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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





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 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





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. 

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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.




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).




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




  • "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"

Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.