JACK underperformed the S&P 500 by 370bps and 210bps over the past week and month, respectively.  The under-performance raises some alarm bells going into its earnings release on Thursday.  All of the work done during the quarter suggests that the fundamentals have been shaping up well.  Commodity inflation is one concern, as it is for the vast majority of restaurant companies, but we believe that the market has long taken this into account when assessing JACK.


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 10.3X EV/EBITDA.  However, excluding CMG and GMCR and DNKN, the QSR average multiple drops to 8.7X EV/EBITDA. 


I see FY3Q11 same-store sales growth guidance of +2-4% for Jack in the Box company units as reasonable, given the sequential improvement in two-year average trends during fiscal 2Q11 and the stable/improving QSR macro environment. 





The following are some of the important forward-looking statements from the last JACK earnings call and our take on the current quarter trends.





“We're on track to substantially complete our restaurant re-image program system-wide by the end of the calendar year. And we're ahead of our timeline to increase franchise ownership to 70% to 80% of the Jack in the Box system.”


“Overall commodity costs are now expected to increase 4.5% to 5.5% for the full-year with Q3 inflation expected in the 6% to 7% range. Restaurant operating margin for the full-year is now expected to range from 12.5% to 13.5%, with better sales versus our prior guidance largely offsetting higher commodity inflation."


“We have not changed our full year guidance for diluted earnings per share of $1.40 to $1.65. Gains from refranchising are expected to contribute $0.70 to $0.83 to EPS, with the penny increase on the upper end due to the lower expected tax rate for the full-year.”


“Operating earnings per share, which we defined as diluted EPS on a GAAP basis less gains from refranchising, are expected to range from $0.70 to $0.82 per share. EPS includes approximately $0.10 to $0.12 of incremental re-image incentive payment franchisees in fiscal 2011 as compared to fiscal 2010. The incremental re-image incentive payments for Q2 were $0.02 higher and year-to-date $0.03 higher than in fiscal 2010, although re-image incentive payments were $2.7 million year to date versus $650,000 through Q2 of 2010.”


“We would expect that our restaurant operating margins at the conclusion of our refranchising strategy will be above 16% in a normalized inflationary environment. In addition, we have said previously that we expect G&A excluding advertising as a percentage of consolidated system-wide sales to be in the 3% to 4% range. And Q2 year to date, we were at approximately 4.3% of system-wide sales.”


“We’ve raised our full year same-store sales guidance for both brands. Same-store sales are now expected to increase approximately 1% to 3% at Jack in the Box Company restaurants versus our prior guidance of down 2% to up 2%. At Qdoba, we now expect system-wide same-store sales to increase 4% to 6% versus our prior guidance of a 3% to 5% increase.”


“For the third quarter, we expect same-store sales for Jack in the Box company restaurants to increase from 2% to 4% and system-wide same-store sales for Qdoba to increase 4% to 6%. Our guidance reflects the sales trends we've seen thus far in the quarter.”


“So, driving the AUVs in all of the system restaurants is going to be important. So if you look back at when we had the restaurant operating margins that I spoke about earlier, at 16% and then one year as high as – they were over 17%. That was with average unit volumes about 1.440 million. If you look at where our average unit volumes are annualized based upon current year performance, they're about 1.375 million. So we need to get those average unit volumes up, and I think that's going to be a significant piece. We need to continue to grow same store sales. I don't think it will be as simple as just refranchising all of those units; however that is going to be a significant portion of this."



HEDGEYE: The macro environment continues to be challenging for JACK, especially on the commodities side.  However, the employment trends have been improving for JACK in the most important regions.  The “less bad” macro environment, coupled with the SSS momentum that started in last quarter, suggests that this quarter should meet or exceed expectations.  In particular, management has emphasized employment trends among young Hispanic males as being particularly important for Jack in the Box’s top-line trends.


JACK – EARNINGS RELEASE PREVIEW - young male hispanice employment





“As we said on our February call, we expect that Q2 restaurant operating margins will be similar to Q1, which was 12.6%.”

“Based on the increases we've seen in most commodities since that time, we now expect full year commodity inflation to be 4.5% to 5.5%.”


“Beef accounts for more than 20% of our spending and is the biggest factor driving the change in our guidance. For the full year, we are now anticipating beef cost to be up nearly 14% versus our previous expectation of 9% inflation. We expect beef cost to be up approximately 14% to 15% in the third quarter. Our third quarter forecast for beef 90s, in the low $2 per pound range and for beef 50s; we expect prices to average in the $0.95 to $1.05 per pound range in Q3.”


“Pork accounts for about 6% of our spending. It's expected to increase 4% for the full year. Cheese also accounts for about 6% of our spending and we continue to expect a 15% increase for the year. We now have 100% coverage on cheese through the remainder of the fiscal year.”


“Dairy costs, which are over 3% of our spend, continue to be impacted by higher butter prices and are now forecasted to be up 6.5% for the full year versus our prior forecast of up 5%.”


“Bakery accounts for about 9% of our spending and we continue to expect a 1.5% decline for the year. We now have 90% of our bakery needs covered through December of 2011.”


“There has been no change in our outlook for chicken, which is about 9% to 10% of our spending, as we have fixed price contracts that run through March of 2012. Produce represents about 5% of our spending and Q3 and Q4 costs are expected to normalize after the weather-related inflation we experienced in Q2. We have fixed price contracts in place for potatoes, which accounts for approximately 8% of our spending; with 100% of our potato needs for the full year contracted with prices essentially flat versus last year.”


“We’re anticipating Qdoba margins to be about 50 to 60 basis points accretive to our back half margins for the full year.”


“Then getting back into more of your question on the restaurant operating margin, if we can go back to what our initial outlook was for the full year, back in November we were talking about flattish comps down 2 to plus 2. We talked about commodity inflation of 1% to 2% and that was going to drive restaurant operating margin expectations in the 14% range. And now that – the decline from that 14% to the midpoint of our range right now of 13% is largely driven by the commodity inflation, which we're now expecting to be 4.5% to 5.5%.”


HEDGEYE: One key to the bull case for the stock over the next 12-18 months will be the company’s ability to improve SSS and see incremental leverage to the margin structure of the company.  If JACK can get to their goal of 16%, the stock will behave accordingly.  





“We've increased our guidance of – for Qdoba unit growth this year and now expect 60 to 70 restaurants to open system-wide, as franchisees are now expected to open 35 to 45 restaurants.”


“And capital expenditures are expected to be $110 million or less, with the majority of that spend going towards new unit growth for both brands versus maintenance and remodel capital. In addition, the change in our business model should result in growing royalty and rental income streams, be less capital intensive, improved returns on invested capital, and EBIT margins and generate higher free cash flow.”


“We have $25 million available for repurchases under a Board authorization, which expires in November of this year. And last week our Board authorized an additional $100 million repurchase program, which expires in November 2012.”



Howard Penney

Managing Director


Rory Green



GIL: Gong Show


The Gildan quarter came across as what we’d most appropriately call a ‘Gong Show.’ There is so much noise with this company, but the key issue is simple…its’ core category is under pressure, and GIL is losing share in that context. Efforts to make up the slack in other businesses – socks, most notably – are not coming at the margins needed to offset the core. That’s why management moved forward with the acquisition of Gold Toe – to add opacity to an otherwise troubling transparent picture. While the diversification to third party manufacturing and brands is nice, it adds an element of risk to a model that already has proved to be one of the more volatile businesses in retail. We still do not like GIL after the guide down, and think that risk remains to 2012 numbers. We’re at $1.97 vs the Street at $2.34.


With margin compression a clear and present risk, concerns over the company’s base business headed into the 2H were briefly muted when the Gold Toe acquisition was announced in April driving estimates higher. On one hand, greater diversification should improve earnings stability and ultimately the multiple the stock is awarded. However, a sharp deceleration in Q3 shipments to distributors (down -9%) and a reduced outlook for Q4 shipments down -5% vs. +3%E due to softness in the U.S. screenprint channel (roughly 60% of total sales) has rekindled concerns about the base business.


Both Gildan and Broder cited the likelihood of pre-buying ahead of July 5th price increases last year as the primary cause of weaker demand along with differed spending in an attempt to capitalize on declining cotton costs. But what’s more difficult to reconcile is the fact that Gildan lost 90bps of market share to 61% across all product lines in aggregate during the quarter as well. It’s likely due to more aggressive pricing, which was up +26% for activewear and underwear offset in part by a -4% decline in unit volume. In fact, second only to softer industry demand, GIL’s move to start promotional discounting to drive sales in the U.S. distributor channel was the next biggest callout of the quarter resulting in lower margins  and a meaningful reduction to the Q4 outlook (EPS of $0.40 vs. $0.52E).


Moreover, just as margin pressure becomes a reality and the company anticipates a 900bps swing in sequential gross margin, management is becoming increasingly more opaque about the cost at which cotton is covered. Rather than providing a price, they simply confirmed that it’s covered through the 1H of F12. While GIL expects cotton to weigh on margins through the 1H, management has several initiatives (energy, supply chain, ramping Rio Nance IV, and distribution & transportation) underway that could drive material margin expansion over the next 12-24 months, but that’s a long way off for most who are hyper-focused on the next 6-months. Over the immediate-term TRADE (3-months or less) and intermediate-term TREND (3-months or more), GIL is faced with increasing volatility and further downside risk.


Cost induced margin risk can be challenging enough, but the threat of greater variability in the top-line can lead to highly volatile earnings near-term. With the stock trading at 13.5x our EPS fiscal '11 and '12 estimates and a buck a share in debt compared to two dollars in cash prior to the acquisition, there is little room for doubt. It’s one thing to operate a stable business model through challenging times, but Gildan is trying to transition its business from a full vertically integrated manufacturer into expanding both at retail and internationally at the same time the industry is becoming increasingly volatile exacerbating the near-term earnings risk in this name. GIL remains near the top of our short list along with JCP, HBI, and COH.



Notable management commentary from the call:


Inflation outlook:

  • “we have very good visibility and covered for the Q1 and Q2 of next year. And in each of those subsequent quarters, our cotton cost will be less than it was in, obviously, Q4.”
  • The company raised prices to cover cotton costs at $1.50 – right now it’s at $1.05 plus ~$0.10 of basis. Considering it takes ~6lbs. to make a dozen shirts, there is roughly a $2 spread.
  • Inflationary costs across the industry (energy, labor, transportation, dyes, chemicals, etc.) are up roughly $0.80 a dozen offsetting the positive pricing spread.

Volatility in the model picking up:

  • “margins in Q3 were, obviously, over 28%, and we've reported and we've guided to 22% in Q4. That changes really because of the significantly higher cost of cotton that's being consumed in Q4 which negatively impacts margins in Q4 versus Q3 by about 900 basis points.”
  • “Overall, industry unit shipments from US distributors to US screen printers declined by 9% during the quarter according to the CREST report, compared with our assumption in our May guidance, the industry demand will grow by 3%.”
  • The company also guided Q4 down -5% vs. prior expectation of +3% - an 8 pt. swing.
  • Based on weaker demand, the company has initiated promotional discounting in the U.S. distributor channel in order to simulate demand.
  • “the quality of the inventory that's in the marketplace may not be as good as it should be.”
  • Q: “you've covered cotton at dollar x or dollar y or you partially covered dollar x or dollar y into a given quarter. Are you still willing or able to give that degree of color?”
  • A: “No, I don't think we want to provide any more details than what Glenn said. We will be initiating our guidance for 2012 when we report at the beginning of December”


GIL: Gong Show - Cotton 8 6 11


GIL: Gong Show - GIL S 8 11



Casey Flavin


Short Covering Opportunity: SP500 Levels, Refreshed

POSITION: no position SPY


I want to be crystal clear - this market will finally be immediate-term TRADE oversold sub 1153 today. That doesn’t mean I am bullish on US Equities. It’s what I call a Short Covering Opportunity.


Lines that matter across our core 3 investment durations (TRADE/TREND/TAIL):


1.       SELL TREND = 1314

2.       SELL TAIL = 1257

3.       TRADE range = 1153-1183


On my immediate-term TRADE range those are lower-lows and lower-highs of support (1153) and resistance (1183) than I gave pre-open. That’s the way the math works in my model. With every 90 minutes of new data, ranges and levels change.


Follow The Leader,



Keith R. McCullough
Chief Executive Officer


Short Covering Opportunity: SP500 Levels, Refreshed - SPX

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Early August data indicates 34-44% YoY growth for the month.



August is off to a slower start – but still strong – than July with the first week of table revenues of HK$4.5 billion.  Average daily table revenues were HK$647 million versus HK$728 million for all of July.  For the full month Gross Gaming Revenues, we are projecting HK$20.5-22.0 billion which would represent YoY growth of 34-44% but a drop of 6-13% MoM.  July was such a strong month – and surprising considering that July is seasonally slow - we would not be surprised with a sequential slowdown.  It’s tough to reach any definitive conclusions with only one week of data but we are monitoring the data closely for any hints of a sustainable downturn in VIP volumes.


In terms of market share, Wynn and Galaxy were the big takers in the first week.  MPEL lost share but we are hearing that it was hold related.  










Global growth is the key variable in defining investors’ outlook on commodities, it seems.  Goldman Sachs has maintained its constructive outlook on commodities, keeping its overweight recommendation on raw materials relative to other assets, saying that global growth is “sufficient” to drive demand, according to Goldman Sachs.  Commodity prices, however, have dropped on concerns that the global economy may be slowing materially as S&P downgrade may worsen slowdown, according to Bloomberg.



The following comments from TSN today are bearish for restaurant margins: 


“Because many of our sales contracts are formula based or shorter-term in nature, we are typically able to offset rising input costs through increased pricing. However, there is a lag time for price increases to take effect.”


“Chicken prices were up 10.2% - “we expect weak market pricing conditions to continue as a result of an imbalance of available supply relative to customer demand. Current USDA data indicates reduced broiler egg sets and placements in the fourth quarter of fiscal 2011. However, we do not expect to see a meaningful impact of the reduced supply in our results until late in our fourth quarter of fiscal 2011 and continuing into fiscal 2012. Because of these factors, we expect our Chicken segment will likely experience a loss for the fourth quarter of fiscal 2011.”


“Beef were up 13.5% - “We expect to see a gradual reduction in fed cattle supplies of 1-2% in fiscal 2012 as well as exports to remain strong as compared to fiscal 2011. Despite reduced domestic availability, we expect adequate supplies in the regions we operate our plants. Based on these factors, we expect the strong fundamentals in our Beef business to continue in fiscal 2012”


“Pork prices were up 3.0% - “We expect hog supplies in fiscal 2012 to be comparable to fiscal 2011 and to be adequate in the regions in which we operate. We expect pork exports to remain strong in fiscal 2012.”





Restaurant stocks are underperforming the food and beverage categories as commodities slump, particularly sugar over the past two weeks, as concerns over a global growth downturn mount.


THE HBM: MCD, YUM, SBUX, PEET, CAKE, TXRH - subsector fbr




  • MCD July Global comparable restaurant sales exceeded estimates in July, increasing 5.1% versus consensus 4.6%.  US comps grew 4.4% versus 4.1% consensus, Europe grew 5.3% versus 6.6% and APMEA grew 4.0% versus 1.9%.
  • MCD Japan comparable restaurant sales growth fell -3.8%.
  • YUM raised to Outperform versus Neutral at Baird.  The price target is $60.
  • SBUX raised to Outperform versus Neutral at Baird.  The price target is $45.
  • PEET was downgraded to Hold from Buy at Gabelli.



  • CAKE was downgraded to Neutral versus Outperform at Baird, the price target is $30.
  • TXRH was cut to Neutral versus Outperform at Baird, the price target is $16.





Howard Penney

Managing Director


Here is a run through of our thoughts on Brinker heading into the release of the company’s 4QFY11 earnings results. 


Brinker continues to be one of our favorite names in casual dining on the long side.  Knapp Track trends have been robust lately and, given the size of its system, we think Chili’s – especially given the slowing of Applebee’s comps quarter-to-quarter – could be driving that strength.  Below, we discuss the forward looking statements from Brinker’s most recent earnings call.





“I've said it before, but let me reiterate, the financial health of the company is strong, the business model continues to improve, providing flexibility to invest in the business and return value to shareholders through dividends and share repurchase. There's still much work to do to achieve our goal of doubling EPS in five years, but we feel very good about the progress made thus far.”


HEDGEYE: This statement epitomizes the overall tone of the earnings call on April 27th.  Management seemed very confident about the progress it is making in its goal of turning the company around.



“And while, historically, rising gas prices have not had a significant impact on the casual dining industry, we would be in uncharted waters if its prices significantly eclipsed the levels last seen in the summer of 2008, particularly in the light of the slow economic recovery. There's no historical precedent to indicate how we or the industry as a whole might react, so we must ensure our operating model as a whole is sustainable in a variety of conditions by giving the guests better service, better food quality while still delivering our net 400 basis points of margin improvement we promised.”


HEDGEYE: I remember thinking at the time this was a shot across the bow of RT.  Nevertheless, I think positive comp sales that started in February and March (including positive traffic) have sequentially improved throughout the 4th and Chili’s can post SSS of 1-2%.  That would imply that Chili’s could see as much as 150bps sequential improvement in SSS



“As we said last quarter, we are currently targeting three key dayparts, early week lunch, dinner and the Happy Hour, primarily 3:00 to 6:00 p.m. and after 9:00 p.m. Monday through Friday.”


HEDGEYE: We know now that Applebee’s sales trends slowed quarter to quarter.  In part it could be due to the success of Chili’s continued focus the three day parts.





“It is because of the threat of things like a slow economic recovery and inflationary pressures that you do want us working on the strategies we've discussed. These initiatives are geared towards improving our basic financial fundamentals, enhancing value in our menus while delivering a superior customer experience.


HEDGEYE: The only way Brinker can offset any downside in the macro environment is by “improving our basic financial fundamentals.”  If you contrast this to last week’s note on PFCB, the two companies’ approaches to turning around the respective concepts are starkly different.  PFCB’s approach is expense-focused whereas EAT is more focused on cost-cutting.



“And at Maggiano's we continue our impressive sales trends with 3.4% sales growth. That's our fifth consecutive quarter of positive comp sales growth at Maggiano's. And 3.3% increase in guest counts, sixth consecutive quarter of traffic growth.


HEDGEYE: The performance of Maggiano’s is a tailwind for the overall performance of the company.





“While we typically would not outline our projections if they were not materially different than our annual guidance (which contributed to approximately $0.09 to the prior year's EPS), we recognize that it is harder to forecast when we're lacking a 53rd week in the prior year, particularly in this coming quarter, when the extra week occurred a year ago. Thus, we would outline that our expectations for fourth quarter EPS would fall between $0.43 and $0.47.”


“We also expect headwinds on our commodities to increase from trends seen thus far in the fiscal year, including some pressure on the cost of sales line.”


"Predicated on the continued solid performance of the company, I would anticipate incentive compensation in both labor and G&A would continue to be higher than the prior year."


“I'd like to remind you that Macaroni Grill transition service agreement has concluded in the third-quarter.”


“We will continue to assess the impact that inflationary pressures in the economy and competitive activity might have on the consumer, as we thoughtfully consider our pricing decisions and strategies going forward.”


"The net result or our strong P&L that we've got now gives us the flexibility to determine whether there's an opportunity for us to move some share by not taking price. If that opportunity doesn't present itself, then we of course could take price like everybody else. But we would like to see what happens competitively before we make that decision.”


HEDGEYE: Consistent with other companies in the industry, I would expect to see management raise prices modestly this quarter.



“We didn't provide a comp assumption, but you'll recall that overall we expected Brinker aggregate sales to be flat to down 2% for the year, and we still expect to be within that range. And it's underlying that implies it – that we expect it to be flat to positive in the back half of the year, and we got there in the third quarter, and we would expect that to continue in the fourth quarter.”


HEDGEYE: As we’ve said before, we continue to believe that Chili’s is now taking share in the casual dining space.





“With respect to commodities, we are approximately 92% contracted through the end of the fiscal year. Provided this visibility, we expect to be slightly unfavorable as we move into the fourth quarter. We are 54% contracted through the end of calendar year 2011, and anticipate about 100 basis points impact to cost of sales due to inflation in our commodity basket for fiscal 2012 as a whole based on our existing contracts and our forecasts.”


HEDGEYE: Looking for more detailed guidance this week, but there is little chance that there is going to be an upside surprise here.



“Solid margin improvement continues with 160 basis points increase in operating margins, thanks in part to the robust top line, coupled with a menu restructure Maggiano's put in place last fall when we launched the Classic Pasta program.  Maggiano's continues to pull off the simultaneous feat of driving compelling value, but also achieving improvements in their P&L. In February-March, Maggiano's score for great food, also making the guests feel special, and value were at recent historical highs. The strong top line trend bodes well for Maggiano's future.”


HEDGEYE: The performance of Maggiano’s is a tailwind for the overall performance of the company.



“General and administrative expenses increased nearly $4 million over the same quarter last year to $36 million. The increase was primarily driven by an increase in incentive-based compensation costs, professional fees and a reduction in transition services income. These headwinds were somewhat offset by lower stock-based compensation expense and payroll related expenses. We would expect these trends to continue into the fourth quarter.”


“Well, consistent with what we've talked about in the last month or so as we visited many of you, beef continues to present the most significant inflationary pressure in our commodity basket.  That is an item that we have contracted through the August timeframe, particularly for burger meat. So we do expect that in the first half of fiscal 2012, we'll be renewing that contract, and if we were renewing them today, it would present a pretty significant inflation over what we've contracted at today.”


HEDGEYE: Food inflation is an issue for the industry, but EAT is doing what they can to offset its impact as much as possible.





“We certainly feel comfortable with the success of those initiatives, but from a timing perspective they might come a little bit later which might mean a little bit better EPS growth in fiscal '13 than we might have originally thought. But the underlying premise you have of accelerated EPS growth in fiscal '12, we're still comfortable with that, and we'll obviously provide more clarity at our August call.”


“The places where we really haven't got much of a start in terms of impact to the P&L, although I think we're quite a ways down the road in terms of understanding what it could mean in the future, are the installation of the kitchen equipment and the installation of our point of sale and back office systems. Both those are the first kitchen equipments in 15 restaurants today, the point of sale and back office equipment is in 24 restaurants today. Both are anticipated to start rolling out aggressively here in the start of the first quarter, end of the fourth quarter. So we would expect to see progressing benefit from those as fiscal '12 rolls through."


"And the point of sale and back office systems will be complete in fiscal 2012."


"The kitchen retrofit will take even into a little bit of fiscal '13 to get completely through the system. So we would expect to see progress on both of those. And the kitchen equipment is certainly of a magnitude of Team Service and the point of sale back office systems is probably in the order of magnitude of the kitchen of the future prep component that we've already rolled out."


"The full impact of all of it would come in fiscal '13."


HEDGEYE: I continue to believe that the Plan-To-Win is working as management has planned.





“Now on the re-image, we would expect, we'd talked about CapEx being in the $160 million range for fiscal 2012. With some of the capital not being spent here in fiscal '11, some of that may now move into fiscal 2012 and require a little bit more CapEx spend but that will only be to affect things that we were expecting to get done this fourth quarter that may now happen in the first quarter next year, and the bulk of that will be the re-image and the implementation of the new kitchen equipment.”


“So we're moving forward, very optimistic about where we'll go from there and after we finish these next markets, we'll have about 60 restaurants re-imaged and that should be a significant enough number for us to feel good about then aggressively moving it forward.”


“The impact to next year will really be dictated somewhat on how fast we can get the re-image program rolling through but we're optimistic that we can move fairly quickly and that it would have some impact to next year's sales although it won't be huge because of just the timing of when those restaurants will actually have the full remodel in them throughout the year. We are counting on having some impact but I wouldn't say it would be excessive.”


HEDGEYE: The momentum of the remodel program will allow Chili’s to continue to post improving SSS as we move thru fiscal 2012.



From a sentiment perspective, Brinker is still not loved by the sell-side with a mere 33.3% of analysts rating the stock a Buy and 52.4% rating it Hold while 14% rate it a Sell.  From a valuation perspective, too, EAT is attractive with an EV/EBITDA NTM multiple of 5.8x versus RT at 6x, the casual dining average at 6.7x.


EAT - MOMENTUM IS AN IMPORTANT FORCE - sell side sentiment






Howard Penney

Managing Director


Rory Green





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