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SOME SUBTLE AND NOT SO SUBTLE CHANGES AT CMG

We can definitely be accused of not being a bull on CMG, but we have not been short either.  Either way we have a keen eye on trying to figure out when store growth is going to slow meaningfully.  Trying to guess same-store sale trends is not a reason to be short CMG.  The real question is when will incremental returns on new units slow?  When will the company need to slow the unit growth rate?  For the time being we are not there yet, but the recently filed 10-K offers some signs that the company is maturing.

 

Some highlights from the 10-K:

  1. CMG is now looking to “fine-dining” for inspiration
  2. Supply problems - the numbers of store serving you basic fast food chicken and beef is growing
  3. Per store labor costs are increasing
  4. Development costs have stopped going down and could increase in 2012
  5. Inflation is still a concern  

 

FROM QSR TO FINE DINING

 

OLD PHILOSOPHY: Chipotle began with a simple philosophy: demonstrate that food served fast doesn’t have to be a traditional “fast-food” experience. Over the years, that vision has evolved. Today, our vision is to change the way people think about and eat fast food.

 

NEW PHILOSOPHY: Our vision is to change the way people think about and eat fast food. We do this by avoiding a formulaic approach when creating our restaurant experience, looking to fine-dining restaurants for inspiration.  We use high-quality raw ingredients, classic cooking methods and a distinctive interior design and have friendly people to take care of each customer—features that are more frequently found in the world of fine dining.   Our approach is also guided by our belief in an idea we call “Food With Integrity”.   Our objective is to find the highest quality ingredients we can—ingredients that are grown or raised with respect for the environment, animals and people who grow or raise the food.

 

HEDGEYE: CMG is now thinking in terms of a “fine dining” experience – talk about raising the bar in QSR!!

 

 

FOOD WITH INTEGRITY - BUT!!!

 

OLD PHILOSOPHY: Serving high quality food is what motivates us and is critical to our vision to change the way people think about and eat fast food.   As part of our Food With Integrity philosophy, we believe that using fresh ingredients is not enough, so we spend time on farms and in the field to understand where our ingredients come from and how the animals are raised.

 

NEW PHILOSOPHY: Serving high quality food “while still charging reasonable prices” is critical to our vision to change the way people think about and eat fast food.  As part of our Food With Integrity philosophy, we believe that using fresh ingredients is not enough, so we spend time on farms and in the field to understand where our food comes from and how it is raised.  Because our menu is so focused, we can concentrate on where we obtain each ingredient, and this has become a cornerstone of our continuous effort to improve our food.  As of December 31, 2011, we were serving exclusively naturally raised meats in all of our restaurants in the U.S. Continuing to serve naturally raised meats in all of our restaurants is one of our goals, but as discussed below, we have and will continue to face challenges in doing so. Some of our restaurants served conventionally raised chicken or steak for much of 2011, a few markets reverted to conventionally raised beef in early 2012, and more of our restaurants may periodically serve conventionally raised meats in the future due to supply constraints. We define naturally raised as coming from animals that are never given antibiotics or added hormones and that are raised responsibly—that is, in accordance with our animal welfare standards.

 

HEDGEYE: CMG sees the need to raise prices to execute on the current business model.  It’s going to get harder for the company continue to grow at the current pace and keep is integrity with customers and that will find it harder to claim they serve naturally raised food!  As of December 31, 2010, about 80% of the restaurants served naturally raised steak and about 86% of the restaurants served naturally raised chicken.  These percentages, to our knowledge, are no longer disclosed. 

 

 

INCREASED STORE LABOR

 

THE BASICS DONE RIGHT: Each restaurant typically has a restaurant manager (a position we’ve characterized as the most important in the company), an apprentice manager (in about three-quarters of our restaurants), one or two hourly service managers, one or two hourly kitchen managers and an average of 22 full and part-time crew members.

 

HEDGEYE: CMG took the average crew up by 2 people in 2011.

 

 

ACCELERATING UNIT DEVELOPMENT

 

We operated 1,230 restaurants as of December 31, 2011. We plan to increase the number of our restaurants significantly in the next three years, and plan to open between 155 and 165 new restaurants in 2012.

 

HEDGEYE: CMG was looking at opening between 135 and 145 new restaurants in 2011.

 

 

ACCELERTING UNIT DEVELOPMENT LEADS TO NEW CONCERN – LABOR COSTS

 

“One of our biggest challenges is staffing new restaurants. We seek to hire only top-performing employees and to promote restaurant managers from our crew, which may make it more difficult for us to staff all the restaurants we intend to open. Constraints on our hiring new employees are described further below under “ Our business could be adversely affected by increased labor costs or difficulties in finding the right employees for our restaurants .”

 

HEDGEYE: CMG added this new caveat to its 10-K this year. 

 

 

DEVELOPMENT COSTS RISING?

 

“We also have lowered the average development cost of our new restaurants significantly in recent years, from about $916,000 in 2008 to about $800,000 in 2011, and expect development costs in 2012 to be similar to 2011. In the event we are not able to achieve the average development costs we expect for 2012 or sustain the benefits achieved in prior years, which could result from inflation, project mismanagement or other reasons, our new restaurant locations could also result in decreased profitability.”

 

HEDGEYE: CMG will no longer see the tail wind of declining development costs.  This fact coupled with accelerated development could lead to lower returns on incremental invested capital.  This point is critical to keep an eye on.

 

 

INFLATION

 

“Food prices for a number of our key ingredients escalated markedly during 2011 and we expect that there will be additional pricing pressures on some of those ingredients, including beef, chicken, rice and beans, during 2012. We could also be adversely impacted by price increases specific to naturally raised meats or other food items we buy as part of our Food With Integrity focus, the markets for which are generally smaller and more concentrated than the markets for commodity food products. Weather related issues, such as freezes or drought, may also lead to temporary spikes in the prices in some commodities.”

 

HEDGEYE: This was not as much of a problem in 2011 with double digit same-store sales.  What about 2012?

 

 

Howard Penney

Managing Director

 

Rory Green

Analyst


INITIAL CLAIMS: QUANTIFYING LEHMAN'S GHOST

Distortions in the Seasonal Adjustment Factor

After our claims post last week, "The Ghost of Lehman," we had a number of clients ask us if we could quantify the effect we discussed.  Lehman's Ghost is a distortion in the seasonal adjustment factors that the Department of Labor is using to treat jobless claims arising from the shock in the series in late 2008 - early 2009.  The Labor Department uses a five-year lookback in constructing its seasonal adjustment factor, which means that the '08-'09 shock continues to skew the data.  Essentially, the seasonal adjustment sees the increase in claims in September 2008 - February 2009 and reads it as a seasonal factor rather than as a bona fide shock. 

 

To estimate the extent of the distortion from the seasonal factor on this week's data, we examined the YoY increase in NSA claims in February 2009 (+88%) and then backed out the average YoY growth from September 2008 to February 2009 (+60%).  So the February 2009 growth is 28% above trend, YoY.  This should be a rough approximation of the contribution of the seasonal factor from that year.  Since the overall seasonal adjustment takes a five-year average, we divide this number by five to get a 5.6% increase.  The conclusion is that this week's claims data is 5.6% understated.  Instead of being 351k, it should really be 372k.

 

What's Next? 

This week of the year captures the maximum benefit from the distortion - i.e. claims are understated in the last weeks of February by the largest amount.  From now through May, the understatement disappears.  Absent an underlying trend in the series, this effect would drive claims higher by about 20k over the course of the next three months.  By July, the distortion reappears, this time as an overstatement, pushing claims slightly higher still. From July through year-end, the distortion disappears, and the underlying trend will be reflected in the weekly data. 

 

Over the last year, claims have generally moved lower YoY (NSA) by around 10%.  Off of a base of 350-400k, this implies 35-40k improvement this year, or around 3-4k per month. This underlying trend is thus overwhelmed by the distortion for the next few months (as true improvement is masked by the understatement/tailwind reversing).  

 

This Week

The headline initial claims number rose 3k WoW to 351k (staying flat after a 3k upward revision to last week’s data).  Rolling claims fell 7k to 359k. On a non-seasonally-adjusted basis, reported claims fell 20k WoW to 345k.

 

INITIAL CLAIMS: QUANTIFYING LEHMAN'S GHOST - Rolling

 

INITIAL CLAIMS: QUANTIFYING LEHMAN'S GHOST - Raw

 

INITIAL CLAIMS: QUANTIFYING LEHMAN'S GHOST - NSA

 

INITIAL CLAIMS: QUANTIFYING LEHMAN'S GHOST - s p claims

 

INITIAL CLAIMS: QUANTIFYING LEHMAN'S GHOST - Fed and claims

 

2-10 Spread

The 2-10 spread widened 5 bps versus last week to 170 bps as of yesterday.  The ten-year bond yield increased 7 bps to 201 bps.

 

INITIAL CLAIMS: QUANTIFYING LEHMAN'S GHOST - 2 10

 

INITIAL CLAIMS: QUANTIFYING LEHMAN'S GHOST - 2 10 sprea by quarter

 

Financial Subsector Performance

The table below shows the stock performance of each Financial subsector over four durations. 

 

INITIAL CLAIMS: QUANTIFYING LEHMAN'S GHOST - Subsector

 

Joshua Steiner, CFA

 

Allison Kaptur

 

Robert Belsky

 

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MGM TRADE UPDATE

Keith bought MGM in the Hedgeye Virtual Portfolio at $13.91.  According to his model, the TRADE support line is $13.52, and the TREND support level for MGM is at $11.68.

 

 

MGM is not for the faint of heart.  The stock has been on a tear YTD, rising 35% compared to a 8% gain in the S&P.  That’s what a lot of financial and operating leverage will get you in an improving environment.  Much of the investor optimism is attributed to better than expected performance on the Las Vegas Strip in Q4, which was confirmed in yesterday's conference call.  MGM derives over 60% of its EBITDA from the Las Vegas Strip.  While investors have focused on room rates – which have been strong – we think the incremental catalyst is slot volume.  That’s where the leverage is on the margin.  With a high debt levels and a fixed cost operating structure, continued improvement in Strip metrics will have a high flow-through to the bottom line, benefiting results in 2012 and beyond.

 

MGM TRADE UPDATE - mgm


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 80.64%
  • SHORT SIGNALS 78.61%

ISLE F3Q12 CONF CALL NOTES

ISLE F3Q12 CONF CALL NOTES


"Net revenues increased at eleven of our fifteen properties, including each of our properties outside of Mississippi, where the markets have been slow to recover from the flooding last spring and economic issues continue to negatively impact the market. We are continuing to utilize smarter marketing and targeted facility improvements to drive business and improve results.  Our operating successes in Florida, Colorado, Iowa and Missouri were able to largely offset the substantial difficulties facing the Mississippi markets and costs we incurred in Lake Charles while renovating the gaming floor of our primary riverboat and preparing to consolidate our operations."

 

- President and Chief Executive Officer Virginia McDowell

 

PREPARED REMARKS

  • Cape G is similar to their operations in Waterloo, Iowa and Boonesville Missouri
  • Getting started on room remodel for the Lake Charles property
  • $1,165MM of debt with $496 term loans, $10MM on R/C. Have $200MM of borrowing capacity at the end of January 

Q&A

  • Lake Charles had a lot of noise in the quarter with the ongoing renovations at the property
  • Paid down about $15MM of debt in the quarter. At the end of Oct they have $1.184BN and Jan they had $1.165BN
  • They think that the cost savings on the sale of the vessel in Lake Charles will be at least neutral to them if not beneficial.  
  • Sub debt becomes callable at par next month.  They will start to look at redeeming some of those notes opportunistically.  They also have some options on refinancing those notes 15-18 months before their maturity
  • Lake Charles will go from 1,782 to 1,262 slots, 51 tables to 40. No change in hotel rooms - still at 440-450.  They used the vessel for overflow on weekends and holidays so it shouldn't be an issue from a capacity standpoint. They are thinking about a potential on the 3rd deck if necessary - more likely for poker. 
  • Mississippi has been really challenged since the floods. Part of it is due to the tracks in Arkansas which had a big spike in business when the casinos in MS closed for flooding and only some of that business came back.  Biloxi was already weak before the floods. They had a lot more customers in that part of the country that had high teens unemployment and then also had a heavy impact from the floods
  • Impact of new competition on their Kansas City facility?  Geographically, we're the property that is farthest away, and with the construction complete on the bridge, traffic is flowing around and through to our property better than it did before. 
  • They can structurally take out the sub notes before the 7.75% seniors come due. As long as they meet the 2 to 1 covenant restriction within 15/18 months to maturity they can refinance those notes with Senior notes
  • The total business interruption receivable will be a lot larger than what they have received thus far. The discussions with BP were one time and separate from the insurance flood receivables. 
  • Pompano: no impact from Seminole Coconut Creek expansion.
  • They didn't quantify the impact from disruptions at Lake Charles. Aside from the hotel the casino floor disruption is done
  • Capex spending for Cape: 
    • $80MM left to spend. $20MM ish in the 4Q. Generally speaking, 50% of the spending is right at the end because that's when the FF&E gets ordered. 
  • Their leverage is 6.3x vs. 7.35x steps down after Cape opens in F4Q13 (one year from now)
  • Database skews more South and East than West in the Kansas City market. 
  • Thoughts on new opening in Biloxi? 
    • No
  • Step up in promotional spending. Will some of the new projects under way will they see more promotional spend?
    • Most of it was customer reinvestment.
    • Spike was temporary and surrounding new product launches at various properties
  • Majority of Iowan's are still against online poker
  • Cape G is tracking at or under budget

 

HIGHLIGHTS FROM THE RELEASE

  • "We are looking to the future with optimism as we expect to open our Isle property in Cape Girardeau, Missouri by Thanksgiving of this year, subject to regulatory approval, at least a month ahead of our previous schedule."
  • "The Company's results benefitted from increased retail play as a result of generally favorable weather conditions in December and January, several recent facility improvements and continued strong marketing programs."
  • "In Boonville, revenue increased by 3.3% and EBITDA increased by 8%, despite having a buffet closed for renovation during the bulk of the quarter."
  • "With the recent declines in the unemployment rate, we are cautiously optimistic that our retail play trends could continue to improve as we have historically seen a high negative correlation between the unemployment rate in our markets and retail revenues."
  • "Our properties in Mississippi are suffering from a lagging economy and some lasting effects of the flooding which has impacted our overall results. Competition from race tracks in Arkansas, which increased following the floods, impacted revenue streams from Little Rock and several secondary markets."
  • "In Lake Charles, results were directly impacted by renovation disruption, which was completed in early February, and preparing to consolidate operations onto the larger remaining riverboat. We opened a new poker room, installed new carpet on the casino floor and completed other cosmetic refurbishments. We made the decision to invest in improving our product offering during the second and third fiscal quarters, and we believe we are beginning to see positive financial results from that investment. Additionally, we expect to benefit from a lower cost structure now operating only one facility.  We will continue to improve the customer experience with a $15 million refurbishment of the main hotel tower, which is expected to be completed by the end of the second quarter of fiscal 2013."
  • "We are also continuing to upgrade our food and beverage options across the portfolio."
  • "At Rainbow Casino in Vicksburg, we expect to complete the Lady Luck Casino rebranding by the end of the second fiscal quarter of fiscal 2013.  The rebranding will introduce upgraded amenities"
  • "Our upgraded customer rewards program, called Fan Club, is now active in Pompano and Waterloo." 
  • "The decrease [in corporate expense] is primarily due to development expenses in the prior year related to obtaining the Cape Girardeau and Nemacolin licenses.
  • "In the third quarter of fiscal 2012 we recognized $0.9 million of revenue as partial advances of our business interruption claim. Through February 22, 2012 we have received initial payments of $10.1 million related to the claims."
  • Nemacolin Woodlands Resort, Pennsylvania: "The appeal hearing for the gaming license awarded toNemacolin Woodlands Resort for the final resort license in Pennsylvania has been set for March 7, 2012. "
  • 3Q Capex: $11.7MM ($4.5MM related to Cape Girardeau)
  • "Capital expenditures for the remainder of the fiscal year to be approximately $45 million, including approximately $20 million in Cape Girardeau."

THE HBM: JACK, THI, CBOU, DRI, CBRL, TXRH

THE HEDGEYE BREAKFAST MONITOR

 

MACRO NOTES

 

Consumer

 

Initial jobless claims came in at 351k for the week ended 2/18 versus expectations of 355k and 351k the week prior (revised from 348k).

 

THE HBM: JACK, THI, CBOU, DRI, CBRL, TXRH - initial claims

 

 

SUBSECTOR PERFORMANCE

 

THE HBM: JACK, THI, CBOU, DRI, CBRL, TXRH - subsector

 

 

QUICK SERVICE

 

JACK: Jack in the Box reported comps ahead of expectations: +5.3% at Jack in the Box and +3.8% at Qdoba versus expectations of +4.1% and +2.9%, respectively.  EPS came in at $0.27 versus $0.25 expectations.

 

JACK: Jack in the Box was reiterated “Buy” at Lazard.  The firm notes that average check appears to be improving along with better traffic, which could indicate a successful shift from heavy discounting, according to Street Account. The price target is $28.

 

THI: Tim Hortons reported 4Q EPS of C$0.65 versus consensus C$0.62.  Comps in Canada grew +5.5% versus consensus 4.8%.  U.S. comps came in at +7.2% versus 4.2% expectations.  The company announced a new $200m share repurchase program.

 

CBOU: Caribou reported 4Q EPS of $0.14 versus consensus $0.16.  Comps increased 5.6% in the quarter.

 

 

NOTABLE PERFORMANCE ON ACCELERATING VOLUME:

 

SONC: Sonic traded down -3.3% on accelerating volume.

 

PZZA: Top-line miss pushed the stock down -6.9% on accelerating volume.

 

 

CASUAL DINING

 

DRI: Darden prereleased 3Q (quarter ended 2/26) earnings of $1.23-1.25 versus consensus $1.19.  Blended U.S. same-restaurant sales for Olive Garden, Red Lobster and LongHorn Steakhouse for 3Q will increase approximately 4% versus 2% consensus.  FY12 blended comps guidance was reaffirmed at +2.5-3.0% and FY12 EPS growth from continuing operations guidance was reaffirmed at 4-7%, consistent with prior guidance.

 

THE HBM: JACK, THI, CBOU, DRI, CBRL, TXRH - og pod1

 

THE HBM: JACK, THI, CBOU, DRI, CBRL, TXRH - RL pod1

 

THE HBM: JACK, THI, CBOU, DRI, CBRL, TXRH - LH pod1

 

 

TXRH: Texas Roadhouse was reiterated “Buy” at Miller Tabak and the price target was raised to $21 from $19.

 

CBRL: Cracker Barrel PT raised to $62 at Morgan Keegan.  The stock is rated “Outperform”.

 

 

NOTABLE PERFORMANCE ON ACCELERATING VOLUME:

 

TXRH: Texas Roadhouse gained 6.7% on accelerating volume on strong 4Q EPS.

 

CBRL: Cracker Barrel took a step back after trading strongly on 2QFY12 EPS.

 

CAKE: 1Q12 guide-down hurt the stock yesterday.

 

THE HBM: JACK, THI, CBOU, DRI, CBRL, TXRH - stocks

 

 

Howard Penney

Managing Director

 

Rory Green

Analyst

 


SINGAPORE: IS THE HONEYMOON OVER?

It's become clear that Singapore benefited from a significant honeymoon period.

 

 

It happened sooner than we thought.  The number of Singaporean visitors to the Integrated Resorts is falling.  Many markets/casinos experience a honeymoon period but this looks unprecedented.  Of course, we shouldn't forget that the Singapore market exploded out of the blocks.  We still expect 2012 growth but it certainly won't come from the local population.

 

Genting Singapore mentioned a couple of quarters ago that mass market growth has been limited by a stagnant local population and inability to promote gaming to locals.  According to numbers released by Acting Minister for Community Development, Youth and Sports, Chan Chun Sing, total Singaporean visitation for the two integrated resorts dropped 22% YoY.  At RWS, the number of local gamblers fell by 31.7% from 199,783 in 2010 to 136,434 in 2011.  For MBS, the number dropped by 8.9% from 150,691 in 2010 to 137,259 in 2011.

 

This data provides further confirmation of our view that Singapore growth will moderate significantly in 2012.  Without more rooms or junket approval, Singapore growth might slip into the single digits in 2012.  See our note GENTING BLOWS IT (2/23/11).


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