Today we sold our iShares Dow Jones US Home Construction ETF (ITB) position at $22.55 a share at 10:48 AM EDT in our Real-Time Alerts. We originally bought ITB at $22.17 a share on February 20, 2013. After an outstanding week of US Housing data, booking our 6th consecutive gain on the long side in ITB on an immediate-term TRADE overbought signal. We remain Bullish on #HousingsHammer.


TRADE OF THE DAY: ITB - image001

CRI: Eye On Capital Intensity

Takeaway: We liked the CRI print, but we don’t like the change we’re seeing in capital intensity. The movements are severe and could impact returns.

Conclusion: There were puts and takes in the CRI quarter, but the major standout to us is the change that we’re seeing in the capital intensity of the model. The colossal rise in capex and spike in SG&A ups the ante for the well-telegraphed ‘14% EBIT Margin’ bull case we need to see come to fruition in order to prevent a decline in returns. If this happens we think you’ve got 16-17x $4.25 in EPS in 2015, or a 8-10% annualized return on a number that you have to wait 3-years to see. If our concerns about pricing spreads and high cost/low return of international growth play out, we think CRI has downside to about 13x on $3.00, or $15 downside over the next year. Capital deployment shorts don’t play out overnight, but at a minim we’d avoid the long side of this name. There are far better places to be in our opinion.



Obviously the market doesn’t like the CRI print today, and we agree. But we think we don’t like it for different reasons. The stock started to trade down just as CEO Casey mentioned that 1Q to date showed negative comps in Carter’s stores. While that’s not good, we think a bigger negative was the change in tone regarding capital allocation and margin makeup.


Harvesting Is Over: We think CRI is entering a meaningfully different stage in its investment cycle. The way we see it, it just made its second international acquisition in 18 months, it is bringing its product sourcing from 20% of total today to 50% in 5-years, it just took SG&A up 40% in the latest quarter on top of a 14% sales growth rate, and management noted that GM upside (ie pricing better than costs – something it has sparse control over) will need to happen in order to offset higher planned costs. Furthermore, capex in the coming year is slated to be $200mm. As a frame of reference, this is 4x the rate of Carter’s D&A, and it has never spent even half that much in a given year (even as a % of revenue) in all the years it has been public.


Don’t get us wrong. We like when companies spend money – at least those who prove to be good stewards of capital and drive returns higher through share subsequent share gain or margin improvement. But CRI is simply unproven in that regard. We’re not saying that it will fail. But rather that you need to believe that it will succeed in order to buy the stock here.


The ‘14% margins due to direct sourcing’ bull case is very well telegraphed. If we assume that the company gets there within 3-years, we’re looking at about $4.25 in earnings power. That’s a great lift over the $2.86 it printed last year and $3.28 it is guiding towards in 2013. But with the stock at $55, you’re paying 12-13x a best-case earnings number that may or may not happen in 3-years.


In the interim, there are some puts and takes.

International is clearly growing, US Carter’s retail is still putting up mid-teens square footage growth, and is growing nicely – up to 18% of store sales in this quarter vs 11% last year. The new DC should keep this heading higher.


On the flip side, we remain concerned about more normalized product costs and increased competition by both retail partners and competing brands alike. In addition, while International is nice, it’s definitely not a slam dunk.


a)      Bonnie Togs comping down only 2-quarters after it is included in the comp base.

b)      The new dual-brand stores in Canada are launching, but are not proven yet.  

c)       Just after CRI anniversaries the Canada acquisition, it’s investing capital in the last place we want to see incremental money put to work – Japan. For a luxury brand (like Kate Spade, Kors, or Ralph) perhaps that makes sense, but not for a kids mass apparel maker. Also, keep in mind that the dominant brand for CRI in Japan is Osh Kosh, which it has a hard enough time growing in the US nevermind Japan. The opportunity is for the for Carters brand, but Japanese Moms are not US moms. It will cost money to build that opportunity. 

Have Stocks Conquered Commodities?

Since we moved in to #GrowthStabilizing territory in mid-November of 2012, we've been a proponent of the long US stocks/short commodities game plan as the great commodity bubble created by the Federal Reserve deflates. Over the last three months, the S&P 500 has gained +7% while the CRB Commodities Index has dropped -1.1%. 


Have Stocks Conquered Commodities? - CRB SPX

investing ideas

Risk Managed Long Term Investing for Pros

Hedgeye CEO Keith McCullough handpicks the “best of the best” long and short ideas delivered to him by our team of over 30 research analysts across myriad sectors.


We would not short Darden today, as our short thesis that we first outlined in July has become common knowledge, but we retain a bearish bias.  It is possible to construct a valuation/earnings case for 8-20%of downside but, for want of catalysts, we would not be taking a short position today.  With the emergence of a catalyst, we may become more vocal on the short side of DRI but for now we are covering our short position in the Hedgeye Restaurants Position Monitor.


Our rationale:

  1. The company has announced that earnings over the next 5 quarters will be disappointing
  2. SRS are likely to see a sequential uptick in 3QFY13
  3. The company has reduced capital spending enough to cover the dividend

Our bearish bias remains due to capital spending plans that remain overly aggressive and the fact that Darden’s most important asset – The Olive Garden – is a long way from being fixed.  



Summary of Our Thoughts on the Darden Meeting


The theme for the meeting, “Operating Successfully in a New Era”, was the first indication that this presentation would be somewhat detached from reality.  Several of the statements from management surprised us but most striking was the company only now stating that the change in the casual dining industry has been structural, not cyclical.  Darden has the largest system in casual dining.  Its national competitors have been recognizing the structural nature of the shift in casual dining customers’ habits for several years.  The demographic changes that we have written about are among the most obvious indications that the go-go days are over for casual dining.



Core Brands Remain the Problem


We believe that management has been tone deaf to consumer trends.  That may sound like an exaggeration but the two charts, below, speak to that argument.  An objectivity-damaging trust in internal customer satisfaction results rather than actual traffic trends is one factor we inferred from the presentation content.  The fact that the “Darden i-Tracker” is implying a consumer perception diametrically opposite to the trend in same-restaurant traffic growth perhaps calls into question the relevance of the internally generated metric.


The charts below show that, by the metrics that matter, Olive Garden and Red Lobster need a lot of work.  What’s more, management wasn’t forthcoming with many details on the Olive Garden turnaround; the technology segment of the Analyst Meeting was longer in duration that the Olive Garden segment. 


DRI: EASY YARDS ARE OVER - dri big 2 gap to knapp traffic



Sacrificing Growth to Keep the Dividend


The company pointed out that cash flow had to be managed more conservatively to support the dividend.

  • The current dividend is currently running at roughly $263mm on an annual basis
  • Free Cash Flow is anticipated to be $245-265 million in FY13
  • Mgmt has a policy of raising the dividend each year with a target of 50% payout ratio
  • The roughly $125 million cut in cap ex will eliminate that funding gap for the dividend


Cutting CapEx at Olive Garden

  • Cutting back CapEx from $700-$725 million in FY 2013 to $600-$650 million in FY 2014
  • OG new units scaled back from about 35 to 15 and
  • OG remodels put off until late FY14
  • LH openings from 40+ to 35-40



Olive Garden


The company’s most important business unit had the shortest presentation.  The new President, Dave George, is still settling into his role and impressed us with his observations and perspectives.  There were two major takeaways from the Olive Garden segment:

  • Remodels are being stopped and new unit openings are being slowed likely until sometime in FY14
  • Details of Tuscan remodel being tweaked, logo being updated
  • No new initiatives were announced



Red Lobster


Inconsistency has plagued Red Lobster over the last few years as promotions have failed to deliver steady results.  The Bar Harbor remodel program has been yielding some positive results for traffic but it seems that the turnaround at Red Lobster will take some time.  





Management’s claim that limiting price increases to 1% will help drive incremental traffic growth seems to contradict recent Knapp Track, Gap-to-Knapp, and company data.  The underperformance of Olive Garden and Red Lobster in recent years would suggest that management’s understanding of its customers may not be acute enough to make such a claim.

The theory goes:

  • Management said “we are trying to target the check to the guest that need the relief” but how?
  • They said they are just now building the technology to have the ability know the consumer better, so how can they have target messaging now?
  • This technology will not be in place until late in FY 2014



Truth Hurts


We were a little perturbed by a statement from CEO Clarence Otis, at the end of the second day, that the company’s traffic problem is only a year old.  The data (charts earlier in this post) show otherwise and we believe this Analyst Meeting exposed a degree of detachment between Darden’s CEO and the nuts and bolts of the company’s operations. 





Howard Penney

Managing Director


Rory Green

Senior Analyst






Why Is The VIX Getting Smoked?

It’s all about expectations. I get the front-month VIX is different than the term-structure of volatility’s curve. Looking at expectations, across durations, will amplify my point:


  1. VIX (front-month) TREND resistance = 17.18, and that was only violated to the upside for ½ a day
  2. VIX topped on Monday at another lower long-term-high (on DEC28, 2012 the lower-high = 22.72)
  3. VIX was at 40 in Q1 of 2010 after we were legitimately concerned about European Dominos


As you can see in the Darius Dale’s Chart of The Day, front-month Volatility (VIX) continues to make a series of long-term lower highs as the volume of the manic media’s freak-outs make higher-highs. Think they’ll make the call on the end of the world, together?


If this is just a mini-mania of what you saw in November-December (substitute Italy for US Congress), what is it, specifically, that you have a as a catalyst that would stop the VIX from going straight back down to 12 from here?


It’s not going to 12 this week. I get that. But the VIX is probably not going back to 22.72 or 42.96 (the SEP2011 freak-out) this week either. If I see anything real developing that changes my view on this, I’ll just change my mind. I don’t have to do that yet, thank God.


Selling fear has been working since we turned bullish on US stocks in late November.


Crude Intentions

Our thesis regarding the recovery of the US economy involves having a strong US dollar. A stronger dollar helps drive commodity prices down, which in turn helps boost consumption. Consumption is the key to recovery as people consume more and see a material improvement at places like the gas station and grocery store. Right now, the US dollar (DXY) continues to strengthen since the beginning of January while WTI crude oil falls lower. The one headwind we still face in the recovery of the economy is high energy prices and if we continue to see the dollar strengthen, that headwind could soon be a thing of the past.


Crude Intentions - USD CRUDE

Early Look

daily macro intelligence

Relied upon by big institutional and individual investors across the world, this granular morning newsletter distills the latest and most vital market developments and insures that you are always in the know.