We see Brinker as a leader in the casual dining category over the next several years as investments in technology and the introduction of new platforms should continue to differentiate Chili’s versus its most direct competitors.


We are cautious on casual dining as the group has strongly outperformed over the last year and consumer fundamentals have broken down.  Our call on 4/20/12, for “CASUAL DINING CAUTION”, was ill-timed from a price perspective; despite sales trends breaking down as anticipated, management teams effectively squeezed other parts of the P&L to manufacture beats in 2Q which helped sustain the casual dining outperformance longer than we had anticipated. 


That said, we currrently favor QSR over Casual Dining at this point but strictly on a relative basis.  There is one stock, within casual dining, that we do like over the intermediate-term trend: Brinker.  EAT, as the chart below illustrates, has been leading the casual dining space in its outperformance but we believe that this outperformance was largely down to real market share gains and operational efficiencies achieved through investment in technology.  The company’s Plan to Win is working and, we believe, constitutes a compelling reason to own the stock. 





Below we present three reasons to own Brinker in to the quarter and three reasons to wait until after the event or, alternatively, stay away completely. Either way, we believe this stock presents the most attractive opportunity in casual dining on the long side.


Reasons to be long into the quarter:


The comparisons are easy from an earnings growth perspective


As the charts below illustrate, the company has been comfortably comping difficult earnings growth numbers and we expect 4QFY12 to present an easier comparison for Brinker.  With Chili’s taking share from competitors, we see this aspect of the story as being a potential positive for the 4Q release.  





The company is taking share from its competitors via expanded programs supported by technological investments (little incremental labor, if any)


Much of the recent concern on the bearish side of the Chili’s debate has been centered on allegedly overly aggressive cost cutting by management within the four walls.  We would point out, as long-term (since 2Q10) bulls on the stock, that the bear thesis has shifted from costs to sales and back again but our confidence level is high, having taken the time to visit several different locations and understand the investment Brinker has made in the restaurant, that the market share being gained by the introduction of steak, flatbread, and other platforms, is highly accretive to earnings.  Technological improvements in the Chili’s kitchen, such as the impinger oven, have allowed restaurant managers to broaden the selection of offerings available to customers without incurring significant increases in labor costs.



The stock returns a healthy yield and will likely continue to return significant levels of cash to shareholders

This stock currently carries a 2% dividend yield and management continues to buy back shares.  The company’s payout ratio has been increasing and we see Chili’s, with industry-leading top-line performance, holding appeal for investors seeking dividend-yielding safety plays in the consumer space going forward.  That sentence may not sit well with many investors out there that have baggage when it comes to Brinker: past management teams have disappointed investors and many cannot bring themselves to get behind the name.  That’s why, despite the bullish sell-side sentiment, we think there is further room for this stock to go higher. 



Reasons to wait until after the quarter/not be long the stock period:


The stock has been on a tear (see chart 1)

Brinker has been a massive outperformer over the past couple of years and this has begun to cause some concern among investors.  The stock underperformed the S&P 500 by -2.1% and -2.3% over the past one-week and one-month periods, respectively.  We believe that any material disappointment could be met with a decline in the share price but would be buyers of the stock for the intermediate term on any significant sell off. 



Being bullish is consensus and the uncertain macro outlook could present a sizeable downside risk to the stock price

The sell-side is bullish on this name but, on a relative basis, remains more bullish on Darden and as bullish on Buffalo Wild Wings.  The macro environment (particularly employment) poses a big risk to casual dining trends but we see Brinker as the strongest player in the category.





The strength in the P&L has been down to overly aggressive cost-cutting and this will catch up with the company


We have visited numerous stores in different regions of the country and are confident that the margin improvement seen at Chili’s over the last couple of years has been down to improvements in labor efficiency and store productivity on the back of, primarily, sound investment in technology in the back of the house and, secondarily, in improvements in store operations – such as team service – that have benefitted both Brinker and employees alike while providing customers with better service.  The Gap-to-Knapp, which we estimate to have been 250 basis points in 3QFY12, is testament to that.





The most significant risk to owning this stock into earnings is mean reversion.  By virtue of the strong outperformance of the stock over the last couple of years, any disappointment in sales could cause the stock to decline materially.  However, we are confident that the company will continue to take share, outperform the industry benchmark, and return plenty of cash to shareholders via dividends and repurchases.


Howard Penney

Managing Director


Rory Green



A different picture than WMS


  • Unlike WMS who has only been providing significant customer financing for a few years, IGT has used its balance sheet for a long time
  • IGT began a big ramp in financing as replacements slowed in 2008.  Peak financing occurred in late 2009 and then steadily declined.  The level of financing has been surprisingly consistent over the past 6 quarters.
  • Market share has been relatively stable throughout the last four years despite WMS’s aggressive financing efforts



Lower-Highs: SP500 Levels, Refreshed

POSITIONS: Long Utilities (XLU), Short Industrials (XLI)


You’re not going to get the prices you sold into in early April 2012 (at least not yet), but you’re going to get the next best thing – lower long-term highs.


Fundamentally, it’s actually easier to make the sell call now than it was then. Back then at least #GrowthSlowing wasn’t as broad based (ask MCD, PCLN, or RL about that today). Back then, revenues/earnings on the company side were a lot better too.


Across our core risk management durations, here are the lines that matter to me most: 

  1. Immediate-term TRADE resistance = 1408
  2. Intermediate-term TREND support = 1381 

In other words, provided that 1381 holds – everything US Equities is fine, until it isn’t. In the meantime, I think we make lower highs as growth continues to surprise on the downside.


The volume signals I am registering are the most bearish I have ever measured in my career.




Keith R. McCullough
Chief Executive Officer


Lower-Highs: SP500 Levels, Refreshed - 1


CONCLUSION: We see a similar see a similar pattern in consensus storytelling and a similarly-asymmetric price setup as we did in the previous occurrences of our being bearish at cyclical tops in the US equity market and “risky assets” broadly (1Q08, 1Q10, 1Q11, 1Q12).


Extrapolating from anecdotes out of our institutional client base, we’d be willing to bet that the phrase: “I’m bullish because everyone is bearish,” has certainly made its way around the buyside in recent weeks.


Unfortunately for US equity bulls, its conceptually impossible for the majority of investors to be positioned in a contrarian manner all at once. Moreover, is it really contrarian to be bullish from here, or is that merely what many US equity investors are telling themselves to ease the broad-based feeling of cognitive dissonance shared by many domestic stock market operators?


Net-net-net, that is once again the key debate we feel investment teams should be having internally at yet another long-term lower-high in the US equity market, which was largely perpetuated by expectations of incremental Policies to Inflate out of the Fed/ECB.



On MAR 29, 2012 we published a timely note titled, “DEFINING ASYMMETRY: INVESTOR COMPLACENCY AT MULTI-YEAR LOWS” where the conclusion read:


“Measures of investor complacency are signaling to us asymmetric risk from an intermediate-term perspective. As such, we’re either at/near a cyclical top in “risky assets” or we’ve achieved “escape velocity” and are entering a new era of investing. We believe this is the key market debate to focus on.”


The note, which was a precursor to our 2Q Theme “Obvious Asymmetric Risks”, isolated a critical factor within our then-bearish intermediate-term view of US equities and “risky assets” broadly – broad based investor complacency. That call ultimately proved rather prescient all the way through to our JUN 1 note titled, “SHORT COVERING OPPORTUNITY: SP500 LEVELS, REFRESHED”:


“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.”

-Hedgeye CEO Keith McCullough (JUN 1, 2012)


To recap the score: 

  • The S&P 500 dropped -8.9% from MAR 29 to JUN 1;
  • The EuroStoxx 600 Index dropped -9.8% from MAR 29 to JUN 1;
  • The MSCI EM Equity Index dropped -13.4% from MAR 29 to JUN 1;
  • The JPMorgan EM FX Index declined -7.5% from MAR 29 to JUN 1; and
  • The CRB Commodities Index dropped -12.3% from MAR 29 to JUN 1, including a -19.6% drop in Brent crude oil and a -12.7% decline in high-grade copper. 


As we turn to today, we are once again approaching critical levels in the CBOE SPX Volatility Index (~15) and our own proprietary Global Macro VIX (~18-20) that have provided clean-cut sell signals for members of our team dating back to 2007. Comparing 4Q07 to today’s setup, we spot similar patterns of broad-based cognitive dissonance among US equity investors as those ahead of the largest global recession and financial crisis since the Great Depression based upon the OCT 9th concurrent bottom in the VIX (16.12)/top in the S&P 500 (1565.15).






The then-consensus view at that 4Q07 top was that the US equity market was “appropriately” discounting a continuation of then-peak earnings generation was obviously incorrect and lends credence to our view that the crowd is often most wrong at critical inflection points in domestic and/or global GROWTH/INFLATION/POLICY dynamics.


And while we are certainly aware that consensus can remain correct longer than many individual funds can remain solvent, we remain keen to get loud ahead of what we see as pending sell-offs in US equities (1Q08, 1Q10, 1Q11, 1Q12); today we see a similar see a similar pattern in consensus storytelling: 72.5% of S&P 500 companies that have reported Q2 results have beat on the bottom line, overshadowing the 58.9% of companies that have missed top line estimates and a -548bps sequential slowdown in the YoY growth rate of aggregated SPX sales to +0.5% (per Bloomberg Professional).


Needless to say, we see a similarly-asymmetric price setup as we did in those previous occurrences of broad-based cognitive dissonance. Best of luck picking your spots on the short side out there.


Darius Dale

Senior Analyst

Idea Alert: Covering RL

Conclusion: We’re keeping a TRADE a TRADE. The company is doing everything right, but it’s not immune. Earnings power is underappreciated, but we think we have time. For now it’s rangebound.


Keith covered our RL short this morning on the print. We shorted it into the print as a TRADE – simply because top line expectations were high, SG&A is headed up, they just lost their CFO, the global macro climate presented a perfect opportunity for RL to guide down, and this is a consensus long.


After a sharp initial sell-off, the stock is hanging in there reasonably well – most notably it is holding Keith’s $144 level. Breaking (and holding) that level would put $138 in play.


There’s not much that really changed our thought process here. We like the name more and more the further we go out in duration, and we have the earnings in our model to prove it. But the realization of $12 in EPS will not happen in a vacuum.


The reality is that this is the first time in three years that RL missed to this magnitude in its own retail stores. Comps of +1% do not exactly instill the confidence we need to bank on a 2H top line acceleration. They can make it up in the (higher margin) wholesale business, but let’s face some facts… if any power brand like RL wants to find some dollars, they turn to wholesale, not retail. Retail is the best barometer of a brand’s trajectory.


One of the positives is that they are beginning to see the benefit from input cost relief, and that should only improve from here. Unlike brands like Carter's, Hanesbrands, and Gap we think that Ralph has the brand power to keep most of the margin upside. But we’re mindful about ‘granting’ both margin upside AND top line acceleration starting 90 days out. That’s a long time to wait with a lot of unknowns.


Ultimately, where the Street shakes out over the next day or two with earnings estimates will be critical.

In the interim, Keith will do what he does…manage risk around a high conviction longer-term research call by trading a range which today stands at $144-$153.


Based on the research we have in front of us today, we’d need to see that $138 to step up and buy right now.


There are two things that could change that:


1) Time. We think that as each day draws closer to getting past 2Q, the stock has a better shot of working as margin pressure eases relative to last year's compares.


2) The Research. The reality is that the volatility in the business environment has never been greater than it is today. If there’s anyone who will be left standing, it will be RL. But there’s simply limited visibility past the upcoming quarter (where RL likely sandbagged). Could comps at retail be up 10%? Yes. Down 10%? Yes. We’ve got low single digit comps in our model for the remainder of the year. If we gain confidence in them later in the quarter, then all else equal, the stock might make sense here for the intermediate-term. But we don’t see the need to rush.



We have included below our RL Idea Alert from Monday, August 6


Idea Alert: Covering RL - RL Levels

We shorted RL into the print for a TRADE. To be clear on this one, there’s a sharp delineation between where we like RL over each duration. In the event of a sell-off, we'd be looking for a point of entry once the dust settles to get involved with what could be $12 in earnings power. 


TAIL (3-Years or Less): This is one of our favorite TAIL ideas, as we think that the consensus is underestimating RL’s 3-year earnings power by  nearly a dollar. When we add up the opportunities by country, product category, and most notably – by channel (ie, we think that people are underestimating the leverage inherent to this model.  Specifically, we’re looking at nearly $10 in EPS next year, and over $11.50 the year after. A 10% premium to the market suggests a stock near $175. A 1x PEG is $200+ over 2 years.


TREND (3-Months or More): RL still has a full 75% of its (March) FY left to go, so the company will be guarded into the print. RL laps European category expansion (intro of Polo FW), Denim & Supply, FX, and double digit retail comps – which are tougher to bank on this year.


TRADE (3-Weeks or Less): The company has every reason in the world to offer up a cautious outlook – given all that’s going on in the world – especially Western Europe (it has minimal exposure to China) and the clear trend of other companies putting up weak numbers. Add in the Olympic spending, tough wholesale and store productivity comps, and our analysis that stretches to find more than 10% of CFO changes that end up being a near-term positive earnings event, and we’re more inclined to be on the negative side of this print. This is a perfect ‘buy on pullback’ stock. 

NKE: Building An Olympian

NKE: Building An Olympian - usgym nike



The XXX Olympics have been exhilarating to watch, make no mistake about it. It is currently beating out the 2008 Beijing Olympics with ease. It’s also the premier event to put advertising dollars to work and to generate buzz around new products. At the forefront of the marketing blitz is Nike (NKE).


With nearly every top notch/famous athlete that’s competing using Nike, there’s room for all sorts of marketing and advertising from Nike. We believe that two specific campaigns, both from Nike, are going to make a massive impact on the public.



NKE: Building An Olympian - nike VOLTbest



The first campaign is a bit on the subliminal side. If you’ve noticed - Hedgeye Retail Sector Head Brian McGough did during the first week of the games – nearly every team are wearing bright, neon green Nike shoes. Known as the Volt line of footwear, this is the shoe uses Nike’s new FlyKnit technology and go for about $150 a pair and everybody seems to love them. It didn’t hurt that Michael Phelps chose to wear them for his interview with Bob Costas on NBC this past Sunday. With Phelps’ massive size and contrasting black pant, you couldn’t help but stare at the shoes. See below for a screenshot.


NKE: Building An Olympian - michael phelps and bob costas


Speaking of Phelps, this brings us to our second marketing campaign that Nike uses: building an organic brand around an athlete.


Any company can throw some clothes and a check at an athlete, hope they perform and walk away. That’s simple and doesn’t resonate as much with its consumer base. What you need is something emotional and outstanding. Per Brian McGough:


The best brands will take the stories that inevitably rise from performance (in this case, the Olympic Games), and craft stories around key athletes to create an emotional connection to the consumer AFTER the fact. When Liu Xiang, the Michael Phelps of China (he won the gold medal on the 100m hurdles eight years ago in Athens – an unprecedented feat for the Chinese) dropped out of the race last minute due to injury on his home turf in 2008, Nike turned the disappointment upside down, and created a marketing message that made consumers sympathize with the rigors of training at such a high level for one’s country.”


The result? Running revenue accelerated in China. Building brands is important for business; how you do it is everything.

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