“Wherever there is human judgment there is potential for bias.”
That’s a quote from an excellent chapter titled “Are You Smarter Than A Television Pundit” in The Signal and The Noise. Before he moves onto baseball, Silver does a nice job differentiating between quantitative versus qualitative opinions in the partisan media.
“So you will need to adopt some different habits from the pundits you see in TV. You will need to learn how to express – and quantify – the uncertainty in your predictions. You will need to update your forecast as facts and circumstances change.” (pg 73)
If that sounds familiar, it should. This is all encompassing in Hedgeye’s founding principles of establishing Transparency, Accountability, and Trust through independent research. Journalists are not analysts. And only the great analysts in our profession embrace the uncertainty of there being a high probability of being wrong. It’s ok to say it like that. We’re not on TV.
Back to the Global Macro Grind…
China’s 7.4% GDP report for Q3 of 2012 provides a great example of where we were wrong this morning. In our Monday research meeting we discussed what we thought was a heightening probability that Chinese GDP surprised on the upside. It didn’t.
Now if you turn on the radio or TV this morning, you’ll probably see something very different than what I just wrote (or what I have been writing on Twitter). Since most of these sources are journalistically driven, they obviously don’t have forecasting models. Instead, they anchor on other people’s content (the sell-side’s), which at times can be even worse than a journalist’s opinion.
“China beat”, “China has bottomed”, “China is not Spain” – scanning the Old Media’s headlines will get you spew like that. Whereas I we’ll just show you the data within our analytical framework:
- China’s Q3 2012 GDP of 7.4% slowed sequentially (quarter-over-quarter) from 7.6% in Q2
- China’s Q3 2012 GDP of 7.4% slowed -19% year-over-year versus 9.1% in Q3 of 2012
- China’s Q3 2012 GDP of 7.4% slowed more than the low-end scenario in our forecasting model of 7.6%
In other words, across our risk management durations (TRADE, TREND, and TAIL):
- TAIL (3 years or less) – China continues to slow, and surprise both its government and the world on the downside
- TREND (3 months or more) – China continues to slow, at an accelerating rate, sequentially
- TRADE (3 weeks or less) – China’s stock market just moved to immediate-term TRADE overbought on the news
Maybe China has “bottomed.” But I have no high-probability edge on that and neither do you. Or, let me say that more democratically – if you can send me a model that shows me why and how China just bottomed, I’m happy to look at how you’ve analyzed the Chinese government’s made-up numbers. I’m even happier to change my mind.
Made-up, or Madoff? Yes, both American and Chinese guys make up the numbers. And this makes it all the more difficult to make a macro forecast that something has “bottomed” or “topped” with a straight face. It might get you on TV however.
Having had to learn from all the mistakes I have made the hard way, the best risk managed opinion I can give you is that both tops and bottoms are processes, not points.
In forecasting “Principle #1: Think Probabilistically” –Nate Silver
“Instead of spitting out just one number and claiming to know exactly what will happen, I instead articulate a range of possible outcomes.” (page 61)
I don’t love everything Silver thinks, but I do love that. That’s the closest thing I have read in the last year to what we call our Risk Range. That’s what you see at the bottom of every Early Look - our immediate-term range of probable upside/downside (risk) – and I think most people would say that’s the most accurate and repeatable forecast we give you every morning.
So skip my rants and go to the bottom of the note - save yourself some time.
One more point on China - to get Commodities right, we think you need to get the Dollar, Supply, and Demand right. If you think China has “bottomed”, you’re going to have a very different long-term forecast than ours right now. The risks are rising that there’s a decade long-cycle of price and demand topping.
Everything that happens in Macro that matters most happens on the margin. And if the new long-term range of Chinese GDP growth is 4-8% instead of what it’s been (8-12% for the last decade), that could matter, big time.
If and when we get that wrong, we’ll write about it transparently and accountably that morning.
Our immediate-term risk range for Gold, Oil (Brent), US Dollar, EUR/USD, UST 10yr Yield, Shanghai Composite, and the SP500 are now $1, $112.60-115.05, $79.01-79.69, $1.29-1.31, $1.73-1.83%, 2066-2139, and 1, respectively.
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
Takeaway: We remain bearish on $GMCR
Our recent post, “HOW THE MIGHTY (GMCR) HAS FALLEN”, outlines our current thoughts on Green Mountain. Today’s news, that the company has appointed Gerard Geoffrion – head of its Canada Division – as President Of International Business Development has led the stock higher. We remain negative on Green Mountain. From a quantitative perspective, Keith likes it on the short side at these levels. He added GMCR to our Real Time Positions on the short side earlier today.
From a fundamental perspective, the issues facing this company are legion:
- GMCR’s brand portfolio is – to put it lightly – weak
- Increasing competitive pressure is compressing already-razor-thin margins
- The K-Cup patent having expired allows brands such as Starbucks and Dunkin’ Donuts to detach themselves from licensing agreements with Green Mountain
- We expect Starbucks to part ways with Green Mountain at some point. They did so with Kraft by reason of wanting to control their brand and consumers’ experience of it. They will part with Green Mountain for similar reasons.
- Caribou has expressed reservations about the lack of control it has over its club volumes. GMCR’s pricing strategy has negatively impacted CBOU’s profitability. This could harm the relationship going forward and, if typical of other licensees’ experience, could be a negative for GMCR going forward.
- GAAP EPS may turn negative in FY13 as declining margins, negative cash flow, and competitive pressure comes to bear on financial results.
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Takeaway: We are pulling back on our bearish stance ahead of $DNKN's 3Q print on 10/25.
We had a candid conversation with the top brass at Dunkin’ Brands yesterday. Given the timing of the call, and the fact that we have not been positive on the name, we took the call as a bullish sign in and of itself. The details were reassuring and several grey areas were clarified to our satisfaction.
Dunkin’ reaching out to us to schedule a call eight days before the company reports its 3Q earnings was surprising. If you have kept abreast of our writing on Dunkin’ over the past year, we have been critical of the company’s ability to execute on the long-term domestic growth projections that whipped up such excitement as the company came public. On top of that, we have been skeptical of actual same-store sales results meeting expectations in the back half of 2012. Same-store sales are not nearly as important for Dunkin’s profitability as unit growth, given the franchised nature of its business model, but comps do seem important from an investor sentiment standpoint. Below, we address these two aspects of the Dunkin’ story and update our thoughts.
We have consistently voiced our concern about what we perceived as a lack of disclosure, on management’s part, around the company’s new store pipeline. As was explained to us yesterday, in what we thought was a very transparent manner, the company’s future unit growth is partly stemming from existing franchisees. In 2012, 60% of new unit growth is accounted for by existing franchisees. Management explained to us the difficulty they have in calculating the backlog because of the undefined nature of existing franchisee commitments. Many franchisees are seeking to growth their businesses but, given the high level of concentration in existing markets, are looking west for that opportunity.
We have been concerned about 2H12 trends from a headline perspective as expectations are for a V-Bottom in two-year average trends through year end. We argued that even holding two-year average trends flat was likely overly bullish. We still believe that a same-store sales miss is possible but see the investments in technology and strong performance of recent food items at Dunkin’ as strong positives. We have seen with DPZ and SBUX that technology can have a significant impact on through-put, transactions, and both employee and customer-satisfaction.
The overall tone from management was very bullish. The entire senior management team was on the call to directly convey the message and extend an invitation to us to meet with them in person to dig deeper into store-level returns and the company’s growth outlook. We will be taking management up on the offer as soon as time permits.
For now, ahead of the 3Q print, we are pulling back on our bearish stance on Dunkin’. Concerns remain, but we believe that the positive aspects of this story are sufficient to warrant the current valuation.
Takeaway: $MCD is facing difficult top-line compares through February. Despite the attractive 4% yield, we are staying on the sidelines - for now.
McDonald’s reports its 3Q results on Thursday before the market open. The sales results, and outlook, will likely drive the stock price reaction. Global growth slowing is a significant headwind for McDonald’s. We believe that September same-restaurant sales in the US grew in line, or slightly ahead of, what consensus is expecting.
Plenty Becoming Concerned About “Plenty To Be Concerned About”
The sell-side has gradually become less bullish on MCD since April 23rd, when we highlighted our concerns about the macro environment and lack of a new product pipeline in the US that could maintain sales momentum through the summer. We wrote that there was “plenty to be concerned about” for MCD going forward and saw JACK as a better long idea at the time. Six months later, we believe that we are nearing a point where MCD becomes attractive on the long side, but would reiterate our call to remaining on the sidelines through this print and for the time being.
We expect further negative revisions to McDonald's earnings estimates as several headwinds come into view. Difficult compares in the US for 4Q and 1Q, driven by strong underlying performance and favorable weather, and continuing macro headwinds in Europe, are the primary pillars of the bear case. We believe that there could come a point where, from a US sales perspective, consensus becomes too bearish. In general, McDonald’s finds a way to translate economic growth in the US into consistent sales and profit growth in its business by virtue of its omnipresence throughout the country and management’s continuing investment in the product pipeline and asset base. As the chart below indicates, industrial production has led the general trend of MCD US comparable sales growth over the last few years. This is not useful from a quarter-to-quarter perspective, but we use this metric when considering consensus expectations 6-12 months in the future. In conjunction with other analysis, we using this chart to ascertain if and when consensus becomes too bearish on McDonald’s trends.
Below we go through what we would view as good, bad, or neutral comparable restaurant sales numbers for McDonald’s three regions in September. For comparison purposes, we have adjusted for historical calendar and trading day impacts (but not weather).
Compared to September 2011, September 2012 has one less Thursday, one less Friday, one additional Saturday, and on additional Sunday. We expect this to have a positive impact on September’s headline numbers. On average, we expect the impact to be in the region of 1.5%.
United States – facing a compare of 5% including a calendar shift of +0.4% to +1.2%, varying by area of the world:
GOOD: A print above 3.0% would be received as a strong result by investors as it would imply calendar-adjusted two-year average trends in line with August. Additionally, following negative traffic in August with a sequential improvement to flat-to-positive guest counts would be encouraging. We are anticipating a print of 2.5-3.0% for McDonald’s US business in September.
NEUTRAL: Same-restaurant sales growth of 1.5-2.5% would be received as neutral by investors as it would imply roughly flat calendar-adjusted same-restaurant sales and traffic growth versus August. Consensus estimates misrepresent the true expectations of the sell-side, in our view, due to consistent outliers to the downside month after month. We think investors are anticipating a print of 2.5% versus 2.1% Consensus Metrix.
BAD: A headline comp of less than 1.5% same-restaurant sales growth would be negative for MCD, especially given that the company is taking roughly 3% price in the US.
Europe – facing a compare of 6.9% including a calendar shift of +0.4% to +1.2%, varying by area of the world:
GOOD: A print of more than 1% would be received as a strong result by investors as it would imply acceleration in calendar-adjusted same-restaurant sales growth from August to September. We expect continuing strength in Russia, the UK and France but, even in the event of an upside surprise versus consensus, we expect investors to proceed with caution where Europe is concerned. We expect a print of between 0-0.5% for McDonald’s Europe business in September.
NEUTRAL: A print of 0-1% would be a neutral result for Europe as it would imply trends roughly in line with expectations and would provide some reassurance of MCD’s ability to take share on an ongoing basis.
BAD: Negative growth in Europe for the month of September would imply the second such disappointment of 3Q. McDonald’s has not printed two negative months in the same quarter in Europe for 29 quarters.
APMEA – facing a compare of 6.8% including a calendar shift of +0.4% to +1.2%, varying by area of the world:
GOOD: Same-restaurants sales growth of 1.5% or more would be received as a good result as it would imply an acceleration in calendar-adjusted two-year average trends versus August. With the backdrop of negativity on China’s economic outlook, an acceleration in trends into the end of 3Q could be encouraging. We are anticipating a print of 1.0% for McDonald’s APMEA business in September.
NEUTRAL: A print between 0.5% and 1.5% would be considered neutral for investors as it would be roughly in line with consensus, per Consensus Metrix.
BAD: Below 0.5% would imply continuing weakness in calendar-adjusted two-year average trends.
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