Wobbly Understanding

“Even sophisticated researchers have poor intuitions and a wobbly understanding of sampling effects.”

-Daniel Kahneman


That quote comes from Chapter 10 of “Thinking, Fast and Slow” where Kahneman discusses both the Law of Small Numbers and what he calls a Bias of Confidence Over Doubt. After a day like yesterday, I had to re-read that.


Reading and re-reading my notes is what I do. I don’t read books without marking them up. I haven’t gone a market day in almost 13 years where I didn’t systematically take notes by hand on market prices. It’s not perfect. But I have yet to find a better learning process.


Re-think, Re-build, Re-learn. It’s not only my advice for the political leaders of this country, it’s the advice that I rinse and repeat with my team each and every risk management day. If you’re not finding a better way, you’re falling behind.


Back to the Global Macro Grind


I was almost certain that the SP500 was going to finally snap my immediate-term TRADE support line of 1345 yesterday. It did, but it didn’t close there. Closing prices matter more in my model than intraday ones.


Math matters. So do emotions. If you can find a way to harness both, you’ll probably make less mistakes than I did earlier in my career.


Dan Kahneman and his former thought partner, the late Amos Tversky, came up with what they contextualized as “strongly worded” advice for researchers like us. They suggested we consider our “statistical intuitions with proper suspicion and replace impression formation by computation whenever possible.” (Thinking, Fast and Slow, page 113)


Re-read that. It’s really good.


I can’t count the amount of investment research meetings that I have been in over the course of my career where someone just goes off with their qualitative observations. It’s probably endemic to the industry I follow most closely (Global Consumer), but I still don’t get how a billionaire can sit across the table from me talking about the deal he got on a fire-pit at Costco.


Over the years, after making plenty of qualitative assumptions that turned into quantified P&L mistakes, I’ve tried to cleanse myself with the “proper suspicion” of pretty much everything I think. My risk management governor is a repeatable quantitative overlay that captures real-time price, volume, and volatility signals.


No matter what we think we know, the market often has a not so funny way of thinking otherwise.


Obviously if you change the duration embedded in that thought, you come up with price disconnects that you, the great researcher, can capitalize on. But if your process aspires to be Duration Agnostic (measuring risk across different durations, all at the same time), you’ll see that you probably don’t know what you don’t know about a lot of things. That’s why I usually defer to last price.


Let’s isolate the SP500 and consider it across our 3 core durations (TRADE, TREND, and TAIL):

  1. Immediate-term TRADE support = 1345 and resistance = 1360 (we call this our immediate-term range)
  2. Intermediate-term TREND resistance = 1363 (April 2011’s closing high)
  3. Long-term TAIL support = 1267

Now if you are day trader or Warren Buffett, you could very well read into my risk management conclusions in completely different ways. If you are not Duration Agnostic, you probably should. Unfortunately, the market doesn’t care about our individual investment styles.


What happens when you overlay a fundamental Global Macro Research View

  1. US, European, and Japanese fiscal and monetary policies drive currencies
  2. Currencies drive immediate-term correlations in market inflations/deflations
  3. Inflations/Deflations drive real (inflation adjusted) Consumption Growth (71% of US GDP)



What if you have to think, fast – and slow, about all 3 durations (TRADE, TREND, and TAIL) and all 3 fundamental factors (Policy, Inflation, and Growth) – all at the same time?


I call that being Multi-Factor, Multi-Duration. I also call that Wall St 2.0.


Embracing Uncertainty and accepting that (unless we are trading on inside information) we all have a Wobbly Understanding about what is going to happen to our positioning next is what gets me right fired-up every morning. It’s my opportunity to improve the process.


My immediate-term support and resistance ranges for Gold, Oil (Brent), EUR/USD, US Dollar Index, Nikkei225, and the SP500 are now $1, $116.35-119.95, $1.30-1.33, 78.86-79.79, 8, and 1, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Wobbly Understanding - Chart of the Day


Wobbly Understanding - Virtual Portfolio


We see $4-$8 of upside to Jack in the Box as the street gains more clarity on and becomes more comfortable with the company’s plan.


Jack in the Box is on the tail end of a major six-year restructuring of its business model to become more like other franchised QSR players.  It has been a long six years and the stock has been trading sideways over that time.  The goal of the restructuring was to lessen the volatility in the earnings stream from inflation and erratic sales trends.  The question becomes when the street will become more comfortable with the “franchised” business model and potentially revalue the earnings and cash flow stream equal to other dominantly franchised companies. 


The company is hosting its first analyst day since May 2008 in two weeks.  We suspect the reason the company is deciding to host an analyst day now is so that it can communicate to the investment community  what the new business model will look like and what should be expected from the company over the next five-to-ten years.  We expect the broader scope of the presentation to include:

  1. Detail around the stability of earnings and cash flow going forward
  2. Long-term earnings target
  3. Goals for free cash flow generation
  4. Use of free cash flow going forward
  5. Qdoba’s growth profile

The stability of the new business model and visibility on consistent EPS growth is critical to convincing investors that the company’s stock is worthy of a higher valuation.  During the restructuring period, the street has not been able to model the company consistently because of the timing of gains generated by the selling of the company store base.  That lack of visibility and the significant investment the company has made assisting the franchise remodels has been a drag on earnings and, therefore, the stock has been subsequently penalized.


One of the most important characteristics of the franchised business model is the significant free cash flow generation.  During the past six years, the significant investment Jack in the Box has been making in fixing the system has been impairing the company’s ability to generate free cash flow.  In 2012, that seems likely to change with cash flow growing in FY13 and beyond.  The absolute level of free cash flow will likely lag the company’s peer group due to the significant growth opportunity that Qdoba represents.


The analyst day could also prove to be a positive for the stock from a sentiment perspective.  If the street walks away with the impression that the company has turned the corner, we believe that the stock price could appreciate significantly from that shift alone.  In the short run, however, here are the goals we see as most important for the company to achieve.

  1. Getting to 16% margins for the balance of the company store base
  2. More disclosure on Qdoba profitability
  3. More disclosure on Qdoba’s growth prospects
  4. Sustainability of the Jack In the Box same-store sales trends 

The sentiment on the stock has been improving on the name over the last two weeks, but its overall rating on the Hedgeye Restaurants Sentiment Score Card is very low.  While short interest has risen slightly in the past couple of months that has been accompanied by a significant uptick in sell ratings. 


JACK is coming off a strong FY2011 (year ended October 2, 2011) posting same-store sales and transaction growth in every quarter.  For the full year, the 3.1% increase in company same-store sales for the full year was driven entirely by traffic.  We expect the strong performance to continue into FY2012.  



  1. Investments to improve the core menu (focused on classic burgers) and operational execution which should allow for more consistent performance.  The net benefits are higher food quality and better speed of service
  2. The company is on the tail end of a six year restructuring of the business model to being primarily franchised and nearing the end of a comprehensive restaurant reimage program.  At the end of 4QFY11, substantially all company restaurants and nearly 80% of franchise locations featured all of the interior and exterior elements of this program; the balance should be largely completed by the end of the calendar 2011
  3. JACK sold 332 restaurants during FY2011, leaving the Jack in the Box system 72% franchised at the end of fiscal 2011. The company completed the refranchising plan two years ahead of plan and has refranchised more than 1,000 stores over the past six years.  Over the next couple of years Jack in the Box franchise ownership should approximately 80% of the system.


  1. In 4QFY11, same-store sales at company Jack in the Box restaurants increased 5.8% driven by an 8.5% increase in traffic; the fifth consecutive quarter of sequentially improving two-year sales trends
  2. Of the 5.8% increase in 4QFY11 company same-store sales, 8.5% was traffic, check was down 2.7% and price was up 2.7%, which leaves mix down -5.4%
  3. Every major markets posted strong same-store sales growth in 4QFY11 and positive across all day parts
  4. Average weekly sales for Jack in the Box company restaurants were up 14.9% in 4QFY11.  Company AUVs for the full year were just over $1.4 million, up 8.3%; the increases in AUV benefited from increased SSS, the benefit of refranchising as well as the impact of store closures
  5. Breakfast was again the strongest day part, driven BY the $2.99 Jumbo Breakfast Platter
  6. Early in the 1Q12 Jack’s (first seven weeks) continued to see strong same-store sales growth despite more difficult comparisons
  7. Qdoba 4QFY11 same-store sales increased 3.1% system-wide
  8. In contrast to the Jack in the Box concept they continue to increase the percentage of company ownership of Qdoba restaurants; 42% of the system was corporate-owned compared to 36% at the end of last year and 31% at the end of fiscal 2010
  9. In 2011 67 new Qdoba restaurants opened system-wide including 25 company locations. Management also made opportunistic acquisitions of 32 franchise locations in 2011
  10. The plan is to aggressively build out the number of Qdoba Company Qdoba locations over the next several years and make opportunistic acquisitions at franchise locations

HEDGEYE: Coming out of the analyst meeting, we expect that the street will have more confidence in current trends and the growth prospects for Qdoba. 




  1. In 4QFY11 restaurant operating margin was 13.5%, up 100bps YoY and sequentially from FY3Q
  2. Gross margins declined 190bps, but were more than offset by 290 basis points of improvement from refranchising and stores closed.  Commodity inflation was about 7% vs. 3% inflation last year's.  The increase was partially offset by pricing of 2.7% reflecting a 1.4% increase that was taken in mid-May, an incremental 1% price increase taken at the end of August.
  3. JACK sold 106 company-operated Jack in the Box restaurants in 4Q11 and 332 restaurants fiscal 2011
  4. To give you some perspective on the impact refranchising is having on our strategy to evolve to a higher margin company-operated footprint, our pro forma restaurant operating margins for fiscal year 2011 excluding the stores we refranchised this year, would have been approximately 100 basis points higher that we reported above 27%



  1. Commodity costs for the full fiscal year 2012 are estimated to be up by 5%, with higher inflation in the first half of the fiscal year. Almost everything in the commodity basket is forecast to be higher in FY2012
  2. Beef prices (about 20% of spending) will be up the full year 9%- 10%, with inflation in the high teens in the first quarter
  3. Chicken (about 9% of spending) is contracted for the year
  4. The company has 100% coverage on cheese (roughly 6% of spending) through the end of March 12thand 50% coverage through the end of fiscal 2012
  5. 90% of the bakery (about 8% of spending) needs  are covered through December 2011, approximately 70% coverage through March 2012, and 30% coverage through May 2012
  6. Commodity costs for the first quarter are expected to increase by approximately 8%

HEDGEYE:The biggest negative facing JACK in terms of costs is the significant inflation in red meat.



  1. In 1QFY12, the company is guiding to same-store sales at Jack in the Box company restaurants to increase 4% to 5% lapping a 1.5%, putting the 2-year trend at 3%, up from 0.9% in 4QFY11.
  2.  1QFY12 system-wide same-store sales for Qdoba are expected to increase 2% to 3% versus a 6.4% increase in the year-ago quarter
  3. For the full fiscal year, same-store sales are expected to increase 2%-to-4% at Jack in the Box company restaurants and 3%-to-5% at Qdoba system restaurants
  4. SG&A margin is expected to be in the mid-10% range
  5. Capital expenditures are expected to decline to $90 million to $100 million in 2012 from $129 million in 2011
  6. The company’s full-year guidance for diluted earnings per share is $1.10-to-$1.43 with the range reflecting uncertainty in the timing of anticipated refranchising transactions, as well as same-store sales results and commodity inflation. Operating earnings per share, which we define as diluted earnings per share on a GAAP basis less gains from refranchising, are expected to range from $0.90-to-$1.10
  7. Operating EPS includes $0.07-to-$0.09 of reimage incentive payments to franchisees in fiscal 2012, which again are expected to occur mostly in the first quarter. Reimage incentive payments in fiscal 2011 were $8.2 million or approximately $0.11 per share
  8. Gains from refranchising are expected to contribute $0.20-to-$0.33 to EPS as compared to approximately $0.78 in fiscal 2011
  9. EPS sensitivity as follows: For every 1% change in Jack in Box system same-store sales we estimate the annual impact in earnings is about $0.08-to-$0.09 per share, approximately half of which relates to company operations depending on flow through and assuming stable costs, and the other half relates to franchise revenues which are not subject to commodity costs or other inflation. The impact of a 1% change in Qdoba same-store sales is approximately $0.01-to-$0.02
  10. For every 10 basis point change in restaurant operating margin the estimated annual EPS impact is approximately $0.01-to-$0.02 per share on a consolidated basis

HEDGEYE: The numbers JACK is guiding to are better than bad.  The bulk of the capital spending on the system remodels is behind the company and should now be a tailwind from an earnings and sales perspective.  The company’s business model is now in line with its industry peer group, approaching nearly 80% franchised by the end of this fiscal year.  Qdoba is an important part of JACK’s business; approximately 28% of total company-operated units as compared with approximately 5% five years ago. Going forward, management’s plan is to grow the number of Qdoba company locations aggressively through opportunistic acquisitions from franchisees.  Beef inflation is still an issue and will likely continue to be for the foreseeable future. 


At 7.0X EV/EBITDA NTM, JACK is trading at a discount to WEN and SONC.  Given JACK’s sales and earnings trends, the company should trade at a premium to SONC and more in line with WEN.  Although, we might add, we view WEN trading at 8.9X EV/EBITDA as overvalued.  That being said, there is $4-$8 of upside to Jack in the Box as the street gains more clarity on and becomes more comfortable with the company’s plan.






JACK’S COMING OUT PARTY - jack sentiment



Howard Penney

Managing Director


Rory Green





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So/so quarter and guidance doesn't bode well for expensive stock.




  • Some markets were slightly softer then expected, but overall they were pleased with results.  Especially stronger banquet and group bookings.
  • 4Q RevPAR growth for recent acquisitions was nearly 13% in 2011
  • Strongest F&B quarter in 4Q, with higher banquet and meeting room revenue.  69% of F&B came from catering revenues which helped flowthrough.
  • FFO and Adjusted EBITDA were negatively impacted by the $15MM forfeiture fees from Grand Hyatt in DC
  • Special corporate led the way with a 6% increase in demand and a 5% increase in rate
  • Transient revenues increased 7% for 2011
  • ADR is still 13% below the prior peak level
  • Group business: 
    • Continue to see a shift towards the higher rated corporate segment from the discount channel.  First time that group revenue growth matched transient growth (at 6%) and expect that this trend will in continue into 2012. 
    • Association business lagged
    • Still down by more than 14% from peak level, due to 11% lower demand on rooms
  • 2012 revenue growth should be driven by growth in ADR and occupancy. 
  • Booking in 4Q were strong for both the quarter and future
  • Roughly 70% of their group nights are on the books for 2012.  Sees a 2012 ADR increase of 5%.
  • Seeing improvement in association demand
  • Expect an increase in transaction activity in 2H2012.  Guidance assumes no acquisitions.
  • Sheraton NY is due to be complete in June 2012
  • Continue to find construction returns to be attractive, yielding returns above their cost of capital
  • In the process of converting Helmesly into Westin Grand Central
  • 2012 renovations will include:
    • Room renovations at the New York Marriott Marquis, The Hyatt Regency in Washington, the Orlando World Center Marriott and the Ritz-Carlton Amelia Island as well as meeting space renovations at the Ritz Carlton Buckhead, New York Marriott Marquis and the North Tower of the Orlando World Center Marriott.
  • Expect a strong economic recovery to continue into 2012.  Low supply should lead to solid occupancy.
  • 1Q12 dividend of 6 cents
  • Believe that the lodging recovery will continue through 2012 and 2013
  • Top performing market was Hawaii: +23.6% - driven by strong transient and group demand. F&B increased > 18%. Expect it to be a top performing market in 2012.
  • Miami/ Ft Lauderdale was up 16.3%. Expect 2012 will be good.
  • Pheonix RevPAR:15.7% increase.  29% F&B growth in the Q.  Expect 2012 will be in line due to solid group demand.
  • Philadelphia RevPAR: +13.5%. ADR was up 12%. Strength in group bookings drove results.  Expect 2012 will be strong.
  • San Fran RevPAR: +11.2% (ADR 9%). Improvement by rate increase and business mix shift to higher rated segments.  Expect 2012 to continue to perform well.
  • Chicago RevPAR: 6%. Expect 2012 will be another good year
  • NY RevPAR: 5.4% (3% increase in ADR).  Results were below expectations due to lower rate growth. Expect 2012 to be solid.
  • DC RevPAR: flat (ADR down 2%). Soft group and transient group demand. 2012 will be a challenge.
  • Atlanta: RevPAR: -3.9%.  Lower Citywide demand.  Expect it to underperform in 2012.
  • Europe JV: Sheraton Roma negatively impacted Q - would have been +3% without the renovations there
    • 3-5% RevPAR growth is projected at the JV.  Their share of the JV is only 3% of their EBITDA.
  • $1.6MM of bad debt expense from American Airlines bankruptcy
  • Room flow through was 73% and F&B flow-through was 51% - significantly above their expectations
  • Unallocated costs increased 4% due to variable expenses
  • Utilility decreased slightly.
  • 2012 should have good flow-through.  Unallocated costs to increase more than inflation. 9% increase in property taxes.  Higher insurance expenses as well. 
  • Taxes are due to leakage from their leased hotels



  • Atlanta and DC market views:
    • DC is a great long-term market.  It's just not as volatile as other markets but generates strong long-term growth.  2014 Washington will benefit from the new convention center.  Folks are waiting for the opening of that convention hotel and therefore that will have a negative impact on 2012.  Expect to exit some of the suburban DC exposure.
    • Atlanta is losing convention share to Vegas as well as other markets. Would like to reduce their long term exposure to that market.
  • Some of their sale activity will be in West Coast markets - selling suburban hotels and airport hotels. Will also look to sell hotels where the EBITDA is back to peak levels from 2007 and therefore fell like there is less upside
  • View on peak margins:
    • Substantial room to growth their margins from here
    • Real estate taxes are an issue in 2012 but unclear if this is a long-term issue for margin
    • Real issue of reaching peak margins will be ADR growth
  • They expect flatish RevPAR for their European JV (below the JV's projections).  40% of the business to their Euro hotels comes from outside the EU.
  • Weaker flowthrough in 2012 vs. 2011 due to a large increase in real estate and insurance expenses
  • Group bookings look strongest in 2Q and 4Q  - so that may support some outperformance in those quarters margin wise, but expect a pretty even year
  • UUP has performed a little differently from overall growth.  Luxury has driven part of the outperformance of overall growth.  Other sectors have been more driven by transient demand, which outperformed group.  
  • This quarter was the first time that they saw a pickup in group which should help UUP RevPAR.
  • See no reason why HST's RevPAR won't be in-line or better than UUP RevPAR. Doesn't think that there is a material gap today vs. industry UUP.
  • Group business is not just about RevPAR growth but also about what it can do for F&B as evident in the quarter. Banquet business is very profitable.
  • REIT activity dried up in 2H11 because of their inability to issue equity to buy assets due to their stock prices. Seeing more private buyers.  There is a fair amount of debt available at more conservative levels than 2006 - at fairly attractive rates. 
  • Acquisitions for them will be mostly in the US.  Think that Europe will have some debt coming due that will be hard to refinance so that may lead to more distressed opportunities.  In Asia, their focus remains in markets like Australia.  In the US, their focus is West Coast and Miami. 
  • Have about 716MM shares outstanding.  They don't assume additional shares in their guidance
  • Expect NY to perform in-line in 2012 but their RevPAR will be impacted by ongoing renovations at Sheraton and W Union Square.  In some cases though, their work overlaps with work done in 2011- hence expectations of in-line performance. 
  • Expect modest to flat RevPAR growth in DC for 2012
  • Renovation impact YoY will be about a wash
  • Financials sector has been growing at a reasonably good rate.  Continuing to see corporate group business come back at their luxury hotels.
  • They are getting to the point in occupancy where they can push rate.  Roughly 50% of their 2012 booked group business was booked in 2011 and half before then. For business yet to be booked, they expect that rates will be higher. 
  • How much of their capex for 2012 is really catch up spend?  Seems like the number is 10% of revenues- which is elevated. 
    • Maintenance capex of $310-330MM is the normal level of capital that they need to spend (6% range)
    • $80-100M of acquisition capex was what they identified when they acquired the assets
    • ROI capital: confident that they will be able to get upper teens returns on those projects
    • They didn't stop investing in their properties during the downturn
  • International travel should continue to grow.  China and Brazil had the best growth.
  • Biggest issue for cost growth is what happens for wages.  For 2012, wage growth is projected to be slightly ahead of inflation. They are looking to keep their CostPAR slightly below inflation



  • Comparable RevPAR came in at 5.9%- lower than the 6.25-6.75% range that HST guided to on their 3Q call
  • European JV RevPAR only increased 1% on a constant Euro basis
  • 2012 Outlook & Guidance:
    • Comparable RevPAR: 4-6%
    • Operating profit margin: +140 to 230bps
    • Comparable hotel adjusted operating profit margins: +25 to 75bps
    • Adjusted FFO: $0.97 to $1.04
    • Adjusted EBITDA: $1,090 to $1,145MM
    • Interest expense: $362MM ($32MM of non-cash)
    • D&A: $650MM
    • Income taxes: $9MM
    • Capex: 
      • Investment in ROI expenditures of $155-175MM
      • Acquisition projects: $80-90MM
      • Renewal and replacement: $310-330MM
    • Dispositions: $100 to $115MM in 1H12

Lower-Highs: SP500 Levels, Refreshed

POSITION: Long Energy (XLE)


So I’m long inflation (Energy, Gold, etc) and that has a tough time on US Dollar up days. This we know.


What we don’t know is what central plan is coming down the pike next. Rather than pay people to sniff around Washington for me, I let the market tell me what the people that know think they know. That’s the best I can do.


Across my risk management durations, here are the lines that matter to me most right now (see chart): 

  1. Immediate-term TRADE resistance = 1360
  2. Immediate-term TRADE support = 1345
  3. Immediate-term TRADE support = 1329 

I have 2 different TRADE lines of support because I have been forced to measure a hyper short-term duration in order to solve for how extended the market is (standard deviations of risk) from my intermediate-term TREND zone.


In other words, if 1345 snaps, 1329 is in play, fast. If it doesn’t, I still think we keep making lower-highs versus the last Policy to Inflate lower long-term high of 1363 (April 2011). Inflation expectations rising slow growth.


Enjoy the chase,



Keith R. McCullough
Chief Executive Officer


Lower-Highs: SP500 Levels, Refreshed - spx.02.14.12

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