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THE HEDGEYE DAILY OUTLOOK

TODAY’S S&P 500 SET-UP – June 25, 2012


As we look at today’s set up for the S&P 500, the range is 17 points or -1.27% downside to 1318 and 0.00% upside to 1335. 

                                            

SECTOR AND GLOBAL PERFORMANCE

 

THE HEDGEYE DAILY OUTLOOK - 1

 

THE HEDGEYE DAILY OUTLOOK - 2

 

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EQUITY SENTIMENT:

  • ADVANCE/DECLINE LINE: on 6/22 NYSE 1140
    • Up from the prior day’s trading of -1901
  • VOLUME: on 6/22 NYSE 1577.41
    • Increase versus prior day’s trading of 82.18%
  • VIX:  as of 6/22 was at 18.11
    • Decrease versus most recent day’s trading of -9.81%
    • Year-to-date decrease of -22.61%
  • SPX PUT/CALL RATIO: as of 6/22 closed at 1.65
    • Down from the day prior at 1.81 

CREDIT/ECONOMIC MARKET LOOK:

  • TED SPREAD: as of this morning 38
  • 3-MONTH T-BILL YIELD: as of this morning 0.08%
  • 10-Year: as of this morning 1.62
    • Decrease from prior day’s trading at 1.67
  • YIELD CURVE: as of this morning 1.33
    • Down from prior day’s trading at 1.37 

MACRO DATA POINTS (Bloomberg Estimates):

  • 8:30am: Chicago Fed Nat Activity Index, May (prior 0.11)
  • 10am: New Home Sales, May, est. 345k (prior 343k)
  • 10:30am: Dallas Fed Manf. Activity, June (prior -5.1)
  • 11am: Fed to sell $8-8.75b notes in 3/15/2014-10/31/2014 range
  • 11:30am: Treasury to sell $30m 3-mo. bills, $27m 6-mo.
  • 4pm: USDA crop progress report 

GOVERNMENT:

    • Washington Week Ahead: Supreme Court may rule on health law
    • Supreme Court may rule on challenge to health-care law
    • House, Senate in session
    • Senate to take up long-term flood insurance reauthorization
    • Heather Zichal, White House energy and climate adviser, speaks on hydraulic fracturing at New Policy Institute, 12pm
    • Export-Import Bank President Fred Hochberg speaks at Center for American Progress, 12pm
    • Treasury Undersecretary for International Affairs Lael Brainard  speaks at Women’s Foreign Policy Group discussion on “International Financial Diplomacy,” 1pm
    • George Walz, VP at Financial Industry Regulatory Authority’s Office of Risk, joins panel discussion on “FINRA Examination Data Collection Process,” 1:30pm
    • HHS, CMS advisory panel meets on Medicare Economic Index price, productivity measurements, 8:30am
    • WTO dispute settlement body meets in Geneva
    • International Trade Commission to say whether it will review findings by 2 of its judges that MSFT, AAPL infringed Motorola Mobility patents
    • Governmental Accounting Standards Board meets in Conn. to vote on state, local pension-reporting rules that would reduce funded levels of plans  

WHAT TO WATCH:  

  • AB Inbev said to near Modelo takeover for more than $12b
  • Supreme Court announces decisions; may rule on challenge to health-care law: preview
  • ITC to say whether it will review findings that MSFT, AAPL infringed Motorola Mobility patents
  • Fitch downgrades Republic of Cyprus to junk
  • European leaders prepare for summit on currency union
  • Tropical Storm Debby may spare Gulf of Mexico oilfields
  • Russell Indexes to post final membership lists for indexes
  • Shire falls after FDA unexpectedly approved a generic version of its hyperactivity medicine Adderall
  • Pixar’s “Brave” opens at No. 1 in U.S./Canada theaters with $66.7m for parent Walt Disney
  • JPMorgan to let CIO make potentially risky investments: WSJ
  • Sales of new homes probably rose in May for 2nd month to 346k annual rate, according to median forecast by Bloomberg News
  • New York settled a lawsuit for $410m with J. Ezra Merkin over claims that Merkin funds secretly placed client money with Bernard L. Madoff
  • Banks need “healthy push” to avoid prolonging crisis: BIS
  • Vivendi, whose mgmt met during the weekend to discuss strategy, said it had nothing to update investors with
  • Bain said to pay $1b for 50% stake in Japanese TV company
  • India plans measures to support rupee, spurring inflation
  • No IPOs expected to price today: Bloomberg data
  • Weekly Industry Agendas: Finance, Media/Entertainment, Industrials, Energy, Real Estate, Consumer, Health, Transports, Technology, IPOs, Canada Oil & Gas, Canada Mining
  • U.S. Health Care, EU Summit, Google: Week Ahead June 23-30 

EARNINGS:

    • HB Fuller (FUL) After-mkt, $0.55
    • Synnex (SNX) 4:01pm, $0.90
    • Apollo Group (APOL) 4:05pm, $0.97  

COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG 

  • Bulls Proven Wrong as Prices Slump Into Bear Market: Commodities
  • Gold Set to Decline in London as Stronger Dollar Curbs Demand
  • Oil Trades Below $80 for a Third Day Amid European Debt Concern
  • Grains Climb as Dry Weather Wilts U.S. Crops, Threatening Supply
  • Copper Seen Advancing for First Day in Four Before EU Meeting
  • Sugar Rebounds on Speculation Prices Fell Too Far; Coffee Slides
  • Fonterra Farmers Approve Plan to Open Exporter to Equity Markets
  • Morgan Stanley Expects Corn, Soybean Prices to Advance on Supply
  • Hong Kong’s LME Deal Spurs Industry’s Steepest Slump: Real M&A
  • Coal Plant Plunge Threatens Billions in Pollution Spend: Energy
  • Hedge Funds Turning Bearish Push Oil Below $80: Energy Markets
  • Florida Orange Trees Threatened on Tropical Storm Debby Floods
  • Oil to End Commodity Currencies’ Divergence: Chart of the Day
  • China Faces Summer Steel Output Cut on Prices: Chart of the Day
  • Silver Seen Extending Drop as Support Breaks: Technical Analysis

THE HEDGEYE DAILY OUTLOOK - 4

 

 

CURRENCIES

 

THE HEDGEYE DAILY OUTLOOK - 5

 

 

EUROPEAN MARKETS


RUSSIA – get the Dollar and the Petro price right, and you get the Petro-Dollar equities right – this is obvious in Russian stocks (next to Egypt’s -9% drop last wk, the RTSI led losers at -5% and has now eclipsed Spain on my drawdown sheet for 2012 at -27% from YTD top vs Spain and Italy at -24% and -22%).

 

THE HEDGEYE DAILY OUTLOOK - 3

 

 

ASIAN MARKETS


CHINA  – Shanghai Composite starting to lead losers in Global Equities as #GrowthSlowing accelerates on the downside (down another -1.6% overnight; down -9.2% since beginning of May) – we highly doubt Bernanke or Geithner have a central plan for China, but you never know…

 

INDIA – Keynesian economic disasters tend to end with currency debauchery, then local crisis – India’s Rupee is in the middle of one of those and it’s a huge problem domestically as inflation is priced in local FX; but do not worry, India is now saying they are unveiling a “dozen steps to save the Rupee” – almost like a Tony Robbins thing I guess…

 

THE HEDGEYE DAILY OUTLOOK - 7

 

 

MIDDLE EAST


THE HEDGEYE DAILY OUTLOOK - 8

 

 

The Hedgeye Macro Team



Who Knows?

“Who knows, maybe they are much better off the way they are.”

-Mitchell Zuckoff

 

That’s a quote that I underlined this weekend in an unbelievably true WWII story of disaster, discovery, and survival – Lost In Shangri-La, by a professor of Journalism at Boston University, Mitchell Zuckoff.

 

Since last Thursday I’ve been lost in my own cash position. It’s weird, people keep asking me when and where I am going to put some cash to work. Who Knows? I’m in no hurry. All I can tell you is that I am getting longer of books, in US Dollars.

 

If you can tell me, precisely, how this all ends (other than not well), I’ll have to risk manage the timing of your view. These markets are as volatile and reactionary as the central planners who are attempting to “smooth” them.

 

Back to The Global Macro Grind

 

I have no idea what risk management moves I am going to make each and every day. I wake-up in the morning, put one shoe on at a time, then grind through the process. Embracing the uncertainty of what Mr. Market is going to signal is what I do.

 

Last week’s uncertainty was solely concentrated on 1 central planning event – Ben Bernanke’s presser. After he didn’t deliver the drugs, the Dollar went straight back up – and everything big beta priced in US Dollars went straight back down.

 

Here’s how that looked week-over-week:

  1. US Dollar Index = +0.77% (up for the 1st week in 3)
  2. SP500 = down -0.5% (down for the 1st week in 3)
  3. CRB Commodities Index = down -1.8%
  4. WTIC Oil = down -5.2% (crashing, down -27% since February)
  5. Gold = down -3.9% (testing down for 2012 YTD)
  6. Russian stocks (RTSI) = -5.1%

Russian stocks? Yep. Russian stocks have been crashing alongside the price of The Petro since March. That’s why we call Russia a Petro-Dollar tape. Get the Petro and the Dollar right, and you’ll get Russian stocks right.

 

Whatever happened to the bull case for “de-coupling”? Is Oil going down because of the Dollar or Demand? They’ve changed their bullish thesis so many times already in 2012 that it’s getting hard to keep track.

 

Who Knows?

 

What I do know is that people who didn’t pay attention to the Correlation Risk in this market are Lost In Q2. Where do we go from here? Do we beg, print, and bail some more? Maybe doing more of the same will work this time? Maybe ‘this time is different.’

 

Right. And Ben Bernanke is going to bailout China this morning too.

 

Chinese stocks have been leading decliners for the last few weeks as Chinese #GrowthSlowing appears to be accelerating on the downside. Last night the Shanghai Composite Index was down another -1.6%. It’s been down -9.2% since the beginning of May.

 

At the beginning of May, there was plenty of opportunity to get out of stocks and commodities. But that’s not how consensus rolls. Instead, those addicted to the Qe drugs keep going back to the same old well of hope.

 

Look at last week’s CFTC Commodities speculation data (ahead of the Fed decision):

  1. Net long contracts on the Commodities basket were up +7% wk-over-wk to 628,540 contracts
  2. Agriculture bets ripped a +13% wk-over-wk move
  3. Gold saw a net long ramp of +5% wk-over-wk to the highest net long (notional) position since May 1st

Go back to May 1st and tell me how buying Gold around $1660 played out. Or go back to the beginning of last week, when these net long contracts perked back up, and tell me how not selling into the expectation of a Bernanke Bailout bounce to $1628 paid.

 

It’s all the same trade, over and over, and over again. With the difference being that this time Ben S. Bernanke’s Fed is out of bullets. Could he poke his head back into our lives in the coming days, weeks, or months? Who Knows. All I can do is proactively prepare for what I can see in front of me and, at the same time, have Mr. Market signal to me whatever else I might be missing.

 

In the US, I’m not missing this week’s Macro Catalyst Calendar:

  1. Monday: US New Home Sales “expected” to be a lofty 346,000 (an acceleration from April’s high, Who Knows?)
  2. Tuesday: US Consumer Confidence (June) “expected” to rise to 63.5 vs 61.9 in May? (Who Knows?)
  3. Wednesday: US Durable Goods (May) “expected” to rise +0.5% vs May (doubt that, but Who Knows?)
  4. Thursday: Will US GDP for Q1 be revised lower than 1.9%? Will Jobless Claims eclipse last week’s high for 2012?
  5. Friday: US PMI for June “expected” to be in-line with May’s 52.7, Who Knows?

All the while, of course, we’ll have the Eurocrats saving the world by piling more debt-upon-debt (EU Summit June 27-28th). Even though the German Parliament needs to ratify anything ESM after the EU Summit (June 29th); and even though the Italians are publically patronizing the Germans ahead of that vote; Who Knows?

 

All I know is that I don’t know until I know. And that’s why, for now, I’m largely in Cash.

 

My immediate-term support and resistance ranges for Gold, Oil (Brent), US Dollar, EUR/USD, German DAX, and SP500 are now $1, $89.06-94.79, $81.95-82.62, $1.24-1.26, 6075-6235, and 1, respectively.

 

Best of luck out there this week,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Who Knows? - ChartoftheDay

 

Who Knows? - vp 6 25


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MONDAY MORNING RISK MONITOR: RISK COOLING OFF FOR NOW

Key Takeaways

 

* US/European bank swaps were broadly tighter last week on the heels of favorable Greek elections and Moody's downgrades being less bad than feared. We'd remind investors that (a) even if Greek austerity terms are eased, the rate of contraction in the Greek economy will make compliance nearly impossible, setting the stage for another showdown, and (b) Moody's downgrades have costs. While we saw lots of commentary about funding costs not being affected by the downgrades, the more salient takeaway is that institutions that moved to triple-B should see derivatives flow move away, on the margin.   

 

* Risk took a breather last week as large declines in high yield, MCDX and higher leveraged loan prices were indications that the temporary calm in Europe was enough for a broad-based rally. Interestingly, the one measure you'd have expected to contract actually expanded: Euribor-OIS.

 

* The 2-10 spread widened modestly WoW. We expect this increase to be short-lived as the the Fed extended Operation Twist on Wednesday, which will put downward pressure on the long-end of the curve. 

 

* Looking at the week ahead, the setup in the XLF in the short term is roughly even, with 2% upside to $14.62 and 2.5% downside to $13.98. 

 

Financial Risk Monitor Summary  

• Short-term(WoW): Positive / 5 of 12 improved / 0 out of 12 worsened / 8 of 12 unchanged  

• Intermediate-term(WoW): Neutral / 3 of 12 improved / 3 out of 12 worsened / 7 of 12 unchanged  

• Long-term(WoW): Positive / 5 of 12 improved / 2 out of 12 worsened / 6 of 12 unchanged

 

MONDAY MORNING RISK MONITOR: RISK COOLING OFF FOR NOW - Summary

 

1. US Financials CDS Monitor – Swaps tightened for 26 of 27 major domestic financial company reference entities last week.   

Tightened the most WoW: JPM, WFC, RDN

Tightened the least/ widened the most WoW: UNM, TRV, AON

Tightened the most MoM: GS, MS, RDN

Widened the most MoM: LNC, UNM, MMC

 

MONDAY MORNING RISK MONITOR: RISK COOLING OFF FOR NOW - American CDS

 

2. European Financial CDS - 31 of the 39 European financial reference entities we track saw spreads tighten last week. The median tightening was 7.4% and the mean tightening was 1.8%. It's notable that the Spanish banks were the worst performers of the group.

 

MONDAY MORNING RISK MONITOR: RISK COOLING OFF FOR NOW - CDS european

 

3. Asian Financial CDS -  Japanese banks were broadly wider last week, while Indian and Chinese banks tightened. It's interesting to note that Nomura is 383 bps, the widest of any major Japanese Financial Institution.

 

MONDAY MORNING RISK MONITOR: RISK COOLING OFF FOR NOW - Asian Financials

 

4. European Sovereign CDS – European Sovereign Swaps were mostly tighter last week. Portugal saw the strongest rally as swaps fell by 195 bps to 847 bps. Spain and Italy tightened by 21 bps and 27 bps, to 570 bps and 510 bps, respectively 

 

MONDAY MORNING RISK MONITOR: RISK COOLING OFF FOR NOW - Sov Table

 

MONDAY MORNING RISK MONITOR: RISK COOLING OFF FOR NOW - Sov CDS 1

 

MONDAY MORNING RISK MONITOR: RISK COOLING OFF FOR NOW - Sov CDS 2

 

5. High Yield (YTM) Monitor – High Yield rates fell 22 bps last week, ending the week at 7.65 versus 7.87 the prior week.

 

MONDAY MORNING RISK MONITOR: RISK COOLING OFF FOR NOW - HY

 

6. Leveraged Loan Index Monitor – The Leveraged Loan Index rose 9.84 points last week, ending at 1654.

 

MONDAY MORNING RISK MONITOR: RISK COOLING OFF FOR NOW - LLI

 

7. TED Spread Monitor – The TED spread rose 0.6 bps last week, ending the week at 38.3 bps this week versus last week’s print of 37.7 bps.

 

MONDAY MORNING RISK MONITOR: RISK COOLING OFF FOR NOW - TED

 

8. Journal of Commerce Commodity Price Index – The JOC index fell 1.5 points, ending the week at -17.41 versus -15.9 the prior week.

 

MONDAY MORNING RISK MONITOR: RISK COOLING OFF FOR NOW - JOC

 

9. 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 has been moving higher of late for the first time in a long time. It ended the week at 43 bps.

 

MONDAY MORNING RISK MONITOR: RISK COOLING OFF FOR NOW - Euribor OIS

 

10. 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. This data shows through Thursday.  

 

MONDAY MORNING RISK MONITOR: RISK COOLING OFF FOR NOW - ECB facility

 

11. 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 16-V1. Last week spreads tightened 8 bps, ending the week at 153 bps versus 161 bps the prior week.

 

MONDAY MORNING RISK MONITOR: RISK COOLING OFF FOR NOW - MCDX

 

12. Chinese Steel - We use Chinese steel rebar prices to gauge Chinese construction activity, and, by extension, the health of the Chinese economy. We look at the average Chinese rebar spot price. Steel prices in China fell 0.10% last week, or 4 yuan/ton, to 4,075 yuan/ton. Notably, Chinese steel rebar prices have been generally moving lower since August of last year.

 

MONDAY MORNING RISK MONITOR: RISK COOLING OFF FOR NOW - Chinese Steel

 

13. 2-10 Spread – We track the 2-10 spread as an indicator of bank margin pressure.  Last week the 2-10 spread increased by 8 bps to 137 bps.

 

MONDAY MORNING RISK MONITOR: RISK COOLING OFF FOR NOW - 2 10

 

14. XLF Macro Quantitative Setup – Our Macro team’s quantitative setup in the XLF shows 2.0% upside to TRADE resistance and 2.5% downside to TRADE support.

 

MONDAY MORNING RISK MONITOR: RISK COOLING OFF FOR NOW - XLF

 

Margin Debt - April: +0.93 standard deviations 

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, it 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. 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. 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 April. 

 

MONDAY MORNING RISK MONITOR: RISK COOLING OFF FOR NOW - Margin Debt 


Joshua Steiner, CFA

 

Robert Belsky

 

Having trouble viewing the charts in this email?  Please click the link at the bottom of the note to view in your browser. 


THE WEEK AHEAD

The Economic Data calendar for the week of the 25th of June through the 29th 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.

 

THE WEEK AHEAD - weeek

 


DRI: ORLANDO, WE HAVE A PROBLEM

As we expected (DRI: SHAPING UP TO DISAPPOINT 6/21/12), 4QFY12 traffic trends disappointed at Olive Garden.  What we didn’t expect, is that Red Lobster and LongHorn would also post such poor same-store sales numbers.  Hiking the dividend is one way to keep investors happy but tough questions have to be asked of management.

 

Darden is an impressive company that has earned the investment community’s respect through years of producing strong financial results.  CEO Clarence Otis, speaking on CNBC immediately after the print, was shining light on the full year results but the trajectory of comps during this most recent fiscal quarter is a concern going forward.  What’s more concerning to us, is the lack of clarity on when consistent results can be expected at Olive Garden and how they will come about.

 

 

FY2013 Guidance and Outlook

 

Management's FY13 guidance lowered the bar versus the company’s long-term guidance.  EPS growth is expected to be 8-12% versus the 10-15% longer term target while blended same restaurant sales growth guidance is 1-2% versus long-term guidance of 2-4%.  During FY13, we expect EPS growth to benefit from more favorable food costs and other cost reduction initiatives.  We cannot advise clients, with sufficient confidence, that a turnaround is afoot at Olive Garden.  While we respect the operational acumen of the companies’ management teams, we are adopting a “show me” stance toward Darden’s numbers over the next couple of quarters.  Hiking the dividend by 16% this morning is likely to help retain long-term holders, but believe that more intermittent volatility is likely for Olive Garden before the chain achieves consistency in its operational performance. 

 

Olive Garden’s new menu and remodel program not being finalized at this point does not inspire confidence that a solution to the difficulties at Olive Garden is around the corner.  Management cannot possibly predict consumer reaction to promotions and, while investors are waiting for the transition at Olive Garden to be completed, we feel that results at Olive Garden are going to continue to be inconsistent.

 

Below we go through our thoughts on the company’s three largest brands, their 4QFY12 results, and their individual outlooks for FY13.

 

 

Olive Garden

 

Darden’s largest chain, and a key focus for investors heading into this morning’s print, posted a disappointing same-restaurant sales number of -1.8% for the fourth fiscal quarter.  According to Consensus Metrix, the Street was looking for 0.5% growth.  Management apportioned most of the blame for Olive Garden’s disappointing comp store sales growth to performance during the month of May; the “Taste of Tuscany” promotion, which started at a price point of $10.95, failed to live up to management’s expectations.  The Tuscany promotion extended into June so, as far as read-through for 1QFY13, the promotion proving ineffective is a negative indication.  A decision not to advertise around Mother’s Day this year was also cited as a factor in the poor momentum at Olive Garden.

 

Looking forward to 2013, management is shifting towards a more “single-minded” approach to affordability.  To that end, management is launching a new promotion, 2 for $25, which offers unlimited soup, salad, or bread sticks plus an appetizer or dessert plus an entrée. We are not convinced that this strategy will meet management expectations; there are many similar offers in the casual dining space.

 

One short-term concern we have is that the new menu is not going to be released at Olive Garden until 3QFY13.  The menu is currently being tested at 40-50 stores.  In the event that any adjustments need to be made to that menu, the start date could be pushed back further.  Additionally, the Olive Garden remodel program – aimed at updating and refreshing 430 of the total ~800 stores – is in its final testing phase.  The Street will be looking for more specificity from the company on the timetable of this initiative.  Any protraction of the remodel program will only delay Olive Garden becoming a more consistent business.

 

DRI: ORLANDO, WE HAVE A PROBLEM - olive garden comps versus unit growth

 

DRI: ORLANDO, WE HAVE A PROBLEM - olive garden pod1

 

 

A Darden earnings call without commentary on the Gap-to-Knapp (performance versus industry benchmark Knapp Track) is about as perturbing as a visit to Olive Garden without breadsticks.  This break from tradition, while unsettling, is not a major surprise when we consider that Knapp Track results comfortably outperformed Olive Garden and Red Lobster monthly comps during 4QFY12.  As keen as COO Andrew Masden was to highlight Olive Garden’s increasing strength versus the industry during 3QFY12, no such color was provided this morning.  Here is the comment from 3/23, on Olive Garden trends versus the industry “Olive Garden same-restaurant sales were up 2% during the third quarter, roughly 60 basis points below the full-service restaurant industry benchmark. However, this is a sharp improvement from the 320 basis point shortfall in the second quarter.”

 

The new menu and remodel program may help end Olive Garden’s travails, but our near-term view is that the concept needs to find a way to become less price-dependent for top-line growth.  On mix at Olive Garden, management had the following to say this morning: “the biggest dynamic is that we experienced at all of our large casual dining brands during 2012, we experienced a meaningful amount of menu mix, negative menu mix. So, guests trading down to lower priced items. Ordering fewer appetizers, fewer desserts. And we think that step-down is going to moderate during fiscal '13. So we wouldn't expect that negative trend in guest behavior to continue.”  Looking at the chart paints a different picture.  Mix was positive in May and negative for 17 consecutive months prior to that. 

 

DRI: ORLANDO, WE HAVE A PROBLEM - olive garden comps monthly

 

 

Red Lobster

 

The Lenten period shift negatively impacted Red Lobster’s 4QFY12 results by 130 basis points.  Same-restaurant sales came in at -3.9% versus Consensus Metrix expectations of +1.3%.  Lobsterfest, a signature promotion for Red Lobster that typically coincides with the Lenten season, performed poorly this year due to the spike in gasoline prices occurring during the Lenten season.

 

The Festival of Shrimp promotion began at Red Lobster in late April and continued through May.  The company took a price increase for the promotion of $1 from $11.99 to $12.99 based on its success last year and on research that suggested consumers were largely indifferent between $11.99 and $12.99.  The same-restaurant sales decrease in May, according to management, shows that the price increase turned out to be too aggressive.  This highlights a key concern we have for the Red Lobster business, as well as Olive Garden; the comps at their two largest businesses are overly dependent on price and the customer is highly sensitive to increases in price.

 

DRI: ORLANDO, WE HAVE A PROBLEM - RL pod1

 

DRI: ORLANDO, WE HAVE A PROBLEM - RL comps monthly

 

 

LongHorn Steakhouse

 

LongHorn’s comps came in lower than expected, which we highlighted as a possibility in our preview post.  Increased competition in the steak category is making it difficult for LongHorn to take share as rapidly but, as a part of the Darden portfolio, we see this concept as a bright spot for the company.  As the chart below indicates, comps sequentially slowed to 3% from 6.7% the quarter prior and Consensus Metrix 4QFY12 expectations of 4.5%.  This stock is important for the longer-term TAIL story, but as we wrote in our preview note published yesterday morning, Olive Garden and Red Lobster are more important for the immediate-term TRADE and intermediate-term TREND.

 

DRI: ORLANDO, WE HAVE A PROBLEM - longhorn pod1

 

DRI: ORLANDO, WE HAVE A PROBLEM - longhorn comps monthly

 

 

Conclusion

 

The underlying fundamentals of Olive Garden are a concern for Darden’s business over the near-term.  We see the transition period as possibly lasting longer than some investors are expecting and there is substantial risk, in our view, of mishaps occurring as the company makes adjustments to its most important brand while accelerating unit growth.   We are content to sit on the sideline for now.  The dividend yield will continue to provide support for the stock but our expectation is for the first and (possibly) second quarter to be a difficult period for Darden. 

 

 

Howard Penney

Managing Director

 

Rory Green

Analyst

 

 


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