Rye and Coke

This note was originally published at 8am on December 28, 2012 for Hedgeye subscribers.

“An intelligent man is sometimes forced to be drunk to spend time with his fools.”

-Ernest Hemingway


In my homeland of the vast plains of Alberta, the drink of choice for many is Rye Whiskey and Coke.  Now normally, I wouldn’t start the Early Look discussing beverages of choices, but given what has been going on in Washington, D.C. over the last few months, what choice do any of us really have but to have a few cocktails to make ourselves feel better? Or, to Hemingway’s point, to enable us to at least suffer this political foolishness.


Now on one hand, I do give President Obama some credit for leaving the golf links early and coming back to work.  In reality, though, does anyone really believe that a last minute meeting tonight with Congressional leaders is going to solve either the fiscal cliff or the coming debt ceiling violation?  Personally, I hate to be consensus on this, but I sure don’t.  Currently InTrade has the probability of the debt ceiling being raised before December 31st, 2012 at 17%.


The issue currently in Washington is that Democrats and Republicans don’t agree with each other.  Ok, that’s not really a new issue, but heading into the deadline of December 31st neither side is acting like they want to work together and get a deal done.  This excerpt from a news article quoting House Minority Whip Steny Hoyer about sums up how divisive things are in the nation’s capital:


“In a sign of just how charged and hyperbolic this year-end debate has become, House Minority Whip Steny H. Hoyer, D-Md., used an unfortunately timed comparison that likened Republicans trying to use the debt limit for leverage on spending cuts to people threatening to shoot their own children.


It is somewhat like taking your child hostage and saying to somebody else, ‘I’m going to shoot my child unless you do what I want done.’ You don’t want to shoot your child,” Hoyer said at a press conference following a brief 10-minute pro forma session for the House.”


Obviously the timing of this quip was bad on many levels, but the reality is that this is obviously no way to set the table for some sort of grand bargain in today’s meeting with President Obama and the Congressional leadership.


So unfortunately heading into 2013, I hate to report but it is likely that politicians and policy continue to inform much of our investment decision making.  That is not to say that everything is negative of course.  In fact, in the Chart of the Day today I’ve borrowed a chart from our Financials Sector Head on the recently released Case-Schiller Housing Price Index. As the chart shows, the last five months (ending with October 2012) have seen consistent year-over-year national home price increases.  In the last couple of Early Looks I’ve been beating this like a dead horse, but this is a real positive for the U.S. economy and consumer.


Unfortunately, a home price recovery will only get us so far as yesterday’s consumer confidence number tells us.   This reading for December came in at 65.1 versus the 70.0 that was expected and the 71.5 reading in November.  So it seems that the uncertainty relating to the fiscal outlook in the United States has likely had an impact, as expected, on consumer confidence.


Given that, the looming Longshoreman strike that looks likely to occur could not be happening at a more inopportune time.  This looming strike will impact 14 major East Coast and Gulf Coast ports. In aggregate, these ports move more than 100 million tones of goods every year, which is about 40% of the nation’s containerized cargo.  So even a shut down of a few days is likely to have a meaningful effect on the economy.


In cheerier news, it is starting to look like the bottoming process in China is taking place.  In terms of commodities, both rebar and iron ore have had very strong quarters of price appreciation.  On the back of this, the Shanghai composite was up more than 1% over night to close at its highest level since the summer.  Once again, this plays into our theme of global growth stabilizing.


In lieu of regularly scheduled macro call this morning, we are going to have our Financials, Industrials and Consumer Staples Sector Heads join the morning call and discuss their top ideas and themes heading into 2013 (if you are not subscribing to receive the morning call service, email for details on how to gain access).  Since I’m the Director of Research at Hedgeye, I’ll take some liberty and highlight what I think are each sector’s top idea long ideas. In my view, they are as follows:


1.   Financials – TCF Financial (ticker: TCB) is a play on housing which is improving, is growing both loans and deposits at a healthy clip, and has a CEO who is older than average which may make it ripe for a takeout.  On a reasonable multiple of price-to-tangible-book, we think the stock has 25% upside over the next twelve months.


2.   Industrials – Paccar (ticker: PCAR) has been one of our key names since launching Industrials coverage earlier this year.  A key tenet of the thesis is struggles at key competitor Navistar, which were reaffirmed to us this week (over the last year Navistar’s class 8 market share has been cut in half).


3.   Consumer Staples – Archer Daniels Midland (ticker: ADM) is a name that we highlighted in our Consumers Staples launch a few weeks back.  High corn price negatively impacted ADM in 2012, but an increase in corn plantings in 2013 should be a beneficial tailwind to ADM.  At just around 1.0x price-to-tangible-book, ADM is trading at a serious discount to its 1.2 average on this metric.


On a closing note, please enjoy the New Year with your friends and loved ones.


Our immediate-term Risk Ranges for Gold, Oil (Brent), Copper, US Dollar, EUR/USD, UST 10yr Yield, and the SP500 are now $1636-1671, $109.42-111.48, $3.51-3.61, $79.21-79.99, $1.31-1.33, 1.70-1.78%, and 1408-1430, respectively.


Keep your head up and stick on the ice,


Daryl G. Jones

Director of Research


Rye and Coke - Chart of the Day


Rye and Coke - Virtual Portfolio


Today we shorted Gold via the SPDR Gold Trust ETF (GLD) at $162.40 a share at 10:34 AM EDT in our Real-Time Alerts. Our macro thesis hasn't changed; we're still bearish on gold and will short when it's green like we did today.




McDonald’s shares have recovered well since the November lows and are outperforming the S&P 500 year-to-date but management has plenty of work to do to ensure EPS growth in 2013.


McDonald’s same-restaurants sales in November were sequentially stronger than October’s, albeit aided by the calendar shift, but December will offer a more meaningful indication of the health of the company’s business heading into 2013. 


Latent Issues Remain


We’ve had concerns about the operational complexities that have manifested themselves over the past 5-6 years.  Like Yum! Brands, McDonald’s has difficult top-line comparisons, from a same-restaurant sales perspective, over the next three months.  Even if our concerns over the operational side of the business are unfounded, we believe that staying on the sidelines for the next three months is worth considering. 


Consensus is expecting sales to recover in 2Q13 but, if our contention about over-complexity in the operational setup is even half-accurate, consensus could be early on the turn.   Street expectations of 5% revenue growth and 9% EPS growth are overly optimistic, in our view, with food inflation running in the low-to-mid single digits.  This, along with ongoing pressure in Europe, represents a risk to earnings growth expectations.

  • We believe that 5% revenue growth could prove to be aggressive by 150-200 bps, in our view
  • The margin recovery story, that the street buys into, seems less and less likely to materialize

MCD'S ISSUES MAY CONTINUE IN 2013 - mcd revenue growth


MCD'S ISSUES MAY CONTINUE IN 2013 - mcd operating margin yy bps chg


Move to Value Has Failed Before


In 2003/2004, McDonald’s made an aggressive move to value that failed to gain traction with consumers and we struggle to understand how value will put sales trends on the right track in 2013.  The company needs to take price or shift mix in order to mitigate margin erosion due to beef price inflation. 



Operational Issues


Increasing complexity in the back of the house can present challenges to restaurant companies.  Management has disagreed with our view that this is happening at McDonald’s but we think three areas need to be addressed to help sales and margins recover:

  1. Menu Optimization:  A typical McDonald’s in the United States  carries out more than 1,000 transactions per day with many items carrying 10-30 transactions, daily.  At a point, the complexity in the menu hampers efficiency to the degree that some of the less popular items need to be taken off the menu.
  2. Espresso-Based Beverages:  The biggest loser on the menu is the line of espresso-based McCafé drinks.  Given that the Chief Executive Office was the primary champion, internally, of placing these items on the menu, we see little chance that management will change course.  More and more advertising dollars need to be pulled away from the McCafé line as, over time, pressure will build on management to invest less and less in an under-performing business
  3. Removing the Angus Burger:  The Angus Burger has failed to meet expectations.  With promotions, restaurants tend to sell roughly 70 per day in US markets.  Without promotions, that number falls to less than 40.  While the $4 price tag helps average check, that the company had to go to the McRib for December implies that Angus burgers are failing to meet expectations.  Removing the Angus could prove to be an operational improvement given the additional features of the Angus versus other burger offerings (extra patty, extra bun)


What is the Company Focusing On?


The company’s global priorities are:

  1. Optimizing the menu
  2. Modernizing the customer experience
  3. Broadening accessibility to our Brand

The menu has not, as of now, been optimized to the degree that it needs to be.  The pricing structure was changed but that strategy has not been positive.  The modernizing of the customer experience is a given, in 2013, and remains an ongoing process.  Broadening accessibility to the brand seems to be an exhausted approach for McDonald’s; increasing accessibility at this point could involve lower returns.


The McRib has always, since 1983, been a three-to-four week promotion, which began this year in November.  While many markets began selling McRib in November, the advertising started in mid-December and it appears that a number of markets are still selling it in January.


Other than the aggressive global value message, details are few and far between on 2013.  The company plans to “relaunch” the Big Mac this year, with the commissioning of a 10-ad special campaign, reintroducing the Big Mac to America.   



Howard Penney

Managing Director


Rory Green

Senior Analyst








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JOBLESS CLAIMS: Modest Improvements

The US economy continues to pump out positive data points with the latest coming from the labor market. Year-over-year NSA claims improved to -9.8%, a sizable improvement than the -6.0% and -5.9% readings over the last two weeks. Remember that a smaller number (i.e. more negative) is better in this instance. With labor conditions accelerating since December, the overall improvement is a welcome addition to our theme of #GrowthStabilizing.


JOBLESS CLAIMS: Modest Improvements  - 1 normal



It’s worth noting that seasonally-adjusted claims "rose" 4k to 371k after last week's print was revised from 372k to 367k. Overall, the seasonally-adjusted series continues to bounce along the 365-375k range it has occupied post Hurricane Sandy renormalization.


JOBLESS CLAIMS: Modest Improvements  - 2 normal


As we wrote about in  “LV STRIP: AN UGLY PRINT COMING” (1/8/2013), the November Las Vegas Strip print of a 12.8% decline in gaming revenues was indeed “ugly”.  Adjusting for normal slot and table hold, Strip gaming revenues were down 7%.  Baccarat volume declined for the 1st time since May 2012 on a not so difficult comp of +16% last year.  That doesn’t sound like a recovery to us.


Gaming details:

  • Slot handle rose 4% and is flat on a rolling 3-month average
  • Slot win fell 10% as hold was 7.3% (compared with 8.4% in November 2011).  On a trailing twelve month average, slot hold was 7.6%.
  • Table volume excluding baccarat rose 5% YoY and +2% on a rolling 3-month average.  Table hold excluding baccarat was 10.0%, compared with 12% on a trailing twelve month average.
  • Baccarat volume fell 16% (compared with 16% growth in November 2011); this is the 1st decline since May 2012.
    • Baccarat win fell 25% on hold of 12.2% vs 13.6% in November 2011.  On a trailing twelve month average, baccarat hold was 12.0%.

SBUX: Full Speed Ahead

Currently, Starbucks (SBUX) has a few tailwinds going for it that could push the stock higher. We believe that SBUX will post another strong year for FY13 thanks to revenue drivers firing on all cylinders. According to the Street consensus, revenues are expected to grow 12.7% in FY13 versus FY12, which we think is possibly conservative given momentum in several other areas of SBUX’s business. Combined with growth in China, the expanded availability of the Evolution Fresh brand, and stronger market share in the single serve and core retail space, Starbucks looks attractive as a long right now. We think top- and bottom-line estimates will rise over the next three months.



SBUX: Full Speed Ahead - SBUXquant



From a quantitative setup, the stock is in bullish formation, with immediate-term TRADE and intermediate-term TREND support at $53.39 and $51.37, respectively. We remain long SBUX in our Real-Time Alerts.



SBUX: Full Speed Ahead - SBUXgrowth

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