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Takeaway: Where's the volume?

Either everyone is at the beach… Everyone is waiting for our Central-Planner-In-Chief's latest messaging ("To Taper, Or Not To Taper") signal tomorrow… or everyone’s waiting for the guy next to them to make the first move.


But any way you slice it, it looks like no one has any real conviction on either side at these levels.


#GotVolume? - Volume YTD


Of course, depressed volume is not a new phenomenon as the trend in aggregate market volume has been one of decline as the 2nd chart below illustrates.  Soft volume month-to-date (around the July 4th Holiday) is not particularly surprising.


#GotVolume? - Volume LT


That said, this ain’t the stuff convicted new market highs are made of.  Keep your head up out there.

Morning Reads on Our Radar Screen

Takeaway: A quick look at some stories on Hedgeye's radar screen.

Keith McCullough – CEO

Elon Musk to Release ‘Hyperloop’ Tranport Plans Next Month (via Bloomberg)

Thousands of Greeks join strike against public sector layoffs (via Reuters)

Mexican Marines Captured one of World's Most Notorious Drug-Gang Leaders (via BBC)


Morning Reads on Our Radar Screen - earth1


Josh Steiner – Financials

Homebuilder confidence surges:  Strongest print since Jan 2006. (via NAHB)

Goldman Beats Estimates on Investment Banking, Debt Gains (via Bloomberg)


Tom Tobin – Healthcare

Johnson & Johnson results beat forecasts  (via Reuters)

HCA Jumps After Preliminary Earnings Top Estimates (via Bloomberg)


Jonathan Casteleyn - Financials

Tesla CEO Musk Morphs From Tony Stark to Henry Ford (via Bloomberg)

Charles Schwab profit misses estimates as expenses increase (via Reuters)


Matt Hedrick – Macro

Iceland Bucks EU Entry-Decision Plea Amid Mackerel Spat (via Bloomberg)


Kevin Kaiser – Energy

Celebrity house for sale: Wayne Gretzky (via Bankrate)

Huge disparity between US (6-year high) and European (2-decade low) car sales (via Bloomberg H/T to Bespoke)


Prior to Monday’s retail sales data point, the broad restaurant macro indicators have been gradually improving and restaurant stocks have surged.  As we mentioned in a post last week, casual dining sales trends look more like the recent retail sales print – very disappointing.  CMG will report on Thursday and give the street a more relevant look into the how the industry is faring. 


Overall, consensus estimates indicate the expectation of a challenging quarter for Chipotle.  Consensus is looking for a 16% increase in revenues and only a 10.5% increase in EPS, numbers similar to 4Q12 when the company had little leverage in its business model.  Over the past three months, the consensus estimates for 2Q13 have remained relatively stable, while the stock has returned 14.6% versus the S&P 500’s 8.2% gain.


The street remains on the bearish side of CMG, but this trend has been improving.  Short interest is currently at 9.09% of the float, the lowest it has been in a year, as valuation appears rich but not excessive.  We continue to believe that Chipotle is one of the best positioned growth companies in the restaurant industry.





Coming into 2Q13 earnings, management has guided to flat to low-single digits same-store sales before the impact of any future menu prices increases.  In the second quarter, the company lost 70bps of price, but was able to pick up an incremental trading day due to Easter’s impact on 1Q13 results.


The street is looking for a sequential improvement in same-store sales of 3.8% in 2Q13 versus 1.0% in 1Q13.  The 2Q13 number is slightly better than the implied 3% run rate the company had previously alluded to as the trend line at the conclusion of 1Q13.  Overall, this implies a 100bps slowdown in the two-year trend to 5.9%. 


The potential for an upside surprise to the 2Q13 same-store sales estimates could be driven by a significant increase in marketing spending over the course of the quarter.  In 2Q13, CMG likely spent 2% of sales on marketing, up from 0.7% in 2Q12. 


HEDGEYEWe believe the street’s estimate for 3.8% same-store sales growth in 2Q13 is conservative.







Restaurant level margins decreased 110bps in 1Q13, primarily driven by higher food and occupancy costs.  During the first quarter, CMG was able to leverage G&A by 160bps in order to drive operating margins higher by 60bps to 16.5%.  Management noted that 1Q12 included a one-time cost of $5.6 million for long-term incentive performance shares that were issued in 2010.  We believe Chipotle is likely to see a more significant decline in operating margins in 2Q13.  We expect to see a 2bps and 140bps decline in restaurant and operating margins, respectively. 


HEDGEYE – We expect that CMG’s margin trends in 2Q13 will look slightly worse than in 1Q13.  We believe that an increase in food costs and other operating expenses will drive restaurant level margins down 160bps versus 103bps in 1Q13.  With little G&A leverage, we could see operating margins decline by 142bps.








Food costs were 32.9% in 1Q13, up 72bps year-over-year, due to inflation in salsas, produce, chicken and dairy.  However, food costs were down 53bps sequentially from 4Q12, primarily driven by lower avocado and dairy costs. 


Looking at 2Q13, we expect food costs to be relatively stable and remain around 33%.  The company is at risk for an increase in beef prices and seasonally higher avocado costs.  Currently, CMG is seeing inflation around 3-5%; if that accelerates from here, we would expect to see the company raise prices.


HEDGEYE – Chipotle is lapping against an 85bps decline in 2Q12 food costs.  At 33%, food costs seem quite reasonable, however, we believe there is an upward bias to this number.  Food cost trends remain a wild card for CMG.







Labor costs declined 10bps to 23.6% in 1Q13, driven by higher sales volumes (higher menu prices) and efficiencies.  The company typically believes it can leverage its labor costs when generating 3% same-store sales.  The street is modeling labor costs of 23.1% for 2Q13, down 0.05% year-over-year.    


HEDGEYE – With the street modeling 3.8% same-store sales growth, there is little confidence that management will be able to leverage labor costs.  We believe there is room for an upside surprise to labor costs this quarter.






Other operating expenses were 17.1% in 1Q13, up 45bps year over year.  In 2Q13, other restaurant expenses are expected to be 16.4%, or down 71bps sequentially.  Management has indicated that CMG ramped up their marketing expenses significantly in 2Q13, up to 2% in 2Q13 versus 0.7% in 1Q13.


HEDGEYE – We believe the increase in marketing expenses should help drive incremental traffic during 2Q13.



Daily Trading Ranges

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FDX: First Read of 10-K Looks Clean Enough



Our first review of the FDX 10-K did not reveal anything new of great relevance.  There is some additional discussion of the restructuring, but no new specifics that we saw.  The language around “independent contractors” or “owner-operators” is frequently switched to “independent small businesses”, perhaps better reflecting the evolving structure of the FedEx Ground model.  The most highlighted new risks are the inclusion of operating leases as liabilities on the balance sheet under proposed accounting rules and the EU Emissions Trading System.  The former is likely a 2016 event (if it happens) and the latter would impact all competitors.






Always Tough to Declare Clean:  Looking through a full 10-K and deciding there is nothing of interest is somewhat harder than finding new interesting disclosures.  That said, we didn’t see anything alarming in the filing.  Bloomberg picked up the disclosure of a couple of deliveries to embassies in violation of OFAC/Iran Threat Reduction Act regulations, but the ~$400 dollars in revenue is not likely to be relevant (it is our understanding that FedEx and UPS are often helpful to authorities). 


Segment Outlooks:  The segment outlooks read much the same as the earnings call discussion.  In general, those comments seemed aimed at pushing back the expectations for timing on the profit improvement plan at Express.  That seemed an odd contrast to strong FY4Q Express profitability, but managing expectations is not a bad idea for a long-term restructuring program.  The language around Freight seemed slightly more positive than the earnings call (removal of "modestly" etc).


Leases Added To Balance Sheet: The risk disclosure of the potential addition of lease assets and liabilities to the balance sheet is noticeable.  Although there is no date set under the current exposure draft, this is likely to be a 2016-ish event.  Lease consolidation would result in significant increases in reported assets, liabilities and leverage metrics.  However, nothing would change economically or operationally at FedEx – just the presentation.  We also note that UPS uses short-term leases and charters, which, while economy similar (they need those aircraft), would likely not be consolidated to the same extent.


Pension/OPEB:  Remeasurement of pension assumptions allowed for a very favorable change in the discount rates (as we discussed previously) in 2014. In particular, the discount rates used to estimate the benefit obligation vs. benefit cost diverged very favorably.  The net aggregate pension expense change of $190 million in 2014 vs. 2013 should more than offset the postal contract headwind.  The company is even lowering its expected return on plan assets to 7.75% from 8%.


Reserves and Accruals:  Given the previously undisclosed ‘true-up’ that left FedEx Ground with a tough comp in FY3Q2013 vs. FY3Q2012, its noteworthy that the self-insurance accrual grew year-over-year instead of staying flat (that was an investors best clue last year).  Other accruals and reserves didn’t appear noteworthy.


Kept Charges in FY13 & Purchase Price Allocation:  Although not a new disclosure, reviewing the 10-K highlights that FDX took a number (~$660 million) of charges last year.  While mostly just pulling expenses forward in a way that does not change the economics of a business, charges do generally help future reported profits.  If it weren’t so small, we would also gripe about the purchase price allocations in the acquisitions.  From the long side, prospective low quality/non-economic earnings growth always reads a little bit more favorably.  But again, the numbers are very small for FDX.


More Capacity Out?  As we noted with UPS, capacity in the international air market appears too high.  FedEx is again highlighting that they “will be evaluating additional capacity reductions and other actions in 2014.”  Capacity discipline in an oligopoly should be easy – they should all keep at it until pricing is stronger.


Independent Contractor Language Change: FedEx Ground has seen significant legal challenges to its independent contractor model over the years.  In response, FedEx Ground has restructured the model so that the vast majority of ‘contractors’ would be multi-route, multi-employee ‘businesses’.  The language in the 10-K was adjusted to reflect the larger size of the service providers. (See here for our expert call on independent contracting risks at FedEx)


International Domestic:  The focus of recent acquisitions, as well as the highest growth segment of Express, has been the International Domestic.  We continue to think TNT, which would add to this category, would make a good fit.  Disclosure on the profitability of International Domestic would be very welcome, but was not included.  If International Domestic revenues increase to $2 billion or so, we would expect more disclosure granularity.  Currently, International Domestic is lumped in with other international businesses, leaving the trade down from International Priority to International Economy and other trends harder to evaluate.


USPS Risk Removed:  We thought it was interesting, if not particularly material, that FDX removed the disclosure on the discontinuation of certain USPS services, such as Saturday delivery.  The USPS was not permitted to remove Saturday delivery earlier this year, but other potential changes associated with USPS loss mitigation plans are still worth keeping an eye on. (See here for our expert call on the USPS with Dan Blair, former head of the Postal Regulatory Commission)


Complimentary, accretive, and strategic acquisition for BYI.



BYI announces an agreement to acquire SHFL for $23.25/share in cash for total consideration of ~$1.3 billion (including debt of $8 million and cash of $41 million).  Once combined, BYI expects to achieve annual synergies of at least $30MM. The Company initiates fiscal 2014 guidance for Diluted EPS of $3.70 to $4.05, in-line with HE and consensus.



  • Accretive to EPS and FCF in 1st 12 months after expected close of transaction in C2Q 2014
  • BYI will gain significant share in the e-table market and in international markets i.e. Asia and Australia.
  • Fully committed debt financing - new $1.3MM term B facility and $138.4MM transaction impact on excess capacity on RC facility 
  • Bally has 660 gaming systems; will be poised for growth in FY 2014 and beyond 
  • Propietary table games will be a new opportunity segment for BYI
  • Transaction will increase Bally's international revenue as a % of total revenues from 16% to 24%
  • Bally/SHFL combo (incl $30MM synergies): 
    • LTM REVENUE: $1.252BN 
    • LTM FCF $204MM
  • SHFL had $124MM (LTM) in recurring revenues 
  • $30MM Synergies: economies of scale, supply chain, regulatory licensing, public company fees, marketing and tradeshows, facilities
  • Joint integration team will be formed
  • Comined debt/adjusted EBITDA expected to be 4.0x at closing
  • FQ4 2013 earnings will be disclosed August 15, 2013
  • F1Q 2014 - will see some impact from the transaction in terms of costs


  • Does not answer whether Gavin will be at the combined company post close
  • Any pushback from BYI customers given they're now selling across entire casino floor? Confident customers will be happy by the transaction.
  • Proxy will be out soon
  • Capital allocation strategy:  priority will be reducing debt levels
    • Target leverage level (pre-acquisition):  2-3x

Asian Contagion

Client Talking Points


With the exception of Japan, every single major Asian Equity market remains bearish TREND in our model. We called this #AsianContagion on our Macro Themes Call yesterday (let us know if you want the replay). India has inflation rising now that the Rupee is down -8% year-to-date vs US Dollar. The government there is rhetorically trying to defend the Rupee this morning. Action speaks louder than words. BSE Sensex down -1% on that tighter #confusion.


Spain? It's bearish TREND and breaking down faster this morning after failing to rally alongside everything else that ticks yesterday. It's down -1.5% for the IBEX right now as the Troika sniffs around Portugal (it doesn’t smell very good, evidently). Meanwhile, the Euro is failing at our TAIL risk line of $1.31 vs USD. That is still a big risk.


Brent is not letting up this morning. It's still a $109 handle. The immediate-term upside is to $110.29/barrel. This represents a sequential consumption tax for the world in Q3 versus Q2. No, this is most definitely not what 99% of the world's population needs – not now. Oil prices matter. We are watching this one closely. 

Asset Allocation


Top Long Ideas

Company Ticker Sector Duration

WWW is one of the best managed and most consistent companies in retail. We’re rarely fans of acquisitions, but the recent addition of Sperry, Saucony, Keds and Stride Rite (known as PLG) gives WWW a multi-year platform from which to grow. We think that the prevailing bearish view is very backward looking and leaves out a big piece of the WWW story, which is that integration of these brands into the WWW portfolio will allow the former PLG group to achieve what it could not under its former owner (most notably – international growth, and leverage a more diverse selling infrastructure in the US). Furthermore it will grow without needing to add the capital we’d otherwise expect as a stand-alone company – especially given WWW’s consolidation from four divisions into three -- which improves asset turns and financial returns.


Gaming, Leisure & Lodging sector head Todd Jordan says Melco International Entertainment stands to benefit from a major new European casino rollout.  An MPEL controlling entity, Melco International Development, is eyeing participation in a US$1 billion gaming project in Barcelona.  The new project, to be called “BCN World,” will start with a single resort with 1,100 hotel beds, a casino, and a theater.  Longer term, the objective is for BCN World to have six resorts.  The first property is scheduled to open for business in 2016. 


Health Care sector head Tom Tobin has identified a number of tailwinds in the near and longer term that act as tailwinds to the hospital industry, and HCA in particular. This includes: Utilization, Maternity Trends as well as Pent-Up Demand and Acuity. The demographic shift towards more health care – driven by a gradually improving economy, improving employment trends, and accelerating new household formation and births – is a meaningful Macro factor and likely to lead to improving revenue and volume trends moving forward.  Near-term market mayhem should not hamper this  trend, even if it means slightly higher borrowing costs for hospitals down the road. 

Three for the Road


My wife's pre game advice (as I was walking out the door): "play nice with the other tv people today"



History records that the money changers have used every form of abuse, intrigue, deceit, and violent means possible to maintain their control over governments by  controlling money and its issuance.

James Madison


The price of gold is off sharply from the record highs of 2011, when it touched $1,900 an ounce. Despite its gains this past week, gold is still down 24% since the beginning of the year.

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