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Takeaway: 3Q13 Earnings Trends: Credit remains the big positive driver while loan growth and NIM are showing improvement, but efficiency is worsening.

Not Beating Expectations, but Not Missing Either

As Financials earnings season starts to wind down, we find it useful to examine the trends that have emerged. Our Hedgeye Financial Earnings Scorecard below shows patterns in the results based on nine metrics and our own score of overall strength (from -10 to +10) for each issuer and in the aggregate. So far, the results have been quite mixed, with an overall score of zero, suggesting that, all things considered, things are coming in just about in line with expectations. The money center banks (-4), credit card companies (-2) and trust banks (-1) have generally disappointed, while the regional banks  (+2) have been, on balance, more positive. 


3Q13 Earnings Season Themes

With the earnings season for Financials now largely in the rear-view mirror, it's clear that the strongest areas of contribution are still coming from credit with a preponderance of companies still showing sequential improvement in NCOs, NPAs and at least half of companies still seeing earnings contributions from reserve release. Efficiency actually deteriorated this quarter across the sector as well over half of companies have reported a sequential increase in costs relative to expenses. Regarding the top line, the news is generally positive. Almost three-quarters of companies are now reporting positive loan growth, albeit slow growth. The margin front also showed some improvement vs recent trends. Half of companies reported that NIM sequentially improved this quarter, up substantially from prior quarters. 


EPS: 26 out of  49 companies (54%) have beat consensus EPS estimates, while 11 have been in line, and 12 have missed (25%). Keep in mind that we are looking at the optical (unadjusted) numbers. 


Revenues: 10 out of 49 companies (20%) have beat consensus revenue estimates, while 22 were in line and 17 missed (35%). For reference, we consider +2%/-2% the threshold for a beat/miss on top line. 


Credit: 26 out of 49 companies have released reserves this quarter, or 53%. 13 of 49 (26%) have built reserves and the rest were essentially provisioning in-line with net charge-offs. NCOs were predominantly better again this quarter with 71% of companies reporting a sequential improvement in the level of net charge-offs. The data was better still on a forward-looking basis, where 88% of companies reported a sequential decline in NPAs.


Margins: NIM pressure seems to be abating modestly. 49% of companies reported a sequential NIM increase while 51% reported a decline. On average, NIM was higher by 1 bps while the median NIM was unchanged sequentially. Some of the worst NIM changes came from ZION (-22 bps), CBSH (-10 bps), MTB (-10 bps), NYCB (-11 bps), PNC (-11 bps) and WFC (-8 bps).


Loan Growth: 74% of companies reported positive loan growth this quarter, with the median company reporting +0.9% QoQ. The banks posting the most positive loan growth include HBAN, CBSH, GBCI (Acq-driven).


Stock Performance: 48% of companies have seen their stock price rise on the trading day post earnings, and the average change has been +0.3%. Relative to the XLF, the average change has been -0.2%. 






The chart below shows the percentage of companies that beat/missed earnings and revenue, the percentage that showed sequential improvement or deterioration by category, and the percentage that saw their stock prices rise/fall following earnings on an absolute and relative (vs XLF) basis. 




The charts below show the best and worst performers in loan growth, NIM, and efficiency on a sequential basis.  








Joshua Steiner, CFA


Jonathan Casteleyn, CFA, CMT


Hershey's: Sweet Runway Ahead

Takeaway: A rock star quarter.

This note was originally published July 25, 2013 at 14:21 in Consumer Staples

Hershey's: Sweet Runway Ahead - hersh2

Hershey’s Q2 performance shows it is running on all cylinders. HSY is lapping 2012, a year in which it took price to offset inflated input costs; it’s now seeing significant volume gains, up +6.6% versus the prior-year quarter, lower input costs, and solid market share gains in the U.S. in every channel that it competes in (including mints and gums that are typically weak). We expect this strong momentum to continue in 2H, especially given the strong merchandising around Halloween and the holidays.


Our quantitative set-up shows HSY trading near its immediate term TRADE resistance level of $93.95. We’re waiting and watching to see if it can break through this level; if it can we like that it’s firmly anchored by its support lines (the two green lines), over the TRADE and TREND durations.


Hershey's: Sweet Runway Ahead - hedrick



What we liked:

  • Q2 EPS beat consensus ($0.72 vs $0.71), up 9.1% versus the prior-year quarter
  • Revenue in line with consensus at $1.51B, or 6.7% versus the prior-year quarter
  • Volume rose 6.6% (including 1% from Brookside and +0.1 FX benefit)
  • GM up 290bps in the quarter on lower commodity costs, profitable sales mix, and cost savings
  • Input cost deflation of $29MM was better than original estimates
  • Momentum in U.S. and key international markets
  • In the US, with the exception of gum, sales increased at the high end of the historical growth rate
  • Gained market share in the U.S. in every channel that it competes in., and overall took a 1.3% market share gain in chocolate
  • Strong performance from Brookside and expected to contribute 1pt of growth in 2013
  • International - China, Mexico, and Brazil solid performance
  • International sales (excluding Canada) up 8% in the quarter. Expects international to accelerate over 2H and FY sales up 15-20%
  • Q2 interest expense of $21.1MM, declined vs $24.3MM last year
  • In 2013 expects interest expense to be $90-95MM and FY adjusted tax rate to be the same as last year [35.7% tax rate in Q2 (in-line with expectations) vs 32% last year]
  • Expects FY advertising up 20%. Specifically for International, advertising up 45-50%


Guidance FY:  Net Sales up 7% (including the impact of FX); EPS $3.68-3.71 (up 14% year-over-year vs previous 12% guidance); GM up 220-230bps (vs prior estimate of 190-210bps, due to improved sales mix and higher productivity, and sees no change due to input cost inflation).



Matthew Hedrick

Hedgeye Senior Analyst




Friday, October 25th at 11:00am EDT  

We will be hosting a call today with the CFO of Brinker International, Guy Constant, to discuss 1Q14 results, the outlook for the balance of the year, and the emerging role of technology in the casual dining industry.




  • Bringing technology to the casual dining industry.
  • A more detailed look at 1Q14 results.
  • Why traffic trends in the casual dining industry look bleak.




Guy Constant is Executive Vice President, Chief Financial Officer and President of Global Business Development for Brinker International.  In this role, he is responsible for overseeing Planning and Analysis, Mergers and Acquisitions, Investor Relations, Treasury, Tax and Accounting, Domestic Franchise Business Development, and Corporate, Chili’s and International Finance in addition to overall Development.  Guy added his global responsibilities in January 2013 and is responsible for overseeing global operations.




  • Toll Free Number:
  • Direct Dial Number:
  • Conference Code: 733231# 



Howard Penney

Managing Director

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[podcast] Steiner Talks Financials

Hedgeye Financials Sector Head Josh Steiner fills in for CEO Keith McCullough on this morning's conference call and offers insight into how the sector is faring. Steiner notes that since September 5th, when the 10-year peaked at 3%, Financials have underperformed the market by 100 basis points and is the 2nd worst performing sector. 



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.

Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.