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Takeaway: We anticipate $DNKN missing expectations for the second successive quarter.

Dunkin’ Brands’ IPO took place over a year ago amidst what we called a coffee bubble in valuations within the category.  When Dunkin’ came public, valuations for the Dunkin peer group had gained an average of 56% over the previous twelve months.  Additionally, we estimate that the aggregated market capitalizations of GMCR and (the US division of) SBUX in July 2011 were almost equal to the entire United States coffee market’s annual revenues.  The table below shows the swings in valuations of the stocks of some QSR names over the past couple of years.


DNKN BUBBLE NEXT TO POP? - qsr valuations table1


Dunkin’ Brands stands as one of the most expensive QSR names at  13.5x EV/EBITDA NTM (Chipotle is the only company with a higher valuation).  The bull case hinges upon a belief that the company’s franchised business model and the Dunkin’ Donuts “white space” growth opportunity within the U.S. justifies the premium valuation.  We do not agree.


If we were conspiracy theorists, which we are not, we would likely frame the Dunkin’ Brands story something like this:

  1. The insiders could not get out fast enough, with their “swan song” leveraging up the company to buy the remaining stake this month
  2. Of the 14 members of the DNKN board, 5 are representatives of the selling stockholders  
  3. The insider selling occurred as SSS at Dunkin’ Donuts accelerated from 2% to 7% on massive new product introductions and the introduction of K-CUPS.  Both events will not reoccur in over the next 12 months making comparisons very challenging
  4. The selling to investors of the “white space” growth opportunity was made possible by the new franchise distribution agreement.  In theory, this should help accelerate franchise unit opening.  Franchise units opening have been slowing for two quarters (U.S.  Gross openings were flat year-over-year in 2Q12, while net openings of U.S. Dunkin’ Donuts units came to 19 versus 54 expected by the Street)
  5. In trying to put their best foot forward to generate investment banking fees, sell-side expectations for what DNKN can do operationally are stretched.  For example, for nearly every company we track, consensus expectations have 1 and 2 year SSS trends slowing over the next two quarters except DNKN and DNKN is lapping its most difficult SSS compares in over 5 years
  6. As you can see from the chart below, consensus expectations are for the company to reaccelerate unit opening after missing for the past two quarters
  7. Valuation compression is likely in the coming months

DNKN BUBBLE NEXT TO POP? - dunkin net new unit



How long is your list of list of consumer companies that is going to see a V-Bottom in two-year average sales trends in the back half of 2012? 


We would imagine that list is very short and are almost certain that Dunkin’ is not on it.  However, consensus is modeling an acceleration in two-year average trends even after the 2Q12 miss.  After the 2Q unit openings miss the bulls have shifted from “growth” to “comps” and will have nowhere to go if the comp number comes in light for Dunkin’ Donuts.  Even maintaining flat two-year average trends is likely overly-bullish but that scenario, illustrated by the chart below, shows comps missing consensus by 154 and 233 basis points in 3Q and 4Q, respectively.


We don’t think comps are overly material for Dunkin’ Brands; it is a franchised business whose future earnings growth is primarily predicated on unit growth.  Nevertheless, the decelerating trend in same-store sales numbers over the remainder of the year and in to 2013 will not help generate incremental franchisee demand for the Dunkin’ Donuts brand.




Howard Penney

Managing Director


Rory Green





Takeaway: The political rhetoric surrounding the inflationary impact of quantitative easing is poised to accelerate meaningfully.

CONCLUSION: The political rhetoric surrounding the inflationary impact of quantitative easing is poised to accelerate meaningfully from now through the general election, potentially keeping the Fed on hold with respect to that duration.


"…in a world where unemployment is as high as it is, allowing inflation to tip over the current central bank target of 2% could well be part of an appropriate policy. The central bank may have to give a little bit on the inflation front to do better on the employment front… I don't anticipate stagflation, a condition of weak growth and high inflation, returning largely because the Fed won't repeat the policy mistakes of the 1970s.”
-Federal Reserve Bank of Minneapolis President Narayana Kocherlakota (AUG 15, 2012)

From our vantage point, there are three very obvious things wrong with Kocherlakota’s statement (in reverse order):

  1. The Fed is, in fact, well on its way towards repeating the policy mistakes of the 1970s.
  2. Members of the Federal Reserve continue to blatantly confuse inflation with growth (likely because the former is far easier for them to produce), which wrongfully leads them to conclude that their Policies to Inflate are a catalyst(s) for improvement in the US labor market.
  3. Despite the disproportionally-harmful effects of headline inflation on several US consumer groups, the Fed continues to anchor on core inflation as their preferred CPI measure.

To point #1, the Fed’s holdings of US Treasury debt (some refer to this as “monetization”) as a percentage of total was 10.7% per the latest data point(s); that is the highest ratio we’ve seen since the early 1980s. Another LSAP – which members of the manic media and Federal Reserve regional banks are begging Bernanke to introduce – is likely to push this metric back into the mid-teens – last seen when then-Federal Reserve Chairman Arthur Burns was, too, monetizing Federal debts.




To point #2, We continue to argue that Chairman Burns' well-documented failures in promoting sustainable economic and employment growth during the 1970s can be largely attributed to his academically-dogmatic Policies to Inflate. The chart below highlights how his stagflation-inducing rips in CPI led proactively predictable spikes in the unemployment rate.




To point #3, we use BLS Consumer Expenditure Survey data in the first of the two charts below to highlight how the Fed’s “transitory” commodity inflation disproportionally impacts the poor. In the second chart, we use ICI data to highlight a common sense conclusion: poor people don’t own many stocks; thus, they are disproportionately impacted by the negative effects of QE and receive hardly any of the offsetting benefits (i.e. stock market inflation). Republican Vice Presidential Candidate Paul Ryan has been outspoken about this very topic; for more details, please refer to our note from JUN 15 titled: “WILL ROMNEY AND RYAN FORCE BERNANKE INTO A BOX?






Perhaps the 15.1% of the US population that is considered to be officially impoverished according Census Bureau calculations won’t matter in this election. Perhaps they will. One thing is for sure, the political rhetoric surrounding the inflationary impact of quantitative easing is poised to accelerate meaningfully from now through the general election, potentially keeping the Fed on hold with respect to that duration. Key catalysts on that front include:

  • AUG 27-30: Republican National Convention in Tampa, FL;
  • AUG 31-1: Central banker bonanza in Jackson Hole, WY;
  • SEP 13: FOMC Rate Decision, Fed’s updated economic projections and Bernanke press conference; and
  • OCT 24: FOMC Rate Decision.

With respect to Jackson Hole, we would not be surprised to see political rhetoric on the Fed’s role in the economy heat up into and through that event. Stripping the Fed of its dual mandate – specifically the “maximum employment” portion – has the potential to develop into a key political issue in the US monetary policy arena over the intermediate term, especially if the GOP is successful in its bid for House and Senate majorities. Intrade currently has the odds of each occurring at 85% and 55%, respectively.


Darius Dale

Senior Analyst

IGT: What’s In A Buyback?

Takeaway: IGT is big on buybacks and the trend will likely continue. The company now needs to focus on growing its share price back above $20.

International Game Technology (IGT), one of our heavily-covered gaming names, just completed another round of share buybacks after reporting a mixed third quarter in late July. The company bought back $1 billion of shares and will probably continue to buy back shares going forward. IGT is no stranger to buybacks – it has bought back over 110 million shares in the past 8 years, equating to about 30% of the outstanding shares.



IGT: What’s In A Buyback?  - IGT sharechart



According to Hedgeye Gaming, Leisure and Lodging (GLL) Sector Head Todd Jordan, the buyback “…has been very accretive to EPS but hasn’t done much for the stock.”  The stock is at the low end of its 8 year range and 76% off its high in early 2008.

For IGT’s 2013 fiscal year, we see 25% EPS growth. While on the lower end of expectations, meeting this target would result in significant share appreciation to the delight of investors. Looking at the above chart, you can see that IGT needs to do something to boost the price of its stock in order to get it above $20 a share, a level not seen since 2009.


It’s worth noting that subscribers can get Jordan’s full breakdown of IGT’s earnings, complete with a scorecard and dissection of the company’s future plans to grow revenue. 

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The Mining Bubble







Yesterday, Industrials Sector Head Jay Van Sciver put out a note on Caterpillar Inc (CAT) that detailed how we’ve hit peak levels in the mining sector. The company will struggle to grow and drive revenue going forward as the cycle winds down and the miners slow equipment purchases. This morning, mining giant BHP Billiton (BHP) said that it was stalling and scaling back projects worth $50 billion collectively. Falling commodity prices with rising currencies do not bode well for miners. Xstrata recently announced it would also be scaling back projects in an effort to preserve capital. Van Sciver called peak mining several weeks ago and now it’s coming to fruition in the mainstream media.




That’s Philadelphia lingo for you right there, but seriously, have you seen the new Lebron X shoes from Nike (NKE)? They go for $315 and are on the fast track to usurp Jordans as the “must have” shoe that gets released in a new iteration each year. Pre-orders have sold out and any retailer selling these will have a line snaking around the block of people camping out for a pair. Here’s what Retail Sector Head Brian McGough thinks about the Lebron X hype (we’re inclined to agree):


In no way, shape or form does this have any bearing on the broader revenue stream of a $25bn company. But it shows how their marketing engine is synching with innovation in order to test price points that were never before even a pipe dream. A more commercial version will be sold to the masses at $180 – again, a price point that most would think is unattainable in this environment.”




The Congressional Budget Office (CBO) is set to release its updated budget and economic outlook today. We’ll put out a fully detailed analysis of the note later on, but we do not expect the release to be positive. Similar to the rhetoric of Paul Ryan, it’s likely to recommend drastic cuts to spending combined with an effective growth policy. This is nothing new. The US is spending its way into a fiscal nightmare that we soon will not be able to wake from. Please remember that the direction of the U.S. budget is a key factor that will drive the value of the U.S. dollar over time.






Cash:                  Flat


U.S. Equities:   UP


Int'l Equities:   Flat   


Commodities: Flat


Fixed Income:  DOWN


Int'l Currencies: Flat   








Nike’s challenges are well-telegraphed. But the reality is that its top line is extremely strong, and the Olympics has just given Nike all the ammo it needs to marry product with marketing and grow in the 10% range for the next 2 years. With margin pressures easing, and Cole Haan and Umbro soon to be divested, the model is getting more focused and profitable.

  • TAIL:      LONG            



The former Liz Claiborne (LIZ) is on the path to prosperity. There’s a fantastic growth story with FNP. The Kate Spade brand is growing at an almost unprecedented clip. Save for Juicy Couture, the company has brands performing strongly throughout its entire portfolio. We’re bullish on FNP for all three durations: TRADE, TREND and TAIL.

  • TAIL:      LONG



LVS finally reached and has maintained its 20% Macau gaming share, thanks to Sands Cotai Central (SCC). With SCC continuing to ramp up, we expect that level to hold and maybe, even improve. Macau sentiment has reached a yearly low but we see improvement ahead.

  • TAIL:      NEUTRAL







“6% of us poor, poor Americans don’t have high speed Internet access. Yet 15% are on food stamps. Can ANYONE explain that to me?” -@SchatzWSJ




“The average, healthy, well-adjusted adult gets up at seven-thirty in the morning feeling just plain terrible.” –Jean Kerr




$315. The price of a pair of Lebron X sneakers being released by Nike in collaboration with Lebron James.


Currency Wars

“The first panacea for a mismanaged nation is inflation of the currency; the second is war.  Both bring a temporary prosperity; both bring a permanent ruin.  But both are the refuge of political and economic opportunists.”

                -Ernest Hemmingway


Anyone who has analyzed the United States federal budget understands that this fine country spends a lot on its military.  In fact, based on estimates from the nonpartisan Congressional Budget Office defense spending, that is considered discretionary, will total $635 billion in fiscal 2013. This is more than 52% of the total discretionary budget of the U.S. government and just under 20% of total federal government spending.


In terms of all global defense spending, the  U.S. is dominant.  According to the Stockholm International Peace Research Institute’s (SIPRI) 2012 Yearbook, the U.S. spends more than 40% of the combined global military spending pie.  The next four countries on the list are as follows: China at 8.2%, Russia at 4.1%, the UK at 3.6%, and France at 3.6%. 


Since the U.S. spends the most on defense on a gross dollar basis and as a percentage of GDP at 4.7%, it is obvious that the U.S. has solidified its so-called “hyper power” status as the world’s primary military power.  As a Canadian, I can assure you that I appreciate the powerful U.S. military and the people that currently serve and have served in the military.  But as a global macro analyst, it is difficult not to question whether the U.S. is overspending, if not at least spending inefficiently.


The most recent military spending controversy occurred last month when a well-connected supplier received a contract to produce oil pans for $17,000 a pop.  (If I could get a deal like that, I might even consider getting out of the research business!) Yesterday, in fact, the ever-controversial Grover Norquist made the following statement regarding wasteful defense spending:


“Conservatives need to remember that, just as spending money on something called education doesn't mean people are educated and spending money on welfare doesn't mean it adds to the general welfare calling something national defense doesn't mean it is. It may not be. It may undermine national defense if it's a waste of resources, if it's a misallocation of resources.”


Later today the CBO will release its updated budget and economic outlook, we will analyze this update in a note, but we certainly do not expect positive news from the CBO.  It’s important because the direction of the U.S. budget is a key factor that will drive the value of the U.S. dollar over time. 


The obvious conclusions from the CBO’s reports will likely be that the U.S. needs to drastically cut spending and that an effective growth policy needs to be implemented to juice revenue.  On the military spending front, an improved spending outlook will come from more efficient spending and also more unique ways of waging war.


To the last point, next Wednesday at 11am we will be hosting a conference call with Jim Rickards, the author of Currency Wars: The Making of the Next Global Crisis. A key catalyst for writing this book was that Rickards has been a long time consultant to the Department of Defense and has participated in large-scale economic war games. 


Rickards’ view is that the U.S. is already facing national security threats via economic warfare including: clandestine gold purchases from the Chinese, to hidden agendas of sovereign wealth funds, to explicit threats from the Russians about diversifying away from the dollar.  In an even more controversial stance Rickards believes that the biggest economic threat we currently face may well be from an overly exuberant Federal Reserve Chairman in Ben Bernanke.  While it sounds like Rickards is carrying Hedgeye water so to speak, we actually disagree on a number of key points and will be pushing him on some of his more extreme views.


On the call with Rickards we will also provide you with our updated investment views on the major currency pairs.  Our institutional subscribers will automatically get access to the call, if you are not a current institutional subscriber but would like to participate, please email .


Now as for the war that is currently going on in your portfolio, I have a couple of points to highlight this morning.  Near the close yesterday, we released a note that emphasized the quantitative set up, which is what we call an “outside day”.  This occurs when the SP500 trades higher than the previous close intraday but then closes below it.  From a fundamental perspective, this suggests that there is likely a good overhead supply of stock for sale at that level.


The inability of the SP500 to break through that key level is even more negative when combined with where we see investor sentiment, which is in a word: complacent.  For starters, as we’ve stated repeatedly, the VIX at/or near the 15.0 level has consistently signaled a time to sell equities over the past three years.  After yesterday’s action, the VIX also became bullish from a TRADE duration in our models. This implies the VIX has even more upside in the short term. Further, the bull/bear spread from the U.S. Investors Intelligence Poll is now 2,260 basis points wide to the bull side.  So, yes investors are leaning long.


And on the old global growth watch, Japan posted a -8.1% decline in exports on a year-over-year basis.  Not surprisingly, exports to the European Union were down -25% and to China were down -11.9%.  But don’t worry, Japan is only the fourth largest economy in the world . . .


Our immediate-term support and resistance ranges for Gold, Oil (Brent), US Dollar, EUR/USD, 10yr UST Yield, and the SP500 are now $1, $113.52-115.18, $81.91-82.46, $1.22-1.24, 1.75-1.82%, and 1, respectively.


Keep your head up and stick on the ice,


Daryl G. Jones

Director of Research


Currency Wars - Chart of the Day


Currency Wars - Virtual Portfolio

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