PNRA remains on the Hedgeye best ideas list as a SHORT. 




PNRA has now missed expectations for the second straight quarter.


In 2Q13 PNRA reported 16% EPS growth on 11% sales growth, which missed consensus by $0.03 and 2%, respectively.  In addition, the 3.5% increase in same-store sales missed the consensus expectation of a 4.5% increase.  Traffic trends declined 0.5% in 2Q, making it the third straight quarter of traffic declines. 



Panera's Traffic Problem

As we mentioned in early April, PNRA’s position as a healthy QSR option that is relatively free of competitors is gradually changing.  An increased number of casual dining chains are now offering lower price points and other QSR chains are upgrading their menus.  These menu upgrades include items that are marketed competitively as healthy eating options and are cheaper than PNRA’s core offerings.  As a consequence, this secular trend is manifesting itself in the components of comparable sales growth as PNRA traffic trends have shown weakness lately. 


As the chart below illustrates, PNRA’s traffic trends have been declining for the past three quarters.  In 1Q13, management attempted to attribute the decline in traffic to poor weather.  Given the current trends and the lowered sales outlook for the balance of the year, our short thesis appears to be playing out well.


In today’s press release, management offered up the following initiatives to help solve the company’s current issues:


“We now believe that to consistently operate at the very high sales volumes we are generating and to prepare for additional sales from our initiatives to expand access to Panera and utilize marketing, we must improve our peak hour throughput.  While results in the next few quarters may be choppy as we invest in both sales-building initiatives and operational capabilities, we believe that our efforts will ultimately enable us to deliver an enhanced customer experience, grow sales and expand earnings.”


While management does not share our view on the competition, we also believe that some of the issues the company faces are self-inflicted.








Labor Cost Trends

Shown in the chart below, PNRA has seen a year-over-year decline in labor costs for 12 of the last 13 quarters.  This is a trend that is unsustainable and will likely lead to customer service related issues in the future.  We believe that this trend will need to be reversed in order to fix any peak hour throughput issues.






The company is hosting its earnings call tomorrow morning at 8:30am ET.  We’ll post on anything incremental after the call.




Howard Penney

Managing Director



Margins drive a small beat. Not enough confidence in FQ4 - you can fit the Fed balance sheet in the guidance range




  • NA Machine sales outperformed; continue to capture Canadian VLT market share.
  • DoubleDown recently surpassed Zynga Poker as the top grossing social casino app on Facebook
    • Had the highest grossing social casino app on the iPad
  • 39% increase in NA replacement unit shipments; confident maintained leading ship share in past quarter
  • 4% increase in international sales due to lower mix of used machines sales.  Despite ongoing challenges in certain regions, there is still significant potential.
  • Gaming Ops:  
    • GGR trends were lower  
    • Installed base flat with some mix shift away from megaJackpots into leased operations
    • Positive interest rates have a favorable impact on margins and jackpot expenses
    • Initiatives: Increasing megaJackpot team, introducing game changers
  • DoubleDown monetizing at awesome rates; mobile revenues up 41% sequentially.  DoubleDown will be GAAP accretive in F1Q 2014.
  • Repurchases 345,000 shares ($6MM); suspended stock buyback in the quarter due to 'technical reasons' - IGT was probably involved in bidding for WMS and SHFL

Q & A

  • Product Sales:  2Q Canadian VLT units: 3,300; Illinois VGT units: 1,300
  • 2014 opportunities:  Oregon and some other new states 
  • DoubleDown:  As they enter international markets, bookings rate may be pressured but it didn't materialize in F3Q
  • Wide range of F4Q guidance:  some lumpiness in timing of international orders for F4Q
  • Stock buyback restrictions in Q?  Refuse to elaborate.  $520MM in stock available; continue to target using that authorization over next 2-4 years.
  • Leverage:  a little underleveraged at the moment
  • Will not comment on whether they continue to be restricted in the stock buyback program
  • Will look at opportunities to expand installed base but will not chase yield
  • GGR trends:  calendar 2H 2013 - haven't seen much change in operators' comments in terms of budget volume. 
  • Last major shipment to Canada will conclude next quarter.  Expect FQ4 will be less robust than FQ3.
  • Would not say that 1,300 a quarter in Illinois is a good run rate because last quarter, IGT saw a significant contraction in demand.
  • GGR is having most significant pressure on yield #s. Nothing significant has changed in this part of the business.
  • Canadian/Illinois VLT units mainly drove down ASPs; there was some mix shift out of MLD product which is a higher priced product.
  • Online New Jersey:  waiting for the operators to start up; purely in a B-to-B model with a revenue share model
  • Upgraded DoubleDown poker product and done well with tournaments.
  • International market monetizes at a lower rate than domestic market but will try to convert players at the same level in domestic market.  The launch of new languages will be a tailwind.
  • Mobile growth has been fantastic.  IGT has spent equal time commitment on desktop and mobile platforms. 
  • MegaJackpot G2E lineup will be exciting and diverse e.g. bonus features, new maps, new display format.
  • International:  optimistic on seeing the 6% growth in ASP and growth in installed base
  • South America could be a great opportunity if they can solve the structural issues of getting a product there
  • Asia:  early games have been a success
  • Europe: growing the slowest among the international opportunities;  'very spotty' and depends on the country and product type.  VLTs seem to be growing a bit faster than the traditional casino business. Remain bullish on the international markets.


Last week Hedgeye presented its Q3 2013 Macro Themes call for institutional clients, introducing the three major themes our Macro team has identified as significant drivers of investment strategy for the current quarter.



As a review, our Q2 Macro themes were:

  • #StrongDollar – The Dollar continues to reverse what has been a forty-year slide.  Renewed strength in the currency keeps pushing ahead despite Bernanke’s policy statements designed to weaken the Buck.
  • #GrowthAccelerating – Hedgeye has tracked significant growth in a number of key sectors, including declining unemployment, strength in the housing market, and an upturn in the birth rate, reversing a forty-year decline and leading to a boost in new household formation.
  • #EmergingOutflows – The BRICs are BROKEN, even “stable” countries like Turkey are in the grip of unrest.  The US is once again the safe haven.

The Macro View

Macro trends are sensitive to government policy.  When governments meddle in the financial markets, they compress natural market and economic cycles.  This causes volatility to spike – free money for short-term high-frequency traders (especially those who get economic news a few seconds early), and a trigger for waves of nausea for the individual investor.


But while high-frequency traders focus on specific economic numbers, scalping a few pennies on a short-term lift in Financial stocks when the Fed looks dovish, Hedgeye’s broad Macro work focuses on rates of change in the economy.  A public statement from Ben Bernanke may provide shot term profits for algorithmic traders, but it’s not a signpost to America’s economic future.  Nor is it anything the individual investor can rely on. 


Our analysis focuses on rates of change – we look at theslope of the line, the cumulative rate of change over time in key economic indicators.  If you track rates of change, you will see where the growth comes from – or fails to come from.  If you know where the growth is in the economy, you can position yourself to succeed as a long-term investor.

Hedgeye’s  Macro Themes for Q3 2013:

  • #RatesRising
  • #DebtDeflation
  • #AsianContagion

Our themes are simple.  The dollar has been strengthening.  Meanwhile housing, employment and consumption have all been surprising to the upside – not major blow-out numbers, but the slope of the line is definitely in the direction of Growth.  In this environment, Fed “tapering” is a pathetically weak dog wagged by a potent tail: interest rates are rising, the Dollar doesn’t want to go down, and growth has taken root in key areas of the economy.


Throughout the Middle Ages, the most educated people in Europe were convinced the sun rotated around the earth.  Today we chuckle derisively at how they could reject proofs from the likes of Copernicus and Galileo.  In the face of real signs of accelerating growth, Bernanke is behaving like the Defender of the Faith, as though he had the authority to direct gravity.  He needs to have his King Canute moment and publicly allow the sea to wash over him.  We’re convinced the waves are about to break.


Here we offer the first of our three Macro Themes, Rates Rising.  



‘POP!’ goes the bubble as interest rates start to rise, reversing the most asymmetrical set of relationships on our Macro screen.  The gradual decline in rates that has prevailed for forty years is turning.  Like the Queen Mary, it turns ponderously – so slowly that at times you can’t tell it’s reversing course.  As the slope for interest rates turns up, so much that has been tied to declining rates will unravel.  Hedgeye continues to emphasize this on our bearish call on commodities.


Keith went out on a Macro limb and said we are not likely to see the 2012 lows on ten-year bond yields again.  Not soon, and maybe not ever.  With longer-term historical rates averaging over 6%, there’s more than four hundred basis points – over four full percentage points – for rates to reflate as the 40-year bonds bubble pops without entering the historical Danger Zone for inflation.  Hedgeye expects the bond bubble to melt over the coming 3-5 years.


What’s an Investor to Do?

Keith digs into the historical record and shows that rising interest rates are not the enemy of economic growth.  To the contrary, historically there is a high coincidence of rising bond yields during periods of high economic growth.  Mr. Bernanke’s fear mongering notwithstanding, there’s no reason to believe it has to be any different today.


In a growth environment, as characterized by rising 10-year bond yields and a strengthening Dollar, Consumer Discretionary and Financial stocks tend to perform well, along with Industrials and, to a lesser extent, Energy.  Yield plays – notably Utilities – are at a disadvantage, as increases in current yields are offset by declines in the price of the stocks.


But Growth isn’t Good News yet, as too many major investors have large portfolios based on declining rates – and short-term traders are enamored of the volatility created by Fed uncertainty.


To us, the problem continues to be political.  Wall Street boasts many of Washington’s biggest donors, money managers and bankers whose largesse in recent years has come from the built-in guaranteed profits of declining rates, as they repeatedly locked in the spread between 10-year Treasurys and 2-years.  Like the Fed, a lot of these folks hold an awful lot of fixed income paper – Treasurys, but also corporate, and even mortgages – all of which will decline in price as rates climb.  Unlike the Fed, they can’t print their own money to remain liquid.  Write-downs on these bond portfolios could get ugly.  Even if managed right, it won’t be easy to get out of billions of dollars’ worth of bonds without getting spanked.


So Bernanke keeps the myth alive, the sun continues to revolve around the earth, and the house of cards stands firm as the Inchcape Rock.  Until it doesn’t.  Meanwhile, volatility in your portfolio will likely be the order of the day.  That, and uncertainty about the future.


You weren’t planning on retiring any time soon…?


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If there's one data point that makes us feel like we’re not bearish enough on emerging market asset classes it’s this one:


“In the four years through 2012, investors poured $3.9 trillion into emerging markets, outstripping the $3.1 trillion they added in the same period leading up to the global financial crisis, said SLJ Macro’s Jen, citing data from Institute for International Finance Inc.


When the liquidity starts to reverse, investors start to find out just how [il]liquid EM debt and equity capital markets really can be! 





#RatesRising - Stage 5: Acceptance?

Takeaway: Interest rate volatility is declining as investors accept economic reality and the positive implications of #RatesRising.

What the *&%! Just Happened” headlined yesterday’s release of GMO’s quarterly investment letter.   While the title is probably accurate in capturing the prevailing, post-Taper announcement sentiment of the larger investment community, that the initial inflection in a bond bubble 30Y’s in the making occurred with some price convexity, and not a wimper, shouldn’t be particularly surprising.  


In fact, if you have been long U.S. growth for the last 8 months, the Taper announcement itself was more a confirmation of economic reality than a prodigious central planning event.  The acceleration in the domestic macro data since late November and the slow creep higher in the 10-2 spread were heralding some measure of a policy shift.


In so much as a widening in the yield spread <--> expectations for QE Taper <--> Improving Domestic Macro, is a transitive relationship, the recent “bear steepening” in rates should be taken as positive confirmation of an improving domestic growth outlook.  This first step function move higher in yields is simply the market adjusting to the positive gravity of the domestic economic data and the implications of a sober policy response. 


In essence, the initial move in rates represents the ball under water moving towards being only half-submerged. 


From here, particularly given the Fed’s much communicated ‘data dependency’, the next 100+ bps higher should be viewed more as a growth dependent return to interest rate normalcy than a tightening in the conventional sense.  If the fundamental data is such that the controlling, dovish contingent at the fed is willing to signal a rate increase - even a small, gestural increase  -  we’d argue that pro-growth exposure should continue to outperform in the run-up to that event.


As we’ve moved past the acute response phase, the market has seemingly come to accept and price in a reduced flow of fed stimulus.   We detailed the implications of #RatesRising on our 3Q13 Macro Themes call last week (replay>> HERE, materials >> HERE).  We’d highlight a couple of incremental events of the last week:  


ACCEPTING REALITY:  Measures of implied interest rate volatility in the options markets have dropped precipitously over the last couple weeks.  Seemingly, the market has absorbed the acute impacts of the initial announcement with investor angst ebbing alongside initial portfolio re-adjustments.


#RatesRising -  Stage 5: Acceptance? - Treasury Volatility


TAPER TIMELINE:  Alongside lower volatility and a newly range-bound 10Y, today’s main policy related headline from Bloomberg that the consensus expectation of economists for Fed tapering (to the tune of $20B) to begin in September is further evidence that the market is getting comfortable in delineating the impacts of tapering vs. tightening.    


Given the practical aspects of implementing a tapering which, practically, means they will reduce the flow of purchases and subsequently monitor the impact before implementing incremental reductions, a September start makes sense.  With Bernanke likely stepping down come January, initiating the reversal of unprecedented policy initiatives which he captained makes sense from a continuity and (Bernanke) legacy perspective.   It also gives policy makers sufficient runway for scaling back purchases with an early eye towards a complete cessation come mid 2014. 


Also, implicit in the reduction in QE purchases is that QE was, in some manner, successful in its objective. This gives the FED and QE as a policy some credibility should they need to re-accelerate easing at some point in the future.   


SEASONALITY REMINDER:  As it relates to the expectation for tapering to begin in September - recall that the seasonal distortion present in the reported employment and economic data will build as a headwind thru August before again flipping to a tailwind over the Sept-March period.   Any prospective delay in tapering due to perceived/optical weakening in the data over the next 6 weeks should be short-lived as the impact of the distortion reverses come September.  Further, any negative drag associated with reduced stimulus may be partially masked by the positive seasonal tailwind as we move towards year-end and through 1Q14. 


(Not So) LATENT RISK:  Duration (price sensitivity to interest rate movement) on 10Y treasuries remains near peak levels while high yield and IG spreads remain near trough levels.  Despite the recent diminuendo in interest rate volatility, risk associated with another expedited back-up in yields remains very much alive across the fixed income spectrum.


#RatesRising -  Stage 5: Acceptance? - Duration   corporate Spreads


Quantitative Setup:  10Y Treasury Yields remain in Bullish Formation (Bullish across TRADE, TREND, & TAIL Durations) with immediate support and resistance at 2.45% and 2.75%, respectively. 


#RatesRising -  Stage 5: Acceptance? - 10Y levels



Christian B. Drake

Senior Analyst 


HEDGEYE TV Presents #RATESRISING Q3 2013 Macro Theme


"POP!" goes the bubble as interest rates start to rise, reversing the most asymmetrical set of relationships on our Macro screen. Hedgeye CEO Keith McCullough goes out a macro limb and says we are not likely to see the 2012 lows on 10-year bond yields ever again. Moreover, McCullough shows that as the slope for interest rates turns up, so much that has been tied to declining rates will unravel.


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