Earnings Week at Hedgeye: Spotlight on Energy


The next two weeks will be busy in the energy sector, with dozens of upstream, midstream, downstream, and oilfield services companies reporting 1Q2012 results, as well as their outlooks for the rest of the year.  The macro backdrop for the quarter is muddled – Brent crude averaged $118.70/bbl in the quarter, +13% YoY and +9% QoQ; NYMEX natural gas averaged $2.50/Mcf, -40% YoY and -28% QoQ; rig count growth slowed in North America to +12% YoY (vs. +19% YoY in 4Q11); and worldwide rig count growth slowed to +9% YoY (vs. +15% YoY in 4Q11).  Our proprietary US E&P inflation index shows that costs for producers were +8.1% YoY in 1Q12, the lowest level of inflation since 4Q10. 


Given those trends, we expect the oil-weighted E&Ps to deliver strong 1Q12 numbers and have positive outlooks on the rest of 2012; that is the only sub-sector we are interested in on the long side at this point.  Our overall view on the energy sector is negative, primarily because we are bearish on global growth and oil prices.  Brent crude has snapped TRADE line support, and we see further downside risk in one of the most-consensus commodity longs.  Should oil prices continue lower, there will be little in the way of macro tailwinds to take the energy sector higher.  That has started to play out with energy (XLE) down 8% over the last month, the worst performing sector in the S&P500.  The XLE is also the only sector that is bearish TRADE and TREND on our quantitative model, with resistance at $70.03 and $72.11, respectively.



Earnings Week at Hedgeye: Spotlight on Energy  - Screen Shot 2012 04 20 at 10.47.39 AM



Below is our outlook for what we think will be the three most interesting sectors to play this earnings season: oil-weighted E&Ps, natural gas-weighted E&Ps, and oilfield services.


Oil-weighted E&Ps:  Oil prices hanging in +$100/bbl coupled with cost pressures finally starting to ease is a recipe for margin expansion for the oil-weighted E&P group.  We expect rigs and equipment to continue to move out of gas plays like the Haynesville, Barnett, and Woodford shales, and into oil/liquids plays like the Eagle Ford, Permian, and Cana; the additional capacity in those plays will lead to lower cost inflation.  In terms of production growth, we expect big 1Q12 numbers and 2012 guidance from the group, particularly from those with production focused in the Eagle Ford and Bakken, where producers are moving from exploration to more efficient development drilling.  A non-consensus way to play this consensus sub-sector long is via SM Energy (SM).


Gas-weighted E&Ps:  NYMEX gas averaged $2.50/Mcf in 1Q12 and is hitting new lows today at $1.90/Mcf; there may not be a dry gas play in North America that is EPS breakeven at the current prices.  While the dry gas E&Ps have gotten beat up recently (KWK and UPL are down 40% YTD), we think that there is more to come, as consensus estimates and current multiples do not reflect even strip pricing.  Look for gas-weighted E&Ps to slash 2012 capex budgets and production guidance, especially those that have little liquids exposure in their production mix – SWN, UPL, and ECA are on the top of that list.


Oilfield Services:  Halliburton (HAL) kicked off the earnings season yesterday with a better-than-awful quarter and outlook, though concluded the conference call with this reply to a question on what could go wrong this year, “I would say the biggest single risk [to hitting forecasted margins] probably is more around ensuring – well, I'd say, not that we can ensure it, but it's more around the continued expected progression of rig count through the balance of the year than any other factor. It looks good right now, but we have been disappointed before by the amount of growth.”  In other words, macro matters more than anything else to HAL (and the OFS industry in general).  We are negative on global growth and oil prices, and think that rig count trends lower over 2012.  While many argue that these names look “cheap,” the most cyclical subsector in energy always looks cheap at the top of a cycle.  Stay away from this group, particularly small cap pressure pumpers and land drillers.



Earnings Week at Hedgeye: Spotlight on Energy  - Screen Shot 2012 04 20 at 10.47.48 AM















THE HBM: MCD, CMG - subsector





MCD: McDonald’s reported 1Q12 EPS of $1.23 versus $1.23 and global same-store sales of 7.3%.  Overall, we thought the quarter was not great but not terrible.  We believe that the market was pricing in a worse quarter than what transpired; during the first quarter of the calendar year, MCD traded down 2% versus the 10% gain that the S&P 500 posted. 


THE HBM: MCD, CMG - mcd us


THE HBM: MCD, CMG - mcd eu


THE HBM: MCD, CMG - mcd apmea


THE HBM: MCD, CMG - mcd ww



CMG: Chipotle reported another great quarter with EPS coming in at $1.97 versus $1.93 with strong top line trends helping the company to gain leverage over its costs.   Same-store sales continue to exceed lofty expectations and the growth profile of the company, with the ShopHouse concept showing good promise.  The same-store sales chart is below.


THE HBM: MCD, CMG - cmg pod 1 white




PNRA: Panera declined on accelerating volume.  The market does not like the COO departure news.


SBUX: Starbucks declined on accelerating volume.







PFCB: P.F. Chang’s declined on accelerating volume.


TXRH: Texas Roadhouse declined on accelerating volume.


THE HBM: MCD, CMG - stocks



Howard Penney

Managing Director


Rory Green




Last week, we expressed our concerns about the casual dining sector’s sales trends in March and early April.  Almost any exposure to the category has returned handsome gains to shareholders over the past six months.  We think taking a little money off the table is a wise move at this point.  Below we run through our thoughts on several names including our (relative) favorite longs and which stocks we see as the best shorts at this time.


There has been a significant amount of volatility in the casual dining space over the past three and six months, in particular.  We will begin by looking at the category’s recent price action together with sentiment, valuation, the macroeconomic outlook and – in the last section of this post – our current view on company-specific factors we see as important for several individual stocks.


Casual Dining


Our Casual Dining Index has appreciated greatly since the equity markets bottomed in October 2011.  The chart below shows how tightly correlated (on an inverse basis) the Casual Dining Index is to Initial Jobless Claims.  If Hedgeye’s call on growth slowing is correct, then a softer employment market could bring a sustained correction in casual dining stocks.  Furthermore, the “Ghost of Lehman” effect on jobless claims that has been boosting headline numbers because of a distortion in the seasonal adjustment factor for much of this year-to-date has dissipated and is set to reverse in a few months.  We wrote about this topic in early March after the Financials team, led by Josh Steiner, first published on it in great detail. 


CASUAL DINING CAUTION - initial claims vs casual dining



In terms of the near-term sales outlook, we would highlight the recently released Blackbox Intelligence data that shows 1Q12 casual dining same-store sales increased +1.7% including a -1.2% move in traffic.  The March numbers were particularly disappointing, coming in at -0.2% and -3.4% for same-store sales and traffic, respectively.


CASUAL DINING CAUTION - casual dining blackbox





Looking at the divergences shown in the table below, we can see that several stocks have seen substantial outperformance versus the broader equity market over the last six months and, given Hedgeye’s view on growth slowing, along with the fact that the industry outlook is deteriorating, it is worth refreshing our thoughts both on casual dining and some individual stocks.  We will focus on PFCB, BWLD, and EAT in our company commentary at the end of the note.  







In terms of valuation, we can see that with the exception of KONA, DIN, and BBRG, consensus has valued the casual dining space significantly higher over the past six months.  BWLD is the standout from the chart below with its EV/EBITDA NTM multiple increasing by almost three turns over the past six months.  PFCB has also seen a large appreciation in its multiple along with RUTH and TXRH.  The contraction of DineEquity’s multiple is notable; a heavily-franchised industry leader should not have traded as poorly as this stock has over the past six months, particularly when a competitor – EAT – has traded so well. 







Sell-side analysts have been cautious on casual dining for some time, remaining so despite the generally strong price action.  Buy-side investors, too, have preferred QSR and Fast Casual as a means to gain exposure to restaurants and this shows in our Casual Dining Sentiment Scorecard, below.  With so much upside apparent, it seems that there could be some risk to adopting an overtly bearish stance at this point; it is possible that the macroeconomic fears currently weighing on sentiment could be dismissed or postponed if employment growth continues to be positive and gas prices fail to impact the American summer driving season as much as many seem to be anticipating.  In that scenario, investors that have been looking to QSR rather than Casual Dining may change course and boost the group higher.  We are not anticipating that as we see restaurant industry data corroborate our macro team’s view that growth is slowing as inflation accelerates, but we believe it is worth highlighting the risks to our current stance.  Being selective on the short side, however, we see several attractive opportunities that we will discuss below.


PFCB and EAT are still the undesirables of the casual dining space and we view that as a positive for the longer-term TAIL story of both of these stocks.  DRI remains the bellwether for the space with investors generally remaining neutral-to-positive on the stock.  


CASUAL DINING CAUTION - casual dining sentiment



P.F. Chang’s


P.F. Chang’s has been a favorite name of ours since February 6th.  In that note, “PFCB – TURNING THE QUEEN MARY”, we wrote: “We’re confident that the current consensuses of $1.61 for 2012 is not reliable in that there are several estimates included in that number of $1.80 where, our guess would be, the analyst responsible has not updated his/her model for a while.”  That turned out to be correct, and the FY12 EPS estimate is now at a much more realistic $1.56.  In that same note, we also said that we would be buyers of PFCB on down days for the ensuing three months.


While we expected the three month period starting February 6thto be positive for PFCB, it is fair to say at this point that the ~14% gain since then has been above our expectations at the time.  At this point, we remain positive on the longer-term TAIL but would not be buyers here. 


From a price perspective, as we mentioned, the 14% gain since we turned positive on February 6thhas exceeded our expectations.  Relative to the S&P 500, the stock has outperformed by ~1100 bps. 





Our style does not anchor heavily on valuation but back in late 2011 when we began considering this name as a possible long, it traded as low as 5.5x EV/EBITDA NTM (consensus).  At that point, we were seeing a business that was clearly in disarray but also a management team that was no longer skirting around the issues.  With a sum of the parts analysis indicating at that point that downside was limited and management’s change in tone, improving macro trends led us to turn positive on the stock in February. Now, the situation has changed.  The stock is valued a turn higher and while steps are clearly in place to fix the business, there is now some downside risk and less likelihood, in our view, of incremental positive news over the next three months or so. 


CASUAL DINING CAUTION - pfcb evebitda hist



For P.F. Chang’s, like most casual dining concepts, employment growth is an important driver of its business.  Excluding the impact of self-inflicted wounds, the realization of which led investors to exit the stock en masse for the first nine months of 2011, this stock has largely followed inverted rolling claims, as the chart below shows.   The correlation over the duration of the chart below is weak but, as the investment community gained clarity on the company’s plan going forward, the stock traded more in line with the space.  From October to present, the correlation between the two data sets shown in the chart below is -0.87 (the scale on the left axis is inverted) and has been getting progressively tighter.   


CASUAL DINING CAUTION - claims vs pfcb



In short, we believe that the dislocation that existed between P.F. Chang’s and the rest of the casual dining space has largely been corrected.  From a sentiment perspective, there is more fuel in the tank; the sell-side remains bearish on the name and short interest, although has varied between 36% and 19% over the last three years, is currently at the low end of that range. 


Going forward, how the stock trades from here is largely dependent on the impact of the new lunch initiative at the Bistro together with the overall macro environment (typified by initial claims).  P.F. Chang’s reminds us in many ways of Brinker in mid-2010.  Obviously Brinker’s subsequent resurgence depended on market conditions, several other well-executed initiatives, and other company-specific factors.  We will continue to frame our view of P.F. Chang’s in the same way.



Buffalo Wild Wings


Buffalo Wild Wings is our favorite short in the casual dining space.  The top line is what hurt us, and other investors and analysts with a bearish stance on the stock, when the company announced 4Q results earlier this year.  The first six weeks of the year were strong for the company; same-restaurant sales came in at 12.9% and this data point overshadowed the fact that the fourth quarter of 2011 saw operating margins contract despite much higher than expected sales growth and benign commodity inflation. 


At this point, investors know that the top line numbers for 1Q will be strong for Buffalo Wild Wings.  Wingstop, a company that we believe offers a good proxy for Buffalo Wild Wings’ from a same-restaurant sales perspective, reported 1Q12 comps of 10.5%.  If BWLD’s comps come in where we expect them to, also at 10.5%, that would imply a sequential slowing of comps through 1Q. 





What will really move the stock, however, will be the forward-looking commentary that management provides.  How much weather was in the 1Q comps?  How much will traditional wing price inflation impact 2Q, 3Q, and FY12 EPS versus prior guidance?  From the second chart, below, it seems that constrained chicken supplies could persist for some time.  This risk-reward is highly skewed to the downside, here, in our view.  From a price perspective, BWLD has outperformed the S&P 500 by almost 30% over the last three months.  Additionally, the EV/EBITDA multiple that consensus is awarding the stock has increased by two turns.  With the headwinds facing the industry and BWLD specifically, we believe that this stock could fall to $75 or lower.


CASUAL DINING CAUTION - chicken wings1 


CASUAL DINING CAUTION - egg sets wing prices 




Brinker has been one of our favorite names in casual dining for the last eighteen months.  As the chart below indicates, the employment picture is extremely important for the company.  As we wrote earlier, our view on P.F. Chang’s is similar to that which we had on Brinker back in 2010.  Now that the stock has ran up this high, the obvious question becomes whether or not it is time to take some money off the table.  Depending on duration, we think it could be the right move. 


Over the longer term TAIL, three years or less, we believe that this company is doing the right things to take share.  The primary competitor of Chili’s is Applebees and that is a company that we believe is facing some top line headwinds over the next year in addition to any that may be facing the industry.  Chili’s should continue to take share and reap the rewards of its upgraded kitchen and asset base.


Over the Trade and Trend durations, which are three weeks or less and three months or more, respectively, we have reservations about buying the stock at this price.  Coming into the quarter, we are concerned that traffic may not be strong enough to indicate that the company is on track to meet FY12 comparable restaurant sales guidance.  Following the company reporting 2QFY12 earnings, the stock sold off on concerns that top-line trends were suggesting that the company may not hit comparable restaurant sales targets for the full year.  While the stock has more than recovered from those concerns, we believe that the recent industry trends are likely to revive investor anxiety as the next catalyst, 3QFY12 EPS on 4/27.


In terms of the Trend duration, there are two factors giving us pause.  Firstly, the macroeconomic outlook has been softening.  The improvement in initial claims data has reversed: claims are now rising.  Secondly, we need to find evidence that Chili’s is seeing positive traffic as it laps the impact of the lunch combo introduced on January 10th, 2011.  Weather may distort that picture, but we expect the Street to press management for comments on the 4QFY12 trends-to-date. 


Macro has been a significant factor for Brinker’s strong performance.  The correlation between claims and EAT has been 0.95 since the equity markets bottomed in October.   Given our outlook on the macro environment, industry trends, and hesitance on the company’s traffic being positive at this point, we have change with the facts.





Howard Penney

Managing Director


Rory Green





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CHART OF THE DAY: The Best and Worst of Times


CHART OF THE DAY: The Best and Worst of Times - Chart of the Day

The Best and Worst of Times

“It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness, it was the epoch of belief, it was the epoch of incredulity, it was the season of Light, it was the season of Darkness, it was the spring of hope, it was the winter of despair, we had everything before us, we had nothing before us, we were all going direct to heaven, we were all going direct the other way - in short, the period was so far like the present period, that some of its noisiest authorities insisted on its being received, for good or for evil, in the superlative degree of comparison only.”

-Charles Dickens


First of all, sorry for the long quote this morning.  I’m sure after reading some of my more eclectic quotes and missives this week, you are all awaiting Keith’s return with bated breath.  But as I was contemplating the stock market this week and the earnings results that were released, somehow Dickens’ quote from “A Tale of Two Cities” seemed appropriate.


The SP500 opened Monday up near 1,380 and closed yesterday at near 1,378.  So despite the sizeable swings mid-week, the broad equity market has done nothing all week.  It seems Mr. Market, just like the Dickens’ quote, can’t decide:  Is growth slowing? Or is growth accelerating? Is Europe out of the woods? Or is sovereign risk accelerating in Europe?  Is China going to ease more? Or is inflation more of risk than growth in China?


We’ve been somewhat definitive on our views that we believe global growth is slowing sequentially, but the market hasn’t totally come around to accept the Hedgeye views just as of yet.  (I guess we will have to get Keith on CNBC more next week to preach the gospel.)  On the growth front, an interesting data point we recently picked up was that traffic through the Suez Canal was only up 1.2% for the month of February year-over-year basis and has been in steady decline for really the last year.  In the Chart of the Day, we show this trend and have combined it with a couple pictures of Hedgeye friend and former NHLer Jeff Hamilton.  As the pictures show, life as a pro hockey player is sometimes good and sometimes bad as well.


Obviously this is but one data point, but this is literally the worst month of traffic through the Suez Canal since the end of the most recent global recession.  As well, the Suez is far from an insignificant indicator.  It is estimated that in total almost 8% of the world’s sea trade is transported through the Suez Canal.  So, this is a data point worth writing in the notebook.


Just as with the continued angst over the direction of global growth, there remains debate over the direction of Europe from a debt perspective.  Some, like Bank of America, are ready to call a bottom in Europeans debt woes as indicated by B of A’s positive call on European Banks this morning.   The actual sovereign market itself, as manipulated as it is, begs to differ though, as Spanish yields on 10-year government bonds are back above 6.0% this morning.


My brothers up in Canada are even getting into the European mix this morning.  Canadian Finance Minister Jim Flaherty came out publically yesterday to propose that non-European nations should have a collective veto when European nations come to the IMF to ask for aid.  Obviously, Flaherty sees what we see, which is that the likelihood of a Socialist getting elected in France means that “the ask” from Europe could soon get a lot bigger.


As well, you can’t really blame Canada (pun intended) for pushing back on continued carte blanche aid to Europe.  In 1993, Canada’s fiscal house was in terrible order and Standard & Poor’s rightfully downgraded Canada debt.  The Canadians then righted the fiscal ship the hard way by implementing a consumption tax and making tough budget cuts, by some estimates almost 20% across the board.  As Canadian Finance Minister Paul Martin said at the time, “Let there be no doubt about that. We will balance the books.”  There are some other nations that could use some of that Canadian fiscal resolve.  (Incidentally, we like the Loonie on the long side over the long term in part due to this.)


As usual during earnings season, we are going to have a note up on our website later today that discusses our view of the broad energy sector this earnings season.  One quote from the note is worth sharing this morning, which is as follows:


“The macro backdrop for the quarter is muddled – Brent crude averaged $118.70/bbl in the quarter, +13% YoY and +9% QoQ; NYMEX natural gas averaged $2.50/Mcf, -40% YoY and -28% QoQ; rig count growth slowed in North America to +12% YoY (vs. +19% YoY in 4Q11); and worldwide rig count growth slowed to +9% YoY (vs. +15% YoY in 4Q11).  Our proprietary US oil and gas inflation index shows that costs for producers were +8.1% YoY in 1Q12, the lowest level of inflation since 4Q10.”


To say that the energy pictures is currently muddled is definitely the Hedgeye understatement of the week, but the key fact I would point out is that natural gas is down 40% y-o-y and oil is up 13% y-o-y.  Thematically, those companies that use natural gas as an input, like certain industrial and chemical companies, are receiving the input cost boon of a life time. 

Meanwhile, any company that competes with the price of gasoline for the consumer’s wallet is certainly feeling the pinch.


The immediate-term support and resistance ranges for Gold, Oil (Brent), US Dollar Index, Japanese Yen (vs USD), Euro/USD, and the SP500 are now $1, $116.71-119.34, $79.25-79.65, $81.12-82.67, $1.30-1.32, and 1, respectively.


Enjoy the weekend with your families,


Daryl G. Jones

Director of Research


The Best and Worst of Times - Chart of the Day


The Best and Worst of Times - Virtual Portfolio