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Jobless Claims: Happy Holidays

Jobless claims rose 18k to 361k last week, but the 4-week rolling average declined 14k to 368k bringing us back to pre-Hurricane Sandy levels. If we examine state data for NY, NJ and PA, the areas most affected by the storm, they’ve fully re-normalized. Despite the first rise we've seen the past five weeks, we expect claims data will continue moving lower in the coming months thanks to a seasonality distortion tailwind (i.e. holiday help). Add in the positive growth we’ve seen in the housing market recently and financials like Bank of America (BAC) and Citigroup (C) should benefit from the data.


Jobless Claims: Happy Holidays - 1


Jobless Claims: Happy Holidays - 12


Jobless Claims: Happy Holidays - 3

Bullish: SP500 Levels, Refreshed

Takeaway: Bullish is as bullish does.

POSITION: Long Consumer (XLP, IGT, ADM), Short Commodities (XLE, OIL, CLB)


Bullish is as bullish does, and this market continues to hold all 3 durations of support (TRADE, TREND, and TAIL). Buying stocks at VIX 17-18 has worked for the last few months too (sell at VIX 14-15).


Across our core durations, here are the lines that matter to me most:


  1. Immediate-term TRADE overbought = 1449
  2. Immediate-term TRADE support = 1429
  3. Intermediate-term TREND support = 1419


In other words, the refreshed immediate-term risk range = 1, and there’s more upside than downside from here (there was more downside than upside from yesterday’s highs).


Keep making high probability gross and net exposure decisions – and keep moving.



Keith R. McCullough
Chief Executive Officer


Bullish: SP500 Levels, Refreshed - SPX

Warming Up For Winter

Despite the relatively mild temperatures here in the Northeast part of the United States, winter is fast approaching and as more of the population keep their homes heated, the price of natural gas and oil are on the rise. However, in recent weeks, both commodities have bucked tradition and dropped in price as the US dollar strengthens and the commodity super cycle we’ve experienced begins to deflate. Currently, natgas stands at 3.45/MMBtu and Brent crude oil at $110.06/bbl. We believe that oil will continue to fall in price over the coming weeks and is in for a particularly nasty drop.


Warming Up For Winter - energychart


Darden Restaurants released its full 2QFY13 results this morning.   There were few surprises in the press release but the earnings call made for some interesting listening.


“There will be more rejoicing in heaven over one sinner who repents than over ninety-nine righteous persons who do not need to repent.

-Luke 15:7



First Thing’s First


The big news from this morning’s earnings call is that the company is cutting its capex budget for FY14 by ~10%, driven mainly by a reduction in new unit growth.  FY13 new unit growth is now expected to be 100 units, versus prior guidance of 100-110.  The reduction in capex is being carried out to ensure the maintenance of “solid debt metrics that preserve our investment grade credit profile”. 


The company is still guiding to $1 billion in operating cash flow this year.  This will be helped by working capital turning to a source, from a use, of cash this year versus last year.  It should also be a source next year.  We believe it could be difficult to achieve this level of cash flow, given current fundamentals at the “Big Three”, and believe that investors’ expectations of the dividend’s growth trajectory may be at risk.


For the long-term, is this slide from the company’s most recent Annual Report still representative of management’s expectations?  The blade on that hockey stick seems to be getting longer.  We will be seeking more specificity on this going forward (chart below).


On the point of capital budget reductions for 2014, there seemed to be some incongruity in the message being delivered to shareholders.  Brad Richmond, Darden’s CFO, said that FY14’s capital budget is likely to come down by “as much as 10%”.  In response to the first question of the Q&A segment of the call, Clarence Otis, Darden’s CEO, stated that this figure would be “at least 10%”.  We can only deduce from this that 10% is, as the questioner suggested, the “opening bid” and a more drastic reduction in growth is possible if restaurant-level performance does not improve.


DRI ALMOST REPENTS - darden cash flow table annual report



Top-line Numbers Speak to Greater Strategic Issues


Recognizing the need to slow growth is one step on the path to redemption for this company but this quarter did not represent a full mea culpa.


The pre-announced same-restaurant sales numbers highlight significant challenges being encountered at OG, RL, and LH.  This morning’s earnings call brought us more of what we have heard before: unclear and meandering statements that fall well short of reassuring investors of the company’s position.  While the capex budget will be cut, management’s repeated claim that there has been “meaningful progress” made at each brand over the last three years is not supported by the facts.  The effectiveness of management’s promotions has, as we have been arguing for several quarters, been hit-or-miss at best.  The company’s ability to discern what products will perform well at market is under much doubt this morning:


“We've got a much more dynamic market than we have historically. And so, consumer confidence moves around a lot more. The competitive dynamic is such that people are in and out with things a lot more than they used to be. And so for sure, as we test something, we have to discount those results more than we've had to do in the past because the environment where we launch may have some pretty important differences from the environment where we tested and so, we recognize that.”

-Clarence Otis, CEO of Darden, 12/20/12


DRI ALMOST REPENTS - og comp detail




DRI ALMOST REPENTS - red lobster comp detail




DRI ALMOST REPENTS - lh comp detail





Recognizing that the margin profile of the company needs to change is also an important step for the company to regain its footing.  Olive Garden’s value leadership position has been eroded over the last few years but, clearly, repositioning a system as large as Olive Garden will take time.  The turnaround will likely involve recalibrating the consumer’s perception of the brand and this could take time.



The “Big Three” Are What Matters For Now; The Rest Is Noise


This is a company that derives roughly 87% of its revenue from its three largest concepts: Olive Garden, Red Lobster, and LongHorn Steakhouse.  While yesterday’s article in The Wall Street journal highlighted the Specialty Restaurant Group, which constitutes 12% of the consolidated revenue, and its growth potential for Darden, clearly the company’s share price will continue to be primarily driven by the performance of Olive Garden (OG), Red Lobster (RL), and, to a lesser extent, LongHorn (LH), over the next number of years.



What Now?


We believe that the takeaway from this earnings call is that casual dining is embarking on a period of war between the largest chains.  Nobody wins in a nuclear war and we expect lower prices at Darden’s chains to have a significant impact on all of casual dining. 


We remain unconvinced that Darden’s dividend is safe or, indeed, that the question about the dividend is how much it will grow by, as Clarence Otis suggested this morning.  Tough times lie ahead for Darden and, while we are not stating that we believe the dividend is definitely getting cut, we are placing the burden of proof squarely on management’s shoulders.


This stock, for us, has been a “show me” stock for several quarters as the company’s reactionary strategies have yielded disappointing results.  Confirmed by the line of questioning on today’s call, we believe that the investment community is adopting a similar stance, becoming less and less willing to give management the benefit of the doubt.


For much of calendar 2012, earnings revisions have been negative.  The stock price has largely ignored this as some analysts touted the yield and “stable cash flows” of the company as reasons to buy.  If confidence erodes further in the security of the dividend, expect the share price to correct significantly.





Howard Penney

Managing Director


Rory Green

Senior Analyst



We expected 2013 yield guidance that will disappoint the Street but 1-2% is alarmingly low.


"We remain well positioned for a recovery in 2013 and beyond ...as consumers continue to capitalize on cruising's superior value versus land-based vacation alternatives. We continue to focus on a measured growth strategy through the introduction of two to three new ships per year and the development of emerging cruise markets in Asia. Based on 2013 guidance, we estimate that cash from operations will reach $3.3 billion for the year while our capital commitments will be just $2.0 billion.  As a result, we anticipate significant free cash flow in 2013, which we intend to continue to return to shareholders."


- Carnival Corporation & plc Chairman and CEO Micky Arison





  • 2 cent impact from Hurricane Sandy. Pricing on close-in bookings were higher than expected, favorable currency exchange rates also helped the quarter
  • Almost half of the yield decline in the 4Q were driven by Costa.  Ex Costa, the decline was 2.4%. 
  • EAA brands: Net ticket yields in Asia were up nicely
  • Ex Costa, they had a 2% increase in onboard yields across all major categories
  • Consumption per ALBD declined 4.4% this quarter.
  • Over the next few years, they expect to fully recover from the Costa incident
  • By the end of December, they will pay a 25 cent share regular dividend, special dividend of 50 cents, and buyback of $3.5 million. This will mark the second year where they will return all of their FCF
  • Few unique items in 2013 which will push unit costs higher
    • Higher costs due to higher occupancy on Costa
    • Higher insurance costs
    • Charge from closed pension plans for certain British officers
    • Investment in new markets
    • Bottom line, costs will be up 1-2% (ex fuel) YoY/ per ALBD
  • Expect to use 24% fuel per berth in 2013 than they did in 2005
  • 10% change in fuel impact:  $0.30/share
  • Fuel derivative portfolio: 10% change would result in no impact in first move, and then $4MM for the next 10% move. Protection begins when Brent goes above $127. They pay one of the fuel derivatives when Brent falls below $100. 
  • 10% change in FX impact: $158MM or $0.20/share
  • 3.6% increase in cruise capacity in 2013
  • Guidance for 2013 assumes no fiscal cliff
  • Anticipate continued struggling economies in Europe in 2013 similar to 2012.  Longer term, they believe that Europe will improve over time and their scale in Europe provides them with a significant competitive advantage.
  • In Asia, they are planning a significant increase in their SQFT. Sun Princess Japanese deployment. In SE Asia, they are adding a new ship doubling their capacity. They achieved profitability in China in 2012. Recently established an Asia office in Singapore.
  • In Australia, Carnival introduced Carnival Spirit which was well-received. 
  • Booking outlook for 2013:
    • Costa's pricing is still behind 2012, but they expect to lap that post Jan
    • Encouraged by recent NA booking patterns especially with the recent elections and fiscal cliff looming. Think things will pick up once fiscal cliff is resolved
  • 1Q13
    • Very little inventory remaining to be sold
    • Revenue yield comparisons are tougher for NA which was up 5% last year. 
  • 2Q13: 
    • Continue to expect to see similar close in booking patterns
    • Expect to see a catch up in booking and revenue yields for 2Q during 1Q



  • EAA revenue yield color:
    • Will have higher yields in NA
    • Will have higher yields in Costa (but will only recover 1/2 of their losses from 2012- full occupancy recovery but not full pricing recovery given the weakness in the European economy).  Also pricing for Costa will be down in 1Q13 so that impacted FY guidance.
    • Rest of Europe will have lower yields. Some of this is due to absorption of increased capacity in a weak economy.  It's also very difficult to forecast yields given the very close-in booking patterns.
  • Travel agents are implying that NA yields are more robust than what their guidance implies.  Their guidance implies that NA yields are more muted than what the sell-side is seeing.
    • Caribbean is strong but European and longer cruises are not doing well
    • Remember they are going to be down 2-3% in 1Q because when Costa happened they were already almost fully booked so they had a very strong prior year.  
    • Likely that travel agent feedback doesn't relate to the lapping of the tough 1Q comp and is more reflective of 2Q-4Q
  • NA challenges are more pace/ booking related -more so than pricing. That could change in WAVE season.  They are also facing the challenge of higher air fares for long cruises. 
  • Has their outlook changed meaningfully from the last time they reported?
    • Northern Europe and the UK have been strong. They are starting to see some effects of economic weakness in Germany and UK. So they are a little concerned going forward, especially as the booking curve has tightened.
    • They also have a large capacity in Germany this year. However, all the research they are seeing is predicting a bounce back in Germany.  Their 2 largest competitors have increased their N. European capacities by 20%.
  • Directionally, they are satisfied with 1-2% net yield increases. Consensus doesn't always meet reality. They have more capacity increases in 2013 (on top of 2012 increases) than some of their competitors. They like the German / N European markets. They still get excellent returns with yields down 1-2% there. They don't think that moving ships around to Asia is a very poor short-term solution. You need to look at the yield improvement post 1Q which is better.
  • Their focus is profitability more so than yields.  In order to get fuel down 5%, they made some itinerary changes that may lower yields. They would take lower yield for better profit per berth.
  • There will be more announcements related to Asia going forward regarding deployments to that region
  • It is more expensive to operate in Asia than Europe. If you look at Australia and the Princess deployment, yields are still up. They have a very limited fleet in Asia. As they get more infrastructure there, over time costs will decrease.
  • What they are seeing is a close-in booking pattern in both Germany and UK. They haven't seen pricing issues yet, but if bookings don't pick up they may need to discount to fill the ships. Clearly, the German economy weakened in the 2H12 so it's not surprising that they are seeing some weakness given that that is where they are increasing capacity
  • UK does have a longer booking pattern but they also have some very long around the world cruises
  • Onboard trends for 2013 are very similar to 2012 when they were up just over 2%.  Their guidance for 2013 is very similar.
  • They will return cash to shareholders and once they know what the changes to the tax laws are, they will review their strategy with the board.
  • Thomas Cook and TUI implied that things are flattish for the next 6 months in Europe for them.  Why the difference? 
    • Not sure how to compare. They can control capacity to some extent. 
  • Only have one ship coming online for Costa until 2014 - so they wouldn't see profitability increase until 2015 as a result of that addition. 
  • They are typically 85-90% done booking wise for 1Q at this point and their guidance includes their best guess on yield guidance.  They built in solid close in booking patterns for the remaining 10% of available capacity.
  • They will be building 2-3 ships a year and that's still their plan regardless of exact ship pricing. So given that they just announced 2 new ships, there is nothing imminent. So for 2016 and beyond there is no need for them to make commitments today. They have plenty of time.
  • Given that this part of the year is usually difficult to give guidance in, coupled with the recent elections and the fiscal cliff, and the close-in booking patterns, there is just limited visibility into 2013 at this point.



  • 4Q earnings "were better than anticipated in the company's September guidance. Stronger than expected revenue yields combined with lower than expected fuel costs more than offset higher than anticipated operating costs"
  • "Through the significant efforts of our brand management teams, we were able to maintain full year 2012 net revenue yields (excluding Costa) in line with the prior year. In addition, we drove down net cruise costs, excluding fuel, slightly and fuel consumption by four percent... Unfavorable changes in fuel prices and currency exchange rates reduced earnings by $300 million, or $0.39 per share, compared to the prior year."
  • In 4Q, CCL "announced it had reached an agreement for the construction of two new cruise ships – a 2,660-passenger ship for its Holland America Line brand to be delivered in 2015 and a 4,000-passenger vessel for its Carnival Cruise Lines brand to be delivered in 2016.  Both are the largest ships ever built for those brands."  
  • FY 2013 outlook:
    • "Since September, booking volumes for the first three quarters, including Costa, are running in line with the strong volumes experienced last year at slightly lower prices. At this time, cumulative advance bookings for 2013 continue to be behind the prior year at slightly lower prices."
    • "During 2013, the company expects to carry over 10 million guests on its global fleet and will introduce two new ships, the 2,192-passenger AIDAstella which is scheduled for delivery in March and the 3,560-passenger Royal Princess, which is scheduled for delivery in May."


CAG continues to make sense to us

When we initiated coverage of the consumer staples sector earlier this week, we suggested that consensus EPS estimates were too low for CAG.  This morning’s reported results bear out that position, in part, as CAG reported Q2 EPS of $0.57 versus consensus of $0.55.  Additionally, the company raised EPS guidance from $2.03 - $2.06 to “at least” $2.06.  Our forecast remains above that at $2.11.  The increased guidance comes without the benefit of share repurchase as the program has been suspended with debt reduction becoming the preferred use of cash as the company digests the RAH acquisition (calendar Q1 close, expected).


We see CAG as a relatively inexpensive name (13.8x calendar 2013 EPS versus the packaged food group trading at 17.6x) that has additional upside to earnings on a standalone basis as well as a transformative acquisition that is scheduled to close during calendar Q1 2013 that should provide investors a path to a higher EPS profile through accretion and synergies.  The knock on an otherwise fine quarter was the decline in volumes (-4%) as the company continues to lap pricing activity in the prior year.  Volumes should improve sequentially as the bulk of the pricing activity impacted prior quarters (70% by management commentary).  Further, investors should put these volume declines in perspective and compare and contrast with the “old” CAG where management would have been more concerned about chasing volume and less concerned about preserving profitability.  Instead, management delivers on profitability while continuing to invest in brand building, which should reap rewards in the coming quarters.


Also, a declining input cost profile as mentioned by the company and consistent with both our sector thesis and macro view should provide income statement flexibility going forward.  We see an opportunity for the stock price to move to the mid-$30s in the coming months.



Robert  Campagnino

Managing Director






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