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Collision Course

“Life is a series of collisions with the future; it is not the sum of what we have been, but what we yearn to be.”

-Jose Ortega y Gasset


Yesterday we (Keith and I) held a conference call with former Speaker of the House Newt Gingrich.   We invited him to join us for a call because, frankly, he and former President Bill Clinton were the last two politicians to shut down the Federal Government, so he better than anyone understands the strategy of what is currently occurring in Washington, D.C.  Even though he is an admitted conservative Republican, the call was both insightful and objective.


A key point that Gingrich raised is that a government shutdown is not as abnormal as it is being hyped and, in fact, may be a safeguard practice intended by the founding fathers.   Certainly, government employees will be furloughed and people’s lives will be interrupted, but as the former Speaker pointed out, this has happened many times in U.S. history.  In fact, it happened 12 times while Tip O’Neill was Speaker of the House.  Overall, there have been 18 government shutdowns in U.S. history, including the current one.


Not surprisingly, most government shutdowns have been very short lived.   In fact, the longest shutdown was 21 days in 1995 – 1996.  The shortest government shutdown lasted only one day.  In the Chart of the Day, we look at the length of every government shutdown over time.  As the chart shows, the average government shutdown lasted 6.5 days.


Naturally, when we pressed Gingrich on how long he thought this shutdown would last, being the astute student of history he is, he answered 3 days to 3 weeks (which is what history shows).  His view is that neither side has anything to gain by making this protracted.  His caveat, though, was that there are currently no negotiations occurring as President Obama is unwilling to cede anything at all on the Affordable Care Act.  According to Gingrich, while he and Clinton would go at each other in the press, and certainly had their differences, they would grind out solutions at the negotiating table.


The current set of actors are both polarized and talking matters personally, which is much different than the mid-1990s.  There has never been much cross talk or cooperation between Boehner-Pelosi or McConnell-Reid, and it is seemingly only getting worse in this time of “crisis.”  This unwillingness to negotiate and compromise is only exacerbated by the fact that neither President Obama, nor Speaker Boehner, have any concerns of getting reelected, so they are willing to expend personal approval for what they perceive as their party’s fundamental beliefs.


On the last point, disapproval is definitely mounting.  As it relates to the President, his most recent approval polls are as follows:

  • Gallup – Approve 44, Disapprove 50 -> Disprove +6;
  • Rasmussen – Approve 47, Disapprove 51 -> Disapprove +4; and
  • The Economist – Approve 43, Disapprove 53 -> Disapprove +10.

Not great numbers for Obama to be sure, but the approval numbers for Congress are even worse.  According to the most recent Economist poll, a full 74% of Americans disprove of the job Congress is doing.  Clearly, our elected officials are on a collision course with the next midterm election in which the polls turn to votes.  If any of them yearn to be re-elected, they have a lot of work to do over the next year to gain back America’s trust.


Coming back to the government shutdown, if the politicians in Washington have any acumen, they will resolve their differences over the next few weeks before the fear mongering on the debt ceiling begins to accelerate.  The stock market has been weak due to the dysfunction in Washington, but if amateur hour continues as the debt ceiling looms, risk assets are likely to be sold even more aggressively.


The White House is actually starting to use the debt ceiling as a bargaining chip and the Treasury Department released a report yesterday that outlined the potential macroeconomic effects of debt ceiling brinkmanship.  According to a preview released by the Treasury Department:


“The report states that a default would be unprecedented and has the potential to be catastrophic: credit markets could freeze, the value of the dollar could plummet, and U.S. interest rates could skyrocket, potentially resulting in a financial crisis and recession that could echo the events of 2008 or worse.  By looking at the disruptions to financial markets that ensued in 2011, the report examines a variety of economic indicators – including consumer and small business confidence, stock price volatility, credit risk spreads, and mortgage spreads – through which a similar episode might harm the economic expansion.“


In as much as the economy doesn’t need brinkmanship over a debt ceiling, it also doesn’t need fear mongering from the Secretary of Treasury . . . but I digress.  Ironically enough, the fiscal outlook of the U.S. has actually been improving, so in theory the rating agencies should be upgrading their outlook on U.S. debt and not considering downgrades due to partisanship in the nation’s capital.


Next week, we will be releasing our quarterly themes and this focus on the dysfunction in Washington will be front and center as we update our views on the U.S. economy and outlook for the U.S. dollar.  An emerging conclusion is that Europe is starting to get relatively more interesting, which is supported quantitatively by the recent move in the Euro.


As you head into the weekend, we’ll leave you with a quote from Gingrich:


“What is the primary purpose of political leader? To build a majority.  If voters care about parking lots, then talk about parking lots.”


Sadly, none of our leaders, whether it be in Congress, the White House, Treasury Department, or Federal Reserve, know much about building a majority as of a late.


Our immediate-term Global Macro Risk Ranges are now:


UST 10yr Yield 2.59-2.65%


USD 79.82-80.35

Euro 1.34-1.36

Brent 108.61-109.98

Gold 1


Keep your head up and stick on the ice,


Daryl G. Jones

Director of Research


Collision Course	 - Shutdown

Collision Course	 - Virtual Portfolio



Takeaway: While we believe PBPB will be the beneficiary of a recently hot IPO market, we suspect the stock will be on a short leash.

Potbelly is on deck for an IPO tomorrow.  The company plans to sell 7.5 million shares and recently raised the expected price of its IPO to $12 to $13 per share. 


In this note, we offer up our take on the latest IPO in the restaurant space.  It is important to note, however, that we did not have the opportunity to meet with management nor did we attend any of the company’s road show presentations.


With that said, we believe Potbelly will be the beneficiary of a recently hot market for growth related restaurant stocks.  The offering size is rather small at slightly over $95 million and demand should be high.  A number of veteran restaurant analysts will be comfortable with the CEO, Alwin Lewis, who is a familiar name in the industry.  Lewis spent 13 years at YUM, including a stint as COO, before leaving in 2004 to become the CEO of Sears. 


Potbelly should do fine initially, but it could be on a short leash.  It is a premium player in a very crowded, highly competitive sandwich (sub) market.  Regarding the latter point, all of the company’s direct competitors, including, but not limited to, Subway, Jimmy John’s, Firehouse Subs and Jersey Mike’s, are private companies, which makes direct comparisons difficult to come by. 


Its important to note that IPOs, particularly those from companies with strong growth stories, have fared extremely well lately.  NDLS, for example, gained +104% on its first day of trading.  But, investors expecting another Noodles-like performance should heed caution, as we believe this was more of an aberration than the norm.  In fact, despite their similarities as fast casual operators, the two have stark contrasts.  Potbelly competes in a crowded segment of the industry as opposed to Noodles, which brought more of an innovative, fresh concept to the table.  In addition to competing in a less-crowded Asian segment, we would argue that NDLS is also perceived to be healthier than PBPB.


All told, Potbelly does have compelling unit economics and plenty of room to grow.  The company currently has a domestic base of 286 locations in 18 states and the District of Columbia.  However, the units are incredibly concentrated, as over 50% of its units are located in Illinois, Texas and the District of Columbia.  Furthermore, the company has little presence outside the Midwest and Northeast.  Recent expansion efforts have been strong, as management opened 21 and 31 company-operated shops in 2011 and 2012, respectively, and plan to open an additional 32-35 company-operated shops in 2013.  At this time, the company does very little franchising.


The unit growth story will have to save the day, as the trajectory of same-store sales is below average for a chain this size.  The company’s same-store sales grew +1.5% in 1H13, but traffic declined by -1.1%.  It appears the segment is having a difficult time amid increased competition from peers and convenience stores.  Subway recently saw sales decline -2% this past summer – its first decline in recent memory.





Portelly construction costs range from $450,000 to $770,000 per store and new stores are averaging about $1.1 million in sales per year, which is quite strong for a "sub" chain.  Management currently targets shop sizes between 1,800 and 2,200 square feet and dining areas that typically seat between 50 to 60 people.



As it stands, we have several positive and negative takeaways from our analysis.



  1. Fits the current “growth” style investing theme
  2. Compelling unit economics
  3. Strong brand presence in its communities


  1. It will be difficult to expand the day-part mix
  2. Traffic trends have been weak lately
  3. Two states and the District of Columbia account for 53% of company-owned units


Below, we examine how PBPB’s margins stack up against some of its publicly traded peers.


Average Unit Volumes

Average unit volumes are below the publicly traded peer group, but are strong relative to other sub chains.  While there is certainly room for improvement, day-part expansion will be difficult to achieve.





Cost of Sales

Food costs are in line with the peer group.  Higher food costs suggest that the company is focused on selling a better product than the average QSR chain.  If food costs begin to head lower over time, this could be a bad sign.  In our view, a decrease in food costs would be a leading indicator of negative traffic.





Labor Cost

We’re not close enough to the company to know what they can do to bring labor costs down from here.  As for the company’s peers, we believe PNRA’s labor costs are headed higher and view CMG as the model of efficiency in the restaurant industry.  PBPB’s labor costs falling between the two suggests that they are not excessive and there still may be room to the downside.





Restaurant Level Margins

Potbelly’s restaurant level margins are very strong.  That said, it is hard to tell if there is significant room for improvement without leverage from higher AUVs. 






PBPB is currently investing for future growth and, we believe, this is where the majority of the leverage is in Potbelly’s business model.  The company must successfully execute on its unit opening strategy in order to eventually leverage its G&A costs.





EBITDA & Operating Margins

We believe there is significant room for improvement in operating margins.  Given current restaurant level margins, most improvement in EBITDA & operating margins is likely to come from management leveraging its G&A. 








Howard Penney

Managing Director




McCullough: Shame on Lew

Takeaway: The bond market doesn't believe a single word from Treasury.

By Keith McCullough


President Obama and Treasury Secretary Jack Lew are completely misrepresenting the default risk for political gain. It's shameful.


McCullough: Shame on Lew - lewo


In case you somehow missed it, the Treasury Department grabbed headlines today warning the U.S. economy could fall into its deepest crisis since the Great Depression if Congress doesn't raise the debt ceiling. 


"A default would be unprecedented and has the potential to be catastrophic," Treasury said. "The negative spillovers could reverberate around the world, and there might be a financial crisis and recession that could echo the events of 2008 or worse."


Really? Lew should be ashamed for spewing this fear-mongering nonsense.  


As for the Bond Market...It doesn't believe a single word from these guys on default risk. Otherwise yields would be ripping.


Check out the chart below.


McCullough: Shame on Lew - drake1


Keith McCullough is the Founder & CEO of Hedgeye Risk Management.

INITIAL CLAIMS & ISM: Steady Strength vs Sequential Softness

Summary:  The Labor market strength remains ongoing as claims make another YTD and multi-year low.  ISM Services declined sequentially with all components losing MoM.  Seasonality has shifted to a data tailwind while policy (manifest in Down Dollar & Down Rates) has shifted from benign to discrete growth headwind.     


One down datapoint (ISM Non-mfg) does not a trend make, but all trends start as trades - and the probability for a negative macro Trade to evolve into a Trend breakdown in growth heightens considerably when the principal, causal factor in our model (policy) inflects negatively.  


Keep the $USD front in center here as it moves towards testing its TAIL line of support at $79.21




The ongoing strength in the domestic labor market remains impressive.  Inclusive of this morning’s release, the 4-week rolling average of non-seasonally adjusted Initial claims, our favored read on underlying labor trends, registered its strongest rate of improvement since July of 2010.   To quickly review the data:


NSA Claims: Non-seasonally adjusted claims printed 252K, down 3K WoW while coming in < 300K for the 10th consecutive week.   The 4-week rolling average was -18.3% lower YoY, which is a sequential improvement versus the previous week's YoY change of -17.5%


SA Claims: Headline, seasonally-adjusted initial jobless claims fell -1K to 308K vs the prior week (revised) 307K.  The 4-week rolling average fell -4K WoW to 304.75K – the lowest level since May of 2007.


As a reminder, in additional to the prevailing organic strength in the claims data, the series will see a building seasonal tailwind over the September to February time period.  Separately, it’s worth noting that federal workers are eligible to collect unemployment while furloughed, so that may introduce an upward (albeit transient) bias in next week’s claims data and any subsequent releases so long as the shutdown remain in effect.  


INITIAL CLAIMS & ISM:  Steady Strength vs Sequential Softness  - NSA Claims 100313


INITIAL CLAIMS & ISM:  Steady Strength vs Sequential Softness  - 1


ISM: Sequential Softening

The ISM Non-Manufacturing Composite Index declined -4.2 to 54.4 in September with all principal components declining sequentially.  Business Activity (-7.1) and Employment (-4.3) led component declines and while Export Orders (+7.0) and Prices (+3.8) were the lone gainers.


The Trend (trailing 3M/6M/12M) across the balance of sub-components remains positive at present and, notably, New Orders was down just -0.90 to 59.6 – only a modest decline in the context of last month’s ( and the cumulative 2-month) material advance and still a solid absolute reading.  


On the consumer side, the recent multi-month trend has been one of improving consumption of Goods while spending growth on Services has been flat to decelerating on both a YoY and 2Y average growth basis (2nd Table below).  Coupled with the fiscal policy constraints to an acceleration in disposable income growth over the near-term, today’s ISM data presages another middling growth number for Consumer Spending on Services with the September release.     


One marginal negative datapoint does not a trend make, but all trends start as trades - and the probability for a negative macro Trade to evolve into a Trend breakdown in growth heightens considerably when the principal, causal factor in our model (policy) inflects negatively.  


Keep the $USD front in center here as it test its TAIL line of support at $79.21. 



INITIAL CLAIMS & ISM:  Steady Strength vs Sequential Softness  - ISM Non mfg table 


INITIAL CLAIMS & ISM:  Steady Strength vs Sequential Softness  - Income   Spending 092613


INITIAL CLAIMS & ISM:  Steady Strength vs Sequential Softness  - ISM Services vs Service Spending


Christian B. Drake

Senior Analyst


Takeaway: Another week, another solid jobless claims print.

Prior to revision, initial jobless claims fell 2,000 to 308,000 from 305,000 week-over-week (WoW), as the prior week's number was revised up by 2,000 to 307,000.


The headline (unrevised) number shows claims were lower by 1,000 WoW. Meanwhile, the 4-week rolling average of seasonally-adjusted claims fell -4,000 WoW to 304,750.


The 4-week rolling average of non-seasonally adjusted (NSA) claims (which we consider a more accurate representation of the underlying labor market trend) was -18.3% lower year-over-year, which is a sequential improvement versus the previous week's YoY change of -17.5%. In fact, it is the fastest rate of improvement seen year-to-date and is actually the fastest rate of improvement seen since the first half of 2010.




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Daily Trading Ranges

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