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JOBLESS CLAIMS: MORE GOOD THAN BAD WITH A TAILWIND SET TO KICK IN

Takeaway: Most of the news on the labor front is positive with a big tailwind set to kick in, but there are a few storm clouds on the horizon.

Big Picture - Where Are We With Respect to Employment?

The good news: jobless claims are still below the threshold level of 385-400k that we've identified as the break even point for the unemployment rate. Below that threshold, the unemployment rate falls and vice versa. Also, on a year-over-year basis, rolling non-seasonally-adjusted jobless claims are still improving, down 7.8% YoY this past week. These two reference points suggest that the health of the labor market is intact. Further, we are on the cusp of the seasonal adjustment factor headwind becoming a tailwind. Recall that the Lehman-based distortion reaches its maximum headwind in August/early September, and begins to unwind thereafter, reaching its peak tailwind by late February.

 

The bad news: the year-over-year change in the rolling NSA series compressed this past week to 7.8% improvement, down from 8.0% improvement in the prior week. More importantly, this measure is slowly but steadily converging toward zero suggesting the economic recovery is running out of steam. Also, the current disequilibrium between rolling SA claims and the S&P 500 suggests fair value on the market of 1,352, or roughly 4% lower than where it's trading presently.

 

The Numbers

Initial jobless claims rose 2k to 374k last week, but were flat after a 2k upward revision to the prior week's data. Rolling claims rose 1.5k WoW to 370k. 

 

JOBLESS CLAIMS: MORE GOOD THAN BAD WITH A TAILWIND SET TO KICK IN - Raw

 

JOBLESS CLAIMS: MORE GOOD THAN BAD WITH A TAILWIND SET TO KICK IN - Rolling

 

JOBLESS CLAIMS: MORE GOOD THAN BAD WITH A TAILWIND SET TO KICK IN - NSA

 

JOBLESS CLAIMS: MORE GOOD THAN BAD WITH A TAILWIND SET TO KICK IN - Rolling NSA

 

JOBLESS CLAIMS: MORE GOOD THAN BAD WITH A TAILWIND SET TO KICK IN - S P

 

JOBLESS CLAIMS: MORE GOOD THAN BAD WITH A TAILWIND SET TO KICK IN - Fed and Claims

 

JOBLESS CLAIMS: MORE GOOD THAN BAD WITH A TAILWIND SET TO KICK IN - NSA YoY

 

Yield Spreads - More Margin Pressure

The yield spread compressed last week by 5 bps, pushing the 2-10 spread to 137 bps from 142 bps the week prior. Ten year yields fell 4 bps to 165 bps from 169 bps. Currently, the 3Q12 yield spread is down 18 bps QoQ thus far in the third quarter.

 

JOBLESS CLAIMS: MORE GOOD THAN BAD WITH A TAILWIND SET TO KICK IN - 2 10

 

JOBLESS CLAIMS: MORE GOOD THAN BAD WITH A TAILWIND SET TO KICK IN - 2 10 QOQ

 

Financial Subsector Performance

The table below shows the stock performance of each financial subsector over multiple durations. 

 

JOBLESS CLAIMS: MORE GOOD THAN BAD WITH A TAILWIND SET TO KICK IN - Subsector Performance Graph

 

JOBLESS CLAIMS: MORE GOOD THAN BAD WITH A TAILWIND SET TO KICK IN - Companies

 

Joshua Steiner, CFA

 

Robert Belsky

 

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Another Dollar Holler

ANOTHER DOLLAR HOLLER

 

 

CLIENT TALKING POINTS

 

ANOTHER DOLLAR HOLLER

Time for another Dollar Holler as reality starts to set in for those who have been busy smoking the Bernanke peace pipe. There is most likely no further easing coming down the pipe at the Fed’s Jackson Hole meeting and you know what that means? Well if you’ve been paying attention to the market, you certainly would. Gold is heading lower, the US dollar is back in bullish business and commodity prices are set to deflate somewhat. You can’t just keep the QE bandwagon going forever, so now people are starting to holler at that dollar and Paul Ryan is loving it. Furthermore, a Washington Post article pulled an anti-Hilsenrath and basically suggested all we mentioned above, adding fuel to the fire.

 

 

TALKING TO JIM RICKARDS

For those of you who didn’t get a chance to dial-in to the call yesterday, our expert call with Jim Rickards was fascinating to say the least. Rickards touched on myriad topics ranging from chaos theory to countries in crisis reverting back to the gold standard to China buying the Euro. It was a privilege to be able to get so deep into the brain of a man as diverse as he is. Luckily, we live-tweeted the call and then put up a post highlighting the best points that Jim mentioned. You should check it out this morning if you haven’t already – this is the kind of stuff that gets your brain’s cogs turning.

 

URL: http://app.hedgeye.com/unlocked_content/22860-our-expert-call-with-jim-rickards

 

 

SPREAD RISK

The market may or may not have a boiling point. That’s more of a subjective call in terms of what your trading and investing strategy is. But in the big macro picture, there are a few relationships that are important to pay attention to. Measuring this spread risk in the market can help you make your next move accordingly. Keith highlighted three relationships in this morning’s Early Look we think are worth reiterating:

 

1.                    The long-term spread between Money Supply (rising as they print money) and Velocity of Money (falling, fast)

2.                    The long-term spread between the US Dollar and the CRB Commodities Index

3.                    The long-term spread between the SP500 priced nominally versus priced in Gold

 

_______________________________________________________

 

ASSET ALLOCATION

 

Cash:                  Flat

 

U.S. Equities:   Flat

 

Int'l Equities:   Flat   

 

Commodities: Flat

 

Fixed Income:  Flat

 

Int'l Currencies: Flat  

 

 

_______________________________________________________

 

TOP LONG IDEAS

 

NIKE INC (NKE)

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.

  • TRADE:  LONG
  • TREND:  LONG
  • TAIL:      LONG            

 

FIFTH & PACIFIC COMPANIES (FNP)

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.

  • TRADE:  LONG
  • TREND:  LONG
  • TAIL:      LONG

 

LAS VEGAS SANDS (LVS)

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.

  • TRADE:  LONG
  • TREND:  NEUTRAL
  • TAIL:      NEUTRAL

  

_______________________________________________________

 

THREE FOR THE ROAD

 

TWEET OF THE DAY

“Handlesblatt claims Weidmann may threaten to resign if ECB bond buying plan goes ahead and/or he does not get German govt support” -@OwenCallan

 

 

QUOTE OF THE DAY

“A wise man gets more use from his enemies than a fool from his friends.”– Baltasar Gracian

                   

 

STAT OF THE DAY

$3.1 billion. The price Scotiabank is paying to gobble up ING’s Canadian business.

 

 

 


DRI: EXPECTATIONS ARE THE ROOT OF ALL HEARTACHE

Takeaway: "Growth" remains the religion of choice at $DRI. The trends are not sustainable and something's got to give

Darden’s Annual Report arrived this past weekend and made for some great reading.  The primary takeaway for us was that the “growth” ethos at Darden is as entrenched as ever.  Against a backdrop of sustained traffic declines, it is jarring to read the following sentence: “Our brands have strong individual and collective growth profiles”.   We think management is setting itself up to miss expectations.

 

If you have read our Darden Black Book you are aware of our conviction that the continued acceleration of Darden’s new unit growth over the past couple of years has served to mask evidence of a secular decline in the company’s two most important brands.  The Letter to Shareholders in the Annual Report contains no evidence of management slowing growth any time soon.  Management’s growth targets are bold to say the least.  How they get there while maintaining the financial health of the company remains to be seen.

 

This is not the first time we’ve held a view on a stock that is diametrically opposite to that of management.  MCD and SBUX were two names I went against the grain on in 2002 and 2006, respectively.  Of course, we’ve been wrong before but feel strongly about our thesis on Darden.  Conversations with clients and industry experts, without exception, have increased our confidence in our thesis.  This thesis is not going to play out today or tomorrow; we are aware that we are early on this one. 

 

 

It’s Not The Economy

 

Darden’s annual report suggests that management sees the economy as the biggest issue facing the company and, furthermore, sees weakness in trends at its core brands as being transitory in nature.  The longer-term view, as defined by the data, suggests an altogether different story.  On a very basic level, we believe that companies acknowledging their issues are generally more apt to arrive at solutions.  The traffic trends at Olive Garden and Red Lobster clearly are demanding action of management.  The economy is undoubtedly a factor but the poor performance of the “Big Two” versus the Knapp Track casual dining benchmark is a clear indication that the company’s sluggish traffic trends are not entirely attributable to the macroeconomic environment.  The data points that we are pointing to – traffic trends – as a primary reference for our thesis are indicative of, at least in part, self-inflicted wounds. 

 

DRI: EXPECTATIONS ARE THE ROOT OF ALL HEARTACHE - OG RL comps details

 

 

If the company has become dependent on growth as a drug for all ailments, the Annual Report suggests that management does not seem to have freed itself from the “denial” stage of its addiction.  Stating that the “core brands remain highly relevant to restaurant consumers” can be supported by pointing to the average unit volumes at Red Lobster and Olive Garden as being some of the strongest in the industry.  We believe this statement to be misguided, however, when considering same-restaurant sales trends – a far more relevant metric when assessing relevance to the consumer:

  1. Red Lobster’s two-year average same-restaurant sales have declined over 10 of the last 16 quarters
  2. Olive Garden’s two-year average same-restaurant sales have declined over 8 of the last 16 quarters.

Red Lobster’s positive traffic trends in FY12 were driven largely by aggressive discounting while Olive Garden’s most recent data is deeply concerning.  The charts below illustrate the cumulative price and traffic trends for Olive Garden and Red Lobster relative to FY08.  Price has been taken steadily while traffic has generally trended lower with the exception of brief spurts into positive territory driven by LTO discounting.  Our concern is that the core brands of Darden, whether deemed relevant or not by management, are losing appeal for consumers as time goes by. 

 

The remedy for what ails Olive Garden, a system with 430 restaurants in need of remodeling, is not going to materialize imminently.  We believe that more dramatic measures may be needed to boost the competitiveness of the “Big Two”. 

 

DRI: EXPECTATIONS ARE THE ROOT OF ALL HEARTACHE - OG RL cum traffic

 

 

What’s Consistent About Darden’s Margins?

 

The Darden Annual Report states, “our success will be driven by strong total sales growth and consistent margin expansion as we leverage our collective experience and an increasingly efficient support platform.”  We would like to address this quote in two parts. 

 

First: “consistent margin expansion”.

 

Darden’s EBIT margins are consistent in their absolute level but they are not expanding.  Contributing to Darden’s strong EBIT margins are the company’s restaurant level margins which were 23% in FY12.  Darden stands alone among the companies we follow in terms of its margins but we find it difficult to believe that significant expansion in that metric is likely from here given the reality of Olive Garden and Red Lobster’s traffic trends.

 

The outlook for margins is far more important than what is in the rear-view mirror and we contend that the need to improve the relative value proposition at Olive Garden and, to a lesser extent, Red Lobster is likely to lead to an easing in pricing trends.  Maintaining restaurant operating margins under this scenario will likely be difficult.  At the Analyst Meeting in February, management was vocal about lower menu prices improving traffic and allowing Darden to leverage G&A, thereby offsetting the restaurant operating margin decline and even expanding EBIT margins.

 

Second: “our success will be driven by strong total sales growth”.

 

Total sales growth has been strong but rather than focus on total sales or average unit volumes, we focus on traffic and comparable-sales trends as true indicators of top-line health.  Leveraging the balance sheet to buy top line growth is not a winning strategy, particularly for a stock whose ownership seeks stability and yield.  Traffic trends are expected to decline in FY13.

 

 

Operating Cash Flow Targets a Little Rich

 

Darden is projecting a doubling of its operating cash flow over the next five years despite its best-in-industry margins being at peak levels with traffic trends slowing.  This is a lofty goal when we consider that operating cash flow has declined 1% since 2008.  How does the company get there?

 

DRI: EXPECTATIONS ARE THE ROOT OF ALL HEARTACHE - dri operating cash flow

 

 

The chart, above, taken from the company’s Annual Report, shows that the company is guiding to operating cash flow doubling to $1.4-1.6 billion by FY17.  The company is also guiding to sales of $11.5-12.5 billion in the same year.  Looking at operating cash flow margin over the last five years, it seems that FY17 will have to be a very good year for the company to hit its implied target of 12.5%.  Over the past five years only once, in FY10, with 12.7%, did the company achieve or better the operating cash flow margin that is implied by the FY17 estimates.  FY10, it is also worth remembering, saw food and beverage costs decline 6.8% in what was the only year of the last five during which this cost declined for Darden.

 

In order to double its operating cash flow over the next five years, the company will require a sizeable recovery in sales at its two largest brands.  At a minimum, we believe that Olive Garden is two years away from a sales recovery beginning.  Over the past five years, from FY08 through FY12, the company has spent $2.6 billion to generate an incremental $242 million in EBITDA. 

 

 

Big Promises

 

The company has made the following commitments to its shareholders for the period ending FY17.

  1. SRS of 2-4% with 1-2% in FY13
  2. 500 new stores or ~$3.4 billion in capex (Hedgeye estimate)
  3. 2x operating cash flow to $1.5 billion
  4. Cumulative dividends and share repurchases of $3.2 billion

We believe these are tall orders, individually and collectively, for the company to deliver.  We will address these targets below:

 

Same-restaurant sales of 2.4% are dependent, according to management, on “normal” economic conditions (whatever that means).  Historically, the company has had pricing of 2-3% included in its comps but we believe that the primary brands’ pricing power will be diminished going forward.  Traffic in the casual dining industry declined 40 basis points in 2011 and 90 basis points over the last twelve months, according to Malcolm Knapp’s Casual Dining Same-Restaurant Sales Index. 

 

New restaurant growth is a key focus for Darden and the company has sufficient cash flow to grow 500 units over the next five years.  The more salient question is whether or not the company should allocate that capital to 500 new units over the next five years.  We believe the company should slow growth given decelerating Returns on Incremental Invested Capital.

 

Operating cash flow is unlikely to double in five years given the current run-rate of capital spending.  We anticipate roughly $3.4 billion of capex between now and the end of FY17.  As we highlighted earlier, operating cash flow margins need to expand significantly (300 bps) from FY12 to FY17 in order for operating cash flow targets to be made, assuming the sales guidance comes to fruition.

 

Returning cash to shareholders is a key Darden selling point.  The 3.8% dividend yield is highly appealing to investors and, since FY08, the company has raised the dividend 150% while EPS has grown 31%.  More importantly, the operating cash flow of the company has declined 1%, from $767 million to $762 million, between FY08 and FY12.  In order to pay the dividend and accomplish other capital-intensive goals, the company has burned through $689 million in cash.  In FY12, dividend and capital spending accounted for 113% of operating cash flow.  As a result, adjusted debt/EBITDA at the beginning of FY13 was 62% (prior to the recent acquisition), leaving the company little room to maneuver from an operational perspective and raising the stakes should margins decline.  The company’s long-term goal of returning $3.2 billion in cash to shareholders is dependent on expanding operating margins.  If this does not materialize, either the dividend or capex will need to be cut.

 

DRI: EXPECTATIONS ARE THE ROOT OF ALL HEARTACHE - DRI unsustainable

 

 

Conclusion


Senior management at DRI has a very ambitious 5-year plan, where there is very little room for error.  As we see it for management to accomplish this 5-year plan the following must happen:

  1. RL and OG need to improve traffic trends ASAP with no margin degradation.
  2. The company needs to leverage 2-4% same-store sales with little pricing
  3. Enterprise wide cost cutting is must
  4. Real estate site selection must be perfect and new unit sales trends must be above average
  5. Margin expansion is a must and there is little room for food or labor inflation (the impact of the new heath care will likely be inflationary)
  6. The company must overcome significant macro/demographic headwinds
  7. Darden must protect share against some rejuvenated competitors in EAT and BLMN
  8. Margins must be maintained as increased leverage is going to limit the operating flexibility of the company

We believe that Darden could, even while achieving its cash flow targets, burn through between $550-650 million in cash between FY13 and FY17.  The current path for Darden looks to be fraught with risk and largely unsustainable in its current form.

 

 

Howard Penney

Managing Director

 

Rory Green

Analyst

 

 


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Follow The Lightning

This note was originally published at 8am on August 16, 2012 for Hedgeye subscribers.

“I follow the lightning, And draw near to the place that it strikes.”

-Navajo Chant

 

Now I know that a lot of our clients want to talk about what consensus versus contrarian thinking is, in this no-volume marketplace, but I’m thinking they’d have a tough time advising their kids to go hard core contrarian like the early 19th century Navajos did.

 

Admittedly, I am developing a Darwinian confirmation bias in my reading list this summer as I delve into more Native American history with a book I started reading this week titled Blood and Thunder – “The epic story of Kit Carson and the Conquest of the American West.”

 

Whether it was the ability of the Navajo and Comanche tribes to adapt and survive the late 18th and early 19th centuries, or it’s what you are staring at on your screen this performance chasing morning, our goals remain common in human nature; evolve or die.

 

Back to the Global Macro Grind

 

Buy stocks or bonds?

 

Rarely can I time that question as critically as I’ll timestamp it this morning. Yes, these are the thralls of August. But Mr Macro Market couldn’t care less about our summer vacations. Timing matters right here and now, big time.

 

Timing was especially important in answering this same basic asset allocation question in the middle of March 2012 (see Darius Dale’s Chart of the Day): 

  1. Stocks wouldn’t go down
  2. Bonds wouldn’t go up
  3. Volatility went away 

In fact, by the time the VIX hit 14.26 on March 26th (the Russell2000 topped for 2012 on the same day at 846, +5.2% higher than where it is today), there was a massive consensus (both buy and sell side)  that “growth was back” and “earnings are great.”

 

Fast forward to June… and US stocks were gasping for air in the middle of a double-digit drawdown (Russell2000 and SP500 down -13% and -10% from their late March highs) as US Treasuries put on a massive move to the upside (10yr yield dropped -42%, from 2.4% to 1.4%).

 

What drove the correct answer to the stocks vs bonds question?

 

Global #GrowthSlowing. Period.

 

What will get you to the correct answer for the next 1-3 months, from here?

 

Follow The Lightning.

 

The most abysmal volume and volatility readings I have ever recorded in my US Equity model aside, there are 2 basic realities that both bulls and bears have to deal with this morning: 

  1. US stocks are making both intermediate and long-term lower-highs
  2. US bonds are making both intermediate and long-term higher-lows 

In other words, if you believe Growth is going to improve from here, you buy stocks. If you’re more confident (like we and the data are) on #GrowthSlowing, you buy bonds.

 

Our predictive tracking algorithm (the one that called for #GrowthSlowing when few did in March), which is a multi-factor, multi-duration model, is telling us that this is a fairly straightforward call to make because:

 

A)     Oil prices are up +32% (Brent) from the June low (that slows growth)

B)      Corporate Revenue growth’s slope is as weak as it has been, globally, since Q308

C)      Chinese Growth continues to surprise on the downside

 

Chinese what? Yes, while I suppose you could say that China’s Foreign Direct Investment (FDI) print this morning of -9% year-over-year was better than India’s Export growth tanking to -15% year-over-year earlier this week, we highly suggest you take China’s word for it:

 

“In the second half, China’s foreign trade and export situation will be more grim, there will be more difficulties, harder tasks, and the pressure of achieving the full-year target will be bigger…” –China Ministry of Commerce (this morning)

 

Now, before you zap me with the bull counterpoint (for stocks) to this (rate cuts, stimuli, bailouts, etc.), just remember that doing more of the same will only keep food/energy prices higher (and growth slower) for longer. That’s bullish for bonds, longer term. And our long-term TAIL risk line for growth (bond yields) remains intact at 1.94% on the US Treasury 10yr.

 

My immediate-term support and resistance ranges for Gold, Oil (Brent), US Dollar, EUR/USD, 10yr UST Yield, and the SP500 are now $1601-1612, $111.69-116.21, $82.34-82.97, $1.22-1.24, 1.56-1.82%, and 1391-1410, respectively.

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Follow The Lightning - Chart of the Day

 

Follow The Lightning - Virtual Portfolio


THE M3: PONTE 16

The Macau Metro Monitor, August 30, 2012

 

 

PONTE 16 TARGETS PHASE 3 OPENING BY 2014 Macau News

Hong Kong-listed Success Universe Group Ltd. said the target completion date for Phase 3 of Ponte 16 is 2014.  Phase 3 will comprise of an entertainment and recreation complex including a shopping arcade, restaurants and “space for gaming expansion.”  Ponte 16 is 49% owned by an indirect subsidiary of the company, while 51% is owned by SJM.




Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.33%
  • SHORT SIGNALS 78.51%
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