• run with the bulls

    get your first month

    of hedgeye free



A 2014 Coffee War Is Brewing!


Our 2013 bearish thesis on MCD revolves around our “espresso-based conspiracy theory.”  In our opinion, MCD will never be what Starbucks is: a leading destination for espresso-based beverages.  Since the first Starbucks opened in 1971, the chain reinvented the QSR space by selling premium beverages in a “café” setting.  McDonald’s decision to roll out the McCafé concept nationally in 2009 was the first direct attack on the Starbucks business model. 


As an example, in 2009, McDonald’s used the tag line “four bucks is dumb," in what was a clear attempt to spite Starbucks.  Around the same time, McDonald’s remodel program began to emulate Starbucks to a degree, in order to foster a “café” or “third place” environment.







We contend that since 2009, McDonald’s commitment to premium espresso beverages has failed to generate acceptable returns and, more importantly, has complicated store operations.



Relentless Pursuit


Nearly five years later, Starbuck’s stock is up eight-fold, while McDonald’s is still trying to figure out how to successfully sell espresso beverages in its stores.  We have come to the conclusion that this move did not work out too well for McDonald’s and contributes to some of the issues the company faces today; but, apparently management disagrees.  It looks like McDonald’s obsession with Starbucks (and now Dunkin’ Donuts) will be taken to a whole new level in 2014.


McDonald’s CEO, Don Thompson, hinted at such on the 3Q13 earnings call when he said: “We had just begun really focusing on the coffee opportunity.  I think you’ll hear more about the coffee opportunity, as it still does exist, and you’ll hear more about that at the analyst meeting.”


Mr. Thompson’s comments, in addition to other conversations we have had since the earnings call, lead us to believe that McDonald’s plans to “go after the coffee consumer” in 2014.  It appears that McDonald’s senior management in Oak Brook believe they can duplicate the recent success their stores have had selling coffee in Canada.


In our opinion, McDonald’s potential coffee promotion in 2014 is largely motivated by the recent success of Starbucks and Dunkin’ Donuts.  Looking at 2012-2013 same-store sales results, SBUX and DNKN have handily outperformed MCD.  We believe McDonald’s will be seeking to take market share back from these two brands.  Therefore, it would not surprise us to see McDonald’s utilize heavy discounting in the premium coffee category, in a direct attempt to disrupt the current success of both the other brands.





In the U.S., our research indicates that the average McDonald’s store sells hundreds of cups of drip coffee and only 30 or so espresso drinks a day.  This pace of sales suggests that the average McDonald’s consumer has little interest in premium coffee.  It goes without saying, but it seems counterintuitive to put significant resources into a category that consumers don’t care about, especially when the core business is deteriorating.  Management’s decision making process remains flawed, which is one reason we are skeptical the company can gain sales traction in 2014.


We believe MCD’s senior management is not only obsessed with SBUX, but also terrified of DNKN – particularly given the lower price points they sell coffee for.  The charts below exhibit the same-store sales trends of these three companies since 2011 on a quarterly and two-year trend basis.  SBUX and DNKN continue to separate themselves from MCD.







Despite MCD’s failure to penetrate the premium beverage market, frappes and smoothies have worked well for the company, to the extent that they were able to mask a decline in MCD's core lunch business.  To be clear, these products are an entirely different platform than espresso drinks.  In other words, MCD could have rolled out the cold drinks and enjoyed the same level of success without ever putting in espresso machines.





Where Did McDonald’s Go Wrong?


Since opening the first store in 1954, McDonald’s growth had always been driven by one thing: unit growth.  This strategy was successful until the late 1990s, when the company reached a saturation point.  An attempt to sustain unit growth resulted in cannibalization, which caused a steady decline and deterioration of same-store sales and margins, respectively.  Thus, the “Plan to Win” was born.


When McDonald’s first embarked on its highly successful “Plan to Win” in 2003, the company developed a comprehensive program designed to “optimize and simplify operations.”  This led to several major operational and structural changes, including:

  • Fewer sizes of drinks and fries
  • Fewer extra value meals
  • Simplified pricing
  • Streamlined merchandising
  • Intensive hospitality training of employees

Unfortunately, McDonald’s has deviated from this plan and finds itself in a precarious situation once again.  Management wants investors to believe that the macro environment is causing the recent troubles.  However, management has been using the macro environment as a scape goat for poor sales for the past five quarters and continues to deny the notion that the company has operational issues.  We’ve been fairly vocal in sharing our opinion for a while now and our view has not changed – MCD has material internal issues.


Management’s relentless focus on driving the top line has required the franchise system to invest significant capital in facilities and new equipment.  Even worse, from an operating standpoint, this approach has resulted in a burgeoning menu, featuring a seemingly limitless pipeline of new products.  This has complicated back-of-the-house operations and is gradually offsetting much of the progress made during the implementation of the initial “Plan to Win.”  Once again, much like the 2000-2003 period, LTOs are not working as evidenced by a number of recent, unimpressive initiatives, including the national rollout of Mighty Wings.


As we have seen in the past, a disgruntled franchise base is emerging, as operators are finding that the menu is too large and operational issues within the kitchen persist.  We believe the dysfunctional rollout of McCafé is a significant contributor to McDonald’s current operational dilemma. 



McCafé = McMajor Problems


By way of background, McCafé was first launched in Melbourne, Australia in 1993.  McDonald’s first started testing McCafé domestically in the Chicago area in May 2001.  At the time, McDonald’s focus on coffee was designed to take on the growing competitive threat of Starbucks.  In hindsight, the Starbucks impact went well beyond just coffee and brought to life the theory of the “third place” or the “café” setting. 


In the 2001-2003 timeframe, McDonald’s saw the new Starbucks business model as one factor in its own same-restaurant sales declines.  In our opinion, McDonald’s has been obsessing over the success of Starbucks since that time, and has been putting capital to work in order to compete directly against SBUX.  This is precisely what caused MCD to lose its focus in the first place.  The company deviated from its core and stopped executing on what made it so successful – selling burgers, fries, and soda.


Ironically, history appears to be repeating itself, as we believe McDonald’s is once again obsessed with the success of Starbucks.  This continues to cloud management's judgement and will likely lead to poor resource allocation decisions in 2014. Sadly, management continues to stray from its core business model and now finds itself in the position where it is in desperate need of a “Plan to Win 2.0”.



Pulling Back the Curtain on the Starbucks Obsession


Early Stages of the RecoveryBetween 2003 and 2005, MCD realized a significant margin benefit from the “Plan to Win.”  A core tenet of this plan was simplification, which applied mostly to the menu and kitchen operations.  The company’s restaurant level performance benefited greatly from the enhanced emphasis on operational improvement among its existing asset base.


Upgrading Drip Coffee – It was not until 2005 that management began upgrading its drip coffee by using higher quality beans, filtered water, and better tasting cream.  Over the next two years, drip coffee sales surged, giving management the confidence to upgrade the hot drinks menu.


A Beverage Destination – Beginning in 2006, management began to articulate that the success of the drip coffee business gave them the credibility to successfully expand into espresso-based drinks.  Thus, McDonald’s attempted transition from a fast food concept to a beverage concept was underway.


Early McCafé Test Failed – In 2007-2008, the company expanded the McCafé test in Chicago into Kansas City.  The original strategy called for McDonald’s to spend $100,000 per store.  It also involved incorporating separate McCafés in each restaurant, in order to serve a new line of espresso-based products and assorted baked goods.  In the end, the KC test market didn’t work, the construction costs exceeded the budgets and, more importantly, consumer demand was not meeting expectations.


Oak Brook Ruled McCafé Will Be National – Late in 2008, we documented that the company was clearly behind plan in converting restaurants to McCafés.  Management wanted to promote the product by mid-2009.  Despite the challenges in test markets, the Oak Brook-based initiative managed to go national in 2009.  But, this came with one caveat: the rollout strategy had been altered from its original form.  Instead of developing a separate “McCafé” within the store, which was the prototype developed in other markets, management decided to integrate the espresso machines within the kitchens of the other markets.


McCafé Was a Must – MCD "needed" the McCafé platform to implement Phase II: cold beverages.  After four years of successful new product introductions, management found themselves at a crossroads.  They needed to drive traffic, and they determined beverage sales was the way to go.


The Great Recession  In 2009, breakfast sales took a turn for the worse, as higher unemployment rates resulted in less commuting traffic.  As a result, McDonald’s introduced breakfast items to the Dollar Menu at the beginning of 2010.  Prior to frappes and smoothies, the last product the company introduced that had a material impact on sales was the McGriddle sandwich in 2003.


Cold Beverage Success – In early 2010, McDonald’s implemented the cold phase of its beverage program: frappes and smoothies.  Highlighted earlier in the note, these new cold beverages accounted for more than 100% of the company’s same-store sales growth from 2Q10 to 3Q10.  In 2011, MCD continued to benefit from incremental beverage purchases, as the company spent a very high proportion of marketing dollars on promoting the beverage platform.


Masking a Decline in the Core Business – McDonald’s was so successful in driving breakfast and afternoon traffic with the $1 menu and cold beverages, respectively, that they were able to effectively mask the deterioration of their core business.  


Today – McDonald’s management insists on blaming the macro environment for their issues.  McDonald’s CEO, Don Thompson, was President of the U.S. division back in 2009, when the company decided to roll out McCafé nationally.  Therefore, it is highly unlikely that he will acknowledge the company has significant operational issues and the need to embark on a path of real change.  It is much easier to look for blame elsewhere.





Howard Penney

Managing Director


Nikkei Smoked

Client Talking Points


The Nikkei got smoked for another -2.8% loss overnight. It's down -4.5% in the last 3 days. Got interconnected global macro market risk associated with Bernanke trying to bend economic gravity? Expectations of global growth slowing are definitely bending now as the Fed’s balance sheet moves toward +$1 TRILLION year-over-year (+$998.1 billion in last night’s report)


We've got a 10-Year Treasury yield of 2.51% now with no immediate-term TRADE support to 2.46% and no intermediate-term support to 2.27%. Don’t forget how hot the monthly U.S. Economic data was in July-September, so it won’t be hard to see October-November data slow sequentially. The bond market is already front-running that – Bernanke completely missed his window to move.


My 2013 bear case for Gold is ending. Now it’s all about timing the bull case. Gold down -0.3% and Silver down -1.7% this morning. So there’s plenty of time to take our time here. We need to see the $1316-1320 zone hold before I pull the trigger.

Asset Allocation


Top Long Ideas

Company Ticker Sector Duration

In line with our #EuroBulls Q4 theme, we’re long the German DAX via the etf EWG. With European fundamentals showing improvement off low levels, we expect outperformance from Germany, and in turn for the region’s largest economy to pull the rest of the region higher. ECB policy remains highly accommodative and prepared to aid any of its sovereign members to preserve the Union. Inflation remains moderate and fundamentals are positive: confidence readings and PMIs are up since June, with factory orders trending higher and retail sales inflecting to push the trade balance higher. Finally, the unemployment rate has held steady at the low level of 6.9%, all of which signals to us that Germany’s economic climate is ramping up.


WWW is one of the best managed and most consistent companies in retail. We’re rarely fans of acquisitions, but the recent addition of Sperry, Saucony, Keds and Stride Rite (known as PLG) gives WWW a multi-year platform from which to grow. We think that the prevailing bearish view is very backward looking and leaves out a big piece of the WWW story, which is that integration of these brands into the WWW portfolio will allow the former PLG group to achieve what it could not under its former owner (most notably – international growth, and leverage a more diverse selling infrastructure in the US). Furthermore it will grow without needing to add the capital we’d otherwise expect as a stand-alone company – especially given WWW’s consolidation from four divisions into three -- which improves asset turns and financial returns.


Financials sector senior analyst Jonathan Casteleyn continues to carry T. Rowe Price as his highest-conviction long call, based on the long-range reallocation out of bonds with investors continuing to move into stocks.  T Rowe is one of the fastest growing equity asset managers and has consistently had the best performing stock funds over the past ten years.

Three for the Road


Volatility (VIX) not hitting fresh YTD lows as $SPY tests the highs is an impt divergence @KeithMcCullough


Luck is a dividend of sweat. The more you sweat, the luckier you get. -Ray Kroc


The Fed's balance sheet was up another $25.4 Billion week-over-week to $3.839 Trillion.

What's New Today in Retail (10/25)

Takeaway: DECK beats the easy way. AMZN puts up the best SIGMA in yrs. CAB misses due to guns. COLM beats – and as always, issues tepid guidance.



  • Here's a whole host of SIGMA's for the companies reporting after the bell.




Takeaway: Blows away expectations -- printing $0.95 vs the Street at $0.72. But it did so without a revenue beat. As such it kept FY revenue guidance even. The challenge here is that people won't give anywhere near as much credit for a margin beat as a revenue beat. It's all about sell-in for Ugg.


What's New Today in Retail (10/25) - chart1 10 25




Takeaway: Only beat by a penny (and it was because they lost slightly less than the Street estimated).  But revenue smoked expectations -- especially in Media and Electronics, which make up 94% of AMZN total sales. Most notable to us is the SIGMA chart, which swung towards the upper right -- the first time in years we've seen sales grow faster than inventories AND margins improve.


What's New Today in Retail (10/25) - chart2 10 25




Takeaway: The king of the 'beat and guide down' printed $1.57 vs the Street at $1.42. And of course, it guided that 4Q revenue would be down by as much as 2%. The margin direction this quarter was not pretty, and the sales/inventory spread -- while still positive -- eroded on the margin. We'd avoid this one for now.


What's New Today in Retail (10/25) - chart3 1025




Takeaway: CAB misses by $0.02. Prints $0.69 vs Street at $0.71. Comps 3.9% vs Consensus 4.8%. Had it not been for a material slowdown in gun sales, comps would have been 5.3%. I guess we could talk about CAB 'excluding guns', but that would be like referring to Safeway 'excluding food'.


What's New Today in Retail (10/25) - chart4 10 25




Takeaway: Loses less than the consensus expected. Revenue was impressive at $178mm vs expectations of $153mm. 4Q guidance of ($0.03)-$0.01 vs prior guidance of ($0.12)-($0.04). By the looks of the SIGMA, ELY shouldn’t have much problem hitting numbers.


What's New Today in Retail (10/25) - chart5 10 25


TGT - Target in big multichannel holiday push; rolling out in-store pickups



  • "Target Corp. is making a big online push for the holidays, including expanding its in-store pick-up program for products ordered online to all of its U.S. stores by Nov. 1 (the service is now available in about half of the chain’s locations). And for the first time, Target will promote the concept of Cyber Week, with an ad campaign Dec. 1 through Dec. 3 that focuses on Cyber Week deals including Cyber Monday."
  • "Target’s overall holiday campaign, themed 'My Kind Of Holiday,' will extend across all channels, including broadcast, radio, in-store, catalogs, digital and social media."




India Tops Apparel Imports in August



  • "India posted the largest increase in apparel imports to the U.S. in August compared with a year earlier, while Vietnam and Bangladesh, the second and third largest apparel suppliers, respectively, continued to eclipse top supplier China with double-digit gains, a report from the U.S. Commerce Department showed Thursday."
  • "Combined shipments of textile and apparel imports from the world to the U.S. rose 7 percent to 5.4 billion square meter equivalents in August from a year earlier. Total apparel imports were up 5.5 percent to 2.4 billion SME, while textile imports increased 8.3 percent to 2.95 billion SME."
  • "Apparel imports from India rose 17.2 percent to 73 million SME in August compared with August 2012, while apparel imports from Bangladesh increased 16 percent to 161 million SME and apparel shipments from Vietnam rose 14.3 percent to 217 SME. On a combined textile and apparel import basis, Vietnam posted the largest increase with a 16 percent increase to 310 million SME."
  • "Combined imports from China, the top supplier of textiles and apparel to the U.S., were up 10.4 percent to 2.8 billion SME."


Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.51%
  • SHORT SIGNALS 78.32%


RCL onboard revenue growth has grown impressively in 2013, partly due to the success of the new Celebrity 1-2-3 Go program . But can the momentum be sustained into 2014?


  • A revitalization of RCL’s onboard programs has carried RCL through a difficult 2013 operating environment.  The Celebrity 1-2-3 Go program has done particularly well.
  • RCL’s core itineraries in the Caribbean have been 7-9 day cruises, which tend to attract repeat cruisers.  Repeat cruisers generally spend more on the ship.
  • Since 2001, 2013 was the only time where RCL onboard and other revenue grew while CCL’s fell.  It should be noted that the ‘other’ component (Pullmantur excursions) have had an adverse impact so far in 2013.
  • As the charts below show, the last couple of times where RCL ticket revenue growth lagged onboard revenue growth by ~5%+, onboard lagged ticket by at least a couple of % points the following year
  • Because of Caribbean pressures, ticket revenue continues to grow at a tepid pace.  As mgmt mentioned on the call, ticket revenue would play a larger role in 2014, largely due to harder comps on the onboard revenue side.  There’s much more uncertainty with that part of the business.




Boom, Crush!

This note was originally published at 8am on October 11, 2013 for Hedgeye subscribers.

“Boom, crush. Night, losers. Winning, duh.”

-Charlie Sheen


Yesterday was one of those days that people absolutely loved or hated. Watching my Twitter #ContraStream was quite comical actually. Some of the “intellectual” types just couldn’t believe what was happening. Some of the bros were tweet-panting.


I think most of you know that I’m not the smartest player in this game. I think that helps me. I think less when I change my mind and/or position. That’s by design. After making almost every mistake you can make in this game with live ammo (multiple times), I’ve built in blinders (machines) for my emotions. They stop me from over-thinking.


To each their own. Like you, I have my style biases. One of the big ones is approaching this game of globally interconnected-risk from an athlete’s perspective. I know we can’t win unless I grind alongside my teammates. I also know we’ll lose if we don’t respect Mr. Market’s signals.


Back to the Global Macro Grind


VIX snaps @Hedgeye TREND support of 18.98; SP500 rips through 1663 @Hedgeye TREND resistance. “#Boom, Crush!” The Signal within the manic media’s noise made it so simple that even a hockey player could do it.


And what did we learn?

  1. Respect the setup (the signal was screaming into event risk that government could save us from themselves)
  2. Stay with the confirmation (the signal said stay with the early part of the move; don’t sell)
  3. Let it ride (9 LONGS, 3 SHORTS @Hedgeye – with 2 of the 3 SHORTS being bond shorts)

Do you know how many times in the last 15 years that I have violated not one, but all 3, parts of that risk management process? I don’t. And that’s primarily because 5 and 10 years ago, I didn’t have this dynamic signaling model. It evolves.


What you’ll quickly note in steps 1-3 of the decision making tree is that there are no points for intellectual IQ. Mr. Market doesn’t care how smart you are. He couldn’t care less what your position is either. The only thing that matters is how well you listen to him.


For me at least, just getting to step 1 was tough – and that’s primarily because I think the Fed leaning on the long-end of the curve, suppressing rates, and devaluing the Dollar, is a textbook #GrowthSlowing signal. But that fundamental signal should never be confused with a quantitative risk management signal. In the immediate-term they can be 2 very different things.


Once I accepted the VIX/SPY signal for what it was, what did I do next?

  1. Stayed with the confirmation – that means I got longer on green (covered a short, bought a long)
  2. Then I let it ride throughout the day despite every bone in my body telling me to sell

What do my bones have to do with it? Listen to them and prepare to be crushed. “Night, losers.” Letting a winning move ride is easily the hardest thing for me to do. Why? Because I love booking gains. And for that very reason, I tend to book them too early.


So, I need to be better than that and let the signal tell me when/where it’s the right time to sell. I’m nowhere near as bad as I used to be on this front. But I have a lot of room to improve.


Let’s use SP500 levels as an example of why I’d let that ride yesterday and drop our Cash position to 42% (we started the week net short in #RealTimeAlerts and had a 55% Cash position in the Hedgeye Asset Allocation model):

  1. SP500 intermediate-term TREND resistance became support at 1663; that’s a big line
  2. SP500 immediate-term TRADE breakout line = 1681; layered on top of the TREND, that’s even bigger
  3. SP500 immediate-term TRADE resistance = 1708; that’s up another +0.9% from the 1692 close

All the while, I’m considering the emotion and intensity of the move (this is where the Twitter #Contra-Stream I built is priceless) within the context of the prior 2013 US stock market “corrections.”


As you can see from Darius Dale’s Chart of The Day, each of the last 3 corrections has:


A)     been to higher-lows

B)      been less of a % move than the prior correction

C)      been on less volume than the prior correction


Markets that people hate are the best ones to be long; particularly when corrections are confirmed by weak volume and lower-high volatility signals. Again, to contextualize this recent SP500 correction:

  1. SEP 18 to OCT 8 correction = -4.1%
  2. AUG 2  to AUG 27 correction = -4.6%
  3. MAY 21 to JUN 24 correction = -5.8%

And I get it. For the last 3 weeks I wrote to you every day that I wasn’t buying this correction like I did the AUG and JUN corrections. But I also get when and why I changed my mind. There are no rules against doing that. “Winning, duh!”


My Macro Team and I will be hosting our Q413 Global Macro Themes Conference Call at 11AM EST. Ping Sales@Hedgeye.com if you’d like to have access to our most recent research and risk management thoughts.


Our immediate-term Risk Ranges are now:


UST 10yr 2.65-2.71%

SPX 1682-1708

DAX 8601-8729

VIX 15.18-18.98

USD 80.20-80.74

Gold 1271-1311


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Boom, Crush! - Chart of the Day


Boom, Crush! - Virtual Portfolio

real-time alerts

real edge in real-time

This indispensable trading tool is based on a risk management signaling process Hedgeye CEO Keith McCullough developed during his years as a hedge fund manager and continues to refine. Nearly every trading day, you’ll receive Keith’s latest signals - buy, sell, short or cover.