve months is as follows:
THE TOP-LINE AT A GLANCE
I see FY3Q11 same-store sales growth guidance of +2-4% for Jack in the Box company units is reasonable, given the sequential improvement in two-year average trends during fiscal 2Q11 and the stable/improving QSR MACRO environment.
The full-year guidance of +1-3%, though not completely out of reach, seems to be a bit more of a stretch given that the company would have to achieve a nearly 150 bp improvement in two-year average trends during the fourth quarter to hit the low end of the range, assuming 3Q11 same-store sales come in at 2%. I would note that SONC showed a 645 basis point improvement in 2-yr trends at company-owned restaurants between 2QFY11 and 3QFY11 (quarters ended February and May, respectively). For Jack in the Box, the YOY comparison gets increasingly more difficult during fiscal 4Q11 as the company is lapping a -4.0% comp from 4Q10 relative to -9.4% in 3Q10.
The Qdoba same-store sales growth target of +4-6% for both fiscal 3Q11 and the full year seem easily achievable given recent two-year average trends.
MARGIN TRENDS AT A GLANCE
The company’s commodity inflation guidance of up 6-7% in fiscal 3Q11 and +4.5-5.5% for the full year implies commodities are up about 5-8% during the fourth quarter, which will continue to put pressure on restaurant level margins. There is some risk to this commodity guidance as management has been incorrect in its prior guidance of these costs, initially guiding to inflation of +1-2% and then +3-4%. And, given recent commodity trends, I would expect the company’s commodity costs, particularly, its beef costs (guided to a 14% increase in full-year beef costs), to exceed the company’s current expectations.
JACK’s full-year restaurant level margin guidance of 12.5% to 13.5% implies the YOY margin declines moderate during the second half of the year. It is important to remember that following the first quarter’s 170 bp decline in restaurant level margins, management guided to a significant improvement in YOY trends for the remaining three quarters. Fiscal 2Q11 margins, however, declined nearly 290 bps, largely as a result of the larger-than-expected increase in commodity costs. Margins have also been negatively impacted YOY by the company’s investment in guest service initiatives, which at least is a high quality problem.
JACK has posted margin declines for the last seven quarters. I would expect margins to continue to contract YOY during the second half of the year, but the magnitude of these declines should moderate significantly from fiscal 1H11, with the fourth quarter being less bad than the third on a YOY bp change basis. Obviously, if same-store sales growth surprises to the upside, stronger margin trends could result.
JACK has not yet turned the corner, but same-store sales trends have stabilized and turned positive during 1H11. Trends are still fairly negative on a two-year average basis but are improving nonetheless. Margin improvements should slowly follow with margins beginning to stabilize in 2H11. That being said, current commodity pressure will only slow this process.
OTHER THING TO CONSIDER:
Raising estimates but leaving price target intact is stinky analysis. What happens when they have to raise estimates again?
Yesterday, BMO raised 2011 and 2012 estimates to $1.65 and $2.09, respectively. We have two issues with this. First, the analyst left his price target at $21 and rating at Neutral despite the higher estimates. With ASCA almost at $23, wouldn't that make the stock a Sell and not a Neutral? He's been raising estimates fairly consistently on the name but that Neutral rating has been sticky. Second, his estimates are still way too low. We think $2 for 2011 is likely. The only way ASCA does $1.65 is if the economy tanks. If that's what he is projecting, he should have a Sell on the entire gaming sector which has become synonymous with the term cyclical.
ASCA is not a Wall Street favorite. Maybe it's because they aren't in Asia. Maybe it's because they aren't spending a ton of money to drive growth. Maybe it's just not an exciting story. So what? These guys are great operators who are focused on ROI. Free cash flow is growing faster than EBITDA and it won't be long before the company returns more capital to shareholders above the current 2% dividend yield. ASCA is one of only a few gaming companies that actually pays a dividend.
At some point, these analysts will have to raise ratings and price targets as estimates continue to go higher.