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CPB – Praying For Strong Winter Soup Sales

Position: Tactically short on strength.


Campbell’s had a rough quarter to say the least; the stock is trading down -6% intraday on management lowering FY guidance.

 

Despite concerted efforts to reduce costs (CPB completed the sale of its European Simple Meals business, the exit of 4 plants in the past two years, and plans to save an additional $40 in FY 2014) we struggle to get behinds CPB’s plan to increase its marketing spend (and likely promotion) as it accelerates the launch of eight new soups in the next two quarters (Fiscal Q2 and Q3). The drivers under the hood suggest further top-line pressure on increasingly more difficult comps and continued gross margin and operating margin pressure over the next two quarters.  We also don’t think the company has not hit the mark on soups, launching hearty and healthier higher premium soups that look to be missing on the consumer’s value perception given the still very strapped labor market and macro environment.   

 

In short, CEO Denise Morrison continues to under-deliver on her promise to turn around an ailing portfolio; US Simple Meals and US Beverages were clearly significant laggards in the quarter. Fiscal Q1 revenues of $2.17B fell -7.3% in the quarter (underwhelming consensus of $2.29B) and EPS declined -21% to $0.66 (vs consensus $0.86). Management attempted to explain away the decline citing unexpected light retailer inventory building and this year’s late Thanksgiving that will push more shipments into next quarter (Q2).

 

CPB is immediate term TRADE oversold and bearish on the intermediate term TREND.  Therefore, this is a name we’re not comfortable owning over the intermediate term, and may only tactically trade around it to take advantage of price imbalances.

 

CPB – Praying For Strong Winter Soup Sales - z.  cpb chart

 

Given the weakness in the quarter, CPB lowered it FY 2014 guidance: sale 4% to 5% (prior 5% to 6%); EBIT 4% to 6% (prior 5% to 7%); and EPS 2% to 4% or $2.53 to $2.58 (prior $2.58-2.62).

 

CPB – Praying For Strong Winter Soup Sales - z. cpb sales

 

CPB – Praying For Strong Winter Soup Sales - z. cpb operating

 

Matthew Hedrick

Associate 


[VIDEO] Keith's Macro Notebook 11/19: $USD, UST 10YR, COMMODITIES


Commodity Ugly

Takeaway: Commodities. Ugly.

It's been a disaster of a year for Commodities.

 

The CRB Index hit a fresh year-to-date low yesterday down -7.8% (in spite of US Dollar weakness.)

 

After selling Gold into Thursday's Yellen "Mother of All Doves" Bounce, our asset allocation to Commodities is back down to 0%.

 

We are also short Oil in RealTimeAlerts.

 

Commodity Ugly - drake44

 

This is an excerpt from Hedgeye research. To learn more about becoming a subscriber click here.


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 80.28%
  • SHORT SIGNALS 78.51%

JCP: Buy The Event

Takeaway: There are many possible outcomes from JCP’s print. But there is virtually nothing JCP can say to suggest that it is not 100% fixable.

Conclusion: One of two things will happen, either we’ll get tangible evidence of the turnaround – which will make JCP worth buying even if it’s up. Or the company will ‘pull a JCP’ and scare the Street with the print, as it has grown so accustomed to. We think that’s unlikely. But we think one thing is clear, there is virtually nothing the company can or will say to suggest that this company is not 100% fixable. We’re buyers on the event.  

 

DETAILS

First off, let’s be clear about where we stand on JCP. Our positive call is based on our view that not a single thing currently ailing JCP is beyond repair. This company is not broken. Johnson bullied and bruised a few dozen critical functions at the company, and though he may have tried to break them, he failed at that too. We don’t think that Ullman is the right person to rehabilitate JCP, but he is the right guy to take it off life support and administer CPR if necessary. We expect to see a new CEO announced by Spring 2014.

 

Another important point..we’re not arguing that JCP is a great retailer, a great brand name, or in any way deserving of the right to exist as a go-to source for consumers.

 

But let’s keep an important factor in mind…it’s operating at $100 per square foot. That’s embarrassing. Kohl’s, which we think has structural issues and has been at the top of our short list – is running close to $210/sq ft. Before Johnson worked his magic, JCP peaked out at $190 per foot.

 

Our point here is that we don’t have to assume that JCP becomes a great retailer. We don’t have to even believe that it will be an average retailer.  It can remain in the lower quartile – a notch above Sears even – and operate at $140/square foot. And it can get there by simply fixing some of the factors that Johnson damaged during his triumphant reign.

 

Alongside the $140/ft, our other key assumption is that Gross Margins get back to 37%, which we think is very doable – despite the severe pushback we get on this assumption. Note that Ron Johnson’s decimation of JCP’s private label brands cost the company about $1bn in gross profit – that’s what happens when you remove $2.5bn in sales at a 48% gross margin and substitute with $900mm at a 33% gross margin.  

 

All in, those assumptions get us to $1.30 per share, which is meaningfully above the high end of where even the most vocal bulls (if there are any) are posting their estimates. Will it get there tomorrow? No. But it’s math that people will begin to run within 12-month’s time. Keep in mind that over the past few years there has always been a debate alive about what the ultimate earnings power of JCP actually is. That debate today is absolutely dead. And we’re not talking about an unachievable Ackmanist-driven Hail Mary $12-EPS power. In all our travels and phone calls, we can’t find anyone that is willing to acknowledge that JCP can actually earn money. That will change, and we think it happens within 12-months.

 

So, what are we looking for in the quarter?

  1. First off, this is literally a three-year turnaround – it won’t be fixed in a quarter. What we’re looking for this quarter is a mere two or three wins on the road to fixing several dozen problems. That might sound like a shameless hedge – perhaps it is. But there’s going to be a mix of noise and good news in this quarter. That’s upside from the past two years where it’s been all bad news.
  2. We’re looking for about a -5% comp. The company already reported a 0.9% store comp and 38% dot.com comp for Oct. Based on commentary by virtually all retailers, October was the best month of the quarter. -5% seems about right, but could be 2-3% +/-.
  3. Gross Margin change is going to move inversely to comp. We have it modeled +100bps vs. last year – which would mark the first GM improvement in about 10 quarters. Our bias is to the downside on that one, as Ullman told the whole world that he’d end the quarter with positive comps, and he did a +0.9% in Oct. Sounds like he stretched. More likely than not, he told his selling and merchandising team to drive a positive comp come hell or high water. That usually does not come alongside a healthy gross margin. Nonetheless, they’re coming off such low numbers that Gross Margins could be down 100bp and still post a 150bp sequential improvement on a 2-year run rate – which is what we’ll really be looking to see.
  4. We’ve got an operating loss of -$292mm, which compares to the Street at -$384mm. Our number might be on the aggressive side due to gross margin, but we’re reasonably confident that JCP won’t miss the consensus.
  5. Usually, we don’t leave EPS for last, but the company’s print relative to expectations will be relatively meaningless due to the timing of the company’s offering and inconsistency in how people are modeling the fully-diluted share count. The Street is at -$1.70 this quarter, but the range is from -$2.36 to -$1.11. We have JCP losing a little over a buck. But again, share count is uncertain. We’ll look at the operating loss delta as the best way to gage our estimates versus consensus. 

Trashing What's Left Of The Dollar

Takeaway: Janet Yellen looks set to launch a new round of aggressive doveishness. We think this risks trashing what’s left of the dollar.

Trashing What's Left Of The Dollar - yello

The Fed’s ongoing policy to trash the dollar has had the effect of inflating prices of things priced in dollars.  This policy has most notably sent the equities markets through the roof.  But remember that actual economic growth is “priced” in real terms.  A factory that increases productivity by 2% a year can not “put it on margin” to turn that into a 4%-10% annual gain.  Indeed, we are suffering the aftermath of an economy whose growth over more than a generation was increasingly driven by borrowing, borrowing, borrowing.

 

It appears that the Fed really believes it is helping the economy by guaranteeing that the prices of mortgage-backed bonds remain unrealistically high – and using our money to do so.  What is really going on is that asset prices are diverging from fundamental asset values, to the extent that markets risk becoming completely untethered from reality.  Into this morass treads Janet Yellen, who looks set to launch a new round of aggressive doveishness.  We think this risks trashing what’s left of the dollar.

 

Maybe shutting down the government wasn’t such a bad idea.

 

This is an excerpt from a Forbes op-ed written by Hedgeye Managing Director Moshe Silver. Click here to read it in its entirety. 

 


PBPB: NOT WORTHY OF THE MULTIPLE

 

We are adding PBPB to Hedgeye best idea list as a SHORT.

 

Chipotle redefined the quick-service industry with its innovative operating model, Panera created the bakery café segment and Noodles catapulted into the fragmented Asian fast casual category.  All three are unique concepts that have, in a sense, redefined their respective categories. 

 

At the heart of it, Potbelly is a single daypart, low margin, low return sub shop with declining traffic and little competitive advantage over its most basic competitors.  Admittedly, these are not quite the qualities we’d expect to find in a company that is trading at a P/E of 84.3x and 21.7x EV/EBITDA on a NTM basis.  But, this is precisely what we have here.  

 

To be clear, we believe Potbelly is a solid company with a strong management team, but it should not be trading at a premium multiple to its aforementioned peers.

 

With that being said, we would not be surprised to see PBPB decline by 30-40% over the next twelve months.


As we wrote last week, in aggregate, the current valuations seen across the casual dining sector are shockingly high.  In fact, we have no problem referring to them as bubble-like and we’ve found this extends beyond the depths of casual dining stocks to several newly minted “growth” restaurant stocks.  Our CEO, Keith McCullough, did a nice job contextualizing these bubbles in this brief excerpt from yesterday’s Early Look titled “Weird Bubbles”:

 

 

From a US stock market “Style Factor” perspective, check out the score:

  • LOW YIELD (i.e. GROWTH) stocks = +40.4% YTD
  • Top 25% EPS GROWERS (by SP500 quartile) = +37.2% YTD
  • HIGH BETA stocks = +35.8% YTD

 

From a pure “Style Factor” perspective, PBPB fits the bill of a “growth” restaurant stock.  Let’s consider management’s aggressive guidance:

  • New unit growth of 10%+ for a “long period of time”
  • Low-single digit same-store sales growth
  • At least 20% annual adjusted EBITDA growth
  • At least 20% annual net income growth
  • At least a 25% return on invested capital, as measured by the second full-year profit of new shops
  • Shop margins above 20%

At its core, Potbelly is a local sandwich chain competing in the most competitive segment of the restaurant industry – the sandwich segment.  Although many people like to refer to it as the newest fast casual concept, the reality is it’s only at the “intersection between the fast casual and sandwich categories.”  Needless to say, Potbelly’s operating model, while solid, is nothing close to jaw-dropping.

 

 

Peer Group Operating Model Comparison

  • Potbelly’s average unit volumes are low.
  • Food costs are in-line with Panera’s.  There is very little room to move lower without downgrading to lower quality food.
  • The company appears to be very efficient, with labor costs running at 27.96%.
  • Other operating expenses are also very low, which could be the difference-maker in maintaining 20% store-level margins over the long haul.
  • Excluding IPO expenses, Potbelly’s G&A costs are running closer to 8%, which puts it fairly in-line with its competitive set.
  • Even after adjusting for lower G&A costs, operating margins remain low and will require sales leverage for any further upside.

PBPB: NOT WORTHY OF THE MULTIPLE - chart1

 

 

Same-Store Sales

Management’s long-term guidance of “low-single digit same-store sales” implies that they believe, or want us to believe, they have the ability to take price in order to consistently drive average check higher.  In fiscal 2012, Potbelly’s average check was $7, which, on the surface, appears to be in-line with other fast casual operators.  With average check already at this level, relying on price as the primary driver of future profitability is a risky proposition.  Needless to say, we haven’t seen anything recently that would suggest this rate of same-store sales growth will come from traffic gains.  Potbelly has seen traffic decline for at least the past 3 quarters and expectations are for this trend to continue into the first half of 2014.

 

PBPB: NOT WORTHY OF THE MULTIPLE - chart2

 

 

Average Unit Volumes

The Potbelly mission is to be “the best place for lunch.”  While a strong focus on lunch is important, restaurant companies that generate the best returns operate across multiple dayparts and, in turn, generate higher average unit volumes.  Depicted in the chart below, at $1.1 million, Potbelly’s average unit volumes are below all of its primary public peer competitors.  Given the inherent unit economics of a Potbelly shop, we find the company’s premium multiple very difficult to justify even with the “growth” story as a backdrop.

 

PBPB: NOT WORTHY OF THE MULTIPLE - chart3    

 

 

Restaurant Level Margins

Given the rapid projected growth rate of the company, PBPB will be facing downward pressure on restaurant level margins for the foreseeable future.  On average, new Potbelly shops will open up with shop level profit margins in the high-single digit or low-double digit range.  It will require nearly flawless execution on store openings to avoid being stymied by incremental margin pressure.

 

PBPB: NOT WORTHY OF THE MULTIPLE - Chart4

 

 

Low Returns

Relative to its competitive peer set, PBPB generates a very low return on assets.

 

PBPB: NOT WORTHY OF THE MULTIPLE - chart5

 

 

Strong Balance Sheet and Cash Flow

PBPB is expected to have $48.87 million of cash and short-term equivalents on its balance sheet at the end of 2013 and is expected to generate approximately $7.8 million in free cash flow after allocating $31.16 million to capital expenditures in 2014.  The company has not formally announced what it will do with its excess cash, but we can safely presume they will use it to fuel their self-funding model and accelerate new unit growth in the second half of 2014 and 2015.

 

 

Valuation

Per our comments earlier and the visuals from the charts below, PBPB is a very expensive stock that we, at the very minimum, find quite unattractive from a valuation standpoint.

 

PBPB: NOT WORTHY OF THE MULTIPLE - second to last

 

PBPB: NOT WORTHY OF THE MULTIPLE - last

 

 

Conclusion

As it stands, PBPB’s operating model has little room for error.  To justify the current multiple, it needs to be clear that there is significant upside from current consensus EPS estimates.  We don’t anticipate this coming to fruition and, with short interest comprising 15% of the float, it appears as though we are not the only ones.

 

 

 

Howard Penney

Managing Director

 

 


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