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CMG LEVERAGE DRYING UP IN FY13?

Chipotle Mexican Grill reported (pre-announced) 4Q and FY12 earnings after the close.  Comps and earnings were in line with consensus expectations and the pre-announced figures but some important metrics, which we flagged in recent research notes, inflected in the fourth quarter.  Below, we recap 4Q12 and offer some thoughts on 2013.  

 

From here, we remain reluctant to chase the recent move in the share price.  A significant reason behind that is that consensus is, in our view, too optimistic in its view of food and labor costs. See the second-to-last chart of this post for more on this point.

 

 

4Q12 Earnings Recap

 

Important Drivers:

  • Same-restaurant sales grew by 3.8%, year-over-year, in 4Q which was in line with preannouncement
  • The comp was driven by 3.8% traffic, 90 bps of price, offset by mix
  • The company opened 60 new units versus consensus expectations of 42
  • RLM decreased by 150 bps vs 4Q11 as food costs increased +130bps
  • Wage line delivered for the first time in over five years “as wage inflation, including promotional increases more than offset any leverage from the comp”. We think this is a trend

 

CMG LEVERAGE DRYING UP IN FY13? - cmg recap

 

 

2013 Outlook

 

The broad guidance parameters are unchanged:

  • 165-180 new units in 2013
  • Flat-to-low-single-digit comp growth

 

Other points:

  • No decision on menu pricing but inflation “so far makes it more likely”,  Dairy and protein prices are likely to force management’s hand in this respect
  • Management seems reluctant to take price and hinder transaction growth
  • Management is trying to gain leverage from G&A
  • The international business is producing altogether different returns from that of the domestic market.  Volumes and returns are lower, with brand awareness taking some time to elevate to desired levels.

 

Key Metrics

 

The good news for Chipotle this quarter is that New Unit AUV Growth seems to be slowing at a decelerating rate.  This is a good sign for revenue growth and returns if the bottoming process plays out.

 

CMG LEVERAGE DRYING UP IN FY13? - CMG AUV Growth vs New AUV Growth

 

CMG LEVERAGE DRYING UP IN FY13? - cmg sales growth new unit volume growth

 

 

More of a concern is the margin side of the earnings equation.  Food costs are being guided to 33.5% to 34% and labor costs, long a source of margin, could now be turning higher. 

 

If management takes price, which seems likely given the earnings call commentary, then food as a percentage of sales could come in below guidance.  The worry is how great of an impact that will have on traffic.  

 

Consensus Metrix shows the sell-side expecting continued labor leverage in 2013.  We are less confident; the company’s hiring practices have come under scrutiny and cost of compliance, along with the stated driver of wage inflation, could drive labor costs higher going forward.

 

CMG LEVERAGE DRYING UP IN FY13? - cmg labor cost tailwind

 

CMG LEVERAGE DRYING UP IN FY13? - CMG pod 2

 

 

Howard Penney

Managing Director

 

Rory Green

Senior Analyst

 

 


HBI: Financial Model Changing Again

Takeaway: After an incredible debt reduction and mgn recovery story over the past yr, $HBI needs to grow organicly, achieve new peak mgns, or aquire

Usually a company’s print will leave us squarely supporting either a bullish or bearish case. But in the case of HBI’s 4Q12, we come out right in between.

 

The Positives…

On the plus side, HBI is the poster child why you should never count against a company that is paying down its debt to drive EPS. We did not appropriately respect this factor, and it was a mistake. Over the past year HBI pas paid off nearly 40% of its debt, taking interest expense down by $40mm during a time when EBIT was off by $20mm (due to product costs). During that time period, HBI’s stock went from $22 to $38. Yes, the market was partially banking on a materials/pricing-driven margin recovery, but we’re hard pressed to find anyone who owned the stock who did not have debt reduction as part of their core thesis.

 

Management highlighted this many times on the call – arguably more than necessary. But when we step back and analyze the situation, we could see why. Back in 2006 when Sara Lee spun out Hanesbrands, it did so with a $2.5bn debtload and minimal cash. Rich Knoll wasn’t too happy about it back then, and has had the team  focused on reducing debt (balanced with sporadic bolt-on acquisitions) over the past six years. He’s finally got the end in sight. We give the team credit.

 

The Concerns…

After the debt reduction, we really couldn’t find a lot to get excited about. Consider the following.

1)      Operating margins in the last two quarters came in at 13%, and guidance for next year has margins at new peaks. This level pegs HBI in line with brands like Under Armour, and within a point of Nike. We know that the businesses are different, but as a simple litmus test we wonder if HBI can consistently operate at a level above those brands.
 

2)      The company noted that a 3-4% digit top line growth rate can be leveraged into double digit EPS growth ‘for a very very long time’. This is consistent with past statements. But with margins at new peaks and the de-leverage story nearly complete, it has to come in large part from top line growth. That’s harder to bank on than deleverage for a company in this business.   
 

3)      We give the company credit for investing an extra 3-4% in SG&A in 2013 in advertising – which is something we’ll almost always applaud. But aside from that, there wasn’t much mentioned in the way of major initiatives to drive the top line. We heard a lot about driving efficiency, but ultimately the top line is what will get us excited given that HBI is operating above peak margin levels.
 

4)      Management discussed acquisitions in the context of growth – which is fine. After all, it’s worked for them in the past. Put we’re incrementally concerned that we might need to rely more on deal activity.


 

In the end, we think that the company is being managed well, and that that the risk of being blown up in this position near-term is not significant at 11x a doable FY13 number. But on the flip side, we simply struggled to find anything that makes us excited to buy this name after such incredible (and well deserved) performance.

 

We don’t think we’re alone in the group of people that wants to see -- in much greater detail -- how HBI is going to drive its financial model on a go forward basis when it hosts its investor day later this month. 


A Longer View of Ag Equipment

A Longer View of Ag Equipment

 

  • North American Tractor Market in Units:  Looking back, North American agricultural equipment has had quite a run since the period of underinvestment in the 1980s.

A Longer View of Ag Equipment - d1

 

  • Increasing Horsepower & Productivity:  Tractors have increased in horsepower at roughly 3% a year for some decades and a high-end tractor today is roughly 50% more productive than it was 10 years ago, according to Deere.  If the unit sales are horsepower adjusted, the recent gains in equipment sales become even more noticeable.

A Longer View of Ag Equipment - d2

 

  • At the Trough (FY 1986): “Depressed conditions in the North American agricultural industry continued in 1986, as retail demand for farm equipment declined for the fifth consecutive year….The Company’s sales and production were significantly lower in 1986, and the level of North American dealer inventories of farm equipment was reduced considerably.” DE FY1986 10K
  • At the Last Peak (FY 1975):   “Retail demand for large farm tractors and harvesting equipment for wheat, corn and soybeans remained very strong during 1975….More recently world prices for food and feed grains and other agricultural commodities have increased sharply….causing additional acreage to be brought back under consolidation.” – DE FY1975 10K
  • Closer to Peak? (FY 2012):  “Relatively high commodity prices and strong farm incomes are expected to continue supporting a favorable level of demand for farm machinery during the year [2013].…Industry sales for agricultural machinery in the United States (U.S.) and Canada are forecast to be about the same for 2013 in relation to the prior year’s healthy levels” – DE FY2012 10K
  • DE v. AGCO:  We spent time earlier this year pursuing AGCO (which reported this morning) as an alternative to Deere.  AGCO has much less exposure to the US market, which we view as closer to peak demand than trough.  While European tractor sales may be less “toppy,” the market has bounced and is heavily and awkwardly subsidized, among other problems.   If we had to make a bet for the next 5 years, we would guess that AGCO outperforms DE.  Fortunately, we don’t have to bet – at least not yet.
  • No Easy CallCurrent sales of combines and tractors are likely well above replacement demand.  The North American Ag equipment market could boom for years more, driven by greater use of biofuels, high commodity prices, aging farmers, healthier farmer balance sheets and other factors.  We suspect that is what is priced into many of the Ag equipment share prices.  However, history suggests that tractor sales could stagnate or even decline in coming years.  That risk does not look priced in.  We find it easier to get on board with depressed cyclicals that are showing signs of recovering and are in great industries. That is where we usually find value.  DE and AGCO both have strong franchises in consolidated, well-structured industries.  However, from a cyclical perspective, we have a tough time getting on board and that excludes the uncertainty from currencies, crop prices and exports discussed here.   

 

Bonus from DE 1975 10K: “It is believed that coal and electricity will become more important fuels in the future, and coal has been substituted for natural gas in a number of operations.”  How times change.

 

 


Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.64%
  • SHORT SIGNALS 78.61%

TRADE OF THE DAY: ITB

Today we bought the iShares Dow Jones US Home Construction ETF at $22.83 a share at 10:38 AM EDT in our Real-Time Alerts. Josh Steiner reiterates his call this morning on #HousingsHammer (the bulls aren't bullish enough).

 

TRADE OF THE DAY: ITB - TOTD


WMS YOUTUBE

In preparation for WMS's F2Q earnings release tomorrow, we’ve put together the recent pertinent forward looking company commentary.

 

 

YOUTUBE FROM FQ1 CONFERENCE CALL

  • "The VLT market in Illinois opened, and we shipped our first 193 new units in the September quarter, and with the Gaming Control Board continuing to approve additional tavern locations, we expect to continue to ship more units in fiscal 2013 and into fiscal 2014."
  • "I have been to a dozen G2E shows. In all that time I have not observed WMS ever have had more positive customer response to our products than we had this year... The strength that I differentiate to our products and enthusiasm from our customer displayed reminds me of 2006 when we introduced a significant number of new game play technologies that have now become staples on slot floors, such as sound chairs, transmissive real technology and community gaming style games. Or 2008 when we launched the BLUEBIRD 2e cabinet with its, at that time, next generation CPU-NXT2 operating system."
  • "CPU-NXT3 operating system is already approved, and we've already submitted the Gamefield xD cabinet and is approved in some jurisdictions already. And that we expect to submit our exciting new Blade cabinet later this month. We anticipate shipping the first units of both these new unique cabinets which utilizes the CPU-NXT3 platform in the March quarter."
  • "My Poker product, which we expect to expand our footprint to a portion of casino floor that we not previously serviced, were launched this quarter at Station Casino in Las Vegas and in the March quarter, Caesars Entertainment Properties in seven regional markets."
  • "We continue to expect our ship share to new casino openings and the Illinois VLT market to average in the high teens"
  • "We expect the average selling price during fiscal 2013 to be more variable than in the past, and likely lower year-over-year due to the higher mix of lower-priced VLT units, particularly if Illinois VLTs become a greater portion of the unit mix."
  • "The improvement in our gaming content during the past year has resulted in higher than normal conversion kit sales over the last five quarters, and we expect this will continue at least through the launch of the Blade cabinet."
  • "With a total of 17 new participation games expected to launch over the balance of fiscal 2013, including CHEERS, a new Godfather theme and the KISS game in the current quarter, and SPIDER-MAN and WILLY WONKA & THE CHOCOLOTE FACTORY later in the year, coupled with the launch of the Gamefield xD cabinet with new MONOLOPY and WIZARD OF OZ games, and additional new games in both the March and June quarters, we expect our installed footprint will continue to grow throughout fiscal 2013 to drive further revenue growth."
  • "We also expect to see our average daily revenue improve in the second half of our current fiscal year. At the end of September 2012, about 70% of our installed base of gaming machines has been upgraded to new hardware and operating system platforms with just under 35% of the installed base having the latest games that were launched in the last three quarters."
  • "We intend to continue to increase our global staff of engineers, artists and game developers, leading to higher R&D expenses on a quarterly sequential basis. For the year-end total, we expect our R&D expenses to average 15% to 16% of total revenues, higher on a relative basis in the first half of the year, and lower on a relative basis in the back half, as we expect revenues to accelerate."
  • "In fiscal 2013, the total incremental increase in planned R&D, depreciation and amortization and selling and admin expenses for our interactive products and services is anticipated to be in a range of $30 million to $35 million. We expect the non-marketing expense amounts to ramp slightly every quarter throughout the year, largely reflecting additional head count to support additional revenue growth.  We expect marketing costs in the December quarter to increase more significantly on a quarterly sequential basis as we moved past the launch phase Jackpot Party Social Casino, and expect that marketing costs will then level out thereafter at levels more akin to industry standards in a range of 30% to 40% of Jackpot Party Social Casino revenues."
  • "Revenues are expected to grow modestly from the September 2012 quarter to the December 2012 quarter, and to slightly exceed those reported in the December 2011 quarter. However, lower margin VLTs are expected to exceed 25% of new units sold this quarter, resulting in product sales margin declining to a range of 48% to 49%, and operating income is expected to be slightly lower than the September 2012 quarter, reflecting an incremental cost to support interactive products and services."
  • "On an annual basis, benefits from our higher revenues this year will be offset by planned higher spending to support new product flow and the building of a foundation for our interactive products and services."
  • "Our first rollout of a fully managed B2B real money online casino site will be in collaboration with Groupe Partouche in Belgium, utilizing our jackpotparty.com platform and operating infrastructure. We anticipate beginning with a soft launch later this quarter with full go live in January 2013." 
  • "Our B2B managed services provides casino operators with a full suite of products, games and platform and both front end and back office to services, such as marketing, operations, IT and payment services. We'll earn a negotiated revenue share from Groupe Partouche and the other B2B managed services contracts we expect to enter into."
  • "We recently announced deals with two customers Betsson and Unibet that have an aggregate more than 12 million registered players. This is essentially a content licensing revenue model where we earn a revenue share every time an online player uses a WMS or Jadestone game on one of our customer's sites, enabling us to broadly distribute our content and games through leading online operators in Europe.  We expect to go live with the initial WMS games early in calendar 2013. A key milestone will be for us to reach agreements with additional online gaming operators with whom interest has been very high."
  • "Early last month, the Play4Fun Network went live with our first installation for the Meskwaki Bingo Casino in Iowa... We're paid an initial integration fee by our casino operator partners at launch and we also see recurring monthly management fees."
  • "Jackpot Party social casino that we launched on Facebook at the beginning of July.... for the quarter, we averaged just over $55,000 in net daily revenue to WMS, and a monetization level that is better than most of our competitors in this space... today, our daily revenue is tracking more than 50% higher than our first quarter average daily rate."
  • "We currently expect to generate $35 million to $40 million in interactive revenues in fiscal 2013 at attractive gross margins, and as you can see in the September quarter, we generated $9.5 million of revenue."
  • "I think the regional operating budgets...are pretty much flat year-over-year. There might be some little bit of an uptick, maybe I would say 3% to 5%." 
  • "We're going to be putting more WAP product out there and that drives a higher yield"

IS IT TIME TO HEDGE FOR A SELLOFF ACROSS “RISK ASSETS”?

Takeaway: While it may “feel” like "risk assets" are poised to run out of steam here, the “data” suggests otherwise.

SUMMARY CONCLUSIONS:

 

  • All told, a positive outlook for global economic growth looks to overcome tired pessimism about US fiscal policy, Eurozone sovereign debt woes, Chinese growth scares and other 2012-style bear theses to continue underpinning “risk asset” prices – for now at least.
  • Specifically, our modeling of the key indicators and indices suggest there is further upside to be risk managed over the intermediate term.
  • We’re now at +2.6-3.4% for full-year 2013 global real GDP growth. That compares to roughly +2.1% in 2012 and the implied positive delta therein should continue to cushion risk asset prices – at least until all the good news is priced in.
  • A confirmed TRADE line breakdown on the SPX would be one of the key early signals of that occurring domestically.

 

Our five-person Macro Team has three former collegiate ice hockey players, a former collegiate football player and a former semi-professional body builder. Needless to say, we’re not the most sensitive bunch – particularly when it comes to our feelings.

 

In fact, I’d argue we’re not very good at interpreting our feelings at all – especially when making research calls and risk management decisions. That’s why we’ve grounded our two-pronged investment process in the embracement of uncertainty, in addition to constantly supplementing it with as much data as we can legally acquire.

 

Looking to the global macro universe, our fundamental research and quantitative risk management processes continue to suggest further upside to “risk asset” prices from here.

 

On the fundamental research front:

 

  1. Global growth continues to track higher: The median of our 39-index sample of PMI data from all of the key countries and economic blocks accelerated 1.3ppts MoM to 51.5 in JAN.
  2. Higher-highs: Manufacturing activity – which was once a core tenet of the global economic recovery – is now making higher-highs on a TTM basis per the JPM Global Manufacturing PMI.
  3. Higher-lows: 10Y-2Y Nominal Sovereign Yield Spreads – which we consider as reliable a proxy for growth expectations as any – have indeed stabilized and are, at worst, making higher-lows across the four largest economies (US, Germany, China and Japan).
  4. Expectations suggest limited upside for positive economic surprises: Looking to the relationship between Citigroup’s G10 and EM Economic Surprise indices and global equity markets, the MSCI World Equity Index has tended to register a cycle-peak 1-2 months after the G10 index registers its cycle-peak. If this pattern holds, that puts us within striking distance of a short-cycle market top.
  5. But the post-crisis countercyclical buffer suggests more room to run: We consider any demonstrable delta in global energy prices as the closest thing to Fed tightening in the post-crisis era of ZIRP. The latest run-up in global energy prices, or lack thereof, suggests room for more upside with respect to global growth. The MSCI World Equity Index has tended to register a cycle-peak when the 3M % change in the front-month Brent Crude Oil future registers +20% or more. We’re currently only at 8.6% on this metric, suggesting global energy prices must continue higher (partly because the comps get harder from here) for us to anticipate a material drag on global growth and “risk asset” prices.

 

IS IT TIME TO HEDGE FOR A SELLOFF ACROSS “RISK ASSETS”? - 1

 

IS IT TIME TO HEDGE FOR A SELLOFF ACROSS “RISK ASSETS”? - 2

 

IS IT TIME TO HEDGE FOR A SELLOFF ACROSS “RISK ASSETS”? - 3

 

IS IT TIME TO HEDGE FOR A SELLOFF ACROSS “RISK ASSETS”? - 4

 

IS IT TIME TO HEDGE FOR A SELLOFF ACROSS “RISK ASSETS”? - 5

 

On the quantitative risk management front:

 

  1. Energy prices are still a headwind: We’d be lying if we said we were not at all worried about the impact of global energy prices and the potential for $110-plus Brent Crude Oil weighing on global consumption and fixed capital formation. Brent prices are indeed bullish TRADE and TAIL on our quantitative factoring, so at a bare minimum, it’s tough to anticipate meaningful downside without some currently unforeseen catalyst.
  2. USD strength could be just that: While the burning yen (13.6% of the DXY basket) has insulated the dollar’s 3M slide to some degree, the melt-up in the euro (57.6% of the DXY basket) has really weighed on the USD in recent weeks. We continue to anticipate that the DXY will make a series of higher-lows with respect to the long-term TAIL on the strength of a continued recovery in US housing and the US labor market. If, however, the DXY doesn’t hold its TREND line of support at 79.44, the aforementioned research view will continue to be subject to a great deal of Duration Mismatch.
  3. The flows continue to support “risk assets”: Bearish TRADE and TREND from a price perspective, both US Treasury bonds and Gold have broken down on our quantitative factoring. The former demonstrably so; the latter – which continues to be supported by more religion than research – far less so. Gold is currently testing its TAIL line of resistance ($1,674) and a confirmation of the recent breakdown would continue to supplement our fund flows argument.

 

IS IT TIME TO HEDGE FOR A SELLOFF ACROSS “RISK ASSETS”? - 6

 

IS IT TIME TO HEDGE FOR A SELLOFF ACROSS “RISK ASSETS”? - 7

 

IS IT TIME TO HEDGE FOR A SELLOFF ACROSS “RISK ASSETS”? - 8

 

IS IT TIME TO HEDGE FOR A SELLOFF ACROSS “RISK ASSETS”? - 9

 

All told, a positive outlook for global economic growth looks to overcome tired pessimism about US fiscal policy, Eurozone sovereign debt woes, Chinese growth scares and other 2012-style bear theses to continue underpinning “risk asset” prices – for now at least. Specifically, our modeling of the key indicators and indices suggest there is further upside to be risk managed over the intermediate term.

 

Our updated World GIP outlook is included in the chart below. We’re now at +2.6-3.4% for full-year 2013 global real GDP growth. That compares to roughly +2.1% in 2012 and the implied positive delta therein should continue to cushion risk asset prices – at least until all the good news is priced in. A confirmed TRADE line breakdown on the SPX would be one of the key early signals of that occurring domestically.

 

Darius Dale

Senior Analyst

 

IS IT TIME TO HEDGE FOR A SELLOFF ACROSS “RISK ASSETS”? - WORLD


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