A Thousand Pebbles

“Fragility is the quality of things that are vulnerable to volatility.”

-Nassim Taleb


We have quoted Nassim Taleb a number of times at the start of the Early Look and, admittedly, I didn’t check to see if this was a recycled quoted. Nonetheless, it is a very apropos quote for the topic of today’s Early Look and for contemplating risks in markets generally.


 The title for today’s note comes from a story, which is referenced in Taleb’s most recent book “Antifragile”, that emanates from rabbinical literature (Midrash Tehillim) and is about a king that is angry at his son.  In fact, the king is so angry at his mischievous son that he explodes one day and tells his son he will crush him with a large stone. 


Herein lies the dilemma according to the story: a king who breaks his oath is considered unfit to rule.  The king is now faced with the decision to either crush his son, or to give up his throne.  Luckily before the poor prince was crushed, an advisor (the Hedgeye of the era perhaps?) came up with a solution.  The king should cut the stone into very small pebbles and pelt his son with these pieces.


Taleb’s point in this analogy is to explain how fragility stems from non-linear effects.  That is, if you double the dose, you get more than twice the effect.   By way of a practical illustration, if you have five shots of Jack Daniels, you have a buzz.  But if you have ten shots of Jack Daniels, your wife (or husband) makes the couch up for you to sleep on that night.


Back to the global macro grind . . .


As it relates to non-linear impacts on the global markets as of late, interest rates have certainly had the most critical impact.  In the Chart of the Day, we highlight a slide from our most recent Q3 Theme Presentation that looks at quarter-over-quarter moves in interest rates.  As the slide shows, the move in interest rates in the last quarter was the largest percentage increase in fifty years.  (Yes, the last time this happened Sandy Koufax was pitching for the L.A. Dodgers.)


We were on the road in Europe talking to clients last week and not surprisingly interest rates were a key topic of discussion.  Many of the more astute investors actually narrowed in on this precise point of interest rate volatility.  Our view is that volatility of rate increases will be more benign moving forward, which, as we’ve been stating, should be positive for the U.S. dollar, domestic economic activity and U.S. stocks.


To the extent that volatility picks up, the effects of interest rate increases will be non-linear.  In reality, a move from 1.63% on the 10-year treasury to 2.63%, or an increase of 100 basis points, shouldn’t have a meaningful impact on asset classes or the economy.  The markets become fragile, though, when this 63% back up in rates occurs in a very compressed time period, as it did in May – June.   In pushing the interest rate ball under water, the global central banks have created a set up in which interest rates are very fragile (to use Taleb’s definition).


In addition to the risk of rates increasing at a rate that is highly volatile, the other key focus area of investors in Europe on our visit related to the impact of #RatesRising to housing.  This is certainly a legitimate question as the wealth impact from home price increases is a key reason we are bullish on U.S. consumption.  Specifically, as a consumer’s balance sheet improves via an increasing home price, so too does their confidence, ability to borrow and subsequently spend.


Based on our long run analysis of housing, the recent accelerated move in rates has not altered the fact that the affordability of purchasing a home remains at historic lows.  On the basis of median mortgage payment as a % of median income, the housing market is at 22% and well below the twenty-five year median of 28%.  On the basis of median mortgage payment to median rent, the housing market is at 99%, which is also well below the long run average of 131%.


This is not to say, of course, that housing won’t be impacted by a volatile move in rates, but the housing market is still so depressed based on historical levels it should have the ability to manage through #RatesRising.  June data from the NAR seems to support this as existing home sales were up 15.2% year-over-year and the national median home price in June was up 13.5%.  So yes, housing can do well if rates continue to rise.


Switching to infomercial mode for second, I want to highlight that we will be expanding our U.S. financials research coverage and are launching on U.S. asset management stocks on Monday July 29th at 11am.  Jonathan Castelyn has joined Josh Steiner’s team in a senior role and will be initiating on these names.   As always, we will be actionable and Jonathan will have 2 short ideas and 2 long ideas.  Please email  for access.


Our immediate-term Risk Ranges are now:


UST 10yr 2.47-2.71%


VIX 11.59-13.54

USD 82.01-82.89

Brent 107.21-109.14

Gold 1


Keep your head up and head on the ice,


Daryl G. Jones

Director of Research


A Thousand Pebbles - Treasury L vs NL


A Thousand Pebbles - Virtual Portfolio


We maintain our bullish stance on Wendy’s.


WEN reported 2Q13 EPS results that were $0.02 better than consensus.  More importantly, 2Q13 adjusted EBITDA was $102.1 million versus the Consensus Metrix estimate of $95.1 million.  Same-store sales were +0.4% for company-owned stores and +0.3 for franchised stores versus Consensus Metrix estimates of +1.1% and +0.9%, respectively.  Due to the successful July launch of the Pretzel Bacon Cheeseburger and the recent announcement of strategic operational initiatives, we believe the company is well positioned for the balance of 2H13 and 2014.


Below are some of our thoughts on WEN’s 2Q13 results.



The Big Story

The company announced a plan to sell about 425 restaurants as part of its ongoing brand transformation in order to help optimize its restaurant portfolio.  The company also laid out the anticipated benefits of this initiative:

  • Improved company-operated restaurant margin of 50bps or more
  • Reduced annualized G&A of about $30 million by the end of 1H14
  • Lower annualized depreciation expense of about $30 million by the end of 1H14
  • Higher cash flow due to an increase in rent and royalty revenue, lower ongoing capex, and proceeds from the sale of these restaurants
  • NPC will be a meaningful buyer of the stores, if not all of them 


What We Liked

  • New focus on an asset-light model
  • The company has recognized its operational deficiencies and created a feasible plan to address these issues
  • WEN is trending toward the high end of its full-year outlook for adjusted EBITDA ($350-$360mm) and adjusted EPS ($0.20-$0.22)
  • Strong focus on brand transformation – reimaging, including new restaurants, products and packaging along with a new logo
  • Expect stronger same-store sales in 2H13 and remain on track to achieve full-year same-stores sales growth of 2-3% in North American company-operated restaurants
  • The company raised its annual EPS growth rate target from the high single-digits/low double-digits up to the mid-teens beginning in 2014
  • Wendy’s intends to begin repurchasing shares in 3Q13


Red Flags

  • Although same-store sales numbers improved year-over-year, they fell short of expectations
  • Lost market share in the QSR value landscape, but the outlook is better for 2H13
  • 4Q adjusted EBITDA could be down over 10% year-over-year due to the company’s Image Activation franchisee incentive program
  • 2013 full-year D&A could be up about 15-20%








Howard Penney

Managing Director







Guangzhou is set to become the third mainland city to offer 72-hour transit visas to travelers from dozens of countries.  The city's inclusion in the short-term visa scheme was announced by provincial authorities who described it as a boon for tourism in the Pearl River Delta.  Beijing and Shanghai introduced the visas last year.


Cheong Chi Man, Vice-president of Macau Travel Agency Association, said the measure will not be a driver to boost the number of package tour visitors to Macau, but it is expected to bring more individual visitors.



The number of passengers moving through Changi Airport increased 6.1% YoY to 4,669,334 in June 2013.





Macau visitor arrivals increased by 10.4% YoY to 2,324,935 in June 2013.  In June 2013, visitors from Mainland China increased by 20.0% YoY to 1,464,665, mainly coming from Guangdong Province (629,648) and Fujian Province (64,466). Mainland visitors traveling under the Individual Visit Scheme (IVS) totaled 603,704.  Moreover, visitors from the Republic of Korea (33,570) and India (21,724) also increased by 12.7% and 14.2% respectively, while those from Hong Kong (558,326) and Taiwan (75,889) decreased by 0.1% and 12.8%.  

The average length of stay of visitors held stable from a year earlier, at 1.0 day in June 2013.



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In preparation for LVS's F2Q 2013 earnings release tomorrow, we’ve put together the recent pertinent forward looking company commentary.



POST CONFERENCE CALL FORWARD COMMENTARY (Goldman Sachs Lodging, Gaming, Restaurant and Leisure Conference)



  • "Right now about 51% of the people that come in to Macau don't stay. They go home. I think that's very encouraging, frankly, because that means 49% of the people are staying. And basically, although Guangdong is the closest province with 100 million people, the infrastructure from the bridge, Henqin Island development and other things that are happening with the trains, et cetera, the airports, all create from the distant areas – Beijing, Shanghai, all that– a very, very significant amount of traffic over the next number of years."
  • "We're yielding at the Venetian $12,000-plus a table last quarter. Obviously, we need more tables going forward. Even if we're doing 400 tables, we probably could use another 50 or 100. The junket yields are just down across the market because no matter who you are, you're not getting the yield per table. But we just simply follow the trends. It's hard to predict, but the good news is the government's very helpful, allowing you to move tables around."
  • "We are investing $100 million in the theater and in Site 5, which is in the Holiday Inn, Conrad area to produce 80 more tables at the premium mass level, which will open sometime in the third quarter of 2014."


  • "Our VIP business remains okay. I mean, we did have a great quarter, $18 billion, but we always tell people it's a very concentrated segment that you can't predict quarter-to-quarter. It's $1,000 – $2,000 accounts that really matter in that segment. So, it's highly concentrated."
  • "We'd like to target to get that mass market business back up to about $4.6MM or more a day."
  • "The mall continues to get better and better, and we leased that during a rather difficult time. And as we keep changing out tenants, that gets better by the day and that's a wild asset. The upside of that mall, I think, is yet to be seen."
  • "We're already going to start major room rehabilitation in 2014."


  • [Bethlehem] "We're happy with the results, and unless we're able to get what we want for the property, we have no big rush to sell it and may not sell it."





  • "Based on our current construction schedule and subject to timely government approvals, we're still targeting the opening of The Parisian for late 2015."
  • [SCC] "We're putting in another 80-some odd tables, pushing 100 tables...Our competitors, I'm sure, are doing the same thing. They're putting their underperforming tables to better use and increased revenue. We've got the CapEx approval from our Board of Directors meeting yesterday, and we're moving forward on that. That is going to take about 10 months or so, maybe a little more, 10 or 12 months. It will be ready, I think, next April."
  • [Competition]  "I think it's competitive. Obviously, you have three segments there. Our strength resides in the pure mass. Because our table size and capacity, I think we dominate that segment. The premium mass and super premium mass are obviously very competitive."
  • [Mass table]  "Our goal is to re-segment the Four Seasons, getting more. We did $14,200 per table in the Four Seasons. We want to re-segment that, get a lot more aggressive in that mass table market, or I should say premium mass table market. We want to grow our business, especially at the SCC."


  • "Slot segment continued to show weakness. And that's because Slots is primarily driven by the local market, which has not recovered."
  • "We'll continue to see table growth. We're hoping to see more growth from the slot side as well. But we were back in a positive place in Singapore in the most important segment, the non-rolling and Slot ETG segment.:


  • "There's a lot of noise about Japan, about 100 people in the legislature wanting to get legislation as early as November."


In an effort to evaluate performance and as a follow up to our YouTube, we compare how the quarter measured up to previous management commentary and guidance



  • IN-LINE:  Strong margins and better than expected results from the Interactive division offset lower revenues. Unchanged guidance was a disappointment especially considering the drive a truck through range of 6c for FQ4.



  • SLIGHTLY POSITIVE:  while the number of units sold came in a little below expectations,  ASPs grew 7% to a solid $16.1K and gaming installed base grew by 700 units YoY
    • "There are systemic issues that have impeded participation in some markets, which we are working to overcome. And the economic headwinds in certain regions continue. However, we remain committed to harvesting the investments that we have made in this business particularly in expanding our portfolio of localized content. Long-term, we still expect international markets to outpace the growth of our North American business."
    • "Europe tend to be more macro. The other two (Latin/South America, Asia Pacific) as we look at them probably have more of a systemic issue within the structure of how they allow the business to operate.


  • WORSE:  Continue to be pressured by soft demand trends although Q2 GGR was worse than expected in most markets.
  • PREVIOUSLY:  "We do need some cooperation from GGR trends. And I would say, over the first two quarters of our fiscal year, we haven't seen anything to indicate that we're going to get some positive tailwind in that area."


  • WORSE:  Average revenue per unit per day F3Q was $47.96, down 4% YoY and down 3% sequentially, both primarily due to lower yields, most significantly in MegaJackpots. 
  • PREVIOUSLY:  "We now expect that our objective of achieving flat year-over-year yield by the fourth quarter will be more challenging than previously anticipated. However, we remain focused on improving yields, confident that we can continue to offset a portion of yield pressures by managing costs."


  • MIXED:  DAUs was flat QoQ, below Street expectations but the growth of bookings per DAU was impressive despite IGT's expansion into international markets which has lower monetization rates.
    • "As we develop these markets, we expect that the number of daily active users will grow, but the average revenue per daily active user could decline slightly...we continue to expect the transaction to be GAAP accretive by 2014."
    • "We think we have the right product in place complemented by the IGT content to continue to grow those numbers. I mentioned we're penetrating a couple of different markets with new language offerings and we expect that will drive DAU though it may slightly impact bookings per daily active user. As you get into a market you need to build familiarity before you can convert to paying users. It's incredibly difficult to precisely identify which metric is going to go up. Lately we've seen them all rise and we continue to expect to make forward progress in all and we will continue to balance that which will provide us the greatest long-term return. So I think you can expect to see them move north."


  • BETTER:  Gross margins of 54% came in above its traditional 51-53% range.
  • PREVIOUSLY:  "Traditionally, we're in kind of the low 51% to 53% range and that's where I would expect it to stay over the remainder of the year."


  • SAME:  Last major shipment will occur in FQ4.  Expect FQ4 to be less robust than FQ3.
  • PREVIOUSLY:  "We expect at the moment that we should see the vast majority of the remaining units ship in the year. But keep in mind these are large bulk orders and depending on either customer needs or other impacts, you could see swings and sometimes those swings border on a quarter. Right now I would say that we believe the vast majority of the remaining shipments will occur in the year. And then there may be some follow on activity as locations top off their floors in 2014."


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



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