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DRI: TAKEAWAYS FROM THE MEETING

Investor Days are important events; there are always messages being communicated – explicitly and/or implicitly – by management teams to the Street.  We are adopting a “wait and see” stance with Darden’s stock; management is clear about the direction it is taking the company but we see some twists and turns in the road ahead.

 

The positive aspects of the Darden story are still the same as they have been for some time; the company has a strong balance sheet, is well-organized, and has strong competitive advantages within casual dining due to the economies of scale inherent in its business model.  Before we can get more comfortable on the long side of DRI, some clarity is needed regarding several issues.  Paramount among these issues is restaurant operating margin.  Investors in restaurants absolutely care about restaurant operating margins; healthy margins help to insulate the company from the myriad of macro and industry- or company-related issues that can impact a company over the longer-term. 

 

 

The most prominent messages from the management during Friday’s meeting were:

  1. The business is poised to outgrow the industry over the next five years
  2. The company continues to generate strong cash flow
  3. The current trends at Olive Garden suggest that the worst has passed for the concept
  4. Management is focusing on EBIT margin more than ROP margin going foward

 

THE LONG-TERM BUSINESS MODEL

 

The company reiterated that it expects to achieve 5-year annual revenue growth of +7-9% from annual same-store sales growth of +2-4% and unit growth of roughly 5%.  Given those top-line numbers, management believes that EPS growth of 10-15% can be achieved.

 

By brand 5 year outlook is as follows

  1. OG = 6% revenue growth (+2.5% SSS; +3.5% New Units)
  2. RL = 5% revenue growth (+4.0% SSS; +1% New Units)
  3. LH = 14% revenue growth (+4.0% SSS; +10% New Units)
  4. Specialty = 20% revenue growth (+3.0% SSS; +17% New Units)

 

CASH FLOW GENERATION

 

Management stated that over the next 5 years, they expect to add between $2.6 billion to $3.3 billion in cumulative dividends and share repurchase.  This represents roughly 40-50% of the company’s enterprise value.  Over the longer term TAIL duration, this is a highly positive data point for the stock.  Absent a significant deterioration in the fundamental performance of the company, shareholders will likely be rewarded greatly through the dividend and share repurchase programs over the next 5 years.

 

 

OLIVE GARDEN

 

Olive Garden has been a point of contention for analysts covering Darden.  As the largest component of the Darden portfolio with AUV’s at $4.7 million at the 776 Olive Garden restaurants currently in operation, the Olive Garden’s recent woes have caused many investors to take a step back.  Management assuaged concerns, somewhat, by announcing better-than-expected preliminary 3QFY12 results (following two consecutive misses) with blended same-store sales of 4% versus guidance of 2.5-3% and 2.3% in 1HFY12.  Olive Garden’s preliminary 2% (flat ex-weather) 3QFY12 comparable restaurant sales number was impressive versus its 1HFY12 comp of -2.7%.  While this number was aided by weather, a flat-to-positive top-line print is good news.  However, we are waiting to see more evidence of the turnaround at Olive Garden.  It is important to be cognizant of both the weather impact that benefitted the restaurant industry during the winter months and the fact that over half of the Olive Garden store base is in need of remodeling. 

 

On the negative side, Friday’s Investor Day saw management push out the completion date for the Olive Garden remodeling program by one year to FY15.  The unknown is how the new promotional offerings at Olive Garden will perform.  With offerings like three-course dinners for $12.95 and a new advertising campaign being launched, management is clearly targeting increased traffic while focusing more on EBIT margin than ROP margin.

 

 

MANAGING TO EBIT MARGINS

 

We were interested to hear what we believe is a distinct shift in management’s focus on margins.  While Clarence Otis was correct in saying that the company has always managed to EBIT margins, our chief concern is that this has typically been done via higher restaurant operating margins in the past.  During the 2011 Investor Day, the focus on unit level margins by brand stood out; the company was managing with those metrics in mind.  While EBIT margins were a prominent focus during last year’s presentation, what was noteworthy this year was that management is now suggesting that some restaurant-level margin may have to be given up in order to grow traffic and expand EBIT margins.  In theory this is possible but will likely be more difficult to bring about in practice.

 

We raised this topic with management during the Q&A segment of the presentation and Clarence Otis offered a fair response, saying that the company has been consistent in its focus on EBIT margins in managing Darden.   This may be true from his perspective, overseeing the portfolio from the CEO’s seat, but having covered the company for some time and thinking about the different components of the portfolio over time, Friday’s commentary from management indicated to us that the company is now willing to sacrifice restaurant level margins to grow traffic.

 

With the benefits of the remodel program still a year away and the persistent value perception problem at Olive Garden still unresolved – although efforts are underway to address it – we are going to wait and see before taking a definitive positive or negative view on Olive Garden.

 

 

COMMODITY OUTLOOK

 

Commodities have hampered EPS growth over the past year but management expects food cost inflation to ease meaningfully in FY13.  Food basket inflation is expected to be +12% for FY12 (ending May) versus +2% in FY11.  Seafood costs are expected to be down 3% in FY13 while beef and chicken are expected to be up 12% and 2%, respectively.  Seafood, beef, and chicken FY13 needs are 60%, 95%, and 40% locked, respectively.

 

 

Howard Penney

Managing Director

 

Rory Green

Analyst

 

 

 


Higher-Highs: SP500 Levels, Refreshed

POSITIONS: Long Financials (XLF), Long Utilities (XLU)

 

Whether I like the complexion of the rally or not (inflation rising), higher-highs are bullish in the immediate-term, until they aren’t. That’s why I bought/covered this morning. That’s why I don’t have a SPY or Sector ETF short. I think I can do that again on green.

 

Across our core risk management durations, here are the lines that matter most to me right now: 

  1. Immediate-term TRADE overbought = 1372 (higher-high)
  2. Immediate-term TRADE support = 1358
  3. Intermediate-term TREND support = 1277 

As the SP500 held my immediate-term TRADE line of support on the open (1358), I did what Bernanke is daring me to do – chase yield. Yes, that’s scary. And yes, like in February of 2011, there are huge risks associated with buying at these prices.

 

For today, Dollar up, Oil down is better than the alternative.

 

Keep moving out there,

 

KM

 

Keith R. McCullough
Chief Executive Officer

 

Higher-Highs: SP500 Levels, Refreshed - SPX.02.27


European Banking Monitor: Interbank Risk Continues to Recede

--Interbank risk continues to recede ahead of Wednesday's 2nd LTRO allotment.

 

Below are key European banking risk monitors, which are included as part of Josh Steiner and the Financial team's "Monday Morning Risk Monitor"

 

If you'd like to receive the work of the Financials team or request a trial please email .

 

Positions in Europe: Covered EUR/USD (FXE) and France (EWQ) today

 

Euribor-OIS spread – The Euribor-OIS spread (the difference between the euro interbank lending rate and overnight indexed swaps) measures bank counterparty risk in the Eurozone. The OIS is analogous to the effective Fed Funds rate in the United States.  Banks lending at the OIS do not swap principal, so counterparty risk in the OIS is minimal.  By contrast, the Euribor rate is the rate offered for unsecured interbank lending.  Thus, the spread between the two isolates counterparty risk. The Euribor-OIS spread tightened by 3 bps to 65 bps.

 

European Banking Monitor: Interbank Risk Continues to Recede  - aa. euribor

 

ECB Liquidity Recourse to the Deposit Facility – The ECB Liquidity Recourse to the Deposit Facility measures banks’ overnight deposits with the ECB.  Taken in conjunction with excess reserves, the ECB deposit facility measures excess liquidity in the Euro banking system.  An increase in this metric shows that banks are borrowing from the ECB.  In other words, the deposit facility measures one element of the ECB response to the crisis.  

 

European Banking Monitor: Interbank Risk Continues to Recede  - aa. ECB facility

 

European Financials CDS Monitor – Bank swaps were tighter in Europe last week for 33 of the 40 reference entities. The average tightening was 4.8% and the median tightening was 1.0%.

 

European Banking Monitor: Interbank Risk Continues to Recede  - 111 banks

 

Security Market Program – For a second straight week the ECB's purchased no securities on the secondary bond market.  In the last 5 weeks the Bank has only purchased €246 MILLION, versus €2.243 BILLION in the week ended 1/20 and 3.766 BILLION in the week ended 1/12, with the total facility at  €219.5B. We continue to wonder if the ECB is making up the numbers and not reporting their purchasing. Here we welcome your thoughts.

 

European Banking Monitor: Interbank Risk Continues to Recede  - 111 SMP

 

 

Matthew Hedrick

Senior Analyst


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THE HBM: DNKN, SBUX, DRI

THE HEDGEYE BREAKFAST MONITOR

 

MACRO NOTES

 

Coffee Costs

 

Brazil’s next coffee crop will be 2.6% larger than estimated in November, according to Terra Forte Exportacao e Imporacao de Café Ltda. Brazil is the world’s largest producer of coffee.  As we can see in the chart below, coffee costs have been coming down which will benefit PEET and other coffee retailers.  Starbucks has been locking in coffee costs for FY13 (ending September) having locked in all expected requirements for FY12 during calendar year 2011.

 

THE HBM: DNKN, SBUX, DRI - coffee

 

 

Comments from CEO Keith McCullough

 

2 of the Top 3 Most Read on Bloomberg this morn are about China – no Greece. Analytical progress:

  1. INDIA – obviously a country that is short oil is a country that is going to have a stagflation problem with oil prices ripping like this. That wasn’t new to the Indians last week, but evidently it mattered  to their stock market today – at down -2.8% in a straight line, that’s the problem w/ bearish market SKEW. India’s Yield Curve has gone to flat.
  2. FRANCE – another +0.6% sequential ramp in producer prices this month is only going to perpetuate the stagflation we see in France, Spain and Italy. Who cares about Greece when these 3 majors will have a much larger say in global growth expectations. The CAC’s TAIL remains broken and now the immediate-term TRADE line is under fire (3439). We re-shorted France (EWQ) late last wk.
  3. 10YR – its been a while since the 10-yr bond yield was more wrong than the US stock market on growth expectations. At every turn in the last year, bond yields have told you all you need to know about US Growth Slowing. After failing at the 2.03% TREND line last wk, snapping the 1.97% TRADE line puts 1.91% back in play.

Friday’s close > 1363 SP500 was bullish for a few hours. Prices need to confirm though, so we’ll see about that this week. I’ve not yet re-shorted the SPY or any Sector ETFs. We’re long Financials XLF – and I’m worried about it.

KM

 

 

SUBSECTOR PERFORMANCE

 

THE HBM: DNKN, SBUX, DRI - subsector

 

 

QUICK SERVICE

 

DNKN: Dunkin’ Brands was rated “New Buy” at Citi, price target $36.

 

SBUX: Starbucks Europe President, Michelle Gass, said in an interview published over the weekend that the company is to announce a multi-million pound overhaul and expansion of its European business which will see hundreds more cafes opening in both the UK and across the continent. 

 

 

NOTABLE PERFORMANCE ON ACCELERATING VOLUME:

 

JACK: Jack in the Box traded higher on accelerating volume.  The company is hosting an Investor Day tomorrow in California.

 

 

CASUAL DINING

 

DRI: Darden’s Analyst Day in New York on Friday provided a high level of detail on the company’s future plans.  We will be posting our thoughts on the event in a separate post shortly.

 

 

NOTABLE PERFORMANCE ON ACCELERATING VOLUME:

 

TXRH: Texas Roadhouse traded down -2.7% on accelerating volume after a strong day’s trading Thursday on strong 4Q EPS.

 

 

THE HBM: DNKN, SBUX, DRI - stocks

 

 

Howard Penney

Managing Director

 

Rory Green

Analyst

 


MONDAY MORNING RISK MONITOR: HIGH YIELD HITS A NEW YTD HIGH

Key Callouts

 

*Our Macro team's quantitative model indicates a fairly balanced risk/reward outlook in the immediate term with XLF upside of 1.3% and downside of 1.4%.

 

High yield rates fell to a new YTD low on Friday. This reflects both the perception around diminished risk as well as the Fed's policy to punish savers through zero rates. 

 

* Interbank risk continues to recede with the Euribor-OIS tightening 3 bps and the TED spread tightening 2 bps in the latest week. The second round of LTRO is scheduled for Wednesday and the market expectation is currently for 470 billion euros in additional take-up with a range of between 400 and 750 billion euros. The first LTRO helped curb concerns about a European liquidity meltdown in the immediate term, pushing the Euribor-OIS from 98 to 65 bps since the start of the year. We don't expect the second round of LTRO to be as significant to the market as the first. The first round mattered profoundly, as it finally got the ECB out ahead of the crisis. Nevertheless, one of our key YTD themes has been reflating the European liquidity discount, and the second round of LTRO should be viewed as insurance against a near-term liquidity crisis resurfacing. 

 

* Both European and American bank CDS tightened week over week, on average.

 

Financial Risk Monitor Summary  

•Short-term(WoW): Positive / 4 of 12 improved / 0 out of 12 worsened / 8 of 12 unchanged  

• Intermediate-term(WoW): Positive / 6 of 12 improved / 3 out of 12 worsened / 3 of 12 unchanged  

• Long-term(WoW): Negative / 0 of 12 improved / 7 out of 12 worsened / 5 of 12 unchanged

 

MONDAY MORNING RISK MONITOR: HIGH YIELD HITS A NEW YTD HIGH - Summary 2

 

1. US Financials CDS Monitor – Swaps tightened for 23 of 27 major domestic financial company reference entities last week.   

Tightened the most WoW: RDN, MTG, AIG

Widened the most WoW: GS, MS, AXP

Tightened the most MoM: RDN, MTG, AIG

Widened the most MoM: GS, MS, C

 

MONDAY MORNING RISK MONITOR: HIGH YIELD HITS A NEW YTD HIGH - CDS  US

 

2. European Financials CDS Monitor – Bank swaps were tighter in Europe last week for 33 of the 40 reference entities. The average tightening was 4.8% and the median tightening was 1.0%.

 

MONDAY MORNING RISK MONITOR: HIGH YIELD HITS A NEW YTD HIGH - CDS  Euro

 

3. European Sovereign CDS – European Sovereign Swaps mostly widened over last week. American sovereign swaps tightened by 2.5% (-1 bps to 36 ) and French sovereign swaps widened by 4.1% (7 bps to 185).

 

MONDAY MORNING RISK MONITOR: HIGH YIELD HITS A NEW YTD HIGH - Sovereign CDS 1

 

MONDAY MORNING RISK MONITOR: HIGH YIELD HITS A NEW YTD HIGH - Sovereign CDS 2

 

4. High Yield (YTM) Monitor – High Yield rates fell 21 bps last week, ending the week at 7.11 versus 7.32 the prior week.

 

MONDAY MORNING RISK MONITOR: HIGH YIELD HITS A NEW YTD HIGH - HY

 

5. Leveraged Loan Index Monitor – The Leveraged Loan Index rose 2 points last week, ending at 1636.

 

MONDAY MORNING RISK MONITOR: HIGH YIELD HITS A NEW YTD HIGH - LLI

 

6. TED Spread Monitor – The TED spread fell 1.8 points last week, ending the week at 39.7 this week versus last week’s print of 41.4.

 

MONDAY MORNING RISK MONITOR: HIGH YIELD HITS A NEW YTD HIGH - TED

 

7. Journal of Commerce Commodity Price Index – The JOC index rose 4.0 points, ending the week at -6.82 versus -10.8 the prior week.

 

MONDAY MORNING RISK MONITOR: HIGH YIELD HITS A NEW YTD HIGH - JOC

 

8. Euribor-OIS spread – The Euribor-OIS spread (the difference between the euro interbank lending rate and overnight indexed swaps) measures bank counterparty risk in the Eurozone. The OIS is analogous to the effective Fed Funds rate in the United States.  Banks lending at the OIS do not swap principal, so counterparty risk in the OIS is minimal.  By contrast, the Euribor rate is the rate offered for unsecured interbank lending.  Thus, the spread between the two isolates counterparty risk. The Euribor-OIS spread tightened by 3 bps to 65 bps.

 

MONDAY MORNING RISK MONITOR: HIGH YIELD HITS A NEW YTD HIGH - Euribor OIS

 

9. ECB Liquidity Recourse to the Deposit Facility – The ECB Liquidity Recourse to the Deposit Facility measures banks’ overnight deposits with the ECB.  Taken in conjunction with excess reserves, the ECB deposit facility measures excess liquidity in the Euro banking system.  An increase in this metric shows that banks are borrowing from the ECB.  In other words, the deposit facility measures one element of the ECB response to the crisis.  

 

MONDAY MORNING RISK MONITOR: HIGH YIELD HITS A NEW YTD HIGH - ECB 2

 

10. Markit MCDX Index Monitor – The Markit MCDX is a measure of municipal credit default swaps. We believe this index is a useful indicator of pressure in state and local governments. Markit publishes index values daily on six 5-year tenor baskets including 50 reference entities each. Each basket includes a diversified pool of revenue and GO bonds from a broad array of states. We track the 14-V1. Last week spreads tightened , ending the week at 125 bps versus 127 bps the prior week.

 

MONDAY MORNING RISK MONITOR: HIGH YIELD HITS A NEW YTD HIGH - MCDX

 

11. Baltic Dry Index – The Baltic Dry Index measures international shipping rates of dry bulk cargo, mostly commodities used for industrial production. Higher demand for such goods, as manifested in higher shipping rates, indicates economic expansion. Last week the index rose 1 points, ending the week at 718 versus 717 the prior week.

 

MONDAY MORNING RISK MONITOR: HIGH YIELD HITS A NEW YTD HIGH - Baltic dry 2

 

12. 2-10 Spread – We track the 2-10 spread as an indicator of bank margin pressure.  Last week the 2-10 spread tightened to 167 bps, 6 bps tighter than a week ago.

 

MONDAY MORNING RISK MONITOR: HIGH YIELD HITS A NEW YTD HIGH - 2 10

 

13. XLF Macro Quantitative Setup – Our Macro team’s quantitative setup in the XLF shows 1.3% upside to TRADE resistance and 1.4% downside to TRADE support.

 

MONDAY MORNING RISK MONITOR: HIGH YIELD HITS A NEW YTD HIGH - XLF setup

 

Margin Debt - January

We publish NYSE Margin Debt every month when it’s released. NYSE Margin debt hit its post-2007 peak in April of 2011 at $320.7 billion. The chart below shows the S&P 500 overlaid against NYSE margin debt going back to 1997. In this chart both the S&P 500 and margin debt have been inflation adjusted (back to 1990 dollar levels), and we’re showing margin debt levels in standard deviations relative to the mean covering the period 1. While this may sound complicated, the message is really quite simple. First, when margin debt gets to 1.5 standard deviations or greater, as it did last April, that has historically been a signal of extreme risk in the equity market - the last two times it did this the equity market lost half its value in the ensuing period. We flagged this for the first time back in May 2011. The second point is that margin debt trends tend to exhibit high degrees of autocorrelation. In other words, the last few months’ change in margin debt is the best predictor of the change we’ll see in the next few months. This is important because it means that margin debt, which retraced back to +0.55 standard deviations in November, still has a long way to go. We would need to see it approach -0.5 to -1.0 standard deviations before the trend runs its course. There’s plenty of room for short/intermediate term reversals within this broader secular move, as we saw in December and January's print of +0.53 and +0.70 standard deviations.  Overall, however, this setup represents a long-term headwind for the market. One limitation of this series is that it is reported on a lag.  The chart shows data through January.

 

MONDAY MORNING RISK MONITOR: HIGH YIELD HITS A NEW YTD HIGH - Margin Debt

 

Joshua Steiner, CFA

 

Allison Kaptur

 

Robert Belsky


Emotional Conclusions

This note was originally published at 8am on February 13, 2012. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“The dominance of conclusions over arguments is most pronounced where emotions are involved.”

-Daniel Kahneman

 

Intraday on Friday we finally had a -1% down move in US Equities and a +1.5% up move in long-term US Bonds. So, I covered our short position in the SP500 (SPY) and sold our long position in US Treasuries (TLT) on that. Buy red, Sell green.

 

Buying on red and Selling on green? That’s meant to be an over-simplification of what it is that I do. I love saying it, tweeting it, and doing it – because actually finding it within me to do it when I have so many other risk management signals banging around in my head is quite difficult.

 

On page 103 of “Thinking, Fast and Slow” Kahneman compartmentalizes what’s happening in my little brain and reminds me that I am hostage to what his psychologist buddy, Paul Slovic, coined as “The Affect Heuristic.” It helps explain why “people let their likes and dislikes determine their beliefs about the world.”

 

Back to the Global Macro Grind

 

At least in my own head, I’m crystal clear that I dislike Big Government Interventions, Socializations, and Regulations of free-market pricing. If all I did was trade on the Emotional Conclusions that are embedded in those thoughts, I’d be wrong a lot more than I am. Separating what should happen versus what is going to happen is critical in markets that whip around like this.

 

What whipped around last week?

  1. The US Dollar Index finally stopped going down (1stup week in the last 4) = up +0.3%
  2. Commodity Inflation (18 component CRB Index) stopped inflating = down -0.6%
  3. US Equity Volatility (VIX) ripped to 20.79 = straight up +21.6%

What’s fascinating and sad about this all at the same time is that it reminds us how sensitive market prices are to a devaluation of the US Dollar. Emotional Conclusions drive expectations too. The US Dollar currently has an immediate-term +0.7 correlation to Volatility (VIX).

 

Emotional? Right before they stopped inflating, CFTC (Commodities Futures Trading Commission) data showed that in the week ended February 7th, 2012, money managers ramped up their net-long positions to commodity inflation by +13% week-over-week. At 929,199 contracts (Bloomberg.com), that’s the biggest net-long position since September of 2011. Atta boy Bernank!

 

For those of you who still remember who and what got crushed in September 2011, the CRB Index dropped from 343 to 293 by the first week of October 2011. That was a -14.6% vertical drop as the US Dollar Index ramped +7%. Got Emotional Conclusions about causality?

 

Or was that Correlation Risk? Or was it expectations? Or Europe?

 

Whatever it was, it was the real-time score.

 

That’s the thing about market prices. They could not care less about what you or I think. They do what they do when they do them, rendering our immediate-term opinions about valuation, supply, and demand useless.

 

We’re all book smart. Or at least, technically, that’s what the diplomas say. Being market-smart will be determined many years after we leave this game – when every week, month, and year of our risk management performance has been TimeStamped.

 

In the meantime, we need to know what we are going to do now. As in right now. Markets wait for no one. And now that the Greek “news” is out of the way, I think this week’s focus will turn to:

  1. Japan: nasty Keynesian Growth Slowdown (down -2.3% GDP Growth y/y for Q411) and pending sovereign debt maturity in March
  2. China: growth slowing (again) as global inflation expectations rise (again)
  3. USA: economic data to be reported this week which should already start to show inflating import, consumer, and producer prices

I’ve dropped the Cash position in the Hedgeye Asset Allocation Model from 91% on the day of Bernanke’s Policy to Inflate (January 25th, 2012) to 64% this morning. Effectively, I’m long Inflation Expectations Rising (Energy, Gold, etc.) and I’m right worried about it. If we see the US Dollar hold last week’s gains, I’ll have no problem selling inflated prices on green.

 

My immediate-term support and resistance ranges for Gold, Oil (Brent), EUR/USD, and the SP500 are now $1714-1761, $114.89-120.01, $1.31-1.33, and 1338-1360, respectively.

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Emotional Conclusions - Chart of the Day

 

Emotional Conclusions - Virtual Portfolio


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