The Economic Data calendar for the week of the 4th of June through the 8th is full of critical releases and events. Attached below is a snapshot of some (though far from all) of the headline numbers that we will be focused on.
This turnaround story has been in place since mid-2010. We got behind it then and, while it has not worked in a straight line, the stock has generally worked well as the company has taken share from Bar & Grill competitors. The Brinker story does not end there.
From the outset of this turnaround, Brinker has repeatedly invoked the McDonald’s “Plan to Win” of 2003/2004. The question is whether or not Chili’s can enjoy as lengthy a period of success as McDonald’s has enjoyed for much of the past decade. Over that period, McDonald’s has dominated its main rivals, Wendy’s and Burger King, on nearly every metric. Even today, both chains are still struggling to keep pace with the finely tuned machine in Oakbrook.
STRAIGHT UP THE MIDDLE
Two years into the turnaround, there are a number of similarities we can point to between the Brinker turnaround and the one that McDonald’s engineered almost a decade ago. We see an opportunity for Brinker to take significant market share over the next five years, expanding its competitive horizons beyond the Bar & Grill category and its traditional competitors like Applebee’s and Ruby Tuesday.
The Bar & Grill category is on its last legs. Historically, Chili’s was a hamburger concept that morphed into a Bar & Grill concept as it developed into a national chain. Over the past ten years, the Bar & Grill space has become hyper-competitive with many of its constituent companies pushing to expand their menus to gain share. Strained balance sheets, thinned out management teams and the sea change in consumer behavior that came about as a result of the Great Recession have hampered companies’ ability to do so, however.
Despite this, the financial crisis was in some ways positive for Brinker only in that it compounded prior errors on the part of management to the extent that, for the sake of its survival, the company had no choice but to attack every aspect of its operations to endure. When Doug Brooks announced his company’s version of the Plan to Win, Chili’s had posted its sixth consecutive quarter of negative same-store sales. Central to management’s survival strategy was attacking the middle of the P&L – food and labor costs – and the company has seen plenty of success, thus far, following that strategy.
Having sold off non-core assets and now with Chili’s posting its fourth consecutive quarter of positive same-store sales, the future looks bright for Brinker as the benefits of its revitalization plan are beginning to show up in the numbers. While we see Chili’s as a brand that is strengthening, Applebee’s is a company in a deleveraging process that is also somewhat restricted by its heavily franchised business model in that emulating the advancements Chili’s has made would be difficult if not impossible to bring about in an expeditious manner. Ruby Tuesday’s is clearly a brand in decline. Likewise, when McDonald’s began its turnaround, its competitors were also struggling; Wendy’s was dealing with activist investors and several CEO’s while Burger King was being starved of capital by multiple owners. This allowed McDonald’s to take a measured approach to establishing itself as the best in its segment and then expand the scope of its business to take share from others within the restaurant space. We see Brinker as being in the process of executing a similar strategy within casual dining. The company is entering phase two, which is moving management to measure itself against a new group of competitors.
A HIGHER STANDARD
Chili’s is, in our view, leaving its traditional competitors behind. Ruby Tuesday is a struggling concept and Applebee’s is lagging Chili’s in terms of technology. One quote from management that spoke to this point came on 4/23/12 when CEO Doug Brooks, said, “we have made a lot of changes at Chili’s and one of the most significant changes we’ve made is how we look at ourselves. We’re holding ourselves up to what we call benchmark competitors in the industry today”.
The investment Brinker is making in its Chili’s store base is ongoing and, in speaking with store managers we know that the benefits are far reaching in terms of customer satisfaction and food and labor efficiency. The full benefit of this turnaround will not be evident until 2013 when the entire Chili’s system has been retro-fitted with the “Kitchen of the Future” format. McDonald’s transitioning from batch cooking to a continuous cooking process in 2004 was a similarly important milestone for that company’s turnaround, enabling it to better serve its customers while also helping the stores to operate more efficiently.
Chili’s is nearing completion of a strategy that Darden and other casual dining companies would possibly do well to replicate; it has stopped growing and has focused on maximizing the profitability of its existing assets. Comparing itself to the likes of BJRI, BWLD, PNRA and other concepts will only serve to maintain management’s current focus.
As we near the end of the kitchen remodel program, we expect a ramp up in new product platforms being introduced to the Chili’s customer. We also anticipate significant implications for the company’s top line momentum as a result. The question is whether or not Chili’s can go on a three- or four-year run of positive same-store sales. We think it can.
While McDonald’s and Brinker operate in different segments of the restaurant industry, their respective turnarounds are similar in that they have centered on attacking the middle of the P&L. With margins approaching 20%, if Chili’s can produce a string of positive same-store sales results, the flow through to the bottom line will be substantial.
NEW PLATFORMS BRING NEW COMPETITORS
Chili’s offering steak obviously pits the company against the likes of Texas Roadhouse and Outback Steakhouse. Technological improvements in the Chili’s kitchen have allowed the company to add platforms, like steak, to its menu without adding undue labor to the P&L. For example, the Impinger oven, which we have seen in action in several Chili’s stores, allows the company to easily produce flat bread and pizza. We believe that this places BJRI, another new competitor, in Chili’s cross hairs.
In conclusion, we believe that Chili’s has been executing its turnaround extremely well given the economic circumstances it faces. One stark dissimilarity between the McDonald’s turnaround and Brinker’s is that the economic backdrop today is a world apart from what it was in 2004. Our view of the casual dining category is sensitive to the macroeconomic outlook, particularly employment, but for any investors looking to increase exposure to casual dining, we believe that EAT will outperform over the longer term.
Personal income ticks down materially in conjunction with a weak jobs report. But personal consumption does not. Instead, the personal savings rate (down 40bps to 3.4% -- the lowest rate since 8/08) acted as a buffer and allowed Americans to execute on its most consistent behavioral pattern – spend regardless of changes in the day to day Macro climate. This story does not have a pretty ending.
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The irony with VRA is that positives actually outweighed the negatives with this print – albeit modestly – and the stock is still down 10%. Apparently short interest as a percent of float at 47% was not a factor. Our long-term (which is evolving into intermediate term -- i.e. reality) concerns remain 100% in tact, and there was little in the quarter that we heard to change that. Consider the following:
On the plus side…
On the negative side…
We’re not sure if this is a positive or negative, but in an effort to drive demand, the company is starting to enter categories that it thinks make substantially more sense than its foray into rolling luggage – an incremental positive if it can pull it off. While VRA now offers cell phone covers, the more notable addition is its bigger bet in the baby category with an expanded line of bags, throws and comforters to be launched next year. This is a positive change on the margin and could help reinvigorate demand, BUT we’re still a year out from when this product will hit shelves and VRA is not helping scarcity value by accelerating door growth in the meantime. The ultimate key will be to spend the right dollars in the right places, and take on the right licensing partners under the right terms.
All in, we’re shaking out at $0.35 for Q2 and $1.65 and $1.67 in EPS for F13 and F14 respectively 17% below the Street next year (F14). While the company is beginning to expand into categories that make more sense for the brand (i.e. baby), internationally into Japan, and further in the department store channel, we think these efforts are not enough to offset the declining core wholesale business as it becomes cannibalized by VRA’s own retail stores. We think that the best way to ensure success will be to spend behind it, and we’re not convinced that this is happening. Our model has SG&A and capex climbing in 2H and 2013.
What Drove the Beat?
Top-line sales came in modestly better than expected driven primarily by new store growth and e-commerce coupled with deferred spending resulting in the $0.02 EPS beat of $0.31 vs. $0.29E and our $0.27 estimate.
Outlook: In order to properly measure performance relative to original expectations, we look at management’s Q1 results relative to management guidance as well as any updates to previously provided full year 2013 outlook:
Highlights from the Call:
Continue to be optimistic re long term opportunity in Japan
Gross Margin 55.7% in line with LY
SG&A: deleveraged by 80bps due to F12 infrastructure investments made last year and a shift of marketing spend that will take place in Q2 of this year
Indirect revenue growth of LSD as VRA addresses issues of carry over inventory
GM in line with prior year as they work through remainder of high cost cotton
Other income $1.5mm
Share count 40.5mm
3Q indirect sales growth expected to be LSD-MSD
Expected to open 19 stores
Capital spending remains at ~36mm
Back to College Strategy:
Direct Operating Margins:
Monthly Comp Cadence:
Von Maur – New Dept. Store Distribution:
Carry Over Patterns:
New Store Productivity
Mother Day Performance in Direct Stores:
Third Quarter sales Decline
Rolling Luggage category:
DC under Construction
CONCLUSION: As we advance through the presidential debate and nearer to the NOV general election, the dismal state of the US labor market will likely become an increasingly positive catalyst for the USD as a result of it being a negative catalyst for the incumbent and his Weak Dollar political agenda. Incremental easing out of the Fed remains a risk to our Strong Dollar thesis, though not one we see materializing in the immediate term.
As we wrote in the APR edition of this series:
“As it relates to our intermediate-term outlook for US growth, there isn’t much analysis we can add to this morning’s Jobs Report beyond what has been signaled via the red on your screens today. In short, we continue to anticipate slowing economic growth domestically over the intermediate term.”
To echo Keith’s comments on our Daily Morning Macro Call (email if you don’t yet have access) a +69k MoM gain in US Nonfarm Payrolls (SA) is an “absolute disaster”. Perhaps the greater disaster was the consensus expectation of a +150k gain. Global growth data and various market-based indicators have been slowing/sounding the alarm bells for literally three full months. The US is not decoupling. Refer to our APR 13 2Q12 Key Macro Themes presentation for a refresher on our thoughts here.
To access the replay podcast and the presentation materials, please copy/paste the following two links into the URL of your browser:
As an aside, we find it critically important in an election year to dig into the employment statistics in order to handicap the presidential election odds – particularly given the potential for a political sea change and its impact on the USD, which remains paramount as a leading indicator in our model for helping our clients stay ahead of major asset price inflations/deflations globally.
The USD currently is in a Bullish Formation. To us, that is signaling some combination of a few key factors:
As it relates to point #1, it is our view that the Bernank is handcuffed in the immediate term due to the political risk associated with pursuing an asset price inflation just ahead of or during the general election debate. A necessary ingredient of further monetary easing is likely fear mongering. Will Obama support such dire messaging on the campaign trail? That’s an important question to debate at the current juncture, but in reality Obama probably needs to spin the economy as positively as possible.
In addition to this political headwind, the Fed’s own measure of inflation expectations remain fairly elevated relative to the last occurrences of QE; suggesting to us that there is more downside to come in asset prices before they can justify acting. Even still, as Keith pointed out on our morning call this AM, the Federal Reserve defying reasonable expectations and jumping the gun with more “stimulus” is not an improbable scenario. Key upcoming catalysts on this front include: JUN 5 – Chuck Evans speaks to money marketeers in NYC; JUN 7 – Bernanke testifies to Congress on the US economic outlook; and JUN 20 – FOMC Rate Decision.
To point #2, we’re already seeing this show up in the data. On our own proprietary index, Obama’s odds of securing a reelection victory in NOV have fallen -720bps from their MAR 26 peak to 54.8%. This is coincident with Romney’s presidential odds on Intrade making higher-lows. Slides 38-42 of the aforementioned slide deck walk through the implications of this phenomenon in greater detail.
To point #3, not much else needs to be added beyond Keith and Matt Hedrick’s consistent coverage of the ongoing crisis within the European Monetary Union. Rumors be what they may, but our research is are hard pressed to see the GOP signing off on providing the IMF with both consent and sufficient funding to bail out Spain – or any other country or financial institution for that matter. As recently as last month, Speaker Boehner (R-OH) was on CNBC firmly staking the Republican opposition to further bailouts, bazookas, etc. Furthermore, if Spain were going to be “saved” in the immediate term, you’d likely see it show up in various market based leading indicators, which, as of now, is not the case.
As we advance through the presidential debate and nearer to the NOV general election, the dismal state of the US labor market will likely become an increasingly positive catalyst for the USD as a result of it being a negative catalyst for the incumbent and his Weak Dollar political agenda. Incremental easing out of the Fed remains a risk to our Strong Dollar thesis, though not one we see materializing in the immediate term.
Jumping back to the MAY Jobs Report, in order to net out the effect of the now-infamous NSA Birth/Death Adjustment, we subtract the NSA B/D Adjustment from the NSA MoM NFP number and then take the YoY delta from that. On this metric, MAY registered a sequential acceleration from APR’s awful print:
Looking at the Unemployment Rate SA, the headline number ticked up to 8.2%. By our math, which accounts for dramatic shifts in the size of the Labor Force by using a 10yr average Labor Force Participation Rate (just above a 30yr low of 63.8% in MAY), the MAY Hedgeye-Adjusted Unemployment Rate came in at 11.0%, which ticked down sequentially from last month’s 11.3% reading:
The following four charts compare two Strong Dollar presidents vs. two Weak Dollar presidents in the context of reelection cycles. With the exception of the BLS headline number, President Obama’s employment scorecard improved, very marginally, MoM. That being said, the broader trend in each of our three metrics – which we feel is the “true” state of the US labor market – continues to track painfully in the wrong direction for the incumbent.
Lastly, the following table highlights the nominal and percentage amount of job creation that has occurred in the US economy under each president’s watch through an equivalent point in their respective terms. Through his 40thfull month in office, Obama has grown US employment by +0.1%. This is only lagged by Bush’s -0.9% growth through his 40th month in office.
Have a great weekend,
POSITIONS: Long Utilities (XLU), Short Industrials (XLI)
I think it’s safe to say that consensus now agrees with Hedgeye on Growth Slowing. Now we have to deal with cleaning up their mess. Alongside immediate-term capitulation, we’re finally seeing a Short Covering Opportunity.
Across our core risk management durations, here are the lines that matter to me most:
In other words, we’re right there – right on the TAIL line. And I am making my call to start covering your shorts. Our gross long exposure to this market remains very low.
Keith R. McCullough
Chief Executive Officer
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