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DRI Earnings Preview

Darden Restaurants reports 3QFY12 EPS on Friday.  We are not expecting management to reverse course on its bearish view of FY13 and FY14 and, as we outlined during a conference call with clients on 3/14, we believe the stock is in a “win-win” scenario.  Here is a copy of our recent presentation materials and the accompanying audio link, titled, “DRI: The Unthinkable Long Case”. 

 

While we would not object to a shakeup of the management team or the emergence of an activist investor to bring about a change in strategy, there have been some positive signs that the company is considering fresh approaches to how it is allocating capital. 

 

Two marginal positives in a sea of negatives over the past couple of months include:

  • During the Analyst Meeting, Dave George, the new President of Olive Garden, acknowledged the deteriorated value proposition of the concept, as well as the need to slow unit expansion and focus more narrowly on execution
  • Red Lobster is testing a new “pay at the counter” version of its concept.  Customers place their orders at a counter and a server delivers the food when it’s ready.  It’s difficult to know if this concept will prove effective in attracting customers but we take the company thinking differently about its strategy, and capital allocation, as a marginal positive.  For too long, as we detailed in our Black Book, “DRI: The Unthinkable Short Case”, in July, the company had been slow to react to decelerating trends and made poor capital allocation decisions.  With seafood commodity prices, particularly Lobster, being so volatile, a move to a higher margin concept makes sense to us at first blush.

 

Sales

 

As preannounced, sales continued to be soft at Darden’s core brands during the third fiscal quarter.  With Knapp Track comparable restaurant sales decelerating to -5.4% in February, we would anticipate that trends deteriorated intra-quarter at most, if not all, of Darden’s concepts.  The chart below shows what the sequential acceleration in the Gap-to-Knapp that is implied by Darden’s preannouncement late last month. 

 

DRI Earnings Preview - knapp dri gap to

 

 

Win-Win

 

Given the dividend, which it seems management is intent on preserving, and the fact that Knapp alluded to improving casual dining trends in March, we do not see significant downside to the stock from here.  We believe, that after years of underperformance, any significant deterioration in guidance is likely to prompt intervention by an activist investor.  Even at current levels, we believe the breakup value of the stock is exceeds the current share price.  See the slide deck of our recent call for more details.

 

DRI Earnings Preview - dri win win

 

 

Howard Penney

Managing Director

 

Rory Green

Senior Analyst

  

 


GES: No Process, No Multiple

Takeaway: Newsflash: Fashion companies that blame misses on the economy don’t get big multiples. Even w the after-hours sell-off, this is a value-trap

Conclusion: We’re not at all surprised by the big guide-down at GES, as it’s been on our short list for the better part of a year. We knew this one was overearning, and guidance around margins was like a balloon being held underwater while interim management manufactured earnings sufficient to keep the stock afloat. That said, we wish we’d been louder about this potentially being the quarter where the balloon bursts. The good news is that management has not yet capitulated with its guidance. Earning the lower end of the $1.70-$1.90 guidance is optimistic at best, and if it gets there it will be through cutting costs that arguably should be reallocated to other areas of the business. Our point is that even with the stock trading down, we still like it on the short side. We think GES has 2 to 1 downside/upside.

 

The way we look at it, the Guess? brand is stalling in all but a few markets, the executive suite has a revolving door (losing 3 key executives in 5 months – two on the same day), and the only real bull case revolves around this being cheap on a more ‘normal’ earnings base of $3+ that it earned over each of the past two years. At $26, we might concur with the ‘cheap’ part, but unfortunately, the premise that GES can ever earn $3 again without significant capital investment (i.e. taking earnings down first) is wishful thinking. Carlos Alberini – the best thing that ever happened to GES -- left for greener pastures (Restoration Hardware) knowing that he was leaving peak earnings power in the dust.

 

We think that $3 will prove about elusive as Bigfoot, and until then you’re left with an annuity earnings stream of something closer to $1.50-$1.60. What’s a zero-growth earnings stream worth? Whether we use a no-growth retail multiple of 10-12x, or capitalize by a 10% cost of equity (we hate arbitrarily picking cost of equity, but 10% is probably close). Either way a mid-teens stock is not out of the question.

 

Not only would we argue that it is currently expensive on the real earnings power of the company (16-17x the $1.50 we think GES should earn), but there is literally nothing in place to get the brand momentum moving upward again.

 

One thing that’s important to consider is that it's 2/3 of GES’ business that is causing the problem – and that’s North America Retail, and Europe. Unfortunately, the company is blaming the economy – again. GES needs to understand – as we do – that investors absolutely have zero tolerance for a management team that does not have a process to drive its business in the face of a downturn in the economy.  Is Ralph Lauren complaining about the economy? No. It’s growing its top and bottom line by driving its brand across product, channel and customer categories in a synchronized way. Guess, on the flip side, is really good at making excuses.   

 

In the end, we think we’ll need to see new blood in the executive rank at GES who will then need to fight for – and win – the right to reinvest capital into the business to better stratify the brand and build an omnichannel strategy accordingly. We’d definitely put GES in the bottom quartile with its abilities in those areas. Until then, it’s a value-trap in the mid-$20s. We think best case upside is $30 on manufactured earnings upside through misplaced cost cuts. On the downside we think you've got $15 based on math above.  

 

NOT A GOOD MOVE IN GES SIGMA THIS QUARTER -- AGAIN

GES: No Process, No Multiple - gessinga


GIS - No Need to Chase

What we liked in the quarter:

  • Obviously, beating consensus on both revenue and EPS is better than the alternative
  • EBIT margin did improve slightly in the quarter, even if we aren’t fans of what drove it (see below)
  • Continued sequential improvement in constant currency organic sales growth - +2.6% (versus +5.2% in the lapping quarter).  Last quarter, +1.9% versus +5.4% comparable
  • Strong FCF generation, $2.61 per share in FCF for the nine months of fiscal 2013
  • Share losses in cereal moderated (-0.7 pts in 1H, -0.5 pts in Q3)
  • Yoplait’s growth in the Greek yogurt segment outpaced the category (+137% vs. +49%), against a very low base, of course
  • Progresso growth outpaced the soup category (+7% YTD vs. +5%)

What we didn’t like:

  • Beat consensus by $0.07 in the quarter and took up full year guidance (one quarter remaining) by $0.01 at the low and high end
  • Guided Q4 below consensus – implied guidance of $0.51 for the quarter versus consensus of $0.59 (“EPS expected to be below year-ago - $0.60”)
  • Tax rate ($0.01 per share) and lower interest expense ($0.01 per share) flattered the quarter
  • “Advertising and media expense was 6 percent below strong year-ago levels” – drove some of the decline in SG&A which was the offset to…
  • …lower gross margins in the quarter (53 bps)
  • Yoplait sales growth in the quarter was still negative, despite easy year over year comparisons
  • Big G sales growth was still negative in the quarter

Our inclination here is not to chase this name up, and to be prepared to fade today’s move.  Even if the company is being conservative with its Q4 guidance ($0.54 internally?), consensus still needs to come down by 10% for the quarter.  Valuation isn’t heroic, with GIS trading at 16.9x calendar ’13 versus the group at 20.9x (large cap multiple is 17.0x), but despite the sequential improvement in constant currency organic sales trends mentioned above, GIS is still facing challenges across cereal and yogurt, two key drivers of top line and EBIT.

 

-Rob

 

Robert  Campagnino

Managing Director

HEDGEYE RISK MANAGEMENT, LLC

E:

P:

 

Matt Hedrick

Senior Analyst


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Will Russia Save Cyprus?

This note was originally published March 20, 2013 at 14:51 in Macro

Below is an update on how we see the developments in Cyprus playing out after the Cypriot parliament yesterday firmly rejected the levy on bank deposits with 36 votes against, zero in favor and 19 abstentions. 

 

In short, we see Cyprus turning to Russia for a larger loan to support both its current government budget obligations and to fulfill the Eurozone’s demand that the country contributes €5.8B to the bailout. Should Russia not play ball, there’s no clear fallback plan, yet we expect some form of compromise from the Eurocrats (Eurozone heads and the ECB) due to the group’s biggest fear, contagion. Given today’s market action we think participants have already priced in some form of a deal getting done.

 

Here’s how we think these two scenarios may develop in finer detail.

 

1.       Russia Offers Additional Loan Guarantees:

  • Cypriot Finance Minister Michael Sarris was in Moscow today meeting with his Russian counterpart.
  • This is a critical meeting given that beyond the leverage Cypriot banks have with Greece, Russia has the most skin in the game (an estimated total exposure of €60B, €20B of which in deposits, a sum  roughly equal to the size of Cyprus’ annual GDP).
  • It’s appears likely (in hindsight) that the Eurocrats did not work at all with Russians (which is saying something about geopolitical relations) to limit the failed step it made in issuing a deposit levy.
  • It’s clear that Eurocrats (especially German Chancellor Merkel who is preparing for an election in September) chose this deposit levy option to pander to their constituents by throwing “less” in total bailout funds. However, their game theory in issuing a bank levy and in not consulting with the Russians was squarely wrong. 
  •  No outcome was reached with the Russians today but press reports have indicated that Cyprus asked Russia for a five-year extension of an existing €2.5B loan (maturing in 2016), along with a reduction in the 4.5% interest rate.  We believe this loan will be primarily used to fund the government operations which could not be paid for otherwise. 
  • We suspect that Cyprus will also ask for funding to cover the €5.8B that the Eurozone has asked it to contribute in order to receive a €10B loan.
  • Given Russian interests in having a location outside of Russia to bank (be it to launder money, obfuscate assets, remove assets from Russian territory, etc.) and its potential interest in exchanging more favorable loan terms for physical Cypriot assets (in banks and energy), we think there’s a high likelihood that Russians write the checks the Cypriots request.

2.       Cyprus Calls the Eurocrats' Bluff on Bailout Terms:

  • However, should Russia not write the check, and the Cypriots balk on contributing to the bailout, the Eurocrats will quickly be on their heels with the threat of capital flight and with it bank failure.
  • Just today ECB Executive Board member Joerg Asmussen stoked the fire by saying that banks in Cyprus are not solvent without them being quickly recapitalized via a bailout program. Current ECB rules do not allow national central banks to lend to insolvent banks. So the pillars supporting the banks could give way if deposits walk.
  • Remember, Eurocrats thought they had the upper hand in issuing these deposit levies. While the Eurocrats may ultimately still have the upper hand, as both the Cypriot government and its people do not wish to live in a failed state (much like the Greeks), they too may be testing the waters to call the Eurocrats’ bluff in just how serious they are about the terms of the bailout loan.
  • To buy time and prevent assets from fleeing, it appears that the banks in Cyprus are unlikely to open until next Tuesday (Monday is another official bank holiday), and could be closed all next week depending on the developments. 
  • Should the Eurocrats’ bluff be called there could be renewed discussion around imposing haircuts on debt holders of the major Cypriot banks, however given the Eurocrats initial misstep, this option may too be off the table.  

Bottom line: 

 

If Russia doesn’t step up to aid Cyprus, look for the Eurocrats to be forced to compromise on the loan terms as their biggest fear remains contagion. The optimal outcome for both the Russians and the Eurocrats is for this issue to be resolved so that both sides can largely “get back to business.”   A longer impasse may result if Russia doesn’t play ball in writing a larger loan in which case we think only time will tell just how the Eurocrats come to a concession.  

 

We continue to think that this "crisis" in Cyprus will be short lived; today’s market action is also supporting this view. However, taken together with Italian election uncertainty, we believe the events will continue to put downward pressure on the EUR/USD. We’re signaling an immediate term lid on the EUR/USD of $1.30.

 

 

 


MNST – Supplement or Beverage? Potato or Potato?

In an anticipated move, MNST announced that it will be marketing its product as a beverage rather than as a dietary supplement.  The company certainly has the leeway to make the change, as dietary supplements are “regulated” by the FDA as a category of foods (rather than as a drug), so movement between the two categories is relatively easy.  From the Dietary Supplement and Education Act of 1994:

 

The term "dietary supplement":

  • means a product (other than tobacco) intended to supplement the diet that bears or contains one or more of the following dietary ingredients:
  • a vitamin;
  • a mineral;
  • an herb or other botanical;
  • an amino acid;
  • a dietary substance for use by man to supplement the diet by increasing the total dietary intake.

Based on the definition, it is pretty easy to see how “energy drinks” can pick and choose classifications.  One difference between the two categories is that manufacturers of supplements are required to submit to the FDA reports of serious adverse consequences involving the product whereas notification as a food product is voluntary, and MNST will likely continue to self-report. Investors have suggested to us that this would be a benefit to MNST, but quite frankly we can’t see how – it isn’t  the self-reported data that the company has run aground on – it’s the data from DAWN (see below), as well as claims filed by plaintiffs’ attorneys.

 

From the DAWN report (Drug Abuse Warning Network):

 

Within DAWN, an ED visit is categorized as an adverse reaction when the chart documents that a prescription or over-the-counter pharmaceutical, taken as prescribed or directed, produced an adverse drug reaction, side effect, drug-drug interaction, or drug/alcohol interaction. Although energy drinks are not treated as drugs by the Food and Drug Administration, ED visits involving energy drinks were classified as adverse reactions if the chart documented them as such. If other substances are reported on the chart as involved in the visit, an energy drink is not necessarily the sole reason for the adverse reaction.

 

The data contained in DAWN is collected directly from hospitals, so we will likely continue to hear the drumbeat of energy drinks and emergency room visits.

 

One move on the part of MNST that we are digging in on is the disclosure of caffeine content – the company needed to get ahead of this issue, because we saw it as likely to be mandated sooner rather than later.  One other thing we would like to see the company do is change/eliminate any marketing that potentially impacts the 18 year old and younger age group.  Getting in front of the issue usually tends to be a better strategy as the company can be in a position to be a part of the debate rather than have the debate take place around them and the results forced upon the company.

 

Recently, we have also seen a (small) effort on the part of some jurisdictions to require age verification for the purchase of energy drinks.  We think this is basically a non-starter, as retail trade associations would likely rail against the potential incremental cost and hassle of age verification, particularly if it were at a level other than the current legal age limit for tobacco and alcohol (21).  Further, if the age limit were pushed to 21, we think age restrictions on caffeine for 18-20 year olds are the height of stupidity.

 

Finally, classification as a beverage allows for the use of food stamps to purchase the product - again we aren't seeing a significant material benefit associated with that aspect of the company's decision.

 

Where does that leave us?

 

Well, right back where we started when MNST was a dietary supplement – negative news flow that is likely to persist, though we think the end result of the debate is that significant regulation of caffeine is a Pandora’s box that no reasonable legislator should want to open.  We continue to think that the company needs to be more proactive with respect to this debate.  Finally, our bigger near-term concern is that we remain below consensus for 1H.

 

Call with questions,

 

Rob

 

Robert  Campagnino

Managing Director

HEDGEYE RISK MANAGEMENT, LLC

E:

P:

 

Matt Hedrick

Senior Analyst


Will Russia Save Cyprus?

Below is an update on how we see the developments in Cyprus playing out after the Cypriot parliament yesterday firmly rejected the levy on bank deposits with 36 votes against, 0 in favor and 19 abstentions. 

 

In short, we see Cyprus turning to Russia for a larger loan to support both its current government budget obligations and to fulfill the Eurozone’s demand that the country contributes €5.8B to the bailout. Should Russia not play ball, there’s no clear fallback plan, yet we expect some form of compromise from the Eurocrats (Eurozone heads and the ECB) due to the group’s biggest fear, contagion. Given today’s market action we think participants have already priced in some form of a deal getting done.

 

Here’s how we think these two scenarios may develop in finer detail.

 

1.       Russia Offers Additional Loan Guarantees:

  • Cypriot Finance Minister Michael Sarris was in Moscow today meeting with his Russian counterpart.
  • This is a critical meeting given that beyond the leverage Cypriot banks have with Greece, Russia has the most skin in the game (an estimated total exposure of €60B, €20B of which in deposits, a sum  roughly equal to the size of Cyprus’ annual GDP).
  • It’s appears likely (in hindsight) that the Eurocrats did not work at all with Russians (which is saying something about geopolitical relations) to limit the failed step it made in issuing a deposit levy.
  • It’s clear that Eurocrats (especially German Chancellor Merkel who is preparing for an election in September) chose this deposit levy option to pander to their constituents by throwing “less” in total bailout funds. However, their game theory in issuing a bank levy and in not consulting with the Russians was squarely wrong. 
  •  No outcome was reached with the Russians today but press reports have indicated that Cyprus asked Russia for a five-year extension of an existing €2.5B loan (maturing in 2016), along with a reduction in the 4.5% interest rate.  We believe this loan will be primarily used to fund the government operations which could not be paid for otherwise. 
  • We suspect that Cyprus will also ask for funding to cover the €5.8B that the Eurozone has asked it to contribute in order to receive a €10B loan.
  • Given Russian interests in having a location outside of Russia to bank (be it to launder money, obfuscate assets, remove assets from Russian territory, etc.) and its potential interest in exchanging more favorable loan terms for physical Cypriot assets (in banks and energy), we think there’s a high likelihood that Russians write the checks the Cypriots request.

2.       Cyprus Calls the Eurocrats' Bluff on Bailout Terms:

  • However, should Russia not write the check, and the Cypriots balk on contributing to the bailout, the Eurocrats will quickly be on their heels with the threat of capital flight and with it bank failure.
  • Just today ECB Executive Board member Joerg Asmussen stoked the fire by saying that banks in Cyprus are not solvent without them being quickly recapitalized via a bailout program. Current ECB rules do not allow national central banks to lend to insolvent banks. So the pillars supporting the banks could give way if deposits walk.
  • Remember, Eurocrats thought they had the upper hand in issuing these deposit levies. While the Eurocrats may ultimately still have the upper hand, as both the Cypriot government and its people do not wish to live in a failed state (much like the Greeks), they too may be testing the waters to call the Eurocrats’ bluff in just how serious they are about the terms of the bailout loan.
  • To buy time and prevent assets from fleeing, it appears that the banks in Cyprus are unlikely to open until next Tuesday (Monday is another official bank holiday), and could be closed all next week depending on the developments. 
  • Should the Eurocrats’ bluff be called there could be renewed discussion around imposing haircuts on debt holders of the major Cypriot banks, however given the Eurocrats initial misstep, this option may too be off the table.  

Bottom line: 

 

If Russia doesn’t step up to aid Cyprus, look for the Eurocrats to be forced to compromise on the loan terms as their biggest fear remains contagion. The optimal outcome for both the Russians and the Eurocrats is for this issue to be resolved so that both sides can largely “get back to business.”   A longer impasse may result if Russia doesn’t play ball in writing a larger loan in which case we think only time will tell just how the Eurocrats come to a concession.  

 

We continue to think that this ‘crisis’ in Cyprus will be short lived; today’s market action is also supporting this view. However, taken together with Italian election uncertainty, we believe the events will continue to put downward pressure on the EUR/USD. We’re signaling an immediate term lid on the EUR/USD of $1.30.

 

 

Matthew Hedrick
Senior Analyst
HEDGEYE RISK MANAGEMENT

 


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