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PNRA - FOLLOW THE TRAFFIC PATTERN

PNRA faces some big hurdles in the coming months, especially in 4Q11.  While we think trends remain on track this quarter, sales have softened a bit of late.  For the industry as a whole, the bar has been raised on sales trends, given the significant downturn in consumer confidence and the lack of any significant improvement in the jobs picture. 

 

On the surface it looks like that PNRA's second half comp guidance seems achievable given that a 5% comp (guided to 4.5% to 5.5% same-store sales growth in both 3Q11 and 4Q11) during the third quarter implies a 175 bp deceleration in two-year average trends. 

 

The biggest risk to guidance seems to come in 4Q11, as the difference in transaction growth between 3Q11 and 4Q11 is driven by the distribution of media.  PNRA will print the highest year-over-year growth in media in 3Q11 as the company is rolling out the “Make Today Better” campaign.  For fiscal 2011, year-over-year media spend will be up approximately 40% system-wide.  Also in 4Q11, PNRA will anniversary the MY PANERA loyalty program primarily in 4Q10.  

 

Being conservative, management’s guidance assumes a fairly significant slowdown in two-year average traffic trends during the second half of the year, which is warranted given that the company intends to raise prices in September, resulting in a 3.5% price increase during 4Q11 versus the 2.5% expected in 3Q11 and reported in 2Q11. 

 

PNRA - FOLLOW THE TRAFFIC PATTERN - PNRA sss vs check

 

 

It was encouraging to hear management talk about the potentially negative impact on traffic as a result of the incremental price increase as companies often talk about price increases as being wholly incremental; management also attributed the expected deceleration in traffic trends to economic conditions. 

 

The biggest risk to Panera’s second half comp targets stems from the assumed sequential improvement in mix.  PNRA reported modest check compression of 50 bps during 1Q11, which worsened to 100 bps during 2Q11.  Management attributed this negative mix impact to the company’s new loyalty program, which offered increased discounts and specific to 2Q11, to the later introduction of its Summer Salad Celebrations versus the year prior. 

 

Going forward, management expects menu mix to turn positive and guided to flat to +1% mix impact on check during 3Q11 and 1-2% mix impact in 4Q11.  PNRA’s comp guidance relies on this mix improvement in the back half of the year but the comparisons get much easier as the company took a big hit on mix during 4Q10 (reported +0.3% versus +3.3% in 3Q10), largely as a result of the launch of its loyalty program. 

 

That being said, although we need to see a big improvement in mix quarter to quarter, the guidance assumes fairly even mix trends on a two-year average basis.

 

It will be important to watch how customers respond to Panera’s upcoming price increase and how customers fare overall in the current economic environment, but given recent trends, PNRA’s comp guidance seems reasonable in 3Q but somewhat more aggressive in 4Q11. 

 

From a commodity perspective, Panera is expecting 4.5% inflation for the full year 2011 and roughly 4-5% for 2012.  Wheat is the most important commodity for Panera, in terms of the percentage of its commodity spend that the grain accounts for.  In 2008, soaring wheat prices impacted Panera’s restaurant level margins severely.  A new strategy of buying at least six months out and buying in short periods of time has benefitted the company through inflationary periods but, as management said in early 2010, has allowed some benefits of commodity deflation to elude the company’s P&L. 

 

Coming into 2010, the company had 80% of its wheat costs locked in at just over $8 per bushel and wheat costs for 2011 were locked “approximately flat” to wheat costs in 2010, according to management.  As the chart below shows, wheat is currently tracking approximately flat year-over-year, at roughly $7.25 per bushel, and could be down year-over-year in early 2012.  In the near term, crop damage in the U.S. caused by drought, flooding, and other events will provide support for wheat prices.  Over the longer term and for 2012 overall, global demand may slow if economic growth remains stagnant.  As always, the U.S. Dollar, and the factors that influence it will be a primary driver of what wheat prices restaurant companies face next year.

 

PNRA - FOLLOW THE TRAFFIC PATTERN - wheat 95

 

 

Howard Penney

Managing Director

 

Rory Green

Analyst


INTIMIDATION

This note was originally published at 8am on August 31, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“I used to think that if there was reincarnation, I wanted to come back as the president or the pope or as a .400 baseball hitter.  But now I would like to come back as the bond market.  You can intimidate everybody”.

-James Carville

 

Markets are intimidating and they don’t wait for anyone. Nor do they owe anyone a return, as Keith likes to say.   

 

When James Carville made the above quote, he was referencing the melt up in 10-year yields in the early stages of Bill Clinton’s first term as president.  Bond investors, at the time, were concerned about federal spending.  Subsequent efforts by the Clinton administration to control the deficit, which helped to strengthen the dollar, led to the bond investors’ fears being assuaged: yields trended lower and stocks surged, for the most part, during the remainder of Clinton’s stint as Commander in Chief. 

 

Markets are at least as intimidating today as they were in the early 1990’s, when real-time prices forced the government to sober up.  In the age of social media, where information is more accessible than ever, anyone can be a part of the debate.  In general, I would argue, this is good for the country as it allows a broader range of views to be heard by a broader range of people.  Popular consensus, in a way, is changing on a tick like real-time market prices, thanks to the democratization of information.  For the political players in Washington, this is intimidating.

 

Although real-time communication is becoming the norm, certain members of the financial community will likely resist that move and, like others before them across industries that have resisted positive change, they will be left behind.  The Federal Reserve’s inability to prop up equity prices in perpetuity has set alarm bells ringing in Washington this year as Hedgeye’s call for Jobless Stagflation, induced by ineffective Keynesian policies, has manifested itself.  For now, it appears that policy-makers are sticking to their guns, but to the extent that real-time prices and economic data continue to weigh on sentiment, the time for the incumbent players to act could be limited.

 

Despite Charles Evans’ best attempts, yesterday on CNBC he ignored the fact that markets discount future events (like the cessation of QE), and equity markets have declined globally on expectations that the global economy is slowing.  In the U.S., the primary source of pessimism (and ultimately the primary potential for renewed growth) is the consumer.  Despite trillions of dollars of government spending, consumer’s expectations for an improved economy have not changed significantly over the past three years.   

 

Yesterday’s bomb of a consumer confidence number from the Conference Board came as no surprise to anyone.  In an effort to look for a positive in what was a decidedly negative report, the stat that stood out the most to me was that more than half of consumers expect the stock market to be lower in a year, the first time that has been true since March 2009.  However, this is not March 2009, this is 2011.

 

In my view, there are four primary ailments that need to be addressed for a consumer recovery to take place.

 

(1)    The political machine in Washington, D.C. is broken.

 

This one is obvious.  The debt and deficit debate put the spot light on everything that is wrong with Washington politics.  Dylan Ratigan recently expressed the frustration many Americans are feeling during his rant on MSNBC during which he accused legislators of being “bought”.  Howard Schultz, the CEO of Starbucks, seemingly agrees as he is encouraging business leaders to just say no and stop funding the madness via political donations.  Ratigan, for his part, has shown no mercy for either side of the aisle.  During his now famous rant, Ratigan accused Democrats of “kicking the can down the road until 2017” and “screwing” future generations by not offering long-term solutions for extractions from the economy.  Turning to Republicans, he stated that they simply want to “burn the place down” and pursue a negative agenda.

 

(2)    Perpetually low rates is killing confidence

 

Easy money creates bubbles which have a severe impact on consumer confidence given that consumers are usually the last to the party.

 

(3)    The Keynesian policies of the FED is slowing GDP growth

 

Quantitative Easing is inflationary!  While Mr. Evans was on CNBC, refusing to admit that QE2 was inflationary, it was obvious that he was ignoring inconvenient facts while admitting only those that suited his stance.  Markets are discounting mechanisms and hinge on expectations; the longer-term view of QE2 is highly conclusive; the result was a weakened dollar and a 29% surge in the CRB index over the past twelve months.  Stagflation is back and it is scaring the public.

 

(4)    The Government inflates the data to build up expectations only to be shot down with constant downward revisions

 

The most glaring example of this is seen in the BEA's use of "deflators." The BEA is telling us that they believe that inflation over the prior two quarters has been running at annualized rates of 2.5% and 2.7% respectively and the annualized inflation rate for the prior four quarters was just barely over 2%.  You tell me!!  Is it really plausible that over the last 12 months we saw net inflation of barely over 2%? 

 

On Monday, the government reported that personal spending increased 0.8% in July.  This was a 100 basis point improvement from the month prior.  Consumption is accelerating despite numerous headwinds.  I have become very cynical about government data and it does require a leap of faith to assume that the government has accurately captured what is happening in the real economy.

 

Despite a significant downturn in equity prices during August, the S&P 500 is now 10% “off the lows” into month-end.  The market faces a difficult macro calendar in September including another attempt from the Obama administration to jump-start the economy.  One thing Obama knows is that markets are ready-and-able to tell him if he is not doing the right thing.  Coming up to the election, the incumbent president needs a win, but solutions to the problem of Jobless Stagflation and ideological dogma in Washington, D.C. are what the market of popular consensus is demanding. 

 

Function in disaster; finish in style,

Howard Penney

 

INTIMIDATION - EL Chart 831

 

INTIMIDATION - 1. vp


LIZ: Losing the Ball & Chain

 

CORRECTION: The $85mm value of this morning’s deal was net of debt disposition, not gross that we previously implied. The difference is not immaterial though it does not change our call on LIZ, which is all about driving RNOA sharply higher as it sheds underperforming assets while driving EBIT higher and delevering along the way.

 

 

 

LIZ officially announced the sale of its Mexx business this morning removing one major drag and improving another other – its balance sheet. According to the terms of the deal, the company will receive $85mm in total cash consideration consisting of $25mm of cash in hand and $60mm of debt that will be assumed by the newly formed JV between The Gores Group (81.25% owner) and Liz (18.75%). The deal values Mexx’s ~$700mm in revenue at $105mm and marks the second asset sale in the past 30-days.

 

The terms are below what was rumored by the press last month, but keep in mind a few things… 1) while the market was melting down this deal was widely rumored to be falling apart, 2) The stock was off 37% during this period, and 3) at the same time, its net debt improved by almost 20% . Most importantly, the stock price is at the same level today – and the Enterprise Value 10% lower – than when the biggest pushback we got on our call was “this Board is inactive, management stinks, the balance sheet is too levered, and this company could go bankrupt.’ Anyone want to make sense of that for me?

 

Between this deal and the fragrance business they sold last month, the company is getting ~$83mm in cash and a $60mm reduction in debt providing added flexibility with which to manage leverage during Q3 before paying down a large portion of their debt in Q4. It’s also worth noting that this would get the company within ~$50mm of its goal of $578mm by year-end.

 

Looking out to next year (perhaps sooner), we suspect the company is likely to execute additional sales within its Partnered Brands business that could amount to another $100-$200mm that could be put towards deleveraging the business further.

 

So what’s left after these sales? We have the Partnered Brands business that we expect to generate nearly $20mm in EBIT next year and the three remaining Direct Brands (Kate, Juicy, and Lucky) that we expect to generate at least $80mm. With aggressive deleveraging underway, we are modeling approximately ~$15 in interest expense reduction generating earnings north of $0.45 next year assuming conservative operating improvement among the Direct Brands. We don’t have to drum up heroic assumptions to get earnings over $0.75.

 

With the company actively unlocking value through asset sales, it’s worth considering our sum-of-the-parts analysis below, which suggests a value of $12-$14 taking into account recent sales and a 10% breakup discount. That’s a double from current prices.

 

We think investors will get at least that on LIZ. This remains our favorite small-cap TAIL idea.

 

LIZ: Losing the Ball & Chain - LIZ SOTP Sales 9 11

 

Casey Flavin

Director

 

 


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Weekly Asia Risk Monitor

As usual, we’re keeping it brief. Email us at if you’d like to dialogue further on anything you see below. Also, we are always happy to forward along prior notes which may contain additional color on the specific topics/countries you see below.

 

THEME

QE3 speculation puts hawkish policy back into the forefront.

 

PRICES

Asian equity markets had a great week, closing up +2.7% wk/wk on both an average and median basis. The key outlier to the downside was China’s Shanghai Composite Index, which closed down -3.2% on QE3 speculation (more Fed-sponsored inflation). The +22bps wk/wk jump in China’s 2yr sovereign debt yields and +26bps wk/wk increase in China’s 1yr on-shore interest rate swap spreads is supportive of our view that the market will expect incremental tightening out of the PBOC alongside incremental speculation for additional easing out of the U.S. CDS declined broadly across Asian credit markets, with the fiscally conservative Australia and New Zealand leading the way on the downside from a wk/wk perspective.

 

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KEY CALLOUTS

China: Inflation remains the topic du jour in China, with Prier Wen Jiabao saying earlier in the week that “China’s top priority is stabilizing food prices” and that Chinese officials “do not plan to alter the direction of economic policy”. Though we expect Chinese CPI to decelerate going forward, we do think it will remain sticky enough on an absolute basis to justify the government’s hawkish bias – particularly if Chuck Evans and his Fed colleagues decide to pursue incremental monetary easing over the intermediate-term. China’s August manufacturing PMI, which accelerated marginally on a headline basis to 50.9, confirms our view with the input prices subcomponent ticking up to 57.2 vs. a prior reading 56.3. We have highlighted in the past the strong relationship between this series and China’s headline inflation reading.

 

As it relates to inflation on the fiscal policy front, Beijing decided to link a range of welfare payments to CPI (think: COLA) in order to boost the incomes of those most impacted by inflation. The change was fully implemented nationally at the end of August and should provide yet another incremental boost to Chinese consumption growth in 2H.

 

On the credit front, we highlight the drying up of China’s Local Government Financing Vehicle debt market as a key risk to Chinese banks, which coincidentally have seen their swaps widen dramatically over the last month (on the order of 60-70bps broadly). To the former point, this market, which is a key source of refinancing for China’s 10.7 trillion yuan of LGFV debt (24% of which matures this year), saw the least amount of issuance since Nov. ’08. Should investors start to materially lose confidence in this market, we could start to see a dramatic underperformance of Chinese financial shares as calls for a widespread uptick in defaults, NPLs, and capital raises become louder on the margin.

 

Japan: Earlier in the week, it was confirmed that Finance Minister Yoshihiko Noda will succeed the now-departed Naoto Kan as Japan’s next prime minister – the country’s sixth in five years and the third since the ruling DPJ party took control of the lower house in 2009. Noda, who is among Japan’s most fiscally conservative officials, has upheld rhetoric suggesting that he won’t back away from Kan’s desire to rein in Japan’s fiscal deficit (currently at 8.1% of GDP) and produce a balanced budget in ten years. In fact, he flat out said that the DPJ had let the country down in this regard and called for raising the 5% consumption tax by “the middle of the decade” in order to secure funding for accelerating social security expenditures and a third reconstruction stimulus package totaling around ¥10 trillion. Additionally, Noda appears to have enough internal support to at least begin to have a healthy debate about balancing Japan’s budget without letting politics get in the way of progress.

 

Elsewhere in the Japanese economy, the tired Japanese consumer continues watch from the sideline as consensus carries on with its bullish “reconstruction” storytelling. July retail sales growth slowed to a mere +0.7% on a YoY basis and also slowed to a -0.3% rate on a MoM basis – supportive of our call that upside to sequential gains in Japan’s economic statistics was limited from here. Small business confidence is supportive of this view as well, falling in Aug. to 46.4 vs. a prior reading of 47.1. All is not bearish, however; July housing starts growth exploded to +21.2% YoY (vs. +5.8% prior) alongside an acceleration in annualized housing starts to +955k MoM. Reconstruction lives on!… it just remains to be seen how the heavily-indebted sovereign plans to help finance it.

 

India: 2Q real GDP growth in India came in at a marginally slower rate of +7.7% YoY, which suggests to us that the Reserve Bank of India is more than likely to maintain its hawkish bias over the intermediate term. In fact, RBI Governor Duvuuri Subarao, architect of the fastest tightening in the RBI’s 76yr history, echoes this sentiment with his recent commentary:

 

“If global financial problems amplify and slow down global growth markedly, it would impart a downward bias to the growth projection. Still, the immediate challenge to sustaining growth lies in taming inflation.”

 

This view is in stark contrast to Brazil, which earlier in the week cut interest rates by -50bps to help support its ailing economy. This is to be expected, however, given that India’s real GDP growth is running at nearly double the rate of Brazil’s.

 

Still, Indian GDP growth is slowing, as evidenced by the country’s manufacturing PMI reading falling in August to a 29-month low of 52.6, which is still healthy on a relative basis to the world’s larger economies. Looking past the intermediate-term slowdown and viewing India from a longer-term perspective, we believe that Prime Minister Singh’s tax regulatory overhaul and the recently enacted anti-corruption legislation (Lokpal) are going to reduce the inflationary pressure within the Indian economy and help the country’s real-adjusted economic growth rates accelerate on the margin. The “flows” support this conclusion, with longer-duration FDI accelerating to an all-time high of $13.4 billion in 2Q. This is in heavy contrast to a near three-year high in monthly foreign capital outflows from Indian stocks through Aug. 25 ($2.3 billion).

 

Korea: In a contrarian research note published in early June, we appropriately signaled that Korean economic growth was going to have a meaningful deceleration alongside a pickup in inflation, which would cause the Bank of Korea to be hawkish or, at the very least, limit their ability to respond to the slowing Korean economy via monetary easing. CPI came in much hotter in August, at +5.3% YoY vs. a prior reading of +4.7% and the rate of core inflation also increased to +4% YoY.

 

Meanwhile, Korean economic data – especially the cyclical components – came in quite soft this week: manufacturing business survey ticked down in Sept. to 86 (vs. 91 prior); Sept. non-manufacturing business survey came in flat at 83; industrial production growth slowed in July to +3.8% YoY (vs. +6.5% prior); manufacturing PMI slowed in Aug. to 49.7 (vs. 51.3 prior) – indicating a contraction; and trade balance growth decelerated in Aug. to -$384.5 million YoY (vs. +$1.3 billion prior). It’s no wonder South Korean Finance Minister Bahk Jae Wan hinted that the government might cut its 2011 GDP growth forecast on Monday. Moreover, our model suggests their forecast of +4.5% YoY real GDP growth in 2011 is indeed too high (by roughly 100bps).

 

Thailand: This is yet another Asian economy where inflation remains the key focus of policymakers, which means we’ll continue to see a hawkish lean out of the Bank of Thailand over [at least] the intermediate term. Headline CPI accelerated in August to +4.3% YoY (vs. +4.1% prior) and core inflation also came in faster at +2.9% YoY (vs. +2.6% prior). Recent growth data is supportive of the BoT’s hawkish bias, as Thailand’s trade balance growth accelerated in July to +$3.5 billion YoY (vs. -$662.6 million prior). Furthermore, falling business sentiment (51.2 in July vs. 53.1 in June) would suggest Thai corporate executives are feeling both the pressure and specter of rising interest rates.

 

Australia: After a noteworthy plunge in bond yields across the maturity curve, Australia’s consumer, which is 1.6x levered and has a variable-rate mortgage on 90% of all home loans, finally came off of life support and contributed to Australian economic growth (retail sales growth accelerated in July to +0.5% MoM vs. -0.1% prior). It will be interesting to see how long this lasts, given the weakness in Australia’s manufacturing sector which is weighing on employment growth (manufacturing PMI ticked down in Aug to 43.3 – a 2yr low), falling home prices (growth in RPData’s House Price Index slowed in July to -0.6% MoM vs. -0.4% prior), and the consumer’s general distaste for additional leverage (mortgage loan growth decelerated to +5.9% YoY in July – the slowest pace on record).

 

Net-net, we continue to believe Glenn Stevens and the Reserve Bank of Australia’s next move on the interest rate front is down, though the recent collapse in sovereign debt yields should allow the consumer to cushion the slowing Aussie economy on the margin as its collective interest rate burden declines.

 

Darius Dale

Analyst


The Week Ahead

The Economic Data calendar for the week of the 5th of September through the 9th 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.

 

The Week Ahead - z.1

The Week Ahead - z. 3


FW: If The Price is Right…

We think the high end is slowing, but if so someone forgot to tell the footwear space. Shoes $130 and above are running 40% ahead of last year.  Great for FL and NKE.

 

We’ve been getting very mixed reads on the state of the high-end consumer. Tiffany looking good, some European Lux brands softening, and high hardgoods (watches, etc…) slowing meaningfully. But if there is, in fact, a slowdown, someone forgot to tell the footwear industry.

 

We’re seeing a clear bifurcation between high-end vs. lower end footwear. Simply put, the high end is crushing it. Out of all the price categories the strongest sales performance is $130 and above. While only 10% of the industry in aggregate, its data that we won’t ignore – especially when trending about 40% ahead of last year.

 

Check out charts below.

 

FW: If The Price is Right… - FW 70 band 9 1 11

 

 

FW: If The Price is Right… - FW 100 band 9 1 11

 

 

FW: If The Price is Right… - FW 130 band 9 1 11


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