Book the +3.93% gain. We’re just risk managing the range with a very cautious view of Asian macro risks that are developing, particularly in China. Hedgeye Gaming Analyst Todd Jordan remains bullish on MPEL longer-term.
Takeaway: As we’ve said all along, one of the big risks is that we are right too fast.
(Excerpted from this morning's Hedgeye conference call)
So, last week we had better numbers on jobless claims and the employment report. That’s what’s really causing consternation and constipation in global markets now. It’s that we’re too right on #Growth Accelerating here in the U.S.
If you disagree with that, go ahead and take a look at the chart below of 10-year Treasury yields. This thing is just ripping right now. It's up 55 basis points since the beginning of May.
As we’ve said all along, one of the big risks is that we are right too fast. It’s one thing to be right on growth, it’s another thing altogether to be right too fast. You have to stay aware of the fact that we have a Central Planner still lurking in the weeds. He doesn’t fundamentally believe that the bond market is going to do exactly what it’s doing right now.
Look, you cannot have a Central Planner promise that he will smooth economic gravity and the market expectations embedded therein. You can’t have that in Japan, you can’t have it here in the U.S., and you can’t have it in Uzbekistan. You can’t have it.
Have we forgotten? Free markets exist for a reason.
Takeaway: At 5x EBITDA with an under leveraged balance sheet, we think DF has a conservative 20 – 30% upside from here.
This note was originally published June 07, 2013 at 16:20 in Consumer Staples
Our Consumer Staples team has been touting Dean Foods (DF) for the past couple of months and although the stock has moved, we believe there remains significant value and upside in the name. Before getting into an updated valuation analysis, we wanted to tell you why we like this business (especially at 5x firm value / 2013E EBITDA).
We think DF is a compelling business for the following reasons:
That all said, DF is still a commodity company, even if a branded one, so we do need to consider that fact when evaluating the business along with the highlights above. In our view, the current valuation provides substantial downside protection and fully accounts for the commodity nature of the business.
In the table below, we provide an upside / downside analysis based on 2013E EBITDA and multiples of enterprise value / EBITDA. Currently, we think the stock is at a price in which the risk / reward is compelling. On the downside, absent a dramatic change in the milk market or poor management execution (unlikely), we think the reasonable downside is 4.5x EBITDA, or ~16% from current levels.
In terms of the upside, as noted we do acknowledge that this is a commodity company with only modest top line growth rates, but we do believe given the compelling business characteristics and high free cash flow yield reasonably justify a multiple in the 6.5X – 7.0x EBITDA range, which implies 32% - 44% upside from current levels. From our perspective, a situation in which there is 2:1 upside / downside with fundamentals trending our way is a compelling investment.
The argument for the upper end of the multiple range of course is based on the generous free cash flow nature of this business. While 2013 is a bit of an odd year given the corporate activity (notably the spin-off of WWAV), we believe that on a normalized basis DF will generate in the range of $140 - 150 million of free cash flow to the equity annually. This implies a rough 8% free cash flow yield. In combination, a 8% free cash flow yield and a debt-to-EBITDA ratio of just over 2x makes this a compelling LBO candidate. (Moreover, the debt-to-EBITDA is closer to 1x if we net out the WWAV stake.)
In addition, DF’s publicly traded debt seems to validate our view of the stability of the cash flow, and potential to add more debt to the balance sheet in a LBO type scenario, as all three tranches are trading well above par and tight versus Treasuries. In fact, 5-year DF paper is trading at only 210 basis points above comparable Treasuries.
The key pushback from many is that DF is a “value trap”, or a business in decline, so it is a cheap stock that can get cheaper. Indeed, there have been a number of publicized articles recently that highlight that per capita milk consumption has been in decline since 1970. Even if this is accurate, total volumes have shown a steady increase in recent years, which is more relevant for a market share leader like DF. In fact, in the chart below we show that total volumes have increased by 20% over the last nine years. Not stellar, but definitely the kind of growth and cash flow that gets a private equity firm licking the milk off their moustache!
Daryl G. Jones
Director of Research
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“One of our strategies moving forward is to shift to a balance between our legacy of being family-friendly and adult-focused guest experiences, referencing our legacy. There is no assurance that this shift will be successful or that it will not negatively affect our family guest experience.”
- RRGB 2012 10-K, Risk Factors section
We are adding Red Robin Gourmet Burger to our Best Ideas on the short side. The stock has gotten ahead of the company’s fundamentals and future growth prospects.
PERFORMANCE VS THE S&P 500
The stock has outperformed by almost 60% over the past year and its strong performance versus peers has continued as earnings growth estimates have stagnated.
Traffic Problem is Biggest Fundamental Red Flag
The company is in desperate need of a “brand transformation” to stem the decline in traffic
Capital allocation is one of the most important metrics for casual dining companies. In terms of RRGB’s capital spending, the following bullets and charts offer insight into the effectiveness of the company’s capital allocation decisions.
Repeating Others’ Mistakes
The foot print expansion is leading to declining returns for the company. The question that we, and others, have about the strategy is why so many different initiatives need to be pursued at once. Specifically, the company is growing Red Robin in two different sizes, expanding its Burger Works QSR concept which seems to be producing mixed results, and trying to transform the consumer’s perception of Red Robin as a brand. In our view, this amounts to the company taking on more tasks than it can complete effectively while managing its capital prudently.
Brand transformation is difficult to achieve, for several reasons. Below are some of the concerns we have about RRGB’s particular strategy.
3Q12 IS RRGB’S WATERLOO
Valuation and Sentiment
Short interest in RRGB has been coming down since 2008 but remains the fourth highest in casual dining at 10.5%. The valuation that consensus is awarding the stock has risen sharply in recent months. The sell-side is fairly cautious on the name with 37.5% of analysts rating the stock a “buy”, 50% “hold”, and 12.5% “sell”.
Takeaway: A quick look at stories Hedgeye's research team are reading this morning.
Keith McCullough – CEO
Kuroda Stares Down Bond Volatility With Stimulus Unchanged (via Bloomberg)
Shenzhou-10: China launches next manned space mission (via BBC)
Howard Penney – Restaurants
Krispy Kreme Sloppy Joe Sandwich Debuts At San Diego County Fair (via Huffington Post)
Nestle’s Nespresso to Face New Mondelez Copycat Capsule (via Bloomberg)
Daryl Jones – Macro
Is This Who Runs Prism? (via TPM)
Is The Eurozone Crisis Set To Flare Up? (via streettalklive)
Turkish Police Retakes Square Amid Clashes (via Bloomberg)
Kevin Kaiser – Energy
Encana Taps Former BP Executive as CEO (via WSJ)
Polar Petroleum, Frozen (via The Aleph Blog)
Josh Steiner – Financials
Bank of America’s Laughlin Says Accord Talks Were Tense (via Bloomberg)
Fannie Mae Shareholders Challenge U.S. Takeover in Suit (via Bloomberg)
Takeaway: LULU needed to shore up confidence after 1Q product issues. They blew it. There's margin risk. Maybe not a short. But definitely not a long.
This note was originally published June 10, 2013 at 21:02 in Retail
Conclusion: LULU had to do one thing and one thing only this qtr -- instill confidence in the investment community that the recent product issue was a one-off, and it that management is on offense. Unfortunately, LULU blew it. Its quarter was hardly squeaky clean, the outlook is cloudy, and the CEO tendered the most surprising resignations we've seen in retail in a while. This remains a great global growth story in retail -- one of the best, actually. But there's margin risk to the downside. That matters at 33x earnings. It might be a lousy short. But we'd avoid it long.
In the wake of the Luon pant fiasco throughout the first quarter, there was one thing and one thing alone that LULU needed to do with this print -- and that's instill confidence with the investment community that the right team is steering this ship, and that the issues that caused the stumble are temporary and not a sign of more systemic issues at the company. Unfortunately, the company dropped that ball with the announcement that Christine Day is resigning her post of CEO after 5 1/2 years on the job.
Quite frankly, we were stunned by the announcement. For investors, this is the corporate equivalent of being bitten by your Golden Retriever. There was no warning. Usually when something happens so suddenly, it is the Board's decision, but this one sounds like it was all Christine. Could it be that the Luon pant debacle took its toll on her? Perhaps. But she already canned LULU's Chief Product Officer in April, and the company is in the process of broadening its executive team. We'd be surprised if her departure was due to this issue alone.
Our sense is that Ms. Day -- who is held in extremely high regard by the investment community -- simply sees that the next leg of growth will be tougher to come by. To her credit, she saw the company through the period in '09 when it was a $3 stock and drove it up to $80. That's $11.2bn in value creation -- or a 27-bagger for those keeping score.
While LULU had several wins this quarter, like golf, tennis, men's and e-commerce, in the end, this quarter was hardly squeaky clean. Aside from the Luon issue, the company noted certain misses from a styling perspective, higher expected landed costs in 2H due to factory/production issues, SG&A deleverage through 2H14 as LULU ramps up its East Coast distribution center, and difficulty in finding store locations to facilitate Hong Kong expansion.
We still think that LULU is one of the few iron-clad brands in retail that can put up 20%+ organic top-line growth on a consistent basis for the next 3-5 years (the others are RH, FNP, UA and KORS). But unlike these other brands, we think that LULU has risk to the downside in its mid-20s margin as the company spends more to facilitate its growth. If we compare it to UnderArmour (or FNP or RH), for example, we see that UA has only an 11% margin, and even it is stepping up spending on the margin to maintain top line growth. We think that LULU will maintain a significant premium to UA, NKE, RH and FNP. But in doing so we still think that the risk is to the 20% range as margins (and even high teens) look to find a final resting place.
This still nets us a respectable 20%-ish EPS growth rate by any stretch (25% top line growth less 500bp due to margin erosion). But with the stock trading at 33x earnings (per the after-hours sell-off) we find it really tough to get excited about on the long side.
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