CL, Better than PG, Better than Feared, but no EPS Upside and No Reason to Chase the Multiple

CL reported Q1 2013 EPS this morning and we would expect a bit of a “relief” (if you can call it that after the move the stock has had recently) rally in the name on strength of a very good organic sales growth number (+6.0%) and an EPS result that matched consensus ($1.32).  However, at 20.7x calendar ’13 earnings, there seems to be a whole lot of good news already in CL’s stock price, and we can’t come up with any reason to be involved in this name at these levels any way other than on the short side.

What we liked:

  • EPS met consensus
  • +6.0% organic revenue growth versus a reasonably difficult comp (+6.5%)
  • Organic volume growth across segments and regions (even Hill’s)
  • 33 bps improvement in gross margins (against the easiest comparison of the year)
  • Some modest leverage as +2.7% reported sales growth translated into +3.7% operating income growth
  • 13.5% increase in FCF despite higher capital spending

What we didn’t like:

  • Most difficult sales comp of the year coming up in Q2 (+8.0%) on both a one and two year basis
  • Gross margin comparisons get substantially more difficult as the year progresses
  • Margin weakness in Latin America and Hill’s

It’s tough for us to get excited about CL at these levels, even with a good organic sales growth number in the books – however, we said that at $110 as well.  Bottom line, the results are reasonable, the multiple is not.


Call with questions,




Robert  Campagnino

Managing Director





Matt Hedrick

Senior Analyst


The Cheesecake Factory remains on Hedgeye’s Best Ideas List as one of our favorite ways to play our macro team’s bullish view on US consumption.


The Cheesecake Factory reported 1Q EPS of $0.47, easily beating the $0.42.  As explained on the earnings call, about $0.03 of the EPS upside reflected a greater-than-expected 2Q to 1Q sales shift related to an earlier Easter and related spring breaks.


Up and down the P&L, food costs, labor costs and G&A were well controlled. This contributed to what was a high-quality earnings quarter.


Same store sales rose 1.4% (Cheesecake up 1.6% and Grand Lux Café down 90bps) including a 50 bps benefit from the spring break shift.  The company also mentioned 60 basis points of negative weather impact, centered in the Northeast. The two year average trend at The Cheesecake Factory and Grand Lux both improved sequentially from 4Q12.


We continue to believe that the international story is underappreciated by the street. On the call, the company emphasized the strong performance of its three international units, with higher than planned volumes being delivered at these locations.  Three additional Middle East locations are due to open this year. Management stated that for each Middle Eastern restaurant that open for a full year, it expects $0.01 in incremental annual earnings per share.


The company lowered expectations for 2Q13, due to the sales shift mentioned above, and raised its full year slightly. The midpoint of the EPS guidance range was raised by $0.01. There was nothing in this quarter to suggest that the story has changed and we are keeping “Long CAKE” on the Hedgeye Best Ideas list.


CAKE ON TOP OF ITS GAME - cake pod 1



Howard Penney

Managing Director


Rory Green

Senior Analyst

The Cycle of Deflation

Client Talking Points

Deflation Continues

The great commodity bubble brought forth by the monetary policy of the Federal Reserve has popped. Since the "Bernanke Top" of mid-September, commodity prices have come down considerably across the board. The CRB Commodity Index, which measures 19 different commodities, hit a fresh year-to-date low yesterday and can continue that trend quite easily. The fall of oil and ag prices drastically drags down markets (Russia, Korea, etc.) highly levered to commodity prices.

Pain in Spain

Spain continues to drag the European Union down with a slew of bad economic data. No wonder investors are nervous - the country just reported an unemployment rate of 27.2%. That's more than 1 in 4 people out of work. Whether that's by choice of their own is up to the imagination. So what's next? The ECB will likely cut rates again, giving global markets a shot of adrenaline that's welcomed by everyone.

Asset Allocation


Top Long Ideas

Company Ticker Sector Duration

Decent earnings visibility, stabilized market share, and aggressive share repurchases should keep a floor on the stock.  Near-term earnings, potentially big orders from Oregon and South Dakota, and news of proliferating gaming domestically could provide near term catalysts for a stock that trades at only 11x EPS.  We believe that multiple is unsustainably low – and management likely agrees given the buyback – for a company with the balance sheet and strong cash flow as IGT.  Given private equity’s interest in WMS (they lost out to SGMS) – a company similar to IGT that unlike IGT generates little free cash – we wouldn’t rule out a privatizing transaction to realize the inherent value in this company.


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 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


"$LINE $LNCO probably closes up today, just because nothing about how these stocks act makes sense to me" -@HedgeyeENERGY


"I have long been of the opinion that if work were such a splendid thing the rich would have kept more of it for themselves." -Bruce Grocott


US Initial Jobless Claims fell 16,000 to 339,000 last week, the lowest level in 5 years.

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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.


Systems drove most of the beat but there were a few positive takeaways for IGT.



BYI posted a great quarter last night and expressed its confidence in the future through the announcement of a big stock buyback.  The stock should be up big this am and we continue to like the name for the long-term.  However, after BYI pops on the open, IGT may be the more interesting stock over the near-term.  Much of BYI’s beat was driven by systems which is less important for IGT.  However, some of BYI’s conference call comments gave us more confidence in IGT’s FY2013 and upcoming quarterly earnings announcement.  BYI indicated a large video poker order in the quarter – IGT dominates the video poker segment – and expressed confidence in accelerating replacement demand and improving international orders.  IGT will report FQ2 earnings tonight after the close.


Back to BYI, on the back of record results in its systems business, BYI’s reported a quarter that handily beat consensus and our expectations.  A lower tax rate in the quarter helped offset some “unusual” but unelaborated SG&A expenses as well as a few cents of FX drag. 


In addition to reporting a solid quarter, BYI raised guidance, announced an Accelerated Buyback Program (ala IGT), upsized its share buyback program, and issued an upsizing and extension of their credit facility on more favorable terms.  All-in-all, the business continued to do well and BYI’s management team put their money where their mouths are in reinforcing confidence in the business with an aggressive share repurchase program.




  • Gaming equipment sales came in below our estimate on the back of softer ASPs.  Unit sales were spot in-line with our estimate with NA being slightly better and International coming in a little softer. 
    • BYI shipped more Canadian units than we expected but replacement sales were weaker than we would have thought.  BYI mentioned that there was a large order for video poker replacements that took some capital out of the market.  This bodes well for IGT, which likely got some large video poker orders on the back of some heavy promotions they are running. 
    • Weaker replacements were offset by better market share in new and expansion units
    • We got the impression that international sales should show some signs of a pulse in coming quarters if not next quarter
  • Systems was by far biggest upside surprise in the quarter and based on the commentary on the call it sounds like next quarter will be better with higher margins
  • Gaming operations was slightly ahead of our estimates with upside coming from better WAP placements/yields and what seems to be a lift from Pawn Stars.
  • Other:
    • SG&A:  based on the BYI commentary, the quarter’s $72MM included about $3MM of unusual expenses
    • R&D was higher than we expected
    • The 31% tax rate was below the 36.5% we were modeling
    • We assume that FX losses were in the “Other” expenses
  • We have them at 98 cents for 4Q which is 2 cents above their guidance range
    • That assume growth in systems revenue and margins
    • Improvement in international sales
    • A nice sequential lift in replacement sales
    • Continued growth in WAP placements
    • 2.5MM share reduction from the Accelerated Buyback Program


“Winning is not a sometime thing; it’s an all time thing. You don’t win once in a while, you don’t do things right once in a while, you do them right all the time.  Winning is habit.  Unfortunately, so is losing.”

-Vince Lombardi


Last week I took a few days of vacation and had the opportunity to catch up on some reading.  One of the key books I read last week was, “Top Dog: The Science of Winning and Losing”, by Ashley Merriman and Po Bronson.  As the title suggests, the book is a deep dive into the science behind winning, losing, and competitiveness and has applications that go well beyond athletics.


Last week I was also continuing to enjoy the fact that my alma mater Yale recently won the NCAA ice hockey championships.  To be fair, a NCAA championship, while a big deal to the players, fans and alumni, is a far cry from a gold medal, Stanley Cup, or World Championships.  Nonetheless, it is an example of a team achieving its ultimately goal in a very competitive situation.


Going into the 16 team NCAA hockey tournament, Yale was seeded 15th and a 60:1 underdog according to the Vegas odds makers.  On the path to the championship, Yale also achieved a few things that no team had every done before.  First, they beat three number one seeds (each regional of four teams has a number one seed).  Second, they are the only fourth seed in the Frozen Four to ultimately win.  Clearly, this is an example of a team that overcame significant obstacles to become a champion.


So, what is it that enables some teams to win against extreme odds?  Counter to intuition, team members getting along and being traditional team players is not the key.  In fact according to Merriman and Bronson:


“In the idealized notion of a team, everyone is equal and interchangeable, and this equality drives commitments to the team effort.  But the science argues that the ideal is, if anything, a distraction. The goal is not to live up to the ideal, but to perform.  In real life, teammates are rarely true equals, and they don’t always get along. Having a hierarchy, with its clear divisions of responsibility, is most often the solution to team performance.”


To use economic terms, great teams are usually much more capitalist than socialist.


Now as Keith would say, back to the global macro grind . . .


In terms of global economic statistics, Spain’s unemployment rate is certainly one that signifies that the nation continues to lose economic share.  At a 27.2% rate of unemployment, with an even larger unemployment rate for those new to the work force, Spain is not going to see economic recovery without some help from her teammates.


The key friend to Spain is likely to be ECB President Mario Draghi, especially if he decides to cut rates as he was hired to do.  Luckily for Spain, our quantitative models are also signaling that the ECB is likely to ease again.  Specifically, every major European equity market is now in a bullish formation in our models, expect Russia.  This makes sense as Europe easing would be U.S. dollar bullish, which is negative for the price of oil and Russia is the largest exporter of oil in total barrels per day terms in the world.


Key sovereign debt markets also appear to be signaling some chance of the ECB incrementally easing.  Since the world didn’t end with Cyrpus’ bail under as many market pundits were urging would happen, peripheral yields in Europe have tightened meaningfully.  Despite the aforementioned employment issues, Spain’s 10-year yield is now at 4.38% and Italy’s 10-year yield is now at 4.06%.  As it relates to Italy, this is the lowest yield on the 10-year in more than a year.


Much of the pin action this morning in global equity markets is coming from China.  For those that tuned into our conference call on emerging markets this week, this should be no surprise.  We came into the year bullish on Chinese equities and have reversed that stance based on new data.  The China section in the emerging markets presentation given by my colleague Darius Dale was titled, “Will China Blow?”. Increasingly, this is a very fair question to ask on China.


A key risk or concern over China is whether real estate market prices are in a bubble and whether there is too much debt behind the Chinese real estate market.  In effect, is China about to go through a real estate correction comparable to what the U.S endured starting in 2007?  Some would argue that the high pace of Chinese economic growth inherently supports a rapid increase in real estate values and this is likely true, to a point.


In general, debt and real estate are very much driving Chinese equity markets.  Overnight, the Shanghai Composite closed on its lows as the property subsector once again dramatically underperformed.  This was on the back of a Minister of Taxation official warning that if property prices in second tier cities continue to rise then more property taxes will be implemented.  On one hand, you do have to hand it to Chinese officials attempting to proactively manage bubbles.  On the other hand, the history of government intervention is that governments rarely get things right.


In the Chart of the Day below we’ve highlighted a key slide from the emerging market presentation from earlier this week.  This chart shows the performance of the SP500 and MSCI Emerging Market Index in strong dollar periods and weak dollar periods, respectively.  They key takeaway is that in strong U.S. dollar periods emerging markets underperform dramatically as, among other things, capital flows out of emerging markets.  On the back of this research, we added the emerging markets ETF, EEM, as a short idea on our best ideas list.


Our immediate-term Risk Ranges for Gold, Oil (Brent), US Dollar, USD/YEN, UST 10yr Yield, VIX, and the SP500 are now $1, $97.31-103.34, $82.55-83.44, 97.45-101.36, 1.70-1.76%, 11.33-14.89, and 1, respectively.


Keep your head up, stick on the ice, and keep #winning,


Daryl G. Jones

Director of Research


#Winning - Chart of the Day


#Winning - Virtual Portfolio