- Cutting production - TSN has taken three facilities out of operation decreasing its slaughter capacity by 8,000 a day.
- Shrinking Herd - The chart to the right is a graphic picture of the heard size going back to 1988. As you can see the inventory of cows peaked in the mid-90s and we have seen a continuous decline since then. In 2008, the inventory will be down about 1% and down about the same amount in 2009.
- Chicken and coffee are driving breakfast transactions.......
I'm never going to penalize any management team for investing in growth -- especially in a market (India) with nearly 3.5x the population as the US. But it strikes me as so ironic that the capital investment into Ch-India ticks up when the US market becomes meaningfully more challenged. Unfortunately, the US is more challenged, in part, because imported inflation combined with weak consumer spending is hurting margins. So companies pull back investing in this market at a time when they should probably step it up to take share (in my opinion). Instead, they lack foresight/conviction, and play defense looking towards other markets with seemingly better growth.
Maybe these companies are taking advantage of the fact that the dollar appreciated 10% vs. the rupee in four months. Perhaps. But it is still down 15% from the '04-'06 trend. Also, shouldn't we consider WHY the rupee (and other Asian currencies) are acting horribly? Unprecedented inflation (food and other), political jockeying to curb social unrest, and draconian measures to attempt (attempt is a key word) to prevent India (and half of non-Japan Asia) from slumping deeper still into a borderline stagflationary environment.
My Partner, Keith McCullough, articulates the broader implications far better than me. I encourage you to take 10 minutes and read through his work on the topic.
Ok, first let me acknowledge the bull case. Yes, the brand is hot, the organic growth is good, and the diversity of both the customer mix and geographic base offers some nice safety. Also, returns are high, and management's track record is tough to argue with. I get all that. But I think people are ignoring the potential for this model to inflect across the board. Consider this...
- 1) GES has been a remarkable turnaround story since 2003 under new leadership. But this also happened right alongside a 28% depreciation in the US$ vs the Euro. Something to consider given that nearly a third of sales and 40% of cash flow comes from Europe. Look back to when companies like Nike and Ralph Lauren managed through their first FX cycles as global companies. Not pretty at all. GES has never had to deal with an inflection in FX. The extent to which there is a reversal in currency scares the heck out of me here. Check out the chart to the right. Margins up by 17 points when the USD is off by 28%. Ouch!
- 2) It's also important to at least acknowledge that the GES turnaround happened in an extremely 'easy money' period for the industry as the influx of sourcing savings for this industry was in its sweet spot. This trend injected 3-5 points of margin into this industry by my math. GES definitely saw some of that. 3) A low expense structure is becoming more apparent. With a sub-28% SG&A ratio, GES is about as low as any quality higher-end brand I've seen (RL is close to 40%) - particularly one with such high international exposure. There are many companies out there that grossly under invest in their content. I do not think that GES is one of them. But I do think that GES printed a disproportionate piece of its excess earnings at the top of the cycle rather than reinvest into the SG&A line in the model. There are a few companies I can point to that can pull back expenses to the extent that times get tough. I think that GES has already pulled the goalie.
- 4) I've gotta say that the Sales/Inventory/Gross Margin triangulation mildly concerns me. Over the past 6 quarters, inventories have outgrown sales by an average of 5%, and yet gross margins have been UP. There are certainly examples of others where the disconnect is more severe, but some of the most violent price corrections in retail have come when companies shift out of quadrant 2 in the chart to the right into Q3 or Q4 (clear inventories by way of taking down margins). This is especially the case with higher-multiple retailers like GES. So what scares me about this? Sales are slowing on the margin, and at an unfavorable delta relative to inventories. In that context, Gross Margin trends have been fair at best - and this is at the same time industry tailwinds become headwinds, and SG&A is starting to de-lever - even with relative strength on the top line. With even a moderate incremental deceleration in top line trends from here, this model could churn out significantly lower EBIT growth numbers. I certainly wouldn't want to be long this stock if the dollar turns. Things could get real ugly real fast.
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- Sales TrendsSales trends are horrific - rarely do you see a restaurant company with double digit declines in same store sales. It would appear that the company's remodeling effort and new, upscale look alienated some lower-end customers. In its most recent quarter, same-store sales declined 12.7% (-12.5% in December, -14.2% in January and -11.5% in February). These declines are much more severe than the casual dining segment's average 1.8% decline for that same time period, according to Knapp-Track data. The company has completed 600 remodels in the past 12 months so despite the tough casual dining environment, I would attribute at least half of these declines to the remodels, which represent a change in strategy for the company as it attempted to enter the more upscale restaurant market (some of the company's former loyal customers have obviously not accepted these changes). However, the remodel program, despite the cost, was a must. The reimaged restaurants will take time to attract new customers; it always does in casual dining! Just ask Red Lobster
- Margin TrendsAt Ruby Tuesday's current level of AUVs, EBIT margins should begin to stabilize in the 5-6% range. Double-digit declines in same-store sales coupled with significantly higher D&A have hurt margins and earnings. It appears that there is one more quarter of difficult comparisons, as D&A has stabilized around $80 million (if the company holds its D&A expense steady, it should be able to get some sales leverage beginning in 1Q09). Of course, the big wild card to margin trends will be whether same-store trends stabilize.
- Capital EfficiencyRT's appetite for debt over the past three years has put the company in a precarious financial position, but it appears management has to come to terms with the banks over its debt covenants. RT ended 3Q08 with total debt-to-EBITDA, including operating leases, guarantees to franchisees and letters of credit, at 4.6x times up from 4.1x in 2Q08. The excessive leverage has forced the company to stop growing, which now plans to open only two new restaurants in fiscal 2009. Including these two restaurants, capital expenditures for fiscal 2009 will be approximately $20 million. If the company can keep EBITDA at a $150 million run rate, deleveraging will have a positive impact on the equity value. A key metric for us is the net CFFO/net income ratio, which looks at the proportion of earnings yielding cash. Unfortunately, although headed in the right direction, Ruby Tuesday's can't turn off the development schedule fast enough. This creates incremental volatility in our earnings yielding cash ratio, at least in the near-term.
- U.S. - Continues to struggleI have been saying for some time now that U.S. sales results could lose some momentum in 2008 due to the absence of any real incremental sales layers being introduced into the system. The specialty coffee launch, which although it is receiving much media attention now, is more of a late 2009 event and, I think, may even be pushed out further. Looking at the chart, it is clear that 2-year trends are coming down (outside of February which included a 4% benefit from an extra day due to leap year). MCD's U.S. segment is facing its most difficult comparison year-to-date in May (up 7.4% last year). In March, when the company was lapping its second toughest comparison year-to-date of up 6.2%, it posted a negative same-store sales number (down 0.8%).
- Europe - Starting to follow U.S.'s lead Although MCD's same-store results in Europe have been consistently strong (primarily up in the 5%-plus range), 2-year trends have come down rather significantly in the last couple of months. Based on the Eurozone Retail Sales report released last night that showed European retail sales declined 2.9% in April, more than three times as much as economists forecast, as soaring fuel and food prices undermined consumer spending (and other signs of slowing consumer spending in Europe - refer to my News from Europe post from 5/30), MCD's 2-year European same-store sales trends could get worse before they get better. Although MCD typically outperforms other restaurant companies in a tough consumer environment as people trade down , no company is completely immune (as we have seen even with MCD in the U.S.). Making matters worse, the company is facing more difficult comparisons in May and June (up 8.9% and 11.1% last year, respectively). It is important to note that Europe represented 38% of MCD's consolidated 2007 operating income
- APMEA - How far behind is Asia?Although APMEA's same-store sales trends look great with comparable sales consistently up 8%-plus, the year-over-year comparisons only get more difficult going forward in 2008. Add to that our view that growth is slowing in Asia (please refer to Keith McCullough's portal for his views on that), and MCD could face declining trends in each of its three major geographic segments.
Sales trends are still looking healthy, and I saw nothing in the data to challenge any themes I've been working. A few nuggets...
1) Dollar sales were only up about 1%, but average selling price is up closer to 2%. No one's knocking the cover off the ball with dollars, because there's not enough inventory to do so. I'll take that.
2) Low Performance sales were down 12%. The recent shift I've been discussing continues. Good for FL, bad for SKX.
3) Nike share accelerated for the week by another 50bps, while unit share stayed flat vs last week (+3pts yy). Price points are up 5% -- an uptick from last week.
4) Under Armour business remains healthy. Share in cross training decelerated by a full 10 points to 25%. But price points remain constant. Either inventory is building (which I do not believe to be the case) or UA is simply selling through.
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