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BEIJING: BACK IN BLACK

Takeaway: We're beginning to nibble in China.

China showed solid follow through overnight after Friday’s China #GrowthStabilizing data for Q313 and September. The Shanghai Composite led Asian Equities higher closing up +1.6%. It's back-in-black in China year-to-date. We're starting to allocate capital to it in the Hedgeye Asset Allocation Models.

 

So, the Chinese and the rest of the world continued to exist despite the fear-mongering and dysfunction in DC. Imagine that. Bottom line: If China bases here on the growth curve, an acceleration in 2014 could be next. 

 

Click image to enlarge.

BEIJING: BACK IN BLACK - dale1

BEIJING: BACK IN BLACK - china22


EAT: EARNINGS PREVIEW

We continue to believe EAT is one of the best managed companies in the restaurant space.  Following the earnings report on 10/23, we will be hosting a call with the CFO, Guy Constant, on Friday, October 25th at 12pm.

 

We believe Brinker’s macro commentary from last quarter still applies.  This is a very difficult operating environment for many restaurant companies and we expect to see slightly diminished margins given current sales trends.  Looking back to 4Q:

  • EAT continued to see a fairly lethargic category and the macroeconomic environment was not as strong as they had expected.
  • The restaurant industry was not recovering as quickly as they had expected.
  • In 4Q, the company was negatively affected by the deep discounting of their peers.
  • Management decided not to match this aggressive discounting and remained committed to their Plan to Win strategy.
  • Company-owned same-restaurant sales were down slightly for the quarter.

In 1Q14, EAT’s Chili’s brand is up against its most difficult comparison of the year at +2.8%.  In our opinion, the current Consensus Metrix estimate of -0.4% for Chili’s appears to be aggressive, as this would represent a 40 bps acceleration to +1.2% in the two-year trend.  Given what we know about current industry trends, EAT is unlikely to significantly beat sales estimates.  In 4Q12, Chili’s company-owned same-restaurant sales and traffic were down -0.6% and -2.1%, respectively.  Depending on where same-restaurant end up for 1Q14, management may need to address the current full-year guidance of 1-1.2% same-restaurant sales growth.

 

EAT: EARNINGS PREVIEW - EA

 

 

During the quarter, the company decided it will roll out tabletop tablets to all U.S. company-owned restaurants by the middle of next year.  Franchisees have been given the option to include the devices in their locations.  These devices are all-encompassing, as they can take menu orders, accept credit cards, let customers play games and more.  In our opinion, this should enhance the customer experience at a manageable cost, as the installation costs are minute compared to the returns they will generate.  We view this announcement as a positive, and believe Brinker is well-positioned, particularly compared to other casual dining chains, to take advantage of a changing consumer landscape.  However, we do not expect to see the tabletop rollout have a material impact on sales until the second half of next year.

 

Looking past the near-term sales pressure, the company business model remains in good shape.  In our opinion, food costs is one segment of the P&L that could come in better than expected.  Guidance is for this line to improve in 1Q14. Consensus Metrix estimates indicate the street is looking for a 20 bps improvement in the quarter, which we believe may be too conservative.  The company will also continue to benefit from new operating initiatives, which will result in continued labor and efficiency gains, specifically in the first half of FY14.  We are expecting restaurant level margins to improve 80 bps y/y in 1Q14.

 

EAT: EARNINGS PREVIEW - EAT OPERATING

 

EAT: EARNINGS PREVIEW - EAT RLM

 

EAT: EARNINGS PREVIEW - EAT LABOR

 

EAT: EARNINGS PREVIEW - EAT FOOD

 

EAT: EARNINGS PREVIEW - EAT ITGER OP

 

 

The bottom line is, we aren’t expecting to learn anything shockingly new when EAT reports on 10/23 and we do not know how the stock will react.  Short interest has been coming down over the past month and the sell-side has been becoming more bearish of late.  In our view, the recent incremental bearish bias toward EAT is simply a byproduct of the current industry conditions as opposed to anything company specific.  The excessive discounting from DRI is hurting everyone in the industry, but particularly EAT.  With that being said, Brinker would be one of the biggest beneficiaries from our dismantling Darden thesis, if it played out.

 

EAT: EARNINGS PREVIEW - EAT SAHREs

 

 

Despite the difficult operating environment, EAT remains financially robust.  In 4Q13, the company passed the $1 billion share repurchase mark since its fiscal 1Q10.  Over the same period, management reduced the share base by nearly 33%.  Looking out over the next 12 twelve months, we expect EAT to repurchase another $250 million in stock, effectively reducing the share base by another 7%.

 

 

 

Howard Penney

Managing Director

 


MCD: ENTERING STAGE 1 PANIC?

Takeaway: In our opinion, management remains unwilling to accept the reality of the situation: MCD is in need of structural changes.

MCD remains on the Hedgeye Best Ideas list as a SHORT.

 

In this note, we offer our take on MCD’s current downward trajectory.  The company reported disappointing 3Q13 results and management appears disconnected from, or at least unwilling to accept, the reality that structural changes must be made.


Setting the stage:

  • MCD has now experienced declining traffic for the better part of the year.
  • The company continues to blame the macro environment for declining sales, while insisting that its LTOs are “hitting internal goals.”
  • Management says it doesn't having pricing flexibility, yet it has already raised prices +2.6% this year.
  • MCD lost the head of its U.S. business, the head of its German business, and its U.S. Chief Marketing Officer.
  • Over the last two quarters, the company has slightly lowered its new unit growth rate.
  • ROIIC is in decline.
  • MCD is aggressively pushing the dollar menu.

In our opinion, this is the second time in the last 10 years that the company must accept the need for structural change to their business model.  The company appears to be transitioning from Stage 2 Denial into Stage 1 Panic.  The core business continues to deteriorate, members of the operating team are being replaced, and management plans to slightly slow its new unit growth rate.  If today’s call was any indication, management remains far away from the Healing Process.  To refresh, when a concept gets in trouble, the management team’s decision-making process typically follows a pattern similar to this:

  • Overconfidence – The concept loses its value proposition when management raises prices too aggressively or lowers the quality of food.
  • Stage 1 Denial – Consumers catch on and begin to frequent the concept less often.  Traffic begins to decline and management usually begins to blame the weather or another external event.
  • Stage 2 Denial – In an effort to avoid the inevitable and appease the street, management begins to accelerate growth through the form of new unit acceleration or the acquisition of new brands.  Normally, the core business continues to deteriorate alongside a decline in ROIIC (return on incremental invested capital).
  • Stage 1 Panic – Analysts begin to catch on and management responds by slowing new unit growth, although often not by enough.  The core business continues to decline, as senior management begins to replace the operating team.  Simultaneously, the search for a new advertising agency begins.
  • Stage 2 Panic – Now it really begins to get ugly, as management sacrifices margins to increase customer counts by implementing a deep discounting strategy.  It then becomes clear that major changes need to be made across the enterprise.
  • The Healing Process – Management decides to stop growth and attack the middle of the P&L.

We won’t bore you with the details of the call or the press release, but, to summarize, MCD’s 3Q13 results, as well as their 4Q13 outlook, were uninspiring and consistent with our bearish thesis. 

 

Rapidly decelerating sales trends continue to suggest that management must respond with a viable plan to improve operational efficiencies and spur long-term, sustainable sales growth.  Until this happens, MCD is likely to remain a short.

 

MCD: ENTERING STAGE 1 PANIC? - MCD GLOBAL

 

 

 

Howard Penney

Managing Director

 


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European Banking Monitor: Onward & Upward

Below are key European banking risk monitors, which are included as part of Josh Steiner and the Financial team's "Monday Morning Risk Monitor".  If you'd like to receive the work of the Financials team or request a trial please email .

 

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European Financial CDS - Europe continues to dazzle. Only two EU financials widened last week, RBS (+1 bp) and Banco Popular (+19 bps). The rest of Europe was notably tighter. This continues a theme that's been in place for some time now. In fact, looking at the MoM trend, the mean/median change in EU financial CDS is tighter by 31/8 bps, respectively. 

 

European Banking Monitor: Onward & Upward - zz. bank cds

 

Sovereign CDS – Sovereign swaps were tighter around the globe last week with the sole exception of the US, where swaps were flat at 34 bps. The real takeaway is the MoM change, particularly in Europe. Consistent with our 4Q13 macro theme of #EuroBulls, Portugal, Spain and Italy are tighter MoM by 136 bps, 35 bps and 33 bps, respectively. 

 

European Banking Monitor: Onward & Upward - z. sov1

 

European Banking Monitor: Onward & Upward - z sov2

 

European Banking Monitor: Onward & Upward - z. sov3

 

Euribor-OIS Spread – The Euribor-OIS spread was unchanged last week at 12 bps. The Euribor-OIS spread (the difference between the euro interbank lending rate and overnight indexed swaps) measures bank counterparty risk in the Eurozone. The OIS is analogous to the effective Fed Funds rate in the United States.  Banks lending at the OIS do not swap principal, so counterparty risk in the OIS is minimal.  By contrast, the Euribor rate is the rate offered for unsecured interbank lending.  Thus, the spread between the two isolates counterparty risk. 

 

European Banking Monitor: Onward & Upward - z. euribor



MID-OCTOBER CRUISE PRICING UPDATE

With RCL reporting this Thursday, we’re reporting the results of our most recent cruise pricing survey.  2013 is pretty much in the bag so we have few concerns regarding RCL’s Q3 earnings and Q4 guidance.  For RCL, it is 2014 we are concerned with, particularly in the first half.  RCL 2014 pricing looks weaker than CCL in Europe and Alaska.  As we noted in our note this morning, “SHIPS OF STOOLS NO LONGER,” we think RCL is now the stock at risk.    

 

Below are some observations from our proprietary pricing survey (>12,000 itineraries) for CCL, RCL, and NCLH.  We analyze YoY pricing, as well as relative TREND which is determined by comparing pricing relative to the last earnings/guidance date for a cruise operator i.e. CCL: 9/24; RCL: 7/25; NCLH: 7/29.  For a more quantitative analysis, please contact sales at .

  • CCL:  The good news is that the carnage seen in FQ1 2014 for the Caribbean didn’t get worse in mid-October.  The bad news is that any modest pricing gains for FQ2/FQ3 2014 seen in mid-September disappeared in mid-October.  Mgmt expects pricing to improve significantly in 2H 2014 for the Carnival brand so let’s hope this trend will reverse before Wave Season hits.  Europe pricing continues to be steady while early pricing for the 2014 Alaska cruise season has been quite robust.
  • RCL:  The data looks fine for the balance of 2013.  Our concern remains 2014.  Similar to Carnival, it looks like FQ1 2014 will be very weak in the Caribbean, while Europe and Alaska pricing will drag down FQ2/FQ3 performance.  Not surprisingly, Pullmantur was a notable laggard in mid-October.
  • NCLH:  Steady overall pricing but lower Getaway prices is not encouraging

 

SURVEY TAKEAWAYS

 

CCL

Caribbean – Carnival brand

  • Pricing for the few FQ4 itineraries left was down double-digits YoY but slightly better relative to mid-September’s
  • FQ1 2014 pricing did not move much MoM with close to double-digit YoY declines
  • Summer 2014 pricing continued to be quite volatile.  After moving modestly higher on a relative basis in mid-September, FQ2 2014 pricing trend dropped sharply in mid-October.  On a YoY basis, pricing is now trending flat.  Early FQ3 2014 pricing also reversed course, giving back most of the pricing gains seen in mid-September

Europe

  • Costa FQ4 2013 YoY pricing continued to make gains on top of excellent growth.  Costa’s FY 2014 pricing was unchanged and TREND was stable.
  • Princess and Cunard brands saw modest pricing improvements while Holland America pricing did not move.
    • Interestingly, the new Royal Princess saw significant discounting, which was offset by pricing gains in other Princess brands.
  • Early modest pricing pressure for AIDA’s 2014 Western Europe/Mediterranean itineraries

Alaska

  • Off to a great start in 2014 with Princess leading the charge.  Pricing was much higher on a YoY basis with TREND accelerating.

Asia, Mexico, South America

  • Asia 
    • Holland America and Costa maintained FY2014 pricing in mid-October
    • Princess pricing was slightly lower for FQ2 2014 but nicely higher for FQ3 2014
  • Mexico
    • Carnival brand pricing for FQ1 2014 remained modestly lower YoY but TREND had turned positive
    • Carnival brand pricing for FQ2 and FQ3 2014 TREND lost some steam but remain nicely higher YoY
  • South America
    • Costa’s pricing TREND was slightly higher.  Holland America continued its struggles with FQ4 2013 pricing down significantly and FQ2 2014 pricing lower.  Princess’s FQ1 2014 pricing TREND was roughly flat in mid-October.

RCL

Caribbean

  • RC brand:  FQ4 2013 YoY close-in pricing improved slightly.  FQ1 2014 pricing continued to be significantly lower –a trend seen since July.  Further out in 2014, it’s an unclear picture with slightly better FQ3 2014 pricing offsetting slightly weaker FQ2 2014 pricing; pricing TREND was stable for both quarters. 
  • Celebrity:  FQ4 2013 and FQ2 2014 pricing was slightly higher but FQ1 2014 prices were much lower.  Pricing TREND was stable for all quarters.
  • Pullmantur:  FQ1 2014 pricing fell slightly; however, significant discounting for FQ2 2014 itineraries remained

Europe

  • RC brand:  FQ2 2014 pricing had not improved much from mid-double digits declines.  Pricing TREND was stable.
  • Celebrity:  FQ2 2014 pricing remained lower substantially YoY with stable pricing TREND
  • Azamara:  2014 pricing improved modestly MoM
  • Pullmantur:  Rough seas for this brand in 2014.  The substantial FQ2 2014 price discounting had been extended to FQ3 and FQ4.  Western Europe and Baltic/North Seas regional pricing both look under pressure.  Price TREND was negative.

Alaska

  • FQ2 2014:  RC brand & Celebrity pricing down double digits YoY. 
  • FQ3 2014:  RC brand pricing saw double-digits declines while Celebrity pricing was slightly positive

Asia and South America

  • Asia 
    • RC brand & Celebrity:  Pricing was nicely higher for FQ1 2014
    • Azamara:  Flat pricing
  • South America
    • RC brand & Celebrity:  Sparse itineraries but pricing was nicely higher for FQ1 2014

NCLH

Caribbean

  • Close-in FQ4 2013 pricing deteriorated further in mid-October.  Pricing TREND for FQ1/FQ2 2014 was flat.
    1. Breakaway:  Steady pricing, maintained 35-40% pricing premium over Gem
    2. Getaway:  Pricing was slashed by the low teens in FQ1 2014.  Pricing premium over Epic and Sun reduced from 50-60% in mid-September to 30-40% in mid-October.

Europe/Alaska/Hawaii

  • Steady 2014 pricing

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