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CMG FREE FALLIN’

Takeaway: CMG's decline is not finished. Investors will likely assign a lower multiple to a lower cash flow estimate before this stock bottoms

We believe that CMG is a broken stock not a broken company.  The stock will likely trade much, much lower over the next six months from where it is trading after hours.

 

Chipotle reported very disappointing 3Q12 results and, most importantly, guided to flat-to-low-single-digit comparable restaurant sales growth for FY13 versus the Street at 5%, according to Consensus Metrix. 

 

Earnings could grow at a mid-single-digit pace versus 21% consensus as margins, while difficult to say, could contract to 20-25% depending on how food costs trend over the year.  The biggest impact to the share price, we believe, could come from multiple contraction as investors decide how much they will pay for flat-to-LSD comp growth and declining margins. 

 

 

Outlook

 

Revenue is set to miss current investor expectations in FY13 as comps are projected to grow between 0% and low-single-digit.  4Q12 comps are likely to decelerate from 3Q12 as unseasonably warm weather in December 2011 helped set up a difficult compare for this quarter.  Unit growth is expected to accelerate to 165-180 from a projected 165 this year. 

 

Margins are likely to come under pressure as food inflation is expected to ramp up in 2013.  Additionally, margins will likely contract significantly due to sales deleverage alone.  The implications of sales slowing to the degree that management is expecting are difficult to gauge but we believe that earnings growth could be in the mid-single-digit range for FY13 versus current expectations of 21%, per Bloomberg.

 

The company estimates that its FY13 tax rate will be 39% and announced an additional $100mm stock buyback authorization in conjunction with today’s earnings.

 

 

Recap

 

3Q12 earnings missed across the board but it was the outlook that was most impactful for the stock price.

 

Revenue came in light as same-restaurant sales growth was just shy of expectations.  New unit volume growth was negative for the second successive quarter but remain in the $1.5-1.6mm range.  Management said that it was happy with its transaction trends but fewer beverage orders, possibly due in part to fewer large online orders and an increase in to-go orders.  Management did not directly name Taco Bell but addressed speculation that “a competitor” was taking share, stating that 2Q and 3Q traffic trends were sequentially level and that there interpretation is that none of the rumored market share shift had occurred. 

 

Margins narrowly exceeded expectations as cost of sales benefited from favorable avocado prices which offset rising steak, chicken, and rice prices.  Labor and other operating costs benefitted from higher restaurant sales; we expect these line items to turn unfavorable in 2013 as sales growth slows. 

 

CMG FREE FALLIN’ - cmg earnings recap

 

CMG FREE FALLIN’ - cms pod1

 

 

Howard Penney

Managing Director

 

Rory Green

Analyst

 


Chinese Construction Materials Prices Rally (Back To 2009 Lows)

Takeaway: In our view, a much larger rally in steel, coal, iron ore and other key Asian commodities would be need to improve $CAT's 2013 outlook.

Chinese Construction Materials Prices Rally (Back To 2009 Lows)

  • Investor Area of Focus:  We have received questions on the bounce in construction materials prices in China, suggesting that positive sentiment for mining equipment producers remains at healthy levels. 
  • CAT Guidance: Caterpillar will give 2013 top-line guidance when it reports this Monday.  We believe there is a high probability that management will disappoint, although we note that consensus has dropped significantly since our September 14th Black Book.  We will also be looking for trends in implied orders and order cancellations/delays.
  • Bounced How Much?:  We track real rebar prices, among other indicators, to get a real-time sense of Chinese construction activity.  The rebar price agrees with land sales, construction equipment sales and company comments (e.g. Danaher and American Express today):  Chinese activity continues to be weaker than expected.

Chinese Construction Materials Prices Rally (Back To 2009 Lows) - rebar update

 

 

 

 

 

Jay Van Sciver, CFA

Managing Director


HEDGEYE RISK MANAGEMENT
120 Wooster St.

New York, NY 10012


 


TRADE OF THE DAY: TLT

Today we bought the iShares Barclays 20+ Year Treasury Bond ETF (TLT) at $119.92 a share at 3:24 PM EDT in our Real Time Alerts.

  

Earnings continue to slow, coinciding with our #EarningsSlowing theme we’ve been focused on over the past month. Google (GOOG), Intel (INTC) and FedEx (FDX) are all perfect examples of the trend. Thus, we are buying bonds are higher-lows. Here’s what Keith McCullough had to say in a note put out early this morning:

 

10YR – seeing one of the many moves we have seen in 2012 of bonds selling off fast, but the 10yr yield making consecutive lower highs; seeing that again this morning at 1.81% vs the 1.89% we saw at the Bernanke Top in SEP #EarningsSlowing


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CRI: Insider Buying And Selling

Carter's (CRI) insiders have had a fabulous record of trading the stock as you can see in the chart below (red = sell, green = buy). With the recent insider selling that's been going on, we wouldn't be a buyer if the past is indicative of anything. We remain short CRI in our Real Time Alerts.

 

CRI: Insider Buying And Selling - cri insider1


Conversations On Google

The surprise release of Google’s third quarter earnings report during market hours today has the Twitterverse abuzz. We went to our @Hedgeye followers, as well as followers of @KeithMcCullough, for their reaction. Here’s what they had to say:

 

@KeithMcCullough: If someone can pin the $GOOG leak (on the rev/eps miss) to an analyst, whatever is left of the Old Wall is coming down

 

@firstadopter: Jon Fortt on CNBC: "Google had been calling around for the past couple days trying to prepare analysts for this report not to look so great"

 

@OwenRogers4: @Hedgeye If as was just stated on cnbc goog had been calling around to prepare analysts is that not serious reg FD violation

 

@HedgehogTrader: Probably not a good idea. Shoulda waited for Saturday afternoon. RT: @Hedgeye What are your thoughts on the early $GOOGearnings release?

 

@NorthmanTrader: @Hedgeye the SEC better take a very close look at all the put trades...hard to believe anyone could be that incompetent...

 

@BreckBooo: @Hedgeye I expect the numbers to look better when released after the bell. : )

 

@SwingTrader2012: @KeithMcCullough Considered the most technologically advanced company in the universe, GOOG 's financial reporting has a glitch.

 

@PhattyCorey: @KeithMcCullough do you think someone will actually get caught for this leak or is that bad for this "fair market vacuum system" we have?


COULD THE ELECTION, THE FISCAL CLIFF AND THE DEBT CEILING ALL BE BULLISH CATALYSTS FOR THE MARKET?

Takeaway: Outcomes are far too binary to warrant relying on predictions; rather, it’s best to focus on the scenarios to set oneself up to act quickly.

SUMMARY BULLETS:

 

  • Most of the post-election outcomes are far too binary to warrant relying on predictions; rather, we think it’s best to focus on the scenarios to set oneself up to act quickly and accordingly.
  • Interestingly, we outline multiple scenarios where POLICY catalysts that are currently perceived as negative actually point to further upside to “risk assets” over the intermediate term.
  • In an Obama/Democrat-led Congress scenario, we could see stocks and commodities rip to new highs in Venezuela-like fashion. In a Romney/Republican-led Congress scenario, we could see the FX market begin to price in a material strengthening of the US dollar; that would likely be very bad for stocks and commodities – at least in the near term.
  • Below we outline two scenarios for the Debt Ceiling. In Scenario A (details below), the Treasury is scheduled to hit the Debt Ceiling sometime in MAR ’13; in Scenario B (details below) – the more reasonable of the two scenarios based on the timing of fiscal year expenditures and tax collections – the Treasury is due to breach the ceiling in JAN ’13.
  • A debt ceiling breach could actually wind up being a positive near-term catalyst for the economy, on the margin, if both parties use it as bait during negotiations to mitigate the fiscal cliff as they see fit. In classic Poli-Sci 101 fashion, US policymakers may have effectively created a problem they are likely to seek credit for “solving” at a later date. That would be a real upside risk to consider as it relates to the prices of “risk assets” over the intermediate term – again, assuming a status quo election outcome.
  • While the Fed is currently on course to grow its balance sheet by ~$85 billion per month though year-end and by at least an additional $40 billion per month indefinitely from JAN, we could actually see them respond with incremental Policies To Inflate early in 2013 if the Fiscal Cliff is deemed by them to be an incremental drag on “the economic recovery”. It is likely that members of the FOMC largely anticipate some form of fiscal compromise, but to the extent the fiscal cliff is not completely averted, we could see the Fed announce what would be interpreted by the market as QE4 in short order. 
  • While a growing number of investors have bought into our long-held view that Policies To Inflate do little more than perpetuate slow economic growth via commodity inflation, it would be hard to dismiss the broader institutionalized pressure in our industry to chase “risk assets” to another long-term lower-high(s) in this scenario.

 

How many times have you seen a research report detailing election year returns and post-election cycle performance? While economic history and historical context are always a plus, it typically doesn’t pay to make risk management decisions based upon past performance. As we all learn when we become FINRA certified, “past performance does not predict future outcomes” and even though history often rhymes, we see no reason to treat the upcoming US political landscape like your run-of-the-mill US election. It isn’t. In this light, we use the prose and charts below to walk through exactly which catalysts and scenarios you should be focused on as it relates to the next 3-6 months of US POLICY – an increasingly important factor in our proprietary GROWTH/INFLATION/POLICY analytical framework.

 

CATALYST #1: GENERAL ELECTIONS

Over the past couple of weeks, Keith, Daryl, Matt and I have all been on the road meeting with clients and exchanging our thoughts on the election – an obvious catalyst atop many investors’ minds. From our vantage point, we continue to see the outcome of the election as having a “binary and demonstrable” impact on the US dollar and assets priced in USD. In the table below, we summarize our thoughts on the five most likely outcomes of the general election. We purposefully condense our work into the handy table below; email us if you’d like to engage in a deeper discussion on any of the conclusions.

 

COULD THE ELECTION, THE FISCAL CLIFF AND THE DEBT CEILING ALL BE BULLISH CATALYSTS FOR THE MARKET? - 1

 

The following is a list of probabilities of the various individual outcomes as determined by InTrade, a popular electronic betting market:

 

  • An Obama White House: 63.9%
  • A Romney White House: 36.1%
  • A Democrat Majority in the Senate: 66.4%
  • A Republican Majority in the Senate: 21%
  • A Democrat Majority in the House of Representatives: 8%
  • A Republican Majority in the House of Representatives: 92%

 

As it stands currently, InTrade speculators are widely predicting a continuation of the status quo (56.8% on an aggregated basis) on the federal leadership front. The next highest combo probability is a Romney White House, a Republican Senate and a Republican House of Representatives, at 20.5%.

 

As you note, we were keen to focus our scenario analysis on what we thought the impact of the combination would be upon the US dollar. This is because the performance of most liquid asset classes have diverged sharply from their underlying fundamentals in recent months and are largely hinging on expectations for the value of the currency they are priced in. The following is a sample of notable cross-asset class correlations to the DXY (trailing 60-days):

 

  • S&P 500: -0.93
  • EuroStoxx 600: -0.95
  • MSCI World Equity Index: -0.93
  • Gold: -0.97
  • High Grade Copper: -0.97
  • CRB Commodities Index: -0.73
  • US Junk Bond Yields (to Maturity): +0.92
  • US 5YR Breakeven Inflation Rate: -0.94
  • JPM Emerging Markets Currency Index: -0.83

 

Of course, correlations are never perpetual and only occasionally imply causality. As such, in either of the aforementioned scenarios, we would anticipate that these correlations eventually burn off as POLICY expectations get increasingly priced in and less ambiguous. That certainly does not mean the next few months will be easy to risk manage, however. In an Obama/Democrat-led Congress scenario, we could see stocks and commodities rip to new highs in Venezuela-like fashion. In a Romney/Republican-led Congress scenario, we could see the FX market begin to price in a material strengthening of the US dollar; that would likely be very bad for stocks and commodities – at least in the near term.

 

CATALYST #2: FISCAL CLIFF

The fiscal cliff is obviously a tough catalyst to handicap; this is specifically because any fiscal cliff resolution – an outcome implicitly implied by the Street based on 2013 Bloomberg Consensus GDP growth estimates and forward expectations for S&P 500 NTM EPS growth – depends largely on the outcome of the elections and the resulting partisan composition of the White House and Congress. Rather than waste your time with mere guesses as to what levers that could be pulled or added to the existing schedule of fiscal retrenchment, we think it’s more important to focus on timing of the debt ceiling and how that could impact negotiations, as well as any anticipated response(s) out of the Federal Reserve.

 

COULD THE ELECTION, THE FISCAL CLIFF AND THE DEBT CEILING ALL BE BULLISH CATALYSTS FOR THE MARKET? - 5

 

COULD THE ELECTION, THE FISCAL CLIFF AND THE DEBT CEILING ALL BE BULLISH CATALYSTS FOR THE MARKET? - 6

 

For a detailed primer on the fiscal cliff, please refer to our 10/2 note titled, “The Keynesian Trifecta . . . Taxes, Spending Cliff and Debt Ceiling” as well as our Q3 Macro Theme titled “Keynesian Trifecta” (email us for a replay of the conference call and presentation materials).

 

CATALYST #3: DEBT CEILING

We are keenly focused on the timing of the debt ceiling as it relates to its potential broader impact on various financial markets, as well as its impact on fiscal cliff negotiations. Currently, the Treasury is $195 billion away from hitting the $16.394 trillion debt ceiling agreed upon on JAN 27 of this year. As an aside, it’s very important to note that it’s not really a cliff, per se, as the budgeted impact will be theoretically long-lasting. Specifically, the incremental taxes and spending cuts will be enforced throughout the year and in subsequent years (i.e. $380-450 billion isn’t coming out of the economy all on JAN 1st, 2013). In reality, however, the shock is likely to depress consumer and corporate sentiment, which should ultimately translate to lower economic activity earlier in the process of fiscal retrenchment.

 

To the extent a breach is in play at/near the time of the fiscal cliff, which commences at the start of the new year, we think that will grant additional bargaining power to the Republican party to demand tax relief from the fiscal cliff (assuming a status quo government). In exchange for agreeing to hike the debt ceiling, the GOP may pursue stingier cuts to entitlement spending, thought it’s probability safe to rule out any meaningful structural reforms to those programs over the intermediate term. In this scenario, the Democrats are likely to attempt to mitigate the planned sequestration cuts to expenditures and are likely to pursue some form of tax relief as well (i.e. extending the Bush Tax cuts to members of the middle income households and below).

 

The more we think about it, a debt ceiling breach could actually wind up being a positive near-term catalyst for the economy, on the margin, if both parties use it as bait during negotiations to mitigate the fiscal cliff as they see fit. In classic Poli-Sci 101 fashion, US policymakers may have effectively created a problem they are likely to seek credit for “solving” at a later date. That would be a real upside risk to consider as it relates to the prices of “risk assets” over the intermediate term – again, assuming a status quo election outcome.

 

As it relates to timing, we are currently running two scenario analyses to determine when the Treasury breaches the debt ceiling:

 

  • Scenario A: We grow the existing stock of US sovereign debt at ½ the average pace of the monthly YoY % change in public debt outstanding over the LTM (we divide it by half to be conservative – giving Geithner the benefit of the doubt on manipulating the numbers); and
  • Scenario B: We grow the existing stock of US sovereign debt at ½ the average pace of the OCT, NOV, DEC, JAN, FEB and MAR YoY% changes in public debt outstanding since Obama has been president on a representative month-for-month basis (again, we divide it by half to be conservative – giving Geithner the benefit of the doubt on manipulating the numbers).

 

In Scenario A, the Treasury is scheduled to hit the Debt Ceiling sometime in MAR ’13; in Scenario B – the more reasonable of the two scenarios based on the timing of fiscal year expenditures and tax collections – the Treasury is due to breach the ceiling in JAN ’13. It’s important to note that the breach does not constitute a pending default by the US government. Recall the period from mid-MAY ’11 through mid-AUG ’11 where the US Treasury was technically at its statutory debt limit, but managed to keep the government functioning more-or-less smoothly by pursuing what Geithner has previously termed, “extraordinary measures”.

 

COULD THE ELECTION, THE FISCAL CLIFF AND THE DEBT CEILING ALL BE BULLISH CATALYSTS FOR THE MARKET? - 2

 

CATALYST #4: FEDERAL RESERVE

Despite its obviously dovish lean, the Federal Reserve is a real wild card here. While the Fed is currently on course to grow its balance sheet by ~$85 billion per month though year-end and by at least an additional $40 billion per month indefinitely from JAN, we could actually see them respond with incremental Policies To Inflate early in 2013 if the Fiscal Cliff is deemed by them to be an incremental drag on “the economic recovery”. It is likely that members of the FOMC largely anticipate some form of fiscal compromise, but to the extent the fiscal cliff is not completely averted, we could see the Fed announce what would be interpreted by the market as QE4 in short order.

 

While a growing number of investors have bought into our long-held view that Policies To Inflate do little more than perpetuate slow economic growth via commodity inflation, it would be hard to dismiss the broader institutionalized pressure in our industry to chase “risk assets” to another long-term lower-high(s) in this scenario. The upcoming FOMC monetary policy decisions on DEC 12, JAN 30 and MAR 20 are the key dates to keep on your calendar here.

 

It’s very important to note that the FOMC is poised to get even more dovish in 2013 with the additions of two of the more aggressive and outspoken doves in Chuck Evans (Chicago Fed Head) and Eric Rosengren (Boston Fed Head) to the voting chairs – though balanced out to a small degree by the additions of the moderate James Bullard (St. Louis Fed Head) and the hawkish Esther George (Kansas City Fed Head).

 

In the two charts below, we plot YoY and QoQ performance of the Fed’s Balance Sheet vs. the S&P 500 to show how US stock market operators have become increasingly reliant upon the Fed for performance and increasingly front-running the Fed’s actions – the both of which are fueling an obvious disconnect between the equity market and the economy (i.e. perversely, bad news is good for the market). It’s worth noting that in a handful of election + fiscal cliff + debt ceiling combo scenarios, there is substantial risk that the Federal Reserve incrementally eases US monetary policy over the next 3-6 months. That’s also a key upside risk to consider as it relates to your exposure to “risk assets” and inflation-oriented sectors within those asset classes.

 

 

COULD THE ELECTION, THE FISCAL CLIFF AND THE DEBT CEILING ALL BE BULLISH CATALYSTS FOR THE MARKET? - 3

 

COULD THE ELECTION, THE FISCAL CLIFF AND THE DEBT CEILING ALL BE BULLISH CATALYSTS FOR THE MARKET? - 4

 

All told, most of the post-election outcomes are far too binary to warrant relying on predictions; rather, we think it’s best to focus on the scenarios to set oneself up to act quickly and accordingly. Interestingly, we outline multiple scenarios where POLICY catalysts that are currently perceived as negative actually point to further upside to “risk assets” over the intermediate term.

 

Darius Dale

Senior Analyst


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