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CMG – PROVING THE NAYSAYERS WRONG

We continue to believe that Chipotle is one of the best positioned growth companies in the restaurant industry.  The company reported a very strong 2Q13 and we continue to believe that it is well positioned for the balance of 2H13.  Below are some of our thoughts on CMG’s 2Q13 results:

 

 

WHAT LOOKS GOOD

  • 2Q13 same-store sales of 5.5% beat consensus of 3.7% (as extra day adds 1%) and the two-year trend remains steady at 6.8% vs. 6.9% in 1Q13.
  • Management raised its guidance for 2013 same-store sales from “flat-to-low single-digits” to “low-to-mid single-digits.”
  • We expect 2Q13 traffic of 4.5% to continue into 3Q13.
  • $2.82 EPS was in line as a higher tax rate held back EPS by $0.04-$0.05.
  • Increased marketing appears to be driving incremental traffic.  Marketing costs increased to 1.5% of sales in 2Q13 compared to about 0.7% in 2Q12.
  • The company ended 2Q13 with $775 million in cash and cash equivalent along with no debt.
  • New restaurants are opening at (or above the high end) of the $1.5 million to $1.6 million sales target.
  • The company is expected to delay raising prices in 2H13, as management remains focused on continuing to drive traffic and take market share. 
  • Chipotle opened 44 new restaurants in 2Q13, putting year-to-date openings at 92.  It is clear to us that CMG is likely to exceed the high end of management’s targeted opening range (165-180 restaurants) for FY13.

 

POTENTIAL CAUSE FOR CONCERN

  • The majority of our concerns stem from margin pressure.
  • Restaurant level margin contracted -160bps in 2Q, primarily due to higher food costs.
  • The company reported food costs to be around 33% of sales in 2Q13 as salsa, chicken and cheese added the most pressure to margins.  We suspect that 33% may be the peak in food costs during the current cycle.
  • We continue to monitor new unit performance very closely.
  • Valuation is rich, but we believe the business model is built to stay this way. 

 

CMG – PROVING THE NAYSAYERS WRONG - CMG SSS  JULY19

CMG – PROVING THE NAYSAYERS WRONG - CMG EV EBITDA 1YR

CMG – PROVING THE NAYSAYERS WRONG - CMG EV EBITDA 3YR

 

 

 

Howard Penney

Managing Director

 


Get Out of the Way, Ben

Takeaway: Imagine what would happen to the USD and US interest rates if he took a vacation for a couple of months?

Get Out of the Way, Ben - big gov

 

We’ve said this 10,000 times before, but we’ll take this opportunity to repeat one of our favorite catch-phrases: “Big Government Intervention does two things: 1) shortens economic cycles and 2) amplifies market volatility”.  

 

Both the sell-side and buy-side are explicitly bullish on the US Dollar – for many of the right reasons. But it’s also clear that a broad swath of Foreign Exchange market participants – including banks and corporations – have yet to go all in on #StrongDollar. This is likely largely due to the mixed and convoluted messages they continue to receive from Ben Bernanke.

 

Imagine what would happen to the USD and US interest rates if he took a vacation for a couple of months?

 

For the record, our #StrongDollar, #ShortGold, stay away from Treasuries, get the Federal Reserve out of the way, strategy has been the non-consensus bull case for growth all year.

 

Get Bernanke out of the way once and for all and we will witness a rip for the ages.

 

Get Out of the Way, Ben - moo2


KO Takes It on the Chin

Takeaway: Coke takes it on the chin, but there may be room for optimism.

This note was originally published July 16, 2013 at 14:17 in Consumer Staples

KO is trading down today as volume results for Q2 2013 came in below expectations (globally +1% vs +4% last quarter) with the company citing a challenged macro environment (U.S., Europe, Asia, and Latin America), social unrest, and poor weather conditions (wet and cold across multiple regions) that impacted consumer spending and demand. North America, which is ~ 44% of sales, saw volume down a disappointing -1% in the quarter.  

 

Performance was hit by tough Q2 comps given the especially good weather in 1H last year: Pacific volumes were +2% vs +10% last year; Brazil’s volume was even cycling +6% a year ago; and India’s volume grew +1% versus a +20% comp.

 

The company cited optimism around a turnaround in 2H for its key international markets (China, Brazil, Russia, Mexico, and India) on improvement in the macro environment, continued marketing support of its brands, weather improvements (India performs historically stronger in the back half), and its systems execution.

 

While we expect many of the forces dragging on confidence and demand to remain in the back half of the year,  including  high unemployment (especially in southern Europe), social unrest, and inflation, we like that the back half quarters of 2013 are lapping much easier comparisons year-over-year.  On the top line, the Q3 2012 comp is +0.8% versus this quarter’s +2.8%. Gross margin was pretty consistent throughout last year, however the operating margin gets easier in the final two quarters of last year (+23.6% and +21.7%, respectively) versus +26.1% this quarter.

 

The stock is currently trading above its intraday lows at around $40.45. Our quantitative levels suggest that KO has an intermediate term price TREND line of support at $40.14.

 

KO Takes It on the Chin - hed

 

What we liked:

  • EPS inline with consensus at $0.63
  • Outperformance of still beverages, volume +6%  vs sparkling 0%
  • Packaged water volume up +6% and energy drinks +5%
  • Russia volume +11% with a strong marketing calendar tied to the 2014 Sochi Winter Olympics
  • COGS decreased -5%
  • Eurasia and Africa volume up 9% (benefitting from Aujan partnership)
  • New guidance on the effective tax rate of 23.0% for 2013 vs last quarter’s estimate of 23.5%

What we didn’t like:

  • Net Revenues were down -2.6%  in the quarter and missed estimates ($12.75B vs $12.96B)
  • Operating income fell -1.5% in the quarter
  • Europe volume -4% (vs -4% in Q1 2013) on colder weather and flooding in Germany and central Europe

 

Matthew Hedrick

Senior Analyst


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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.

Behold the US Bull

Client Talking Points

S&P500

Bears are not sleeping well. US stocks notching new all time-highs. (All-time is a long time.) S&P 500 up +18.4% year-to-date. Russell up even more +23.7% year-to-date. It's the seventh consecutive day where all 9 Sectors in our Hedgeye S&P Sector risk model are bullish on both TRADE (3 weeks or less) and TREND (3 months or more) durations. In other words, even the sectors we don't like like Utilities (XLU) and Basic Materials (XLB) aren't shortable, yet. Immediate-term Risk Range for SPX is 1670 - 1701. Bottom line? Buy US Stocks on red; Sell Treasuries on green – rinse and repeat.

ASIA

It's still Japan (bullish) vs China (bearish). Nikkei was down -1.5% overnight to 14,589. But it did hold our 14,448 line of support. Japan was down for the first day in five. We are keeping a close eye on the Nikkei. It's getting interesting there. Meanwhile, Chinese stocks continued to get rocked. China is down 3.7% in the last 3 days. Beijing is a certified gong show right now; its not where you want to be putting your capital. Liquidity trap anyone?

Asset Allocation

CASH 51% US EQUITIES 18%
INTL EQUITIES 9% COMMODITIES 0%
FIXED INCOME 0% INTL CURRENCIES 22%

Top Long Ideas

Company Ticker Sector Duration
WWW

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.

MPEL

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. 

HCA

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

TWEET OF THE DAY

US Equity Fund Flows (ex-ETFs) ripped the perma 2013 bears another new one last wk, +$3.7B inflows w/w

@KeithMcCullough

QUOTE OF THE DAY

“Detroit has been working its way to a level of insolvency for decades, continuing to borrow, continuing to defer pension payments, continuing not to pay its bills on time, continuing a deepening insolvency -- $18 billion.” - Kevyn Orr, Detroit's emergency manager (Bloomberg)

STAT OF THE DAY

The AAA daily tracking of gas prices rose another penny Thursday to $3.66 for a gallon of self-serve regular, the 11th straight day of rising prices. Gas is up nearly 20 cents a gallon, or about 6%, during that period. (CNN)

 


July 19, 2013

July 19, 2013 - dtr

 

BULLISH TRENDS

July 19, 2013 - 10yr

July 19, 2013 - spx

July 19, 2013 - dax

July 19, 2013 - nik

July 19, 2013 - dxy

July 19, 2013 - oil

 

BEARISH TRENDS

July 19, 2013 - VIX

July 19, 2013 - yen

July 19, 2013 - natgas

July 19, 2013 - gold
July 19, 2013 - copper


MCD – EARNINGS PREVIEW

We remain bearish on MCD. 

 

The stock has underperformed since we added it to our Best Ideas list on April 25 and will likely continue to do so.  If we are right on the numbers, the situation could become worse than expected for shareholders.

 

MCD will report 2Q13 EPS before the market opens on July 22nd.  For the quarter, the street is looking for 6% EPS growth to $1.40 on 3% revenue growth.  We believe the 3% revenue target is aggressive and contend that the lack of leverage in the business model will disappoint investors looking for 6% EPS growth.  In 1Q13, MCD reported 2% EPS growth on 1% revenue growth.

 

The company has a lot of work to do in order to improve their operational performance and we fail to see any indication that this will transpire soon.  Looking forward to the 2Q13 earnings call, we expect to hear management’s recital of the (stale) tenets of the current Plan to Win strategy: “Optimize our menu, modernize the customer experience and broaden accessibility to brand McDonald’s around the world.”  We believe 2Q13 results and the aforementioned message will fail to instill confidence in investors, as we do not see the current leadership coming up with ideas innovative enough to counteract the company’s current operating headwinds.

 

 

SALES TRENDS


The short case we laid out back in April was predicated on MCD missing 2H13 sales numbers.  We’ve always envisioned the June/July timeframe to be when our thesis begins to truly materialize.  July is the time when most of the 2013 menu strategy has been implemented, effectively giving the street a better indication of how management is addressing the current issues.  Looking at the three key regions, expectations are for a recovery in sales, however, we give little merit to this view given that the 2-year sales trends appear to be decelerating. 

  

HEDGEYE – We will get a closer look at June sales trends and management’s early view on July trends when MCD reports 2Q13 results.  We believe that both months will produce results below street estimates.

 

MCD – EARNINGS PREVIEW - MCD US SSS

MCD – EARNINGS PREVIEW - MCD EUR CORRECT

MCD – EARNINGS PREVIEW - MCD APMEA FINAL

 

 

MARGINS


A quick look at MCD’s restaurant level margin will show you why the franchisee community is upset with management’s current business plan.  Although the trends in restaurant level margins are less meaningful than the operating margins, they still matter.  With that being said, on an annual basis, since the peak of 4Q10, MCD has given up nearly 180bps of restaurant level margins.

 

In contrast, enterprise operating margins have held up significantly better.  On an annual basis, operating margins peaked in 1Q12 and have only declined 47bps since.  Naturally, there is less volatility in operating margins, but expect sustained subpar same-store sales to inflict further pressure on margins.

 

Regionally, operating margins are down 110bps, 85bps and 59bps in the APMEA region, the U.S. and Europe, respectively.  Given current trends, we believe MCD is vulnerable to further margin declines in both the U.S. and Europe.

 

HEDGEYE – We suspect that a 40bps decline in restaurant level margins will be in line with what the company will report.  Furthermore, we contend that current street expectations for operating margins to hold flat in 2Q13 and to increase 40bps in 3Q13 are overly optimistic.

 

MCD – EARNINGS PREVIEW - MCD Rest Level

MCD – EARNINGS PREVIEW - MCD Op Margin

MCD – EARNINGS PREVIEW - USA Op Margin

MCD – EARNINGS PREVIEW - Europe Op Margin

MCD – EARNINGS PREVIEW - APMEA Op Margin

 

 

FOOD COST TRENDS


Since the lows in 4Q10, MCD has seen global food costs rise 132bps to an estimated 34% of overall sales in 2Q13.  While McDonald’s has a very strong supply chain, it is likely that the company will continue to see their food costs rise for the foreseeable future, particularly due to its exposure to red meat.  MCD benefited greatly from lower food costs in 1Q13, but we expect to see this trend reverse for the balance of 2013. 

 

MCD has guided food inflation to be within the 1.5-2.5% range.  Europe’s food inflation was up around 2.5% in 1Q13 with expectations of a comparable increase in 2Q13.  Full-year food inflation for the region is estimated to be in the 2.5-3.5% range.

 

HEDGEYE – We’d be remiss not to note that any food inflation will have an adverse effect on the franchisee community.

 

MCD – EARNINGS PREVIEW - MCD COGS

 

 

LABOR COST TRENDS


In comparison to food costs, MCD had seen very stable labor cost trends over the past two years.  We believe that the company will continue to face upward pressure on its labor costs for the foreseeable future.

 

HEDGEYE – If the company wants to regain traction on improving same-store sales it will not be accomplished using fewer workers.  Labor costs are headed higher!  

 

MCD – EARNINGS PREVIEW - MCD Labor Costs

 

 

OTHER OPERATING TRENDS


Other operating costs were MCD’s largest source of margin decline in the U.S. in 1Q13.  Overall, operating costs increased 41bps year-over-year, a trend that should persist for the remainder of 2013.

 

HEDGEYE – Similar to labor cost trends, MCD will experience higher costs across the P&L as management seeks to implement a more cohesive strategy to improve traffic trends.

 

MCD – EARNINGS PREVIEW - MCD Other Exp

 

 

SENTIMENT


Highlighted in the chart below, 50% of analysts rate MCD a Buy while the other 50% rate MCD a Hold.

 

This puts sell-side sentiment regarding the stock approaching levels not seen since 2004.  Further, short interest in the stock is only 0.91% of the float. 

 

HEDGEYE – I believe that the 2Q13 results will confirm our bearish thesis on MCD.  The street may have a bearish bias on MCD, but are they bearish enough?

 

MCD – EARNINGS PREVIEW - MCD Buy Sell

 

 

VALUATION


McDonald’s stock is up 14.4% YTD, below the 17.5% increase in the S&P 500.  At 10.6x EV/EBITDA MCD is trading significantly below the QSR peer group trading at 12.3x EV/EBITDA. 

 

HEDGEYE – McDonald's aforementioned operational issues suggest that the stock might be trading at a higher implied multiple.  Valuation is not a catalyst!

 

MCD – EARNINGS PREVIEW - MCD PE CORRECT

MCD – EARNINGS PREVIEW - MCD EV CORRECT

 

 

 

Howard Penney

Managing Director

 


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