In the May 27th issues of the Hedgeye Edge I included BWLD as one of my top ideas.  While it’s still a name I like, we need to start looking at taking some of the chips off the table. 


Within the Casual Dining names, year-to-date, BWLD is the third-best performing name after RRGB and BJRI, up 52.7%.  This outperformance has been driven by the company being revalued in the marketplace; over the past 6 months BWLD has seen consensus EPS rise 7.5% (RRGB, MRT, DIN and EAT all had even better revision trends than BWLD) and its forward NTM P/E multiple 45%.  At the very least, the performance of BWLD is telling you that the NFL lockout will end soon and not disrupt sales trends in 4Q11. 


The sell-side sentiment monitor still stands at a bullish reading of 58.8% buys (was 55.6% in January 2011; while the buy-side sentiment reading (Bloomberg short-interest ratio) has decline from 8.47 in January to 7.29 currently (was 12.44 last August).   


Year-to-date the stock has worked with very little support from the sell-side and the shorts have been covering on the back of better-than-expected sales and earnings driven in part by lower food coast, among other things.  Trading at 9.1x EV/EBITDA, there is about $7.06 (10.7%) of upside if the market revalues the stock to 10.1X EV/EBITDA (and there is no more upward revisions to EPS).   


BWLD - IN THE RED ZONE  - bwld evebitda



We have been pointing out recently that the top-line is, by far, the most important metric investors are considering at the moment and, with respect to this view, we believe BWLD will report a strong 2Q11.  Depending on how strong comparable restaurant sales are for 2Q, 3Q could see a sequential deceleration on one- and two-year average trends.


Regarding food costs, BWLD will be lapping the benefit of lower chicken wing prices in approximately six months.  Below, I discuss more in depth the sales and margin trends.



BWLD same-store sales trends:


Although April same-store sales trends were up an impressive +5.3%, it is important to remember that the company was lapping an easy comparison from April 2010, when comparable sales declined -3.7%.  This +5.3% growth implies a 120 bp slowdown in two-year average trends from two-year average trends in the first quarter.   I would expect to see two-year trends slow somewhat during the second quarter, given the slower start to the quarter and the decreased level of pricing during 2Q11 of 1.9% relative to 2.4% in 1Q11. 


BWLD - IN THE RED ZONE  - bwld pod 1



Management also stated that incremental gift card redemptions benefited same-store sales growth by about 60 bps during the first quarter, which will likely not be as beneficial going forward.  That being said, the same-store sales growth comparison gets easier in 2Q11, so comparable sales growth should continue to be strong on a one-year basis.  I am currently modeling a +3.0% comp for the second quarter. 


The year-over-year comparison gets increasingly more difficult come the third quarter and if the company does not implement another price increase (management said it has not yet decided whether it will take any further menu price increases), pricing will decrease to +1.3% in the second half of the year.  Assuming no disruption to the NFL season, I am currently modeling a 1.5% comp for the third quarter and +4% growth during 4Q11.


During the first quarter, average weekly sales at company units outpaced same-store sales growth by 390 bps.  I would expect company average weekly sales to continue to outpace comparable sales growth as management continues to close underperforming restaurants (the company said it will close or relocate 8 older units) and new unit performance is strong.



BWLD Restaurant-level Operating Margins:


Restaurant-level margins improved about 360 bps YOY during the first quarter.  The bulk of that YOY growth was driven by lower traditional wing prices (traditional wings accounted for 20% of sales), which were down 36% YOY during the quarter.  Accelerated same-store sales growth on both a one-year and two-year average basis also contributed to the company’s increased operating leverage. 


BWLD - IN THE RED ZONE  - bwld pod 2



Given that traditional wing prices averaged $1.02 per pound during the first two months of the second quarter (down 33% YOY from 2Q10’s $1.51 per pound cost and down nearly 22% on a two-year average basis), BWLD should continue to see significant favorability on the COGS line for the remainder of the year.  As a percentage of sales, the YOY favorability should moderate, however, as traditional wing prices peaked during 1Q10.


BWLD - IN THE RED ZONE  - chicken wings 75



Partially offsetting the COGS benefit, BWLD experienced higher labor expenses during the first quarter which management attributed to higher training costs related to its new menu rollout and increased hourly wages as the company invested in speed of service initiatives.  The incremental training costs will roll off during the second quarter but management still expects to experience higher hourly expenses; though it said continued leverage of management wages should result in flat YOY labor expenses as a percentage of sales.  I am modeling some slight deleveraging of the labor expense line during the second quarter given my assumption that same-store sales trends will moderate slightly from the first quarter on a two-year average basis.


All in, I think restaurant level margins will continue to improve for the remainder of the year; though 1Q11 should prove to be the high point from a YOY basis point growth standpoint.  Management’s full-year EPS target of more than 18% growth should be easily achieved, assuming no major NFL disruptions (I currently forecasting full-year EPS growth of nearly 22%).  I would not be surprised to see 2Q and 3Q11 earnings fall short of that annual goal, however, largely as a result of the expected significant YOY jump in preopening expenses during those quarters.



Howard Penney

Managing Director


Rory Green


Pain Trade: SP500 Levels, Refreshed



On this morning’s opening market weakness, I decided to cover my SP500 short position. There is no emotion in the process – or at least there shouldn’t be. And having made enough mistakes in my risk management career, I’d rather not stay the course with another predictable one.


I don’t think this short squeeze is over, primarily because that’s what the math is telling me. What was intermediate-term TREND resistance at 1314 is now intermediate-term support – and now the bulls have every opportunity to squeeze a 1 out of this thing before The Pain Trade subsides (the Pain Trade is higher, not lower – with pain being the move that will hurt the most people).


When the world was complacent about US Growth and Bullish Sentiment was raging (Q1), The Pain Trade was lower. But -7% draw-downs have a funny way of changing both expectations and sentiment. In the last 6 months, the Street has cut their US GDP Growth estimates almost in half and the spread between Bulls and Bears in the II Survey has narrowed by 2,000 basis points from peak perma-bull to fear and frustration.


Across our 3 core risk management durations, we’ve outlined the lines that matter in the chart below: 

  1. Long-term TAIL resistance remains 1377 (I’ve been using a level in that area code for 6 months and don’t see it being violated, for now)
  2. Intermediate term TREND support = 1314
  3. Immediate-term TRADE resistance = 1350 

These are the kinds of markets that can drive you right batty, if you let them. So don’t. If something isn’t working – get it off your sheets, have a coffee, and roll on. A Risk Manager’s role is to be a realist – not dogmatic.



Keith R. McCullough
Chief Executive Officer


Pain Trade: SP500 Levels, Refreshed - 1

Geithner Putting the Fourteenth Amendment Into Play

Conclusion:  While Secretary Geithner's strategy of using the Fourteenth Amendment in defending an extension of the debt ceiling appears to have legal precedent, the potential for a Supreme Court showdown between Democrats and Republicans may make the strategy not worth the gamble.


Secretary of the Treasury Timothy Geithner has heightened the debate over the debt ceiling extension in recent weeks by implying that the President could simply push through an extension of the debt ceiling based on an interpretation of the Fourteenth Amendment of the United States Constitution.   While rumors of this defense have been circulating for the last 8 weeks or so, the idea was more officially circulated at a May 25th Politico Playbook breakfast at which Mike Allen was hosting Geithner.


At that breakfast, Allen asked Geithner about a potential default and the debt ceiling debate and Geithner responded with the following:


“I think there are some people who are pretending not to understand it, who think there's leverage for them in threatening a default.  I don't understand it as a negotiating position. I mean really think about it, you're going to say that-- can I read you the Fourteenth Amendment?"


Even as President Obama as late as last week has avoided opining or interpreting the Fourteenth Amendment, Geithner, who presumably is speaking as a representative of the administration, has made it very clear that he believes that Fourteenth Amendment gives a President the legal right to extend the debt ceiling.


As noted, in the same breakfast Geithner then read the following excerpt, Section 4, from the Fourteenth Amendment:


“The validity of the public debt of the United States, authorized by law, including debts incurred for payment of pensions and bounties for services in suppressing insurrection or rebellion, shall not be questioned. But neither the United States nor any State shall assume or pay any debt or obligation incurred in aid of insurrection or rebellion against the United States, or any claim for the loss or emancipation of any slave; but all such debts, obligations and claims shall be held illegal and void.”


In fact, the U.S. Supreme Court has actually ruled on the Fourteenth Amendment in Perry v United States (1935).  This case was part of a series of cases brought before the United States Supreme Court that were known as the Gold Clause Cases.  The gist of these cases was to question whether the U.S. Congress could change the form by, or terms under which, U.S. debts could be repaid.


The ruling by the Supreme Court in Perry v United States specifically referenced Section 4 in the following excerpt:


“Section 4 of the Fourteenth Amendment, declaring that "The validity of the public debt of the United States, authorized by law, . . . shall not be questioned," is confirmatory of a fundamental principle, applying as well to bonds issued after, as to those issued before, the adoption of the Amendment, and the expression "validity of the public debt" embraces whatever concerns the integrity of the public obligations.”


So, in effect, it would appear that there is some precedent for Geither’s statements as it seems that the United States Supreme Court has previously ruled that voiding a U.S. government debt is beyond the power of Congress.  Since we are far from legal scholars, we have attached below a link to the ruling:


As is outlined in the following chart, the credit default swap markets on U.S. government debt are signaling that a default on U.S. government is highly unlikely and the odds of such haven’t increased much over the last six months, which perhaps also gives credence to Geither’s view.  Currently, CDS on 10-year U.S. treasuries are trading at 58bps, which is well off its highs for the year.  By way of comparison, German 10-year CDS are trading at 59bps, Greek CDS are trading at 1,550bps, and Spanish CDS are trading at 268bps.


Geithner Putting the Fourteenth Amendment Into Play - 2


Even if we accept that President Obama has the legal authority to make a unilateral decision on extending the debt ceiling as Geithner has been suggesting and legal precedent appears to support, the question is really whether it is the most practical or best political path to take. Regarding the latter point, it would seem that while President Obama would get a clear win by trumping the Republican Congress with the Fourteenth Amendment, the downside risk to this strategy is a potentially increased credit risk associated with U.S. sovereign debt and a potential Supreme Court showdown between Republicans and Democrats.


So, would the President and the Democratic rank and file actually pursue the Fourteenth Amendment option? While he doesn’t necessarily speak for all Democrats, Senator Schumer said on a call to reporters on July 1st when asked about the Fourteenth Amendment responded, “It is certainly worth exploring.”




Daryl G. Jones

Director of Research

investing ideas

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European Risk Monitor: Greek Pause as Troika and Credit Rating Agencies Wrestle

Positions in Europe: Long Germany (EWG); Short Spain (EWP)


With the Greek Confidence vote won, austerity approved, confirmation over the weekend that the country will receive its next €12 Billion tranche on July 15th (from its original €110 billion bailout package), and talk that Greece’s second bailout package (est. €70-120 Billion) will be announced in mid-September,  the intense spotlight on Greece may dim in the coming days and weeks. Yet, the debate will now turn to recent proposals from France and Germany that its banks would voluntarily “restructure” Greek debt holdings by extending repayment on shorter term paper (5 years or less) to 30 year maturities. However, the specific terms, including the interest rate commanded, remains uncertain and as they say, the devil is in the details.


Importantly, under such a plan, great friction will develop with the main ratings agencies, which technically rate any form of restructuring (or re-profiling) as default.  We, however, expect some sort of back-door dealings between Troika (EU, ECB, IMF, and institutional banks) and the ratings agencies to modify debt repayments schedules without the mark of “default”, or else some other proposal may be drafted altogether.


Our European Risk Monitor signals that risk has mitigated week-over-week following the insurance from PM Papandreou’s confidence vote and confirmation that Greece will receive its next bailout tranche from the EU/IMF. This is represented in the charts below of sovereign CDS spreads and peripheral government 10YR bond yields.


European Risk Monitor: Greek Pause as Troika and Credit Rating Agencies Wrestle - m1


European Risk Monitor: Greek Pause as Troika and Credit Rating Agencies Wrestle - m2


A similar trend is seen in our European Financials CDS Monitor, in which bank swaps across Europe were wider for only 11 of the 39 referenced banks week-over-week, while 28 were tighter.


European Risk Monitor: Greek Pause as Troika and Credit Rating Agencies Wrestle - m3


While uncertainty surrounds potential restructuring of Greek debt held by public and private institutions, we expect the common currency to hold support with implicit guarantees from Big Brother Troika to prevent default of any member nation, and into the ECB’s interest rate announcement this Thursday (7/7). Trichet has indicated in recent weeks that the Bank is “strongly vigilant” and ready to act against rising inflation that remains above its target of 2% (Eurozone CPI currently stands at 2.7% in May Y/Y). We expect the ECB to raise rates 25bps on Thursday to 1.50%, and remain at that level for the remainder of the year.


In the EUR-USD cross, $1.43 remains a critical short-term support trading level we’re managing risk around. Our TRADE resistance stands at $1.45.


An important catalyst to keep on your sheets is the announcement of the second round of European Bank Stress Tests, expected on July 13th. Rumors swirl that up to 15 of 91 banks could fail the tests, but the number could be a token figure to convey that the tests were "stringent" enough.


Services PMI figures out today showed contracting to slowing figures month-over-month (see table below). Much like Manufacturing PMI figures out last week (for more see our post on 7/1 titled “European Manufacturing Cools in June”), both surveys  point to slowing growth expectations ahead as inflation remains elevated and sovereign debt contagion presses. Italian Services is a notable underperformer in the June survey, with a reading under 50 representing contraction.


European Risk Monitor: Greek Pause as Troika and Credit Rating Agencies Wrestle - m4


Matthew Hedrick



Notable news items and price action from the restaurant space as well as our fundamental view on select names.




Wheat and corn prices rose in Chicago on speculation that last week’s losses, which brought the lowest prices of 2011, may have fueled demand from importers.  On Friday last, the Department of Agriculture said that exporters in the U.S. sold 1.14 million metric tons of corn. 




  • WEN this morning announced that it has completed the sale of Arby’s Restaurant Group, Inc. on the terms previously announced, to Roark Capital Group, effective as of July 4, 2011.
  • MCD is looking to Twitter as one forum for advertising its products.  On Friday, it is estimated, the company spent $80,000 on purchasing two promoted trends: #ANewMcDFavorite and #LoveMcDsSmoothies.  The response from the twitterverse has been heavily negative and perhaps brings into question the wisdom of spending such sums of money on 24 hour promoted trends.  It will be interesting to see how the company’s sales of smoothies fare this summer, especially given the difficult comps the company is faced with.
  • MCD is set to accelerate expansion into South Africa after striking a developmental license transaction with Cyril Ramaphosa’s Shanduka Group Ltd.
  • CMG has gained confidence in its business’ viability in the UK and Europe following the opening of its Charing Cross store last year.  The Independent (London) reports that it has just signed up for its second site in Baker Street, as well as hiring the property agent Michael Peddar & Co to search for sites in London and the UK.
  • PNRA, JACK, CBOU, PEET, and AFCE all gained on accelerating volume on Friday.


  • KONA, EAT, and DRI gained substantially on accelerating volume on Friday following DRI’s earnings call.
  • RT - Ruby Tuesday appoints Steven Becker and Matthew Drapkin to the board.



Howard Penney

Managing Director


Rory Green


Retail Fuel


Conclusion: Sales look decent headed into Thurs. But we think that anecdotes We will fuel the fire for the Street on 2H margin weakness – especially as it relates to earnings season beginning for the vendors in 2 weeks. This has been our call (4.5 Below – 450bos of margin weakness beginning in 2H) and we’re sticking with it. Short JCP, HBI, GIL, COH, CRI, JNY. Long NKE, LIZ, FL.



Before looking forward, let’s set the context as to where we stand today, and what we’ve been fed over the past year at a Macro level.  


As important as things like weather and calendar shifts are, let’s start off with a couple of bigger picture points about the Macro climate ‘then versus now.’

  1. Gross Personal Income was running at about 2.5% compared to about 4.5% today. That’s a function of slightly lower unemployment and marginally higher nominal wage. (positive point)
  2. The two main levers that account for the delta between Gross Income and Personal Consumption pretty much wash each other out.
    1. The consolidated personal tax rate has risen above 10% vs 9.1% this time last year. (negative point)
    2. The personal savings rate, which had been running at 6.1%, has since trended back to 5%.
  3. When we look at what we call ‘essential spending’ (food, energy, healthcare), we’ve seen growth go from 2.6% last year up in nearly a straight line to around 4.3% today.
  4. All that’s left goes into the ‘discretionary spend’ bucket which is far more volatile.  This stood at a healthy 7.5% a year-ago – a level that remains today (at least for now).
  5. Based on our read out of POS data (NPD, SportscanINFO), sales for the month of June were pretty much middle of the road. Apparel decelerated over the course of the month, albeit still positive. Footwear unit growth accelerated, though it the direct result of slightly lower price points. Overall there are nit picks here and there, but the trend overall is unremarkable.

What’s Next?

  1. We think that sales day will be another domino to tip as it relates to giving additional datapoints to the Street about margin weakness – especially as it relates to earnings season beginning for the vendors in 2 weeks. This has been our call (4.5 Below – 450bos of margin weakness beginning in 2H) and we’re sticking with it.
  2. The consumer’s top line – believe it or not – strengthened materially beginning in July of last year. Personal income growth accelerated over 3% -- -and hasn’t looked back. Now we go against that in 2H. Perhaps it stays at that level. But our point is that the yy delta helped out so many in retail – and that’s no longer there.
  3. Could we get a few bps of tax relief to buoy spending? Maybe. But not over 100bp. It’s simply not there – even with the political calendar heating up.
  4. Is the consumer going to draw the personal savings rate back down to 2-3% to free up a few points of spending? It’s possible – especially given US consumer spending habits. This is the biggest area where we could be wrong with our call in 2H. But that will make the setup for 1H12 very grim – i.e. low taxes, trough savings rate, with interest rates nowhere to go but up. That’s the ultimate defensive position for the consumer.
  5. Check out the weekly average earnings chart below. There was a whole lot of nothing until May 2010, until growth accelerated meaningfully – peaking in October, and remained at healthy levels throughout year-end. We’ve got to comp against this.



We all know that ‘the cotton trade is dead.’ That’s been the consensus for 7 months now. But we still think that the ‘earnings trade’ is very much alive. Remember that cotton, oil and other raw materials generally have a 9-12 month lead time. That means that what is selling today was procured last summer/early fall of last year. That’s precisely when costs started their precipitous ascent. We’ll have to deal with this for the next year at a minimum. Likely longer. We still don’t think we’re looking at a recovery until 2013 in this space.


Retail Fuel - SSS CIS 6 11


Retail Fuel - SSS Earnings 6 11


Retail Fuel - SSS Unemployment 6 11


Retail Fuel - SSS FW App June 6 11


Retail Fuel - SSS Cotton 6 11


Retail Fuel - SSS Gas 6 11


Retail Fuel - SSS Otexa 6 11


Retail Fuel - SSS 6 11 YY Chart



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