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CHART DU JOUR: GAS PRICES

Takeaway: So now the regionals have to worry about gas prices too?

  • We’ve shown that historically, high gas prices are a statistically significant hurdle for regional gaming revenues
  • Despite common thought, YoY change has a bigger impact than sequential changes in gas prices – at least, statistically speaking
  • Gas prices are now higher than last year for the first time since March, but not significantly so.  The trend is still a little disconcerting, though.

 

CHART DU JOUR: GAS PRICES - gas2


DNKN: Not A Slam Dunk(in)

Takeaway: $DNKN will have a difficult time growing SSS with a lack of new products in the pipeline. It's also expensive compared with other QSRs.

Dunkin’ Brands (DNKN) is expected to miss expectations for the second successive quarter as it struggles to grow in the coming quarters. Dunkin’ IPO’d a year ago in the midst of a coffee bubble and is running out of growth drivers to save itself as it trades at an extremely high EV/EBITDA multiple of 13.5x. Chipotle (CMG) is the only other company that trades at a higher valuation in the same QSR space.

 

One big problem for Dunkin’ outlined by Restaurant Sector Head Howard Penney in a note from today was that Dunkin’s same store sales accelerated from 2% to 7% due to new products and the introduction of Dunkin-brand K-CUPS for Green Mountain’s (GMCR) Keurig machines. Since these events will not reoccur in the next year, it will be hard to compare and keep SSS growth at a similar level.

 

Penney’s bearish case on DNKN is outlined below:

 

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 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)

4.        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

5.        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

 

 

DNKN: Not A Slam Dunk(in) - DNKNchart


Grandma Isn’t Scared Of Paul Ryan

Takeaway: Democrats and the media would have you think Ryan's cuts to Medicare have seniors scared. The truth is, they're not.

The consensus among mainstream media and Democrats is that Paul Ryan’s plans for Medicare and Medicaid are detrimental to senior citizens as we cut costs and switch to a “voucher” based system. But in reality, the truth is that seniors aren’t scared of Ryan and his Path To Prosperity.

 

A new Washington Post-ABC poll of seniors shows that 41% of Americans have a favorable view of Ryan while 37% rate him unfavorably. Seniors have a 50% favorable view of Ryan and 35% unfavorable view. A third of seniors say they have a strongly favorable view of the Wisconsin congressman, while one-quarter have a strongly unfavorable view. These numbers aren’t bad at all for a man Democrats are painting as Death incarnate.

 

Still, the likelihood of President Obama being reelected remains high despite the massive fundraising numbers being put up by Romney’s camp. Obama has more available “total cash” than Romney (the spread is narrowing quickly) but the monthly fundraising trends favor Romney.

 

Another factor that’s trending is voter engagement. Current numbers and polls suggest that the GOP voter base is highly energized and significantly more engaged than Democrats. What this means is that come election day, when it’s time to get out and actually vote, Republicans will have a stronger turnout. Recent voter restriction measures passed and/or pending across eastern and mid-western states, as highlighted by the ACLU, presents another fringe dynamic that may impact both engagement and turnout.

 

 

Grandma Isn’t Scared Of Paul Ryan - ryanpoll1

 

 

Lastly, there are external circumstances that could damage Republican numbers. The first is Tropical Storm Isaac, which is set to become a hurricane that is forecasted to slam into Florida next week right as the Republican National Convention begins in Tampa. The other problem at hand is Representative William Todd Akin (R-MO), whose recent inappropriate comments on birth control have damaged the Republican party as a whole. It will likely take a resignation on his part to repair the damage he has done and it has been said Paul Ryan has had a long conversation with Akin about doing just that.

 

 

Grandma Isn’t Scared Of Paul Ryan - ryanpoll2

 

 

The election is fast approaching and October’s numbers should paint a clear, concise picture of who’s going to win this battle. For now, the race remains very close with Obama slightly inching out Romney.


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US Oil Refiners Stretched Thin

Takeaway: With crack spreads at peak levels, companies like $HFC and $TSO are ready to short as we get bearish on US oil refiners.

While the US stock market has been lacking volatility this year, our energy sector has been up and down riding the waves of geopolitical risk and the changing value of the US dollar. The refining subsector is stretched thin and as a result, we’ve become bearish on several names as growth slows down and cracking margins reach all-time highs.

 

Two names we’re inclined to short are HollyFrontier Corp. (HFC) and Tesoro Corp. (TSO). We’ve outlined our bearish case for HollyFrontier in the past. As we reach peak levels for crack spreads, which are bullish for refiners when they are high, we believe the time is right to begin shorting refiners as the cycle shifts and cracking profits come down.

 

 

US Oil Refiners Stretched Thin  - HFC crackspread

 

 

With Brent crude oil at $115 a barrel and the Brent-WTI spread at $18, the market is setting up to agree with our bearish case. The US refining index is +65% year-to-date vs. the S&P 500, which is only up +13; the benchmark cracking margin is +91% year-to-date.  We have found that the relative performance of the refiners correlates well with cracking margins (a proxy for the profit margin from “cracking” a barrel of oil into refined products).

 

Hedgeye energy analyst Kevin Kaiser has outlined his concerns into several comprehensive bullet points below:

 

• Refining is a structurally-challenged industry that is plagued by excess capacity, no pricing power, intense regulation, and a secular decline in gasoline demand due to many factors: increased fuel-efficiency, ethanol in the gasoline blend, a deleveraging consumer, weak employment, social media, and more.  (US gasoline demand is down 4% Y/Y.)  

• Over the long-term, revenue growth is limited (a new US refinery has not come online since the 1970s), margins are low, and maintenance capex is high due to increased environmental regulations.

• Cracking margins are highly volatile and cyclical, as are the share prices of the refiners.

• Many investors and analysts have pointed to the high dividend yields and special dividends (HFC in particular) from the refiners as reasons to buy the stocks.  In our view, it is a reason to sell the stocks.  For one, it is an admission that investment opportunities are limited or that the return on invested capital will be poor.  Second, free cash flow (and thus the dividends paid out) is highest when margins are near peak – this is the time to sell the stocks.

• Sentiment is bullish relative to historical levels (more sell-side “buys” and lower short interest).

• The insiders at these companies are selling large amounts of stock: in particular WNR, HFC, VLO, DK, and ALJ.


DNKN BUBBLE NEXT TO POP?

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.

 

DNKN BUBBLE NEXT TO POP? - DNKN v bottom

 

Howard Penney

Managing Director

 

Rory Green

Analyst

 

 


FIRE IN THE [JACKSON] HOLE: BATTLE LINES ARE BEING DRAWN IN THE US MONETARY POLICY ARENA

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.

 

FIRE IN THE [JACKSON] HOLE: BATTLE LINES ARE BEING DRAWN IN THE US MONETARY POLICY ARENA - 1

 

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.

 

FIRE IN THE [JACKSON] HOLE: BATTLE LINES ARE BEING DRAWN IN THE US MONETARY POLICY ARENA - 2

 

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?

 

FIRE IN THE [JACKSON] HOLE: BATTLE LINES ARE BEING DRAWN IN THE US MONETARY POLICY ARENA - 3

 

FIRE IN THE [JACKSON] HOLE: BATTLE LINES ARE BEING DRAWN IN THE US MONETARY POLICY ARENA - 4

 

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


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