Darden reported 3QFY12 EPS of $1.25 was just ahead of consensus $1.24.  Blended US same-restaurant sales for Olive Garden, Red Lobster, and LongHorn Steakhouse came in at 4.1% versus guidance of approximately 4% provided a month ago at the company’s Analyst Day. 


Darden reported a solid 3QFY12 on Friday but there was a lot of noise in the quarter with weather and the impact of an earlier start of Lent this year versus last year.  Less severe winter weather boosted the blended same-restaurant sales number by 200 basis points while Lent positively affected results by roughly 60 basis points (including an astounding 480 basis points at Red Lobster).


Management’s commentary on the macro environment as “choppy” was important; the company sees improving employment being offset by the impact of rising gas prices.  The industry slowed in February, according to management, after a strong holiday and post-holiday season.  Management noted that less severe weather did help results but downplayed the impact somewhat by referring to states such as CA, TX & FL.  In the case of TX, we know from other companies’ commentary and our own research, that adverse weather conditions did impact business in Texas during January 2011 so would argue that a benefit would account for some positive impact on Darden’s Texas restaurants.


In terms of FY13, management will offer more comprehensive guidance on the FY12 call in June but did provide some initial thoughts during Friday’s earnings call, sounding generally bullish but offering little in the way of specifics.


Darden also seems to be stealing a page out of Brinker’s book when talking about the new Olive Garden promotion; Drew Madsen said, “this promotion is representative of our strategy going forward, where we plan to emphasize a broadly appealing platform idea rather than just one or two new dishes.”


The initial improvements in the Olive garden performance are coming from a “more overt value message as well as more affordable core menu dishes” that are pulling customers into the store.  The issue remains how effective the new initiatives are and to what degree the apparent improvements are being helped by the benefit of easy weather.  The new advertising campaign is also a welcome change, but this too needs time to prove itself out.  The biggest challenge to any real improvement in the chain’s performance will be the “bolder improvement initiatives” that include a “remodel that updates and refreshes the dining atmosphere in the 430 non-Tuscan Farmhouse restaurants.”  This suggests that 55% of the chain is suffering from a stale look in today’s competitive casual dining environment. 


Any big leg up in the stock price will likely come from multiple revision based on a stronger secular story from improved same-store sales.  In the short run, the dividend yield and share repurchase will likely keep the shorts on the side lines.  We will look to revisit the story after FY4Q12, which will likely bring a sequential slowdown in same-store sales.


The bottom line for us is that DRI is a strong company supporting a 3.4% dividend yield and that, along with our belief that management will deliver on most if not all of its long term targets, is sufficient to convince us that the longer term TAIL thesis remains intact.  However, the immediate term TRADE and intermediate term TREND prospects of the company are uncertain.  Macro concerns coupled with concept-specific concerns at Olive Garden and Red Lobster concern us over the next few months.  Olive Garden, in particular, is crucial to the stock’s performance given its relative size within the Darden portfolio and we feel that investors need to see an improving top line that is not achieved to the detriment of restaurant operating margins.


Olive Garden


Olive Garden’s 2% 3QFY12 same-restaurant sales growth lagged Knapp Track by approximately 60 basis points which was a sharp sequential improvement versus the prior quarter’s lag of 320 basis points. 


During the quarter, Olive Garden ran two promotions.  The first, baked pasta romana, ran from December through the third fiscal week of January and compared favorably to last year’s lack-luster scaloppini promotion.  The second, which was launched in the fourth fiscal week of January, was the three-course Italian dinner for $12.95.  This promotion succeeded in driving traffic but is also priced $2 higher the promotion from the same period in FY11 (although that promotion was for an entrée rather than three courses).  While 3QFY12 was successful for Olive Garden in that the gap-to-Knapp was narrowed sequentially, next quarter will pose a much sterner test for the chain as the weather benefit goes away.  Management described the environment as “choppy” and this is causing us to remain on the sidelines.


DARDEN THOUGHTS - olive garden gap to knapp



Red Lobster


Red Lobster posted a 6% same-store sales number for 3QFY12, as preannounced, which benefitted by 480 basis points due to an earlier start to Lent 2012 versus 2011.  The 6% number was 340 basis points above the full service industry benchmark but the benefit derived from the Lent shift will reverse in 4QFY12.  Traffic during 3QFY12 was soft, if we adjust for weather and Lent, and it seems that maintaining profitable traffic growth could prove challenging if the effectiveness of promotional efforts is declining.  Soft underlying traffic trends were a surprise given the 4 for $15 promotion that Red Lobster was running in the quarter.


One important concern for Red Lobster is seafood inflation but that is, according to management, going to ease in 1HFY13 and was less acute in 3QFY12 than 1HFY12.  Nevertheless, management not taking any price against seafood led to margin contraction at Red Lobster.  Going forward, the question is whether or not the “broader range of levers” that management alluded to as being core to its sustaining Red Lobster comps is going to be impactful.  Red Lobster has been a strong component of the Darden portfolio during this fiscal year but maintaining that momentum will be difficult in a choppy macro environment.


DARDEN THOUGHTS - red lobster gap to knapp



LongHorn Steakhouse


LongHorn continues to perform well for Darden.  3QFY12 same-restaurant sales growth of 6.7% was 410 basis points above the full service industry benchmark.  Negative mix was one standout from the chain’s results but the successful and profitable efforts to drive lunch business is the primary driver of that trend.  LongHorn is an important growth vehicle for Darden and new LongHorn units continue to exceed sales and earnings hurdles. 


DARDEN THOUGHTS - longhorn gap to knapp



Howard Penney

Managing Director


Rory Green






Hedging The Inflation Trade: EWZ & EWA Combo Trade Update

Conclusion: Our refreshed GROWTH/INFLATION/POLICY outlook points to more downside in both Australian equities and the Aussie dollar relative to Brazilian equities and the Brazilian real over the intermediate-term TREND. Further, we continue to like Brazilian equities on their own merits over the intermediate term – irrespective of this pairing – as a deflating of the inflation provides additional headroom for growth-supportive monetary and fiscal policy amid a baseline backdrop of accelerating real GDP growth.


Virtual Portfolio Positioning: Closed our long position in Brazilian equities (EWZ); and currently short Australian equities (EWA).


Late last week, Keith initiated a long position in Brazilian equities and opened a short position in Australian equities in our Virtual Portfolio (the former has since been booked for a +2.4% gain). While both benchmark indices are fairly levered to the inflation trade, we find that Brazil’s domestic fundamentals are more supportive of equity returns and multiple expansion than Australia’s at this current juncture.


Hedging The Inflation Trade: EWZ & EWA Combo Trade Update - 1


Starting from our baseline GROWTH/INFLATION/POLICY model, Brazil’s 2Q12 outlook appears decidedly more positive than Australia’s from an equity investor’s perspective. We are comfortable adopting this baseline scenario in part due to it being confirmed by the latest high-frequency data via the slopes of both countries’ PMI, employment, and inflation statistics.


Hedging The Inflation Trade: EWZ & EWA Combo Trade Update - BRAZIL


Hedging The Inflation Trade: EWZ & EWA Combo Trade Update - AUSTRALIA


Hedging The Inflation Trade: EWZ & EWA Combo Trade Update - 4


Hedging The Inflation Trade: EWZ & EWA Combo Trade Update - 5


Hedging The Inflation Trade: EWZ & EWA Combo Trade Update - 6


From a foreign exchange risk perspective (both etfs are un-hedged), we continue to see long-term mean reversion risk in the Aussie dollar vs. the U.S. Dollar. For more details regarding this thesis, refer the following notes listed at the conclusion of this note. From an intermediate-term perspective, the Aussie dollar also looks poised to make lower-highs vs. the USD given the AUD/USD currency pair’s preponderance to trade in tandem with commodities and U.S. equities – two asset classes we are explicitly bearish on (short the SPY; ZERO percent allocation to commodities in the HAA). 

  • Trailing 3yr correlation to the CRB Index: +93%; and
  • Trailing 3yr correlation to the S&P 500: +94%. 

Looking at the Brazilian real, there appears to be less downside risk from a mean reversion perspective. The real – which is down -5.8% over the last month vs. the USD amid a politicized commitment to lower the country’s aggregate interest rate burden – is down -8.4% over the LTM and up only +38.5% since its trough financial crisis exchange rate (12/8/08). This compares rather lightly to the Aussie dollar’s +74.9% gain from its trough financial crisis exchange rate (10/27/08).


While the various interest rate markets of both countries are signaling an outlook for continued monetary easing, Australia’s are pricing in decidedly less easing over the NTM – which intuitively makes sense given RBA Governor Glenn Stevens’ reputation as the developed world’s most hawkish central bank chief, as well as Brazilian Central Bank President Alexandre Tombini’s drive to achieve and sustain mid-to-high single digit interest rates in Brazil (with political pressure from President Dilma Rousseff and Finance Minister Guido Mantega).


Hedging The Inflation Trade: EWZ & EWA Combo Trade Update - 7


Hedging The Inflation Trade: EWZ & EWA Combo Trade Update - 8


Net-net-net, our refreshed GROWTH/INFLATION/POLICY outlook points to more downside in both Australian equities and the Aussie dollar relative to Brazilian equities and the Brazilian real over the intermediate-term TREND. Our quantitative risk management levels on both countries’ benchmark equity index are included in the charts below.


Hedging The Inflation Trade: EWZ & EWA Combo Trade Update - 9


Hedging The Inflation Trade: EWZ & EWA Combo Trade Update - 10


Bearish Thesis on the Aussie Dollar:

Bullish Thesis on Brazilian Equities:

Darius Dale

Senior Analyst

PVH: Still Positive Pre & Post Qtr


Conclusion: True to form, PVH raised its outlook intra-quarter and we expect that also true to form it will come in close to a dime above Street estimates – that’s expected. We think the 2012 outlook is headed higher as a result. With our model at nearly $1 above the Street two-years out in 2013, we also expect an acceleration in revisions and expectations ahead for one of our favorite large-cap names in 2012.


TRADE (3-Weeks or Less):

We’re at $1.15 for PVH headed into Tuesday’s print after the close, which is ahead of the Street at $1.09 and guidance of $1.08-$1.10.

  • Over the last three quarters, PVH has come in above consensus by an average of +3% on revenues and +9% on EPS. We don’t think PVH results broke this cadence in Q4.
  • We expect sales to come in better than expected up +9% vs. +6.5%E in Q4 driven by CK up +14% to $284mm, Tommy up +12% to $788mm and the Heritage business essentially flat up +1% to $450mm. With sales running ahead of plan through the first two months of the quarter, we have little reason to suggest that the sales trajectory changed meaningfully in the last month based on what we’ve heard and seen across the rest of retail.
  • As a result of stronger top-line results, we are at GMs of 51.3% reflecting -150bps of contraction over 100bps better than Street expectations for -260bps. Moreover, with the inventory setup favorable heading into year-end, we don’t expect atypical seasonal promotional activity beyond elevated clearance in the Heritage segment.
  • In addition, we expect SG&A of $642mm up 5.5% yy reflecting 140bps of leverage.
  • Short interest remains very low at ~3% of the float.
  • Interestingly, sentiment as measured by our index has become more bullish over the last two-months with the stock up +26% YTD vs. the MVR up +18% and the S&P up +10%.

TREND (3-Months or More):

With the Tommy acquisition no longer artificially boosting sales in 2012, we expect top-line sales to slow on the margin in 1H and to +6.5% for the full-year reflecting uncertain demand at best in Europe and a turn in Fx to a headwind from a +2-4% tailwind in 2011. In addition, we think incremental marketing spend which has proven to be a key sales driver in 2011 and continued uncertainty leading to tighter inventory commitments from European retailers will keep earnings growth at a mid-teens rate. We’re at $6.21 vs. $6.02E in 2012.

  • At CK, we expect revenues to slow modestly next year up +10.5% from +14.5% in 2011 with +8% growth in licensing and +12% growth in apparel driven by continued growth in underwear as well as the new Power Stretch jeans line.
  • At Tommy, with most of its growth coming out of Europe (Germany and Spain top two markets by size), we expect demand to slow over in 1H of 2012 with continued weakness in Spain a key intermediate-term variable.
  • The Heritage business is unquestionably the odd man out among the three businesses over the next two quarters. It’s undergoing a transformation getting out of unprofitable/underperforming lines in 2012. Timberland accounted for ~$80mm in revs, which will account for a 4-5% reduction in sales growth while we expect the core business to stabilize. Coming in ~3pts below historical operating margins of 10% in 2011, we expect profitability to improve (+110bps) on a lower revenue base in 2012.

TAIL (3-Years or Less):

While PVH works to stabilize its cash flow business (Heritage), it’s doing what the best brands do that license out their brands in order to grow into international markets – it’s starting to take back control of its own content. Driving brand sales directly at higher margin was key to RL’s success through much of the last decade as the company bought in its licenses. We don’t expect PVH to be any different.


In fact, as we recently highlighted in our note “PVH/WRC: Understanding Licenses is Key,” we detailed how the recent CK bridge line it took back from WRC could add up to $0.75 in EPS 3-4 years out. Add on a few more of these and PVH’s earnings power could change materially higher.


We see continued upside at Tommy as well as CK resulting in EPS of $8 in 2013, a buck above consensus expectations. Following a strong end to the year, we expect an acceleration in revisions and expectations ahead for one of our favorite large-cap names along with RL and VFC in 2012.


Casey Flavin



PVH: Still Positive Pre & Post Qtr - PVH Sentiment


Management commentary from Q3 call: 

PVH: Still Positive Pre & Post Qtr - PVH Q3 Youtube


Below is a table outlining WRC's product/license portfolio as highlighted in our note “PVH/WRC: Understanding Licenses is Key”:


PVH: Still Positive Pre & Post Qtr - WRC CK Table





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Priced to Perfection?: Short MUB Trade Update

Conclusion: We think any asset class that is trading just shy of all-time highs in prices without a clear outlook for continued improvement in its fundamentals is rife with asymmetric risk to the downside. 


On Friday afternoon, Keith shorted the iShares National Municipal Bond Fund (ticker: MUB) in our Virtual Portfolio. In short, the fundamental thesis behind putting on this risk exposure is twofold: 

  1. From a long-term perspective, we think muni bond yields will rise amid our belief that U.S. interest rates are poised to continue making higher-lows; and
  2. The view that municipal issuers are experiencing a structural improvement in credit quality becomes decidedly less supportive going forward, posing a risk to muni bond prices as demand from the marginal investor slows. 

Looking at muni bond prices from an average yield to maturity perspective, the Bond Buyer U.S. 40 Municipal Bond Index is currently yields 4.65%, down from a cyclical peak of 5.95% in JAN ’11. Then, the story was growing fear of default and oversupply amid an expiration of the Build America Bond program. Since then, muni issuers (particularly on the State side) have shrugged off these credit concerns and continued to strengthen their balance sheets by dramatically reducing expenditures – even amid a sharp decline in federal support.


Priced to Perfection?: Short MUB Trade Update - 1


Priced to Perfection?: Short MUB Trade Update - 2


Now the question going forward is: “How much better can it get from a credit perspective?” While that doesn’t imply an immediate reduction in issuer credit quality, it does imply that fundamentals are unlikely to continue improving from what is known/priced in.  As the chart above highlights, States’ need for fiscal consolidation (i.e. the “hurdle” they must clear from a credit quality perspective) has declined to at least a four-year low in FY13 and is only ~1/4th  the size of the “hurdle” that was cleared in FY10.


Broken TRADE and TREND on our PRICE/VOLUME/VOLATILITY model, the MUB etf is signaling to us that tough questions are, at a minimum, starting to be asked in this traditionally-opaque market. Tough questions, such as: “If Obama wins reelection and the Democrats do better-than-expected in Congressional elections, will the tax exemption of muni bond income come under increased legislative scrutiny as Obama looks to secure additional funding for his ‘fair share’ initiative(s)?” do pose risk to the muni market from a price discovery perspective given that muni bond prices are just shy of their all-time peak (+14bps from YTM perspective).


Priced to Perfection?: Short MUB Trade Update - 3


Priced to Perfection?: Short MUB Trade Update - 4


All told, we think any asset class that is trading just shy of all-time highs in prices without a clear outlook for continued improvement in its fundamentals is rife with asymmetric risk to the downside. Muni bonds fit this framework like a glove; as such, we have decided to trade around muni bonds on the short side in our Virtual Portfolio.


Darius Dale

Senior Analyst

European Banking Monitor: Pain in Spain

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 .


Key Takeaways:

* Spain and its banks are getting worse. Spanish bank default swaps were materially wider week-over-week, rising an average 74 bps, or 18%. All six of Spain's major banks, on which swaps trade, are trading well over 300 bps (the "Lehman line"). Spanish Sovereign swaps widened by 27 bps to 427 bps. While most investors are focused on the rapid deterioration taking place in Portugal, we think Spain is the one to watch more closely. Will 2012 be a redux of 2011 on the Europe front, this time with Spain playing the lead role? Looking at sovereign and bank swaps of a country in conjunction has generally been a solid cointegrated risk measure.    



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 45 bps.


 European Banking Monitor: Pain in Spain - 11. euriibor


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.  The facility reached €785.4 Billion on 3/23.


European Banking Monitor: Pain in Spain - 11.  ecb facility


European Financials CDS Monitor – Bank swaps were wider in Europe last week for 35 of the 40 reference entities. The average widening was 5.6% and the median widening was 6.0%.


European Banking Monitor: Pain in Spain - 11. banks


Security Market Program – The ECB's secondary sovereign bond purchasing program purchased no sovereign paper in the week ended 3/23, for a second straight week of zero buying. February-to-date the Bank has purchased a mere €210 Million versus €2.2 BILLION in the week ended 1/20 and €3.8 BILLION in the week 1/12. When questioned on the lack of buying over recent weeks, ECB President Draghi has only answered that the SMP is a non-standard measure that is “neither eternal nor infinite.” Clearly, with the some €1 Trillion injection of liquidity across the LTROs, the Bank is paring back buying and watching the results of sovereign bond auctions.


European Banking Monitor: Pain in Spain - 11. SMP


Matthew Hedrick

Senior Analyst


Lowering March GGR forecast to HK$23.5-24 billion.



Macau saw some deceleration this week with daily table revenues (ADTR) slowing to HK$664MM from HK$775MM last week and February’s ADTR of HK$776MM. With less than a week left in March, we are lowering our March forecast to HK$23.5-24BN, up 21% to 23% YoY.  As a reminder, March 2011 was the lowest hold month of year at just 2.66% (adjusting for direct play volume of ~6.6% or HK$4.5BN), so the comparisons are going to get tougher for the rest of the year.  While SCC should grow the market, 2011 also had the opening of Galaxy Macau, so the stimulation from new supply should be similar.  We have seen a YoY deceleration play out throughout the last 3 weeks where YoY went from 51% for the week ending 3/11, to 24% for the week ending 3/18, down to 17% this week.


The slowdown in the numbers was also reflected in lower volumes seen across the main gaming floors, so it’s unclear if all of the deceleration seen this week is simply due to changes in weekly hold rates.  Some have speculated that the slowdown could be partly due to some punters holding off their visits for the opening of Sands Cotai Central which is due to open just a few weeks from now.  However, the slowdown prior to new openings has been a little closer in historically.




In terms of market share, Galaxy was the biggest winner this week while WYNN was the biggest share donor.  We believe that the shift in market share was largely due to good luck at Galaxy and poor hold at Wynn.  MPEL’s weekly share was above its MTD trend, while LVS, MGM and SJM all were below MTD share. 



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