We are removing RRGB from the Hedgeye best ideas list as a short.
We remain cautious on the Casual Dining segment and feel RRGB is one of the weaker players in the space. Our short thesis was predicated on the company not delivering on improving traffic (which happened) but misjudged the potential for a significant increase in average check.
For the intermediate term, we no longer see Red Robin as one of the most attractive shorts in the space. Improving 2-year traffic trends make it difficult to remain short the stock. Given yesterday’s results we can no longer defend our bearish case.
The 2Q13 numbers support the notion that RRGB’s brand transformation and new menu initiatives have impacted traffic trends sooner than anticipated. We adopted a bearish stance on RRGB back in early June as we believed the stock had gotten ahead of the company’s fundamentals and future growth prospects.
The bear case was led by the three main deterrents to growth that we expected the company to face in FY13. The first was a decline in traffic. The current casual dining environment suggests a slowing sales and traffic environment, and we viewed a second quarter uptick in traffic for RRGB as unlikely. The second issue we had was with the near-term expectations of the brand transformation. While we agreed RRGB was desperately in need of a brand transformation, we believed this initiative would be a negative in the short-term. The last component of our bear case consisted of a dreadful outlook for 3Q13, a quarter which we have previously referred to as “RRGB’s Waterloo.”
Below we break down the three main tenets of our previous bear case and explain why we have backed away from our short thesis.
While traffic did contract -0.7% in the quarter, the 2-year trend turned positive for the first time in six quarters as the company outperformed its casual dining peers by 240 bps. This suggests that RRGB was able to gain market share during the quarter – a feat that we viewed as unlikely. There’s no way to spin it. A positive 2-year average trend in traffic growth, particularly in a sluggish environment, is a bright spot for the company and portends the largest hole in our thesis.
The company’s brand transformation is still in its early stages and will take time to fully materialize. However, their efforts to-date have translated into a higher perceived value, allowing them to efficiently take +2.3% pricing in the quarter. This, combined with menu enhancements and a renewed focus on higher margin items – alcohol, appetizers, and dessert – led to a +5% increase in average guest check during the quarter. Whether or not this is sustainable is another question. Price is expected to roll off in 3Q and the lift seen from menu enhancements will be difficult to match moving forward.
Several initiatives proved beneficial to 2Q13 results, but it will take time before we can determine the true, long-term impact of the brand transformation. While early results have impressed, it is not a guaranteed success. Moving away from the core customer always carries risk and Bar Works remains a fairly large question mark.
We previously wrote that 3Q13 is RRGB’s Waterloo for the following reasons:
Though we expect 3Q13 to be a difficult quarter for the casual dining industry in general, we now have no reason to believe it will be worse for RRGB than others.
The company has shown it can grow sales in a slowing environment and has managed expenses, in midst of a brand transformation, better than we had anticipated. We would heed caution, however, on a couple of counts. First, 2Q13 restaurant-level operating profit margins of 23.3% are unsustainable, particularly when you factor in the 3Q13 roll off in price. Second, brand transformation expenses are likely to pick up in 2H13, leading to more margin pressure than the first half of the year.
Overall, our thesis for 3Q13 has changed marginally. The one difference is that RRGB has responded to the current environment better than we anticipated. The street seems to have modest expectations for 3Q13, but we continue to believe the casual dining group is likely to see multiples revised lower in the current quarter.
At 8.6x EV/EBIDTA, RRGB is trading in-line with its Casual Dining peer group at 8.7x. And while valuation is at peak levels, it is not a catalyst – and never will be. Though we still have conviction in some of the core tenets of our short thesis, we have lost conviction in the others. Without these, we can no longer make a compelling bearish case.
This note was originally published at 8am on August 02, 2013 for Hedgeye subscribers.
“Think of me like Yoda, but instead of being little and green, I wear suits and I’m awesome. I’m your bro — I’m Broda!”
I’m not going to try to weave that recent #Tweetshow gem from Keith above into some sort of missive theme. It just makes me laugh.
Let’s start somewhere else.
Back in school the bullies used to wait until Picture Day to punch a kid in the face. Risk Management in Central CT starts early.
Yesterday could probably be considered an investor picture day and the market delivered a bevy of black eyes to the perma #EOW contingent.
In related End of World and Recency Bias news, it’s now August and for the better part of the last 5 months, the ‘Sell in May’ mantra has been iteratively thesis drifting towards an un-convicted call to ‘Sell in September’ alongside another crescendo in congressional budgetary and debt ceiling discord.
September, incidentally, also happens to be when the seasonal distortion present in the reported econ data flips from a headwind to a tailwind - serving to (optically) amplify any positive underlying economic trend.
Hearing implied volatility in ‘sell in December & go away’ calls is ripping!
Back to the Global Macro Grind……
For much of 1H13, our pro-domestic growth call was buttressed by some positive redundancy. That is, with our model signaling for the slope of U.S. growth to accelerate out of 4Q12, we had a bullish absolute call for domestic, consumer-centric equities.
With most of Europe Bearish TRADE & TREND, an expectation for slowing EM growth, and upside to troughed out expectations for U.S. growth, we also had a relative call supporting a long bias to domestic exposure.
In essence, even if U.S. growth turned out to be “okay” instead of very good, we were still taking a high probability swing at positive absolute performance.
As it happened, our conviction in the strength of the relative call was tested more acutely as we transitioned out of 1Q. A quick review of the last few months will be helpful in understanding how our view has evolved to where it is today.
As we moved through 2Q, it become apparent that consumption growth, while remaining healthily positive, would not accelerate sequentially. In part, this was not unexpected.
Fiscal policy impacts generally hit on some short lag and the 1Q13 comparison was artificially difficult as consumer spending in 1Q benefited from the special dividend deluge and compensation pull-forward that occurred in December 2012 ahead of impending fiscal cliff related tax law changes.
With the savings rate rising in 2Q and disposable personal income growth largely flat, divining the slope of sequential consumption growth just became simple math.
Further, with federal employment growth running at approx -2% YoY and furloughs for ~700K+ federal employees beginning in July – which, in tandem, equates to ~7% reduction in income for ~2% of the workforce – upside to disposable income growth would likely be constrained in 3Q13 as well.
Would a modest deceleration in consumption matter from a market perspective? – becomes the simple, but nontrivial investment question.
As we highlighted yesterday, when re-evaluating positioning, it’s often helpful to start by detaching yourself from the myopia of trying to contextualize every market tick and, from a broader perspective, remember how this whole reflexive economic thing works. Archetypically,
Rising spending drives income and employment higher which, in turn, drives consumption and confidence higher in a virtuous, self-reinforcing cycle. Credit serves to amplify the cycle with credit expansion following pro-cyclically as loan demand and creditworthiness both increase alongside rising incomes and higher household net wealth.
In short, if the TREND slope of improvement across the balance of key macro drivers (employment, consumption, credit, confidence) remains positive, and if the forward research view and risk management signals are still aligned, the path of least market resistance and the highest probability call is to stick with the TREND - particularly if you don’t have a discrete catalyst for a reversal.
So, how are the aforementioned macro metrics #TRENDing?
Labor market trends remain positive with Initial Claims continuing to register accelerating improvement while employment growth as measured by the BLS’s Establishment and Household Survey’s both remain positive.
Confidence readings across the primary surveys continue to make new 5Y highs and are finally beginning to break out of their post recession channel.
Business and Residential Investment growth has accelerated in each of the last two quarters.
On the credit side, banks are finally beginning to report positive loan growth, Commercial & Residential Real Estate loan demand continues to improve and credit standards across commercial and consumer loan categories continues to ease.
Consumption has shown a discrete acceleration, but faces some well advertised, nearer-term headwinds. If labor market trends remain positive, does the market look past middling consumer spending growth over the next few months with an eye towards a diminishing fiscal drag and easy compares as we annualize the sequestration and the tax law changes in early 2014? That’s an increasingly probable risk for the consensus #EOW bear crowd to manage.
Now, Is Congress a discrete negative catalyst? As our Healthcare Sector Head, Tom Tobin would say; you can never underestimate congress’s ability to create a crisis so they can subsequently save us from it. Congressional risk may rise, on the margin, but this iteration is likely to be mostly noise so long as the fundamental trends remain positive.
Is #RatesRising a catalyst? We have a hundred page slide deck and a 60 min presentation on why we don’t think a return to interest rate normalcy is a threat to growth or market performance. (ping firstname.lastname@example.org if you’d like a copy)
Is today’s Employment Report a discrete catalyst? Yes, but not really. We don’t have any particular edge on the NFP number, but given the ongoing strength in the jobless claims data it’s more likely than not we print something close to consensus at 185K.
So, now that I’ve peppered you with bullish jabs for the last 800 words, I’ll remind you that we’re not bullish on everything at every price. In fact, we moved to net neutral into yesterday’s close (5 longs, 5 shorts) as almost everything pro-growth, domestic consumption (XLY, XLF, $USD) signaled immediate term overbought.
But we’ll take our long exposure higher again on the signal so long as the TREND slope of improvement in the Macro data remains positive. At present,….
“Your Friend, the Trend Remains” - Broda
Our immediate-term Risk Ranges are now as follows:
UST 10yr 2.60-2.78%
80o and sunny on tap for the weekend. Enjoy.
Christian B. Drake
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TODAY’S S&P 500 SET-UP – August 16, 2013
As we look at today's setup for the S&P 500, the range is 37 points or 0.44% downside to 1654 and 1.79% upside to 1691.
CREDIT/ECONOMIC MARKET LOOK:
MACRO DATA POINTS (Bloomberg Estimates):
WHAT TO WATCH:
COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)
The Hedgeye Macro Team
“Fear is static that prevents me from hearing myself.”
Scared yet? For parts of yesterday, I certainly was. I was buying into some really red stuff. And I felt alone. But I wasn’t.
It took me a lot longer (10-15 years) to not live in complete terror of my investment process than it did putting on a pair of skates. Imagine suiting up for every game in complete distrust of everything you have prepared for; imagine every time you were down by a few goals and were getting yelled at, you just left the game altogether (or Twitter)…
I am far too human to explain how and why I make all the mistakes that I make throughout my business building and market timing day. All I can tell you is that when I can’t hear myself – and I mean my process and my principles – I have no business leading anyone into making game time decisions.
Back to the Global Macro Grind…
In yesterday’s Hedgeye Poll I asked whether the SP500’s correction from its all-time closing high (1709) would be:
I chose B. #Wrong again. (No one chose 4% this time, just fyi).
The correction is marked to market now at -2.8%. So now it’s probably time to freak right out.
Since the most differentiated call Hedgeye has had on the US side of growth in 2013 is employment #GrowthAccelerating, I also ended yesterday’s rant by emphasizing the importance of yesterday’s US weekly jobless claims report (pre-open).
If you would have personally handed me the report (that’s illegal) 3 hours before game time, I would have chose option A) and, having perfect “fundamental” economic data in hand, I would have been dead wrong on the market outcome.
In an intraday jobs note, our Senior USA Macro Analyst, Christian Drake, dissected the difference between NSA (yes, we are watching you) and SA:
1. NSA: Non-seasonally adjusted claims, our preferred read on the underlying labor market trend, made a new absolute low for the cycle at 280K - marking its third consecutive sub-300K reading in a row and the lowest since September 2007. On a YoY basis, initial claims accelerated to -11.7% from -9.9% the week prior with the 4-week rolling average improving 50bps to -8% from -7.5% the week prior.
2. SA: The seasonally adjusted, headline claims number printed its best number of the year, and best number since October 2007, at 320K. This week’s data represents an accelerating YoY rate of improvement of -12.8% YoY (vs -9% the week prior) with 4-wk rolling average down 4K WoW.
In other words, the latest bear market crash call has now been edited to “the US employment data is too good.” Alrighty then.
Obviously, if you’ve had this right for the last 9 months, the legitimate “market top” call (that approximately 116 pundits have now tried to make on the US stock market YTD) was to call the all-time top in bonds in November of 2012.
Top calling is not a risk management process. Markets that eventually top:
If you haven’t read that in a book – that’s because I made that up myself. Cool, eh!
What isn’t cool is trying to sell advertising or “thoughtfulness” based on one-way fear. With Twitter, this bearish style is basically the upside down version of what has becomes formally known as perma-bull. Zero Hedge minces no words on this. Sharp guy. Dead wrong on the market this year because perma-bear on US stocks doesn’t work any better than the bullish version does.
Perma-uncertainty? I’ll roll with that instead.
This way we can buy red and sell green; fade fear and book hope. It’s not for everyone. I know. But being everyone’s everything is no way to live anyway.
What to do from here? I’ve already made my move. I put up an intraday note titled “Buyem” yesterday at 1104AM EST. I think the actions (#timestamps) alongside the word were straightforward. The most important new Macro moves I made were:
For better or worse, I’m one of those players in this game who is maybe dense enough to just make calls. But, make no mistake, there is a tested and tried process behind every move I make. And I didn’t learn how to shoot on the #OldWall either – a long time ago, Gretzky taught me that you’ll miss 100% of the shots you don’t take.
Our immediate-term Risk Ranges (we have 12 big Macro ranges in our Daily Trading Range product too) are now:
UST 10yr 2.66-2.79%
Best of luck out there today and enjoy your weekend,
Keith R. McCullough
Chief Executive Officer