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PNRA HAPPY CAMPER FACING QSR WOUNDED BEARS

As the shift in American attitudes towards "traditional" fast food has become more pronounced in recent years, Panera has emerged as one of the happy campers of the restaurant industry.  Wounded bears, in the form of MCD, WEN, and others, pose a danger for PNRA. 

 

In February, we wrote that Panera’s mix growth outlook was negative.  Further evidence is emerging that competitors from QSR and Casual Dining are looking to challenge Panera’s position as the “healthy” option, a factor that could represent an added headwind to Panera comps going forward. 

 

Panera Bread’s position as a healthy QSR option that is relatively free of competitors is gradually changing as casual dining chains offer lower price points and chains like Wendy’s upgrade their menus to include items that are cheaper than Panera’s core offerings but are marketed as healthy eating options.  McDonald’s offering healthier menu alternatives, such as the McWrap, and investing in marketing the item aggressively, further underscores the industry-wide focus on healthier options that are sought by millennial consumers.  

 

PNRA HAPPY CAMPER FACING QSR WOUNDED BEARS - pnra sss components

 

 

Happy Camper, Meet Wounded Bear(s)

 

We believe that the market has been shifting away from Wendy’s, McDonald’s, and other “traditional” QSR players for years.  The impact of this shift in consumer preferences on McDonald’s has been masked, to a degree, by successful but transient products like frappes and smoothies.  McDonald’s “millennial problem”, well described by Maureen Morrison at Adage, is front-and-center for the company’s marketing strategy.   

 

We are not optimistic that McDonald’s marketing shift will solve its issues but we do believe that Panera’s traffic trends are likely to be, on the margin, negatively impacted.  Ultimately, when MCDonald’s hand is forced, the company will invest more meaningfully to change its brand’s perception among millenials who, increasingly, want fresh and organic food offered in a customizable manner. 

 

 

Takeaway

 

McDonald’s and other traditional QSR players are scrambling to change with the times.  Beverage initiatives at McDonald’s have worked as short-term panaceas but we contend that soft sales growth is symptomatic of a changing business environment as well as MCD's business becoming overly-complex.  We believe that traditional QSR management teams see Panera’s brand positioning as an attractive path for the future.  Given the deep pockets of this industry and the highly competitive nature of the companies involved, this will present a headwind to Panera’s same-restaurant sales going forward.

 

 

Howard Penney

Managing Director

 

Rory Green

Senior Analyst


Dick's Sporting Goods: 10K Takeaway

Takeaway: The rate at which DKS has been de-risking its real estate portfolio has halted in its tracks. DKS remains a value trap. Avoid it.

This note was originally published March 25, 2013 at 21:44 in Retail

Conclusion: We think the biggest takeaway from the Dick's Sporting Goods (DKS) 10K is the one that noone will talk about.  Specifically, the rate at which the company has been de-risking its real estate portfolio has halted in its tracks. We recently turned negative on DKS -- and that was before having this data point. A negative change on the margin in its lease portfolio on top of weak comps, peak margins, and a dramatic increase in capital intensity is a great formula for returns to go negative. DKS remains a value trap. Avoid it.

 

Here’s Our Logic

One things we focus a lot on is a given company’s ‘Lease Flexibility Ratio’, which is a term we use to measure the weighted average duration of a company’s operating lease portfolio. We calculate this by dividing the total lease obligations by the payments obligated in year one. Simply put, in almost all cases, the shorter the Lease Flexibility Ratio, the more flexible and healthier it is for the company in question.  This does not mean that the asset is not secured for a longer time period, but simply that the minimum financial obligation associated with the asset is low.

 

Why would a company have a high ratio (ie very inflexible)? One of two reasons. 1) Either it has extremely long-dated leases. Target and Whole Foods are both at 20x, while Kohl’s is 26x (JCP is only 11x -- bad for KSS). 2) The other reason would simply be that a given retailer wants to secure real estate that it can’t afford. If such is the case, then one of three things happens.

 

a)      The retailer signs up for a significantly escalating minimum payment each year, or

b)      It signs up for a location before competitors, and accepts the obligation well before it sees associated sales, or

c)      It removes kick-out clauses or other safety features that would otherwise reduce certain obligations in the out-years of a lease agreement.  

 

We think DKS is a combo of a) and b).

 

Dick's Sporting Goods: 10K Takeaway - dks lease

 

We look at these ratios to compare two things; 1) a given retailer’s lease structure versus competitors, and 2) how a company’s lease portfolio changes on an annual basis versus itself. That’s where Dick’s is interesting.

 

Historically, DKS has had a Flexibility Ratio that we’d call egregious.  5-years ago, for example, DKS’ average portfolio duration was over 12-years. That’s nearly as high as Costco – which sits at 14x. Costco is a destination if there ever was one in retail. Dick’s may be a nice store, but it’s no Costco.

 

The good news is that over the past 4-years, DKS’ weighted average duration has come from 12.2 years down to 8.0 years. That’s been very bullish for DKS’ ability to leverage occupancy with a lower comp than the 4-5% it needed back in 2007. We’ve seen that hurdle rate come down closer to 3% over the past few years. Again, good news.

 

The bad news is that in 2012 it ticked back up again.  It only went up by 0.2x, which is hardly enough for us to cry wolf. But make no mistake, the reduction in its lease minimums is one of the factors why we’re been positively predisposed to owning DKS at certain times throughout the past few years.

 

But today, margins are at peak, comps are trending only in the +1-3% range, and management admitted that it needs catch-up investment to acquire the appropriate omni-channel strategy. As such we’re seeing capex trend up this year by almost a third to $300mm, without an obvious near-term payoff.  Maybe we’d be patient for a retailer with above-average defendability in its business model, but unfortunately, we think that over a third of DKS’ business is at very significant risk from web-based competition (not to mention brands’ own direct brands – mind you, Nike is 17% of sales).

 

Our research call here is clearly negative.


KOSPI LOSING LEADING INDICATOR STATUS?

Takeaway: Korea's KOSPI has been a good leading indicator of global growth, but the currency wars might be changing that.

This note was originally published March 25, 2013 at 15:25 in Macro

SUMMARY BULLETS:

 

  • The impact of the Currency War is perpetuating mixed signals out of the KOSPI, which many Macro analysts consider a leading indicator for the slope of global growth.
  • The fact that the KOSPI chart is not up-and-to-the-right as a pro-growth signal (itself perpetuated by declining prices for energy and raw materials inputs) doesn’t necessarily imply global growth is destabilizing.
  • Rather, it implies a loss of international market share among South Korean manufacturers and exporters to their Japanese counterparts amid the sustained trend of yen depreciation, which remains firmly intact.

 

Manufacturers of “capital goods” (using the Industrials and Tech sectors as proxies) account for 41.9% of the market capitalization of South Korea’s benchmark equity index (the KOSPI). That compares to 29.6% for Japan – South Korea’s chief regional competitor across a variety of key industries and export markets – which itself is also well above the regional average of 20.4%.

 

KOSPI LOSING LEADING INDICATOR STATUS? - KOSPI CapEx

 

KOSPI LOSING LEADING INDICATOR STATUS? - 2

 

Over the weekend, South Korea’s newly appointed finance minister, Hyun Oh Seok, revived his nation’s concerns over JPY debauchery said that the G20 should revisit the issue. On just his second day as finance chief, Hyun firmly proclaimed, “The yen is depreciating while the won is gaining and this is flashing a red light for Korea’s exports… While we will do what we can, we need international cooperation to deal with the weak-yen problem.”

 

Hyun’s whining may fall on deaf ears, however, as Japan was able to escape any semblance of int’l censure of its Policies To Inflate at the last G20 summit. Because Japanese officials have been very careful in their rhetoric that their economic policy agenda is targeted at overcoming domestic headwinds and not for the sake of currency devaluation, G20 finance ministers are broadly on board with Abenomics – making it very hard for South Korea to find reprieve in the form of int’l censure(s).

 

Even if Japanese officials weren’t as adept at sidestepping int’l criticism, it’s unlikely the G20 has the political ethos to censure Japan anyway; the US, Eurozone and the UK have each taken multiple turns at being the world’s biggest money-printers and currency debauchers over the past ~5 years.

 

KOSPI LOSING LEADING INDICATOR STATUS? - 8

 

Net-net, that should continue to perpetuate a loss of market share among many South Korean manufacturers that compete head-to-head on price with their Japanese counterparts. In effect, Hyundai’s loss is Toyota’s gain in a world where consumer demand for automobiles isn’t necessarily robust.

 

KOSPI LOSING LEADING INDICATOR STATUS? - 4

 

KOSPI LOSING LEADING INDICATOR STATUS? - Korea KOSPI

 

All told, the impact of the Currency War is perpetuating mixed signals out of the KOSPI, which many Macro analysts consider a leading indicator for the slope of global growth. The fact that the KOSPI chart is not up-and-to-the-right as a pro-growth signal (itself perpetuated by declining prices for energy and raw materials inputs) doesn’t necessarily imply global growth is destabilizing. Rather, it implies a loss of int’l market share among South Korean manufacturers and exporters to their Japanese counterparts amid the sustained trend of yen depreciation, which remains firmly intact.

 

 KOSPI LOSING LEADING INDICATOR STATUS? - 5


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Not the End of the World

Client Talking Points

Still Bearish on Commodities

Despite the fact that the end of the world crowd stayed vocal the past 24 hours, we, amazingly enough, pulled through and the end of the world isn’t here. What we do see is the same bearish trend in commodities that we have seen when the dollar remains strong. Gold, copper and oil all are weakening as the dollar strengthens for the seventh week in the last eight.

Korea’s KOSPI As a Leading Indicator?

We have looked to Korea’s KOSPI as a leading indicator of global economic growth. However, thanks to the global currency war, and specifically the ongoing depreciation of the Japanese yen, the KOSPI hasn’t performed as well as we might have expected. We think that’s a function of the competition faced by Korean manufacturers because of that weaker yen, and is not suggestive of a weakening global economy.

Asset Allocation

CASH 32% US EQUITIES 24%
INTL EQUITIES 20% COMMODITIES 0%
FIXED INCOME 0% INTL CURRENCIES 24%

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DRI

Darden stands to be a beneficiary from a housing recovery and an improved employment picture, which boosts casual dining trends. Darden reported earnings today that beat Wall Street expectations, though net income declined 18%.

FDX

With FedEx Express margins at a 30+ year low and 4-7 percentage points behind competitors, the opportunity for effective cost reductions appears significant. FedEx Ground is using its structural advantages to take market share from UPS. FDX competes in a highly consolidated industry with rational pricing. Both the Ground and Express divisions could be separately worth more than FDX’s current market value, in our view.

HOLX

HOLX remains one of our favorite longer-term fundamental growth companies given growing penetration of its 3D Tomo platform and high leverage to the 2014 Insurance Expansion from the Affordable Care Act.

Three for the Road

TWEET OF THE DAY

“Shorting European markets, selectively, on bounces is making money; shorting US stocks on that hasn’t” -- @KeithMcCullough

QUOTE OF THE DAY

“Wall Street people learn nothing and forget everything.” – Benjamin Graham

STAT OF THE DAY

$30 million, the price Yahoo! Reportedly paid to buy Summly, a mobile news app, from a 17 year-old British entrepreneur



Sturdy Horses

“Some see private enterprise as a predatory target to be shot, others as a cow to be milked, but few are those who see it as a sturdy horse pulling the wagon.”

-Prime Minister Winston Churchill

 

Winston Churchill smoked cigars effusively, ate almost whatever was put in front of him, came under fire in armed conflicts more than 50 times, and engaged in many political battles over the course of his life.  Despite these potential health risks, Churchill lived to the ripe old age of 91.  He was, by almost any estimation, a sturdy horse.

 

As it relates to his health, many observers often commented on the generous amounts of alcohol that Churchill drank.  In fact, Sir Alexander Cadogan, head of the Foreign Office, noted at the Yalta conference in 1945 that the Prime Minister was “drinking buckets of Caucasian champagne which would undermine the health of any ordinary man.”

 

Churchill himself was not shy about acknowledging aggressive consumption of spirits and once said:

 

“Always remember that I have taken more out of alcohol than alcohol has taken out of me.”

 

For those of you that have been over served, and I will include myself in that camp, you know full well that to gain the upper hand on alcohol, and in particular hangovers, indeed requires that one have the constitution of a sturdy horse.

 

But the purpose of this note is not to delve into the fine details of Churchill’s bad habits, but rather to delve into the realm for which he is most well known – foreign policy.  Based on traditional measures of risk, like volatility, many markets are signaling a future without any major foreign policy blow ups.  In particular, U.S. equities, as highlighted in the Chart of the Day are making new lows in terms of volatility.

 

This, of course, is not to say risk has gone away, but currently equity markets are certainly discounting lower global risk in the future. As a result, it is probably a sign to be even more diligent when searching for TAIL risks.  In the realm of international security, we see a number of red lights on the horizon that are worth monitoring closely, specifically: 

 

1. North Korea – Even if Dennis Rodman has improving relations with this Communist nation, the rest of the world’s relations are deteriorating on the back of a nuclear test that coincided with President Obama’s February State of the Union address.  This followed a long range missile test in December.  In combination these two tests are an attempt by Kim Jong-un to show to the world that North Korea has, or is developing, the ability to launch long range nuclear missiles.

 

In recent history, North Korea has been more of rhetorical threat than a tangible one, but both the United Nations and United States are taking the most recent actions increasingly serious.  As well, Defense Secretary Chuck Hagel indicated he intends to re-allocate $1BN+ to build a missile shield in Alaska to bolster defenses focused on North Korean threats.  This morning the North Koreas upped the ante once more in announcing that they have placed military units tasked with targeting U.S. bases under combat ready status.

2. Iran –Iran has remained largely out of the headlines in the last few months, but this will likely change with the upcoming Presidential election in June 2013.  Current Iranian President Mahmoud Ahmadinejad is barred for running after being President for two terms and has taken to saying “long live Spring” at recent events, a cryptic phrase that is being interpreted as a call for change in the face of the Ayatollah’s attempts to manage the outcome of the election.

 

We emphasize the election because the last Iranian election is generally perceived to be the most tumultuous period of mass protests in Iran since the Iranian revolution.  Since that election in 2009, international sanctions on Iran have had their intended impact with oil subsidies falling and prices of basic foodstuffs accelerating.   So, even as the Ayatollah attempts to manage this election proactively, primarily by jailing potential reformist candidates, he can’t jail every citizen and the citizenry is much worse off now than in 2009.

3. Syria – Since the start of the Arab Spring more than two years ago, Syria has been a hot spot on the political map.  Unlike some of its neighbors in which a change in leadership was relatively swift, Syria continues to be ruled by President Assad, with the ongoing goal of the rebel forces to overthrow Assad by any means.  In fact, as recently as in the last couple of days there have been rumors that Assad had been assassinated. 

 

The reality is that Assad remains in power and the rebels remain disorganized with leadership largely in disarray since the resignation of Syrian National Coalition chief Mouaz al-Khatib. The other reality is that military activity appears to be accelerating with the worst bombing in Damascus since 2011 over the weekend.  Further, there were rumors this weekend that there was a gas attack near Aleppo.  Although even here confusion reigns as no one is sure whether it was the rebels or Syrian government that used the gas.

 

Churchill was well known for his interventionist leanings and once said about Russia that:

 

“Bolshevism must be strangled in its cradle.”

 

In contrast, the current leader of the free world, United States President Obama, has been decidedly non-interventionist. Over his first term, this has certainly not impacted the United States in the short term as the most prominent threat when Obama was first elected, Al-Queda, has been largely contained and there have not been other imminent threats to the United States or global peace.  That said, any acceleration of events in North Korea, Syria, or Iran may be cause for increased U.S. intervention abroad.

 

As we think about managing risk prospectively, especially at lower levels of implied volatility, keeping key areas of potential international conflict front and center will remain critical.  As it relates to our investment themes, accelerating international conflict is actually positive for the sturdy horse of international currencies – the U.S. dollar.

 

Our immediate-term Risk Ranges for Gold, Oil (Brent), Copper, US Dollar, USD/YEN, UST 10yr Yield, VIX, and SP500 are now $1, $106.76-108.64, $3.36-3.47, $82.69-83.34, 94.01-96.72, 1.89-1.97%, 10.79-14.96, and 1, respectively.

 

 

Keep your head up and stick on the ice,

 

Daryl G. Jones

Director of Research 

 

Sturdy Horses  - Dollar is a sturdy Horse EL

 

Sturdy Horses  - Virtual Portfolio


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