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German Data Misses!

Takeaway: Germany may be leading the political cart in the Eurozone, however its economy is not immune to the region’s downturn.

Positions in Europe: Long German Bunds (BUNL)


Today we received German PMI data and German IFO confidence figures – both missed!  Our quantitative levels also show that the German DAX recently broke through its immediate term TRADE support level, which is a bearish indication.

 

From the Preliminary October figures for PMI Manufacturing and Services for the largest economies of the Eurozone, including the regional aggregate, it’s noteworthy that Germany’s PMIs fell month-over-month and missed versus expectations to remain under the 50 line indicating contraction (see chart directly below).

 

German Data Misses! - aa. PMI

 

While we’ve identified the German economy as the strongest versus its peers for many months, it is certainly not immune to the economic slowdown facing the entire region. The slide in PMIs (which began in January 2012) is therefore not a huge surprise.  Nor is the lack of confidence as measured by consumer and business surveys. 

 

Today IFO reported its German Business Confidence survey and Current and Forward-Looking Economic surveys.  All slid month-over-month, marking a move down since April 2012.  

 

German Data Misses! - aa. IFO

 

While the Eurozone’s political positioning on its debt, deficit and banking issues evolves on a daily if not hourly basis, we’re of the position that Germany wants to play ball in maintaining the fabric of the current Eurozone members.

 

Out of self interest, the Germans may not be the first to show their political cards simply because as the fiscally and economically strongest nation, it’s not to their advantage to sign off on paying for the entire region’s bills until it gets some support from other member nations. While this tactic could be view as delaying the process and leading to much of the inaction in policy over the last months and years, there’s plenty of evidence to suggest Germany’s support for the region, including most recently that Germany’s Finance Ministry is considering a debt buyback as a way to help reduce Greece’ debt burden.

 

News today also appears to suggest that Troika will give Greece a two year extension to meet its fiscal consolidation target and will receive its next 31.5B tranche of bailout funding. While we don’t think this will be the last concession/compromise concerning Greece or other peripherals from Troika, implicit in the Troika’s decision making is a sign-off from Merkel too.

 

So it’s under a scenario of a concerted commitment from Merkel and Draghi to save and/or maintain stability in the region versus the reality of an extended period of weak underlying fundamentals that would allow for mispricing across asset classes as the development of an evolving Eurozone are misunderstood. And to repeat, we believe that a fiscal union is a huge step for the region, one we think will be challenging to form given the inability of countries to give up their fiscal sovereignty to Brussels—so clearly there’s much runway for investors to manage around.

 

Our Real-Time Position in BUNL on the long side has worked against us as the last weeks have seen peripheral yields come in and push core yields higher. We are however, worried about the German equities given that the DAX just broke its immediate term TRADE line of 7,331.

 

German Data Misses! - aa. DAX

 

For now we have no other current Real-Time position in Europe besides BUNL.

 

Matthew Hedrick

Senior Analyst


EAT FEAR OVERDONE

Takeaway: $EAT is being valued in line with $RUTH by the market. We believe this presents a favorable opportunity to be long the stock.

The perception of the earnings call was negative and rightly so.  Management’s tone was cautious but we believe that the magnitude of the selloff has resulted in an attractive entry level on the long side.  This afternoon, Keith added Brinker, on the long side, to our Real Time Positions.  A chart illustrating his levels is below.  In short, we do not believe that Brinker is going to miss FY13 EPS guidance.  We are confident that Chili’s remains an outperformer and we expect margins to continue to expand through the year.  We see 20-25% upside from these levels.

 

Recap

 

Brinker’s shares are trading at $30 or 10% below last night’s closing price.  Management’s commentary on the earnings call has been the most significant factor driving down the stock; the print raised no concerns for FY13 earnings meeting our expectations.  The headline 1QFY13 EPS number was a disappointment but the shortfall was driven largely by increased G&A expenses.  The table below highlights the major components of the company’s income statement versus consensus.

 

Points of note:

  • Revenues came in slightly ahead of expectations as Chili’s comps continue to outperform Knapp by over 200bps
  • Chili’s comps actually strengthened into September while the industry slowed sequentially and, for the quarter, accelerated on a two-year basis
  • Restaurant level margins expanded year-over-year, at a greater rate than consensus was expecting as cost-saving initiatives are being rolled out

EAT FEAR OVERDONE - eat recap

 

EAT FEAR OVERDONE - chilis pod1

 

 

Earnings call

 

Management mentioned two factors worth discussing:

 

"Employment growth continues to be sluggish, resulting in a persistently cautious consumer and industry sales are softening."


HEDGEYE: We hold a negative view of casual dining and have long highlighted the anemic level of job growth as a primary contributing factor to our thesis.  Chili’s is still producing best-in-class same-restaurant sales growth and, given the continuing rollout of new products, we expect its outperformance versus the industry to remain in the 2-2.5% range.

 

 

“We expect continued hours overtime associated with the accelerated rollout of new kitchen equipment and point of sale system at least through part of the second quarter…these factors will affect our second quarter EPS growth causing it to fall below the FY13 guided range of 17-25% to $0.48-0.50.”

 

HEDGEYE:  We believe that management is being especially cautious on the second quarter, given the uncertain macroeconomic environment and one-time incremental costs negatively impacting the P&L.  Even with EPS coming in at $0.49, we expect FY13 earnings per share of at least $2.45-$2.50.   The company remains confident of hitting its FY13 implied range of $2.39-2.45 and we believe that this “comp scare” as happened in January on 2QFY12 earnings.  At that time, skepticism was rife that the company’s 2-3% comp guidance would be met.  We believe that today’s sell off has been overdone, as it was in January.

 

 

Conclusion & Levels


Chili’s continues to perform well versus the industry as margin-enhancing initiatives continue to gain traction and drive strong earnings growth for Brinker.  While management’s forthright commentary is well-placed, we believe that the market is currently mispricing this stock.   We would not pay the same multiple for RUTH as we would for EAT; both stocks are valued at roughly 7x EV/EBITDA.  BLMN is a stock we would focus more attention on, as a short idea, at 8x.

Below are Keith’s quantitative levels for Brinker.  The stock has held long-term TAIL support at $29.11 and Keith’s model is highlighting immediate-term TRADE resistance at $32.89.

 

EAT FEAR OVERDONE - eat levels

 

 

Howard Penney

Managing Director

 

Rory Green

Analyst


BYI YOUTUBE

In preparation for BYI's F1Q 2013 earnings release on Thursday, we’ve put together the recent pertinent forward looking company commentary.

 

Bally Technologies Announces Illinois Contracts Totaling Sales and Lease of More Than 4,000 Video Gaming Terminals (9/25)

  • BYI announced constracts with various distributors in IL to provide 4,000 Bally Video Gaming Terminals (VGTs), expected to be deployed over the next 24 months.
  • Two of the largest terminal operators in the state have signed more than 50 percent ship share with Bally

 

YOUTUBE FROM 2Q CONFERENCE CALL (8/9)

 

  • "Our fiscal year 2013 holds excellent opportunities for Bally as we are initiating earnings guidance at $2.95 to $3.30 per fully diluted share. This guidance range contemplates revenue improvement in all three areas of our business: game sales, gaming operations and systems. We also expect gross margin improvement in gaming equipment and continued growth in our web footprint. As a result of these expectations, we anticipate an improvement in our operating margin in fiscal 2013."
  • "We still expect our game equipment margin will approach 48% to 49% within the next two to three quarters due to continued reductions in material costs on each of the Pro Series cabinets."
  • "We anticipate our effective income tax rate in fiscal 2013 will be between 38% and 39%. This rate does not assume reinstatement of the U.S. Research & Development Credit."
  • "We expect to have an installed base of around 1,000 VLT units in Italy by the end of FY 2013."
  • "We should also have our first systems installation in Australia successfully completed during the next few weeks."
  • "We expect to begin initial shipments both for sale and participation-based VLTs in Illinois beginning Q2 FY 2013 pending final approval of location."
  • "With respect to Michael Jackson and GREASE, I think we have said historically that we saw both of these games as having the potential to reach total placements of 750 each, and we still feel that way. The numbers are meeting or exceeding our expectations, and... cannibalization does appear low and low partly because Bally has a pretty small WAP footprint, and because these games are quite unique."
  • "We see normal trends from seasonality, but we haven't seen any impact yet from the consumer"
  • "Average win is meeting our expectations. Overall WAP footprint is up nicely year-over-year and in line with seasonal trends."
  • [Share repurchase] "We've been rather aggressive the last two quarters and going into the first quarter as we mentioned in the press release, but we've traditionally bought back in the $15 million to $20 million a quarter range."
  • "On Italy, we have fairly modest prospects because of our delays in getting approved. So, we have said that we expect to have 1000 machines by the end of this fiscal 2013. I think there is a chance to do much better in Italy over time, but we have to sort of earn our stripes after this delayed technical approval process."
  • "We are looking at further opportunities in New Zealand; we just went live over the last few months and of course, the South Africa installs are going on schedule."
  • "With respect to particularly Canadian VLTs, those come at a slightly lower ASP. They don't have quite as many bells, and whistles. We have guided to a higher margin, so the good news is on a margin dollar basis they are still accretive. Illinois, which is a VLT market, that will come at a little cost to ASPs."
  • "The third thing we are doing is transporting our games content of course, to the internet in legal jurisdictions, which should be again generating revenue for us early on in calendar 2013."

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IS BRAZIL’S RECENT BREAKDOWN A HUGE RED FLAG FOR RISK ASSETS?

Takeaway: The Bovespa’s TREND-line breakdown diminishes our formerly positive bias and affirms our negative cyclical concerns regarding “risk assets”.

SUMMARY BULLETS:

 

  • Since late 2008, the Bovespa Index has generally led global equities on nearly every major intra-cycle rally and correction, with the exception of the most recent intra-cycle bottom and the current topping process.
  • Supported by an improving GIP outlook (chart below) and an anticipated deceleration of Big Government Intervention (there’s growing speculation that the government will allow PBR to raise prices, which would be a noteworthy step in the right direction), we have held a positive fundamental bias on the Brazilian equity market since SEP 25; that’s obviously been the wrong call (the Bovespa is down roughly -5.5% since then). Importantly, the index is flirting with a TREND line breakdown. If that holds, we would expect to see the index re-test its JUN ’12 lows – roughly -8% to -9% lower.
  • We are not smarter than the market here and are inclined to suspend our bullish bias until we receive confirmation of a TREND-line breakout. The risk of that catalyst not materializing is rising rapidly, however, given the ominous Global Macro fundamental picture staring investors right in the face at the current juncture.
  • And given Brazil’s unique qualities as a weathervane of global economic activity and reflation expectations, a failure for Brazil to recapture its TREND line would imply further weakness ahead for risk assets broadly over the immediate-to-intermediate term.

 

Since late 2008, the Bovespa Index has generally led global equities on nearly every major intra-cycle rally and correction, with the exception of the most recent intra-cycle bottom and the current topping process:

 

  • 10/27/08 the Bovespa bottoms; the MSCI World Equity Index bottomed ~4.5 months later on 3/9/09;
  • 4/9/10 the Bovespa peaks; the MSCI World Equity Index peaked 5 days later on 4/15/10;
  • 5/20/10 the Bovespa bottoms; the MSCI World Equity Index bottomed ~1.5 months later on 7/5/10;
  • 11/4/10 the Bovespa peaks; the MSCI World Equity Index peaked 6 months later on 5/2/11;
  • 8/8/11 the Bovespa bottoms; the MSCI World Equity Index bottomed ~2 months later on 10/4/11;
  • 3/13/12 the Bovespa peaks; the MSCI World Equity Index peaked 6 days later on 3/19/12;
  • 6/5/12 the Bovespa bottoms; the MSCI World Equity Index bottomed 1 day prior on 6/4/12; and
  • 9/14/12 the Bovespa peaks; the MSCI World Equity Index peaked on the same day amid mass QE-ternity hysteria.

 

IS BRAZIL’S RECENT BREAKDOWN A HUGE RED FLAG FOR RISK ASSETS? - 1

 

A couple of questions arise here:

 

  1. Why has Brazil been generally led on nearly every meaningful world equity market delta since 2008?
  2. Why has Brazil’s leadership dissipated, as evidenced by the latest cycle?

 

To address question #1, we think Brazil’s unique setup from a capital markets and economic perspective exposes it to getting pulled aggressively in both directions of global inflation expectations (reflation and de/dis-inflation). From an index perspective, the Bovespa is heavily weighted to reflation with 67.6% of its market cap having direct exposure to top line and margin leverage that stems from rising prices of commodities and risk assets (Energy, Basic Materials and Financials sectors).

 

IS BRAZIL’S RECENT BREAKDOWN A HUGE RED FLAG FOR RISK ASSETS? - 2

 

On the way down, the Brazilian economy is heavily weighted towards domestic consumption, so the tailwind of disinflation/falling inflation expectations tends to become a positive for both Brazil’s GROWTH outlook and speculation around easier monetary and fiscal POLICY in Brazil. Eighty-one percent of Brazilian GDP is consumption (household = 60.3%; government = 20.7%) and, on a comparable basis, Brazil’s Unemployment Rate (NSA) continues to make all-time lows.

 

IS BRAZIL’S RECENT BREAKDOWN A HUGE RED FLAG FOR RISK ASSETS? - 3

 

IS BRAZIL’S RECENT BREAKDOWN A HUGE RED FLAG FOR RISK ASSETS? - 4

 

Regarding question #2, which, admittedly, is much tougher to answer, we think the reason investors have appeared far less willing to stick their respective “necks” out there on Brazil early in the selloff like they were in previous Global Macro swoons is largely due to the demonstrable acceleration in perceived political risk (more on this later).

 

As it relates to the current topping process across “risky assets”  we think investors were far less willing to sell Brazil early because it would’ve been a tacit admission that the only catalyst that supported leaning long in the face of terrible fundamental data in the first place (i.e. rising inflation expectations born out of Fed POLICY) was, in fact, culminating. Again these are just our opinions, but, in talking to clients, we can confirm that many of them continue to agree with our negative fundamental conclusions but have chosen to stay long largely due to the Bernank’s explicit dare to chase yield.

 

Delving back into the aforementioned political risk, Brazilian policymakers led by President Dilma Rousseff and Finance Minister Guido Mantega have certainly been busy making Brazil a less attractive destination for international capital in the YTD. Dilma has been at the forefront of an aggressive year-long drive to lower consumer and corporate lending rates, essentially using her influence over the central bank to accomplish her goals. Mantega, on the other hand, continues to use aggressive rhetoric and IOF tax hikes/expansion (i.e. capital gains taxes for foreign investors) to boost manufacturing and export competitiveness by promoting weakness in the BRL, which has declined -13.6% vs. the USD over the past year (inclusive of a -18.9% drop from late-FEB to mid-MAY). As recently as today, Mantega was quoted in the news (Valor Economico) as saying, “the government’s ‘dirty float’ currency policy will last as long as necessary to defend the country’s competitiveness”.

 

All of this has come at a time where Brazil’s southerly neighbor Argentina is demonstrably eroding investor confidence as a result of President Cristina Fernandez’s aggressive series of capital controls. We would argue that the “Fernandez Effect” has painted a dark cloud over the economic reforms Rousseff and Mantega have sought to implement, likely making Brazil’s bout of Big Government Intervention appear worse to investors than it otherwise would have. As such, it’s no surprise that outflows of international capital have accelerated in 2012: since JAN, the Bovespa Stock Exchange has seen an average monthly net outflow of -R$7.9 billion; this compares to an average monthly net outflow of -R$1.4 billion in 2011 and an average monthly net inflow of +R$6 billion in 2010.  

 

IS BRAZIL’S RECENT BREAKDOWN A HUGE RED FLAG FOR RISK ASSETS? - 5

 

WHERE TO FROM HERE?

Supported by an improving GIP outlook (chart below) and an anticipated deceleration of Big Government Intervention (there’s growing speculation that the government will allow PBR to raise prices, which would be a noteworthy step in the right direction), we have held a positive fundamental bias on the Brazilian equity market since SEP 25; that’s obviously been the wrong call (the Bovespa is down roughly -5% since then). Importantly, the index is flirting with a TREND line breakdown. If that holds, we would expect to see the index re-test its JUN ’12 lows – roughly -8% to -9% lower.

 

IS BRAZIL’S RECENT BREAKDOWN A HUGE RED FLAG FOR RISK ASSETS? - BRAZIL

 

IS BRAZIL’S RECENT BREAKDOWN A HUGE RED FLAG FOR RISK ASSETS? - 7

 

We are not smarter than the market here and are inclined to suspend our bullish bias until we receive confirmation of a TREND-line breakout. The risk of that catalyst not materializing is rising rapidly, however, given the ominous Global Macro fundamental picture staring investors right in the face at the current juncture. And given Brazil’s unique qualities as a weathervane of global economic activity and reflation expectations, a failure for Brazil to recapture its TREND line would imply further weakness ahead for risk assets broadly over the immediate-to-intermediate term.

 

Not good.

 

Darius Dale

Senior Analyst


View From the Battleground States

Today we held our expert call with Kenneth Bickers titled "View From the Battleground States." On the call, Bickers discussed the current state of the election, economic indicators and the role they play with voters and shared his view on what his model forecasts as the final electoral college in November. See below for the forecast and draw your own conclusion on whether Romney or Obama will take the White House.

 

View From the Battleground States - Screen Shot 2012 10 24 at 2.32.12 PM


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