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DNKN: BUILDING’S ON FIRE

Those in the know cannot get out of this stock fast enough.  The sequence of events since this company went public does little to inspire confidence that Dunkin’ Brand is the best growth story around.

 

The CEO of Hedgeye, Keith McCullough, often repeats this phrase: “Watch what people do, not what they say”.  When thinking about Dunkin’ Brands’ stock at this point, we feel that his advice is highly apropos. Here is a timeline of events that have occurred since the company went public.

  • 7/27/11: Dunkin’ Brands’ shares have a successful IPO; the stock rises ~38% on the first day of trading.
  • 11/01/11: Dunkin’ Brands announces a secondary offering of 22 million shares of common stock.
  • 11/14/11: Dunkin’ Brands says lead book-running managers are waiving the lock up restriction for certain officers and directors.
  • 1/04/12: Dunkin’ Brands signs an exclusive procurement and distribution agreement with Dunkin’ Donuts franchisee-owned cooperative.
  • 3/06/12: Dunkin’ Brands begins dividend at $0.15 per share.
  • 3/16/12: Dunkin’ Brands announces secondary offering of 22 million shares of common stock.
  • 3/16/12:  Discloses in a regulatory filing that 1Q12 same-store sales are tracking between 6.7% and 7% at Dunkin’ Donuts U.S. stores, which is a sequential slowdown in two-year average trends.

Does this timeline suggest to anyone that the people in the know are excited about the growth prospects of the company?

 

The most significant omission from management’s disclosure continues to be the backlog of contracted new unit openings for Dunkin’ Donuts stores in the U.S.  Dunkin’ Donuts is, by far, the primary driver of growth for Dunkin’ Brands over the next few years and the U.S. market is the “white space” opportunity that has been so heavily touted to investors.  Where is the disclosure on the most pertinent factor for the Dunkin’ growth story?  Last Friday, the company disclosed that Dunkin’ Donuts comparable store sales growth was expected to come in at 6.7-7.0% for 1Q12, which implies a sequential slowdown in two-year average trends and is disappointing in that it also raises a concern about the sustained success, or lack thereof, that the company has had with K-Cup sales versus expectations.  In addition, we would be surprised if many other restaurant companies - particularly those with strong prospects - are seeing a sequential slowdown in two-year average trends with the weather benefit that is helping industry sales this quarter.

 

The question at this point is; if that sales data point is what the company was willing to disclose, how disappointing is the mysterious backlog number?

 

DNKN: BUILDING’S ON FIRE - dnkn pod1

 

 

Howard Penney

Managing Director

 

Rory Green

Analyst

 


THE HBM: DPZ, SBUX, YUM, DNKN

THE HEDGEYE BREAKFAST MONITOR

 

MACRO NOTES

 

Commentary from CEO Keith McCullough

 

I’m on the road seeing clients in Minneapolis – this melt-down in the Japanese Yen remains our top new risk mgt topic:

  1. CHINA – got Growth Slowing yet? Interestingly, but not surprisingly, the Hang Seng (-1.1%) snapped its immediate-term TRADE line of 21,255 overnight, joining India’s Sensex as the 2nd major Asian Equity market to break a significant line of momentum.
  2. US Dollar – my intermediate-term TREND line of support of $79.33 is once again under assault by central planners who are absolutely hooked on the inflation policy born out of it (Obama’s % chance of winning the election just shot up to another new high of 60.5% in the Hedgeye Election Indicator (+200bps wk/wk) - stock market inflation is a big factor in our back-test).
  3. GOLD – rising UST yields is bad for Gold on the margin. Period. Gold’s intermediate-term TREND line of $1691 remains broken as 10yr yields remain comfortably above my intermediate-term TREND line of 2.03%. 

KM

 

 

SUBSECTOR PERFORMANCE

 

THE HBM: DPZ, SBUX, YUM, DNKN - subsectors

 

 

QUICK SERVICE

 

DPZ: Domino’s was downgraded to underperform at BofA.  The PT was lowered to $34 from $41.  BofA believes that the catalyst (special dividend) has passed.  This seems like a good move to us by BofA but we are waiting for further data points to gain conviction that DPZ is going to underperform.

 

DPZ: Domino’s announced the completion of its recapitalization yesterday, along with a special dividend of $3 per share. 

 

SBUX: Starbucks was reiterated Buy at UBS and the PT was hiked to $61 from $52.

 

SBUX: Starbucks has opened the first Evolution Fresh-branded stores in Washington State. 

 

YUM: Yum Brands was initiated Outperform at Oppenheimer with a PT of $82.

 

YUM: Yum Brands’ KFC South Africa division is doubling stores in its delivery stable by the end of this year.

 

DNKN: Dunkin’ Brands is projecting comparable-store sales at its U.S. Dunkin’ Donuts chain will grow 6.7% to 7% for 1Q12.  We still believe that the company needs to disclose its backlog of new units.  The company’s future profitability is far more levered to new unit openings than comps and our contention, going on the information we have, is that the backlog is declining and not growing.

 

 

NOTABLE PERFORMANCE ON ACCELERATING VOLUME:

 

DPZ: Domino’s gained 3.4% on accelerating volume yesterday on news of the completion of its refinancing and special dividend announcements.

 

DNKN: Dunkin’ Brands declined -1.3% on accelerating volume.

 

CBOU: Caribou declined -3.9% on accelerating volume.

 

 

CASUAL DINING

 

NOTABLE PERFORMANCE ON ACCELERATING VOLUME:

 

RUTH: Ruth’s Chris gained 3.4% on accelerating volume.

 

THE HBM: DPZ, SBUX, YUM, DNKN - stocks

 

 

Howard Penney

Managing Director

 

Rory Green

Analyst

 



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Risky Expectations

“Risk appears to be at its greatest when measures of it are at its lowest.”

-Mark Carney

 

Keith and I have been on the road meeting with subscribers this week and spent the first part of the week in Winnipeg, so it seemed appropriate to start the Early Look this morning with a quote from Mark Carney, the current Governor of the Bank of Canada.  

 

Setting aside the fact that Carney played hockey at Harvard, which raises some character questions in our minds, he has had a respectable tenure as the Governor of the Bank of Canada.  In fact, even though we at times question too much government involvement, his actions are rightfully credited for getting the Canadian economy back to normal levels of output and employment quicker than the G-7 following the 2008 meltdown.

 

Personally, after reading the above quote from Carney, I was almost ready to forgive him for wearing the crimson colors of Harvard.  To me that quote shows perhaps the most appropriate understanding of risk, which is that risk in the market is greatest when we least expect it.  For us, a key measure of risk is volatility.  As it relates to equities, a key measure of this is the VIX, or volatility index of the SP500.

 

Like much of modern risk management, the VIX is a relatively new creation.  In fact, it was developed by Professor Robert Whaley in 1993 (courtesy of Wikipedia).  The VIX is a weighted blend for a range of options on the SP500.  More specifically, the VIX is the square root of the par variance swap rate for a 30-day term initiated on the current day.  So, in layman’s terms, it is the expected movement of the SP500 over the next thirty days on an annualized basis. 

 

As an example if the VIX is at 15, the expected return for the next twelve months is 15%.  Over the next thirty days, the range of return is calculated by dividing the VIX by the square root of 12.  Therefore with the VIX at 15%, there is 68% likelihood, or one standard deviation, that the SP500’s move, up or down over the next thirty days, will be 4.3%, or less. 

 

In the Chart of the Day, we show the chart of the VIX going back five years.  The takeaway of this chart, a point we have been hammering home as of late, is that when the VIX reaches levels around 15, it has been a contrarian signal to shift out of risk assets.  In the course of the last two years, this signal has been reached three times – April 2010, May / June 2011, and now.  (Incidentally, we are long the VIX, via the etf VXX, in our Virtual Portfolio.)

 

In our meetings with subscribers, the push back we often receive on the VIX discussion is that in the 2003 – 2007 period, or thereabouts, the VIX reached lower levels and stayed at these levels for sustained periods, which buoyed equity market returns.  So, what’s different this time?

 

This is certainly a fair question.  Our retort is that the economy itself is more volatile than it was in that period.  This is due to the active management of the economy by Keynesian central planners, but also accelerating debt burdens of the economy.  Think of the economy like a highly levered company, with more debt on the balance sheet a company’s earnings become much more volatile, so equity returns are inherently more volatile.  (Not to mention, the “awash with liquidity” period of 2003 – 2007 was far from normal.)

 

In part, this is why we are long Canada in the Virtual Portfolio via the etf EWC and, if you think about, long Mark Carney policy.   Canada’s debt-to-GDP is 83% (per the CIA Factbook), which while higher than we would like, is below the critical 90% bound which historically leads to slowing economic growth, and less than the United States’ ratio that is north of 100%.  In Canada, the deficit is actually now in decline, which will lead to lower debt-to-GDP ratios in the future.  This compares to the United States, which had the largest monthly deficit of any nation in history in February.

 

Another key discussion or debate point in our recent meetings with subscribers has been the outlook for economic growth, both in the United States and abroad.  As we’ve stated repeatedly, we expect lower growth than many Wall Street 1.0 prognosticators.  This is primarily driven by the math of our predictive algorithms and further supported by incremental data points.

 

For us, the price of oil is a critical data point when contemplating economic growth.  As I wrote two weeks ago:

 

“Charles Hall, Steven Balogh, and David Murphy did an analysis of the connection between the price of oil and when recession can be expected, examining the Minimum Energy Return on Investment (EROI). In their assessment, recession is likely to occur when oil amounts to more than 5.5% of GDP. Logically, this makes sense. Even based on the very tainted calculation of CPI, the average U.S. consumer spends 9% of his or her income directly on energy, with the majority allocated to gasoline. This obviously also excludes the derivative impact of increasing energy costs, such, as we noted above, the increasing costs of food.”

 

Incidentally, Brent oil at $116 per barrel is equivalent to 5.5% of U.S. GDP based on current usage patterns.  Brent is trading at $124 per barrel this morning.

 

The most recent data point supporting lower global economic growth came from the mining giant BHP Billiton this morning who said they are seeing signs of “flattening” of iron ore demand from China.  It seems when China tells you they are going to gear down economic growth, they actually will.

 

T.S. Eliot once wrote:

 

“Only those who will risk going too far can possibly find out how far one can go.”


From a personal perspective, I’d agree with Eliot, from a portfolio risk management perspective, not so much.

 

Our immediate-term support and resistance ranges for Gold, Oil (Brent), US Dollar Index, and the SP500 are now $1, $122.96-127.19, $79.33-79.88, and 1, respectively.

 

Keep your head up and stick on the ice,

 

Daryl G. Jones

Director of Research

 

Risky Expectations - Chart of the Day

 

Risky Expectations - vp 3 20


THE M3: NEW LABOR CHIEF; OKADA NO WRONGDOING; NEW FERRY ROUTES; CASINO EMPLOYEES

The Macau Metro Monitor, March 20, 2012

 

LABOUR CHIEF REPLACEMENT MAY OPEN THE DOOR FOR IMPORTED WORKERS Macau Daily Times

The government announced the replacement of current Director of Labour Affairs Bureau (DSAL) Shuen Ka Hung, by Wong Chi Hong, the head of the Human Resources Office (GRH). Apparently Shuen’s performance fell short of the Chief Executive’s expectations, and the speculation is that there will be a change of labour policies to rely more on imported workers.    


The Secretary for Economy and Finance, Tam Pak Yuen said it is the government's top priority to improve the quality of local workers to help resolve the bottleneck situation in Macau’s economic development.

 

OKADA'S ROOM GIFT NO CRIME: TRAVEL EXEC Macau Daily Times

In defense of Okada's room comps Robert Lim Joseph, the chairman emeritus of the Philippines’ National Association of Independent Travel Agencies (NAITAS) told reporters, “the hotel accommodations, even if they were first-class and other freebies are very common in the industry.  Of course, when gaming officials go here, we also would give them the best. We will not place them in a cheap hotel. It would always be first-class accommodations.”

 

The Chairman saw no reason to charge with Pagcor chairman Cristino Naguiat of wrong doing since Okada’s gaming license had already been approved before Naguiat travelled to Macau. “So there’s more reason to dismiss allegations that Naguiat was bribed to allow Okada to operate his business in the country,” Joseph said.

 

PAC ON MAY HAVE 3 NEW ROUTES TO HK AND MAINLAND Macau Daily Times

Within 2 weeks, the Maritime Administration will decide whether to add new routes proposed in 3 applications for new ferry operations in Pac On Ferry Pier.  The new routes would depart from Taipa, to Zhuhai’s Wanzai, Hong Kong’s Sheung Wan and Shenzhen’s Shekou.  There are currently eight ferry routes that depart from Taipa’s Pac On temporary ferry terminal, to Hong Kong and nearby Mainland cities.

 

14.5% OF MACAU'S WORKING POPULATION WORKS IN GAMING SECTOR AT END OF 2011 Macau Hub

At December 31, 2011 there were over 50,000 Macau residents working in the gaming sector, representing a 12% increase QoQ, according to DSEC Manpower Survey released yesterday.  Almost half of those employees - or 22k worked as croupiers, a figure that also rose 16.7% QoQ.  

 

In December 2011 the average monthly salary for full-time workers (excluding bonuses and profit sharing) working in casinos was 16,720 patacas, (US$2,090), up 6.5% YoY, whilst that of croupiers was 14,700 patacas (US$1,837). In December there were more than 2,000 vacancies for casino positions of which 1,500 were for croupiers.


Risk Managing Non-Events

This note was originally published at 8am on March 06, 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 human mind does not deal well with non-events.”

-Daniel Kahneman

 

When you are me, analytical life can get lonely. Every single major Growth Slowing call I have made since 2007 has been met with doubt, denial, and disdain. But growth still slowed.

 

Whether I’m out for a run, on a plane, or in the shower, I’m constantly trying to re-think better ways to communicate our process. What is it that we do? How do we model our assumptions? What are the risk management signals?

 

Ultimately, I’ve come to the conclusion that I can always do better, but I can’t make it any more simple than stating it each and every day before it occurs. I’ll call this Risk Managing Non-Events.

 

Back to the Global Macro Grind

 

What is a Non-Event? You can ask Dan Kahneman for his definition – mine is that Non-Events are constantly occurring and tipping the slopes and probabilities of events becoming obvious.

 

Got tipping points? Consider the following Growth Slowing Signals in our globally interconnected Macro Model from the last month:

  1. Basic Materials Stocks (XLB) stopped going up on February 3rd, 2011 (now down -3.1% from YTD top)
  2. India’s Stock Market (INP) stopped going up on February 21st, 2011 (now down -6.8% from YTD top)
  3. Small Cap Stocks (IWM) stopped going up on February 23rd, 2011 (now down -3.1% from YTD top)

Those are obviously just leading indicators from big, liquid, stock markets. All the while, Copper, 10-year US Treasury yields, and Global Yield Spreads continued to flag what they started flagging immediately after the Ben Bernanke’s January 25thPolicy To Inflate to 2014 – Growth Expectations started falling as Inflation Expectations started spiking.

 

Overlay immediate-term leading indicators (real-time market prices, yields, and spreads) with our long-term Fundamental Research View that:

 

A)     Debt (when crossing 90% of GDP) structurally impairs long-term growth (Reinhart & Rogoff data supports this view)

B)     Inflation, from a certain time/price level, slows real (inflation adjusted) growth

 

All the while, have a Keynesian economist promise you that they can centrally plan just the right amount of “inflation” for just the right amount of employment and economic growth.

 

And you have yourself an “event” (versus consensus expectations) in the making…

 

Non-events are the proverbial grains of sand falling on the pyramid of risk that is our globally interconnected Macro Model. One by one, price by price, data point by data point, they fall onto the sand-pile of expectations.  

 

Then, one day… week… or month, they become “events.”

 

If the deep simplicity of Chaos Theory is this obvious, how do we almighty chosen ones from the Ivy League routinely get this wrong?

 

“A general limitation of the human mind is its imperfect ability to reconstruct past states of knowledge, or beliefs, that have changed.” –Daniel Kahneman (Thinking, Fast and Slow – page 202)

 

That’s why we have to humble ourselves and Embrace Uncertainty. The idea that going to Yale immunizes my mind from being human under pressure is as ridiculous as Bernanke not seeing inflation at $120 oil.

 

There may have been a day in this business, without internet connections or Twitter, that you could have legitimately had an information edge on a company and its implied valuation. A lot has changed since then. Today, my 4-year old son can pull up cash flow multiples with two clicks on Yahoo finance (provided that I give him the ticker!).

 

Risk Managing Non-Events is the next frontier of finance. Yes, it’s a lot harder to do than proclaiming our mystery of faith on the “right” earnings “multiple” for the SP500. That’s why we do it every morning. Risk never sleeps.

 

My immediate-term support and resistance ranges for Gold, Oil (Brent), US Dollar Index, and the SP500 are now $1691-1735, $121.12-123.98, $79.03-79.74, and 1356-1366, respectively.

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Risk Managing Non-Events - Chart of the Day

 

Risk Managing Non-Events - Virtual Portfolio


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