SBUX - ever passionate and overly convincing

On its 4Q08 earnings call, SBUX management made a comment regarding early fiscal 2009, “Over the past few weeks, signs of improving comps have appeared episodically, though it is too early to call a trend particularly with the important holiday period still in front of us. That said, October did not show further deterioration to comps or traffic, a possible indicator that Q4 may have represented a bottom coming out milestone for our company.”

Unfortunately, SBUX had to take back those comments at its analyst conference today because the company has since experienced a further deterioration in its U.S. same stores growth in November. For the first 9 weeks of Q1, U.S. comparable sales are down 9% relative to the 8% decline in Q4. On a 2-year average basis this represents a significant sequential decline to down 5% in Q1 from down 2% in Q4. Additionally, the U.K. continues to worsen as well. Management did not provide specific Q1 EPS guidance except to say that it expects to fall short of current Q1 consensus EPS estimates of $0.22. The company attributed its expected earnings shortfall to the significant investment incurred in the quarter for its leadership conference, to the fact that it is lapping its most difficult comparison in Q1, and of course, to its deteriorating comparable sales trends, the future of which management has little visibility. So, the main takeaway from today’s meeting is that Starbucks has not yet found a bottom.

The only piece of new good news that emerged from the conference stems from the company’s expectation to generate $400 million in cost savings in FY09, up from SBUX’s initial guidance of $200-$210 million. On an EPS basis, this translates into about $0.36 of costs cut out of the P&L relative to the company’s prior forecast of $0.17-$18. Importantly, management highlighted that these savings are engineered to be ongoing and not just a FY09 benefit. The projected savings will come from four sources. SBUX expects to cut $150 million out of its $2.5 billion annual labor expense (For reference, this was the first time the company ever provided the investment community with its total annual cost of labor). An additional $50 million of savings will come out of its waste expense, or what SBUX calls its “cost of quality,” $150 million from procurement and $50 million from manufacturing/logistics. In aggregate, the company expects to cut $200 million of costs at the store level (labor and waste) and $200 million of costs out of its supply chain (procurement and manufacturing/logistics).

Due to these aggressive cost saving initiatives, management stated that even if same-store sales declined 7% for the year, it would still expect FY09 EPS to exceed FY08’s reported $0.71. However, management was quick to point out that it is not providing guidance but instead providing parameters around how to think about the impact of its expected $400 million in costs savings. The savings will provide more leverage to the P&L and offset some same-store sales weakness. Although I would agree that this is a positive development as it relates to improving margins, I don’t think the stock will really rebound until same-store sales growth returns.

From my math, it appears that the company plans on flowing the entire amount of its cost savings to the bottom line. The motivation for doing this most likely stems from the fact that SBUX wants to offset its top-line weakness and grow earnings. I would argue, however, that in this challenging and competitive environment that it would be more prudent for the company to reinvest some of these savings in the brand as the long-term success of the brand would benefit more from increased national advertising. Going forward, Starbucks will require a larger share of voice in order to combat the Dunkin’ Donuts and McDonald’s of the world, each of which will be spending a significant amount of money promoting its respective brand.

Outside of its not investing enough in advertising, I think SBUX is finally properly managing for the long-term. The company will continue to experience near-term pressure from same-store sales weakness, similar to other retailers and restaurants alike, but at some point SBUX will benefit from its renewed focus on operations within its four walls. Slowed unit growth, the closure of over 600 underperforming units in the U.S., reduced capital spending and a more efficient cost structure will all lead to improved store unit economics and inevitably, to stronger returns. At the risk of sounding like the ever passionate and overly convincing Howard Schultz did during his closing comments today, I would agree that two years from today we will be talking about where the stock was and the significant returns that have been made.

GES 3Q Ammo For You

In prep for the Guess? quarter, here’s a margin walk and our SIGMA analysis. This company has one of the worst top line trajectories and biggest 2-year margin risk in retail, in my opinion.

Yeah, the stock looks cheap at 2-3x EBITDA. But short interest is down to only 6% of the float, and I think margins are going from 17.7% to the low teens over 2 years as the extent to which the company has overearned in a favorable FX and sourcing environment puts the margin structure back in check (simply put, GES printed too much profit at the expense of reinvesting). There are other names that are nearly as cheap with margins and returns heading in the right direction (i.e., Ralph Lauren, and smaller cap names like Payless, Hibbett Sporting Goods and Finish Line).

US Employment Trends: Still Dancing with the Bear

When I shorted SPY’s at 11am this morning, my inbox caught a bid. For whatever reason, people don’t like it as much when I am on the bearish side of the “Trade” versus the bullish side. I’m cool with it though. This is a full contact sport.

Anyway, one of the main counterpunches I am getting today is that “Keith, look at the math, jobless claims were better.” While this is true in isolation (on a one week basis), this math doesn’t confirm anything other than the negative “Trend” in the US employment picture. Weekly jobless claims were down week over week to 509,000, but that’s because last week was a nosebleed peak (look at the chart). The way my math works is using the 4 week moving average. On that score, jobless claims we’re UP by another 6,000 jobs testing new cycle highs at 525,000.

Math and narratives dance to whatever tune the assigns them. My process is what it is. If you want to get long this market ahead of tomorrow’s monthly employment report, have fun with that. I’m short that idea at SP500 874.

Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.52%
  • SHORT SIGNALS 78.67%

Quote Of The Day: On UVA's Endowment

“To be sure, this is a startlingly large loss... When put into appropriate context, however, it starts to seem less disturbing.”
-Chris Brightman, CEO of The University Of Virginia Investment Management

Apparently Mr. Brightman has lost a "B" in the last 4 months... as in one billion dollars. But, when you consider that within the realm of his own narrative fallacy, it's not so bad. Everything is relative right?

Disturbing times we live in, indeed. Thank God that the governing principles of Transparency and Accountability are finding their way into the once hallowed halls of institutional investing.


The Las Vegas locals market is in rough shape and the aggregate numbers will continue to look ugly. The only positive for the market is that housing and employment began deteriorating earlier than the rest of the country and could pull out of it earlier. Unfortunately, we are not there yet.
  • So what does a company do in this environment? I say capitalize. Crush the competition. Boyd Gaming has this opportunity. BYD’s primary (and larger) competitor is Station Casino. With their bonds trading at between 8 and 30 cents on the dollar, Station is facing a high probability bankruptcy. BYD, on the other hand, is one of the few gamers with significant liquidity. I think BYD should aggressively utilize this huge competitive advantage. An effective strategy would be to advertise and market heavily, treat employees well, and most importantly, keep the slot product fresh.
  • There is a lot of market share to take (see the 1st chart). Station generated over $1.2bn in net gaming revenues over the past 4 quarters versus only $800 million for BYD. Assuming just a 2% increase in share (see 2nd chart), BYD could generate an incremental $33m in EBITDA, translating into $0.23 in EPS or 33% of the 2009 consensus estimate of $0.70.
  • BYD still faces uncertainty in the locals Las Vegas market and numbers are likely to go lower. However, the company seems to have a tremendous opportunity to capitalize on its liquidity and build market share. The results may not be immediately evident, but long-term gains could be substantial.

Devaluating A Currency: Free Money Has A Price

This morning both the ECB and Bank Of England put on their reactive management caps and cut rates as aggressively as they ever have. Now that we are looking at pending negative real interest rates in Europe, the revisionist historians can remind you that this is generally bad for one’s home currency (see the chart below, the British Pound has been pounded).

Interestingly, European stock markets sold off hard on these reactive management decisions. Bounces in free falling equity markets (like the UK) are actually higher than those you’ll see in bull markets. Don’t confuse short term hope with reality.

Gordon Brown has forced his socialist hand onto the table of the British elite. Tax rates on those earning over 150,000 pounds are being hiked to 45%. There is no question that this is not a good thing for consumer spending in the UK. However, the open question remains as to what those British pounds are actually worth.

We remain short the UK via the EWU etf.

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