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The biggest take away from this quarter’s earnings season was the decline in the earnings outlook for Full Service sector versus the Quick Service sector.



Full Service trends

  • 57.8% of the companies in the FSR space saw DOWNWARD revisions over the last month
  • 36.8% of the companies saw UPWARD revisions over the last month


QSR Earnings Trend

  • 52.9% of the companies in the QSR space saw UPWARD revisions
  • 11.7% of the companies saw DOWNWARD revisions
  • Two companies have not yet reported


Full Service Sales Trends

  • 7 concepts had negative SSS in 4Q10 - Industry average SSS was 2.2%
  • 7 concepts had negative SSS in 1Q11 - Industry average SSS was 2.4%
  • 9 concepts have negative SSS in 2Q11 - industry average estimates SSS is 3.0%
  • The Hedgeye estimate for 3Q11 SSS is 1.5%.
  • The Hedgeye estimate for 4Q11 SSS is 0.7%.
  • As many as 15 concepts could see negative SSS by 4Q11.

The concepts that are negative in 2Q11 are; Cracker Barrel, IHOP, Chuck E Cheese, McCormick & Schmicks, PF Chang, Pei Wei and California Pizza Kitchen.



Quick Service Sales Trends

  • 2 concepts had negative SSS in 4Q10 - Industry average SSS was 5.0%
  • 3 concepts has negative SSS in 1Q11 - Industry average SSS was 2.9%
  • 3 concepts have negative SSS in 2Q11 - industry average estimates SSS is 3.0%
  • The Hedgeye estimate for 3Q SSS is 2.0%
  • The Hedgeye estimate for 4Q SSS is 0.7%

The concepts with negative SSS trends in 2Q11 were Pizza Hut (-2%), KFC (-5%), and Taco Bell (-5%).



Sector Performance Trends


The response to the significant revisions in consensus EPS for the casual dining industry has led to a significant correction in the subsector.  As you can see from our subsector performance table (which we publish every day in the HBM) the group has begun to significantly underperform.  In contrast, the QSR sector has significantly outperformed.


In our view, contrarian investors could profit from looking at the food processing space for potential longs.  The Processing stocks have underperformed for quite some time, despite a correction in commodity prices.  However, TSN, recently commented that it expects protein prices to rise across the board in the coming months and SYY is also expecting high inflation for a few quarters. 


Looking at the broader consumer space over the past three weeks, the QSR segment showed significant outperformance along with Discount Stores.  The two sectors that underperformed the most over the past three weeks were Gaming, Lodging & Leisure and Homebuilders.





Howard Penney

Managing Director


Rory Green



The Cowboy Is Up

Conclusion: With Texas Governor Rick Perry officially in the race, former Massachusetts Governor Mitt Romney looks to be finally facing some meaningful competition for the Republican nomination.  Meanwhile, despite falling to near lows in approval, President Obama continues to poll well against most Republicans. He is vulnerable, but Obama is far from beaten.


President Obama actually trumped Governor Perry’s entrance into the Presidential race this weekend by garnering substantial news coverage of his own.  Unfortunately for Obama, the news coverage was related to the downward spiraling of his approval rating.  Specifically, a Gallup poll ending on August 13th showed Obama’s approval rating at 39%.  With the addition of this poll, the Real Clear Politics poll aggregate for Presidential Job Approval has now fallen to -6.7 – a mere 40bps off the lows of the Obama Presidency.


The Cowboy Is Up - 1


According to the history of Gallup’s polls, this places President Obama as the second least approved of President in the third week of August of the third year of a Presidency for all Presidents going back to President Eisenhower.  Not surprisingly, the least approved President in that period at this point in his Presidency was President Carter with an approval rating of 32%.  The President with the third lowest approval rating at this juncture in his Presidency was President Reagan, with a 43% approval. 


As it relates to contemplating President Obama’s re-election chances in 2012, his approval rating is certainly an instructive factor, but we would caution at reading too much into this one factor so far away from the general election.  As was proven by Reagan’s first term, the ability of a President to rally from a dismal approval rating and be re-elected is very realistic.  In Reagan’s case, he went on to a land slide victory over Walter Mondale winning 58.7% of the popular vote and 97.6% of the Electoral College votes. (Incidentally, Carter was the only Democratic President to not to be re-elected since 1888.)


Certainly there are many differences between Reagan and Obama, but the interesting basic similarities are that they are both incumbents up for re-election with low approval ratings and facing seemingly weak challengers.  In Reagan’s case, Mondale likely put the nail in the coffin of his electoral chances with the following statement at the Democratic convention when he accepted his nomination:


“Let's tell the truth. It must be done, it must be done. Mr. Reagan will raise taxes, and so will I. He won't tell you. I just did.”


In effect, Mondale explicitly told voters he was going to raise taxes.  Even if realistic as a deficit cutting proposal, explicitly indicating you will raise taxes is not the most prudent campaign tactic. 


As it relates to Obama, despite the weak economy, broad dissatisfaction with politicians, and his low Presidential approval rating, Obama still polls well against most Republicans.  In the table below, we’ve outlined the most recent polls of Obama versus some of his key Republican challengers in August:


The Cowboy Is Up - 2


Two key events have occurred since the above polls were taken: Tim Pawlenty has dropped out of the race and the native of Paint Creek, Texas, Governor Rick Perry, has officially thrown his proverbial cowboy hat into the ring. 


As Perry just recently entered the race, no polls yet reflect whether his standing versus Obama has shifted, but InTrade does provide a bit of an insight.  Currently, the contract that Perry will gain the Republican nomination is reflecting a 39% chance that Perry will receive the nomination versus 30% for Romney and 7% for Bachman.


The Cowboy Is Up - 3


Even though no candidate has gained the nomination entering this late into the race, Perry has become the front runner for the nomination over night.  As a result, the Democrats have begun to attack Perry focusing on his love of God, purported lack of intelligence, coiffed hair, and his key platform position of limiting the power and influence of government.  Probably the best example of the tact that Democrats will take on Perry’s view of government came from former Clinton advisor Paul Begala over the weekend, when he wrote:


“Does Tim Pawlenty rant about Social Security? Hah. Perry told The Daily Beast's Andrew Romano that Social Security is “a Ponzi scheme,” and that both it and Medicare are unconstitutional.” 


As Perry steps from the conservative cloak of Texas and attempts to establish a national brand, it will be critical for him to withstand personal and philosophical attacks from the left.  Luckily for Perry he has substance behind his nicely groomed hair, especially as it relates to the economic success of Texas.  As he noted on Sunday at his campaign launch in South Carolina:


“Over the years, we’ve followed this recipe to produce the strongest economy in the nation. Since June of 2009, Texas is responsible for more than 40 percent of all the new jobs created in America. Now think about that, we’re home to less than 10 percent of the population in America but 40 percent of all the new jobs were created in that state. I’ve cut taxes. I have delivered historic property tax reductions. I was the first governor since World War II to cut general revenue spending in our state budget. We passed lawsuit reform including just this last session. Loser pays.”


For now, we are reserving judgement on Perry’s potential, but if the video of his launch, which is attached below, tells us anything, it is that Perry’s ability to reach and communicate with Americans may only be paralleled by the President himself in this race.




The cowboy from Paint Creek is up, now the question is whether he can handle the national political bull.


Daryl G. Jones

Director of Research


On track for another big month.


Macau rebounded strongly from a “soft” first week of August.  Table revenue per day increased from HK$646 billion in the first week to HK$792 million in the past week.  We think the full month of August will come in the range of HK$22.0-23.5 billion, up 44-53% YoY.


Market shares have normalized a bit from the first week as one would expect.  MPEL rebounded from a low hold percentage in week 1 and is now at 14.1% for the first half of August.  Still below trend but still above the Street in HK$ terms as far as we can see.  LVS looks weak at 13.5%, down from 15.0% in week one.  Wynn continues to impress with market share in line with the pre Galaxy Macau numbers.


MACAU REBOUNDS IN WEEK 2 - macau 081411

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I found this related-party transaction footnote in the DNKN 10Q 10 be of interest:


(14) Related-Party Transactions


(a)    Advertising Funds


At June 25, 2011 and December 25, 2010, the Company had a net payable of $21.3 million and $23.1 million, respectively, to the various advertising funds.”


This bullet is important for understanding a key item in the DNKN P&L. 


DNKN collects a range from 1.0% to 6.0%, of gross retail sales from Dunkin’ Donuts and Baskin-Robbins franchisees to be used for various forms of advertising for each brand.  For fiscal 2010, franchisee contributions to the U.S. advertising funds were $290.0 million. For the six months of 2011, franchisee contributions to the U.S. advertising funds were $147.8 million.


According the 10Q, “the contributions from franchisees in fiscal 2010, are almost exclusively franchisee-funded and cover all expenses related to marketing, advertising and promotion, including market research, production, advertising costs, public relations and sales promotions. We use no more than 20% of the advertising funds to cover the administrative expenses of the advertising funds and for other strategic initiatives designed to increase sales and to enhance the reputation of the brands.”


Several things come to mind:

  1. The Franchisees can’t be happy that the company is holding back some of their Advertising funds!
  2. The $21.3 million represents 14% of the advertising funds collected YTD.  If you include another 20% the company spends on administrative expenses the advertising message is weakened.
  3. The franchisee contributions to the U.S. advertising funds of $147.8 million are below the implied rate of growth in points of distribution of 3.6%.
  4. The $23.1 million at December 2010 represents 86% of the 2010 net income. 
  5. The ad fund expensing looks like a big “reserve fund” for a rainy day!  Is there now an earnings charge/change/manipulation potential in the out quarters or years?
  6. Management is in a quiet period so I can’t get much more color on why this payable is on the company’s balance sheet.
  7. I looked at MCD, DIN, WEN, and YUM, (all companies with significant franchise systems) most recent filings and do not see an equivalent entry.


Howard Penney

Managing Director


Rory Green



European Risk Monitor: Tea for Two

Positions in Europe: Short EUR-USD (FXE); Short UK (EWU)

European capital markets whipped around last week alongside a decision late Thursday by France, Italy, Spain, and Belgium to ban short selling of bank and insurance stocks as the Swiss National Bank announced it would intervene to weaken the CHF.  We continue to believe that Europe’s sovereign debt contagion has a long term TAIL and the uncertainty on the European community’s go-forward program (more below under “Calendar Catalysts”) should support marked downside in the periphery and a drag on the core over the immediate and intermediate terms. For now, investors hope Sarkozy and Merkel can cure ills over tea tomorrow – we’ll take the other side.


Short Selling Ban

To put the short selling ban in context, our Financials Sector head Josh Steiner wrote a note on Friday titled “Banning Short Selling Helps for about 5 Hours” in which he cites the short-lived bounce that US Financials (XLF) received on 9/18/08 on the SEC ban on short selling US financial stocks.


He notes specifically that “the US ban triggered a trough to peak move of 32% that lasted essentially 5 trading hours, all of which was given back over the next seven trading days. For reference, post the short-squeeze highs of $24.50 in the XLF on 9/18/08, the XLF proceeded to lose 76% of its value to its intraday low of $5.88 on March 6, 2009, roughly six months later.”


We use the US Financials short selling ban as a reference point for European bank stocks, especially for the banks of the PIIGS, France, and Germany, that saw heavy selling leading into last week’s short selling ban. To say the least, we don’t see any near term selloff as a clear buying opportunity.


Calendar Catalyst

There are a few calendar catalysts over the near to intermediate term, and the problem remains the political uncertainty on a road map to shore up sovereign debt contagion, especially as the spotlight moves to Italy and Spain. Here’s what’s ahead of us:

  • Merkel and Sarkozy meet tomorrow (8/16) in Paris
  • European banks, through VOLUNTARILY Private Sector Involvement (PSI), are scheduled to reduce Greece’s debt through exchanging existing bonds for new bonds with lower interest rates and longer maturities in late AUG/early SEPT
  • The terms, but not size, of the EFSF will be voted on in mid to late September by EU member states

We continue to warn that we’re likely to see indecision across countries on if not the terms, but eventually the size, of the EFSF, which we see far undercapitalized to handle any bailout needs of Italy or Spain. Remember, the EFSF must be ratified by ALL EU countries, which cannot happen until parliament returns from summer recess. There are no rumors that tomorrow’s meeting between Merkel and Sarkozy will bring any clear decision, besides further stamping out the possibility of issuing a Eurobond (note: different from EFSF bonds), that the Germans are squarely against.


We think the ECB’s decision to re-engage the SMP bond purchasing program on 8/8 is a response to the lack of resolve on the terms and size of the EFSF, including its ability as a facility to shore up sovereign debt fears. To this end, we learned today that the ECB bought a monster €22 Billion in sovereign bonds last week! While sovereign bond yields have come in over the last week, importantly down to around 5% for Italy and Spain, there was no indication that this recent respite will hold. [Note: even in the days following the second bailout of Greece on 7/21 yields remained elevated (see chart below)].


European Risk Monitor: Tea for Two - meme1


European Financials CDS Monitor

Bank swaps in Europe were mostly wider last week.  34 of the 38 swaps were wider and 4 tighter.   With the banks of no country immune to the move last week, the critical call-outs are the banks in Belgium, Germany, Greece, Italy, Portugal and Spain.


European Risk Monitor: Tea for Two - meme2


We remain short the UK due to the country's sticky stagflation and short the EUR-USD.  Our trading range is $1.42 to $1.44, with the intermediate term TREND line at $1.43.


Matthew Hedrick

Senior Analyst


DNKN was covered this morning in the Hedgeye Virtual Portfolio.


This morning, Keith covered DNKN in the Hedgeye Virtual Portfolio as the stock was oversold on an immediate-term “TRADE” basis.  From a fundamental perspective, we remains negative on the company’s prospects of justifying the still-egregiously high multiple the stock price is implying.  For a comprehensive overview of our analysis on DNKN, please email us or for a copy of the DNKN Black Book and other research notes on the company.


DNKN: TRADE UPDATE  - dunkin levels



Howard Penney

Managing Director


Rory Green