Research Edge Portfolio Position: Long EWZ

May unemployment data released by IBGE today showed the second modest sequential decline to 8.8%. As the Brazilian stimulus measures continue to be implemented, the stabilizing employment situation is a direct result of public sector job creation outpacing reduced headcounts in the manufacturing, mining and energy industries.  Unemployment levels still registered in double digits for several major urban areas, but are down across the board on a 3 year basis.

Average wages showed significant year-over-year increase with per capita household real income up 3.4% Y/Y; still trailing CPI by almost 1%, but providing the central bank with room to maneuver at their July meeting. Currently the benchmark Selic is still over 9%.

The positive data was a welcome relief to the equity market and the Bovespa finished the day up 3.7% while the EWZ ETF rose by 4%. With a cost basis of 53.83, we are still down by slightly over 1% in the long position we put on last week.

Although much needs to be done to eradicate pervasive poverty and to improve education levels we continue to be bullish on near term prospects for the Brazilian economy based on improving internal demand and global commodity dynamics.

Andrew Barber




In the past, CKR management has been very clear about its menu strategy:

"While many of our competitors responded to the ongoing macroeconomic challenges by offering low priced margin impairing products, we continued to differentiate our brands by focusing on premium priced innovative products."

"So, while other places are hopping on the value bandwagon and, thus, promoting their smallest and lowest-quality menu items, we'll keep doing what we do best by giving our customers what they really crave: big, delicious, premium-quality burgers."

"I don't think the competitors can maintain this level of discounting and actual food giveaways for very long. So we're going to maintain our discipline and our profitability and try and address those issues in the short term."

"The two ways we will not deal with the issues are by trying to drive business through discounting our products, serving inferior products, or massively couponing."

CKR has stressed that it offers good "value" by selling premium $6 burgers that are comparable to the more expensive burgers found at casual dining restaurants. It has also said in recent past that it must also offer affordable items for its customers that have less money to spend, but that it would never risk hurting margins by selling items at a price lower than cost. Yet, today when discussing its more affordable items, management said that CKR has the best tasting burgers and chicken sandwiches for $0.99. This sounds a little like a dollar menu to me! And based on comments made by CKR CEO Andrew Puzder last year, the company is selling these items below cost.

"As long as we serve a burger that's as good or better, and I think better, particularly this Prime Rib burger, than the casual dining places serve, and as long as we approach it as a -- you know, we market value different than other companies. You've probably seen the fake restaurant ads but we're not saying come in and get a piece of gut fill for $0.99, when everybody knows you couldn't go to the grocery store and make something for $0.99 that was edible, and you're not paying labor and rent. Instead of doing that, we say look, here, you know, people are willing to pay $14 for this burger in a restaurant. You can get it at Carl's or Hardee's for $4, $5, or $6."

Last quarter, management acknowledged that it would be adding more affordable items to its menu but that it would not use media support to promote them. Today, the company said it would promote some of these lower priced items outside of its four walls to increase awareness of its value items. Specifically, the company will advertise its Teriyaki burger that will sell for $2.89 and its 2 for $4 Western Burgers. The company also said that it has begun testing a new snack menu to address its affordability issues. Using advertising dollars to promote these lower priced items for the first time and testing a new snack or lower priced menu sounded like a "value initiative" to me. However, when I asked management about these "value initiatives," the CEO seemed a bit confused as to what I was referring.

This company has spent so much time defending its position on keeping its focus on a premium menu strategy and maintaining industry-leading restaurant-level margins that the CEO seemed to question my use of the word "value," which in this industry, often goes hand in hand with discounting. Although he allocated a good portion of today's earnings call to a discussion around creating awareness of the value inherent in the company's $6 burgers and the affordability of some of CKR's products, such as the burger and chicken sandwich for $0.99, the company will most likely not go far enough with its promotion of these products to really drive traffic because management will not want to be accused of discounting.

After today's conference call, I was left questioning what direction CKR is headed? Will CKE only pursue premium products in an attempt to preserve the high margins to which investors have become accustomed while sacrificing traffic? Or will they begin to go after the bottom feeder customers with more advertising of its lower priced items? Management seems a little unsure as well, saying that it will manage for the long-term and not for short-term sales pops in one breath and that it will do what it can to adapt to the new consumer environment in another. Either way, margins are at risk, but CKR risks losing substantial market share at Carl's Jr. if it does not act fast with a coherent market strategy to drive traffic.

Making matters worse for CKR is the fact that McDonald's will likely roll out its Angus burger in August with significant couponing. This premium burger offering at McDonald's will only create more competition for Carl's Jr. in the coming months.


CKR - MINCING WORDS - ckrmargiins


Quick Call Out On Consumer Confidence


We put together the two charts below that outline consumer confidence levels at various income levels.  As might be expected, those that make more money generally have higher confidence based on this measure.  From mid-2006 to mid-2007, those that made more than $50,000 per annum had almost twice the confidence of those that made less than $15,000 per annum.  Beginning in mid-2007, this confidence gap began to narrow as the group that was making the most money saw a marked fall in their confidence level.

In Q4 of 2008 and Q1 2009, the confidence delta between the income groups narrowed to a point where confidence levels of the those making the least, or under $15,000, and those making the most, or over $50,000, was basically flat. That is, there was no difference in confidence levels  between these disparate income groups.  Since March we have seen confidence rebound sharply, albeit off of low levels, and have also seen the delta between high earners and low earners widen once again.  The most obvious interpretation is that those who make more money also have a large amount of their assets invested in the stock market, so as these market related investments decline, so too will their confidence, while the inverse is true, so as the stock market rebounds, as we have seen since March, the higher income earners should see a disproportionate rise in confidence.

For those that play the consumer stocks, being aware of this widening spread, as it sustains itself, will be a key driver of consumer spending patterns in the coming quarters.  As always, let us know if we can put you in touch with our consumer research teams (McGough, Penney, and Jordan) to take advantage of this trend on a stock specific basis.

Daryl G. Jones

Managing Director

Andrew Barber


Quick Call Out On Consumer Confidence - MH1

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Here is what BOBE had to say:

"There are a number of federal, state and local proposals and regulations to require restaurants to provide nutritional information on menus and/or require that restaurants label menus with the country of origin of meal ingredients. For example, our Mimi's Cafés located in California are subject to a state-wide menu labeling law that will become effective on July 1, 2009. We are concerned that the continued imposition of such regulations, especially at the state and local level with varying requirements, could have an adverse effect on our results of operations and financial position, as well as the restaurant industry in general. In particular, we are concerned about the increased operating costs we will incur to comply with these requirements, as well as the potential impact on our sales and profitability if the disclosures change guest preferences and menu mix. We support the uniform standards that would be implemented across the United States under the Labeling Education and Nutrition Act (LEAN Act), which is pending in Congress."

Here are some details of the new California Law, according to the Arnold and Porter LLP.

On September 30, 2008, Governor Arnold Schwarzenegger signed into law SB 1420, making California the first state in the nation to enact statewide legislation requiring restaurants to provide nutritional information on menus and menu boards. SB 1420 applies to restaurant systems with at least 20 locations in California. Over 17,000 restaurants will be affected.


SB 1420's requirements are imposed in a two-stage process:

By July 1, 2009, covered restaurants must provide brochures that disclose calories, saturated fat, carbohydrates, and sodium. The brochures must be available at the point of sale, and drive-through areas must display a conspicuous notice stating that the disclosure of nutrition information is available upon request. Restaurants providing sit-down service may provide the information on a table brochure, table tent, menu, or menu insert.

By January 1, 2011, covered restaurants must additionally post calorie content information next to each menu item on their menus, indoor menu boards, or menu tags (for display case items). Restaurants offering "combination" menu items comprised of one or more other items must disclose both minimum and maximum calorie information for the combination on menus or menu boards, based upon all possible combinations. Furthermore, for menu items that are intended to serve more than one individual, menus and menu boards must state the number of individuals intended to be served as well as the calorie content information per individual serving.

From the CAKE 10K - No mention of the California law only the following comments:

"New information or attitudes regarding diet and health could result in changes in regulations and consumer eating habits that could adversely affect our revenues.

Regulations and consumer eating habits may change as a result of new information or attitudes regarding diet and health. These changes may include regulations that impact the ingredients and nutritional content of our menu items and bakery products. For example, a number of states, counties and cities are enacting menu labeling laws requiring multi-unit restaurant operators to make certain nutritional information available to guests or restrict the sales of certain types of ingredients in restaurants. The success of our restaurant operations is dependent, in part, upon our ability to effectively respond to changes in consumer health and disclosure regulations and to adapt our menu offerings to trends in eating habits. If consumer health regulations or consumer eating habits change significantly, we may be required to modify or delete certain menu items. To the extent we are unable to respond with appropriate changes to our menu offerings, it could materially affect customer demand and have an adverse impact on our revenues."

I asked CKR today on its quarterly earnings call about the potential impact of the law and management stated that a similar law has already gone into effect in parts of Washington St. and has not seemed to impact sales. Additionally, the company already makes the nutritional and caloric content of all of its menu items available on its website. Management does not think this information will change people's eating habits and recognizes the new law as a hassle; though, the company will, of course, comply. Interestingly, management seems to think the posting of such caloric content could help their sales as their young guy consumers tend to use the high fat content and high calories for what the company called "bragging rights."



Domo Arigato Mr. Bernanke

The Fed's decision yesterday to continue the zero funds target rate "for an extended period" -as well as continuing with a program to spend hundreds of billions in additional dollars to prop up the long end of the curve sent a clear signal that, from their perspective, deflationary concerns have subsided while fears that inflationary pressure on the margin may expand are still far on the horizon.

For inflation hawks who have been watching oil and other components in the energy and industrial commodity complex, as potential canaries in the coal mine, the Fed's decision sets the stage for a potential nasty spike if any external catalyst develops. Based on my anecdotal research, traders old enough to remember the twin energy crises of 73 and 77-79 seem to be much less inclined to discount this risk.

On the rate front, the resilience of Chinese and Japanese lenders combined with Bernanke's blank check sets the stage for a sustained stay here at zero. Despite contracting by over 25 basis points since the first week of the June the spread between the 10s and the 2s continues to hang in above 250 providing the gang that could shoot straight -our government backed banking community, with more time to cash in on the free money spread feast. As long as this steepness continues we can presumably look forward to GMAC continuing to run those funny ads for their Ally subsidiary that take cheap shots at the surviving members of the banking community that haven't mugged the taxpayer yet.

Meanwhile, with absolute rates at absolute historical lows, it's an absolute sure thing that scores of supposed geniuses at funds and big banks are piling into the "reverse carry" trade -borrowing in dollars to buy higher yielding bonds issued by Brazil or other muscular developing economies. This will make them look absolutely brilliant when the dollar finally rolls over decisively.

With all that taken into account, our strategic thoughts remain relatively unchanged beyond some duration adjustments:

  • We still expect that inflationary pressure will start to return in earnest during Q4 -and furthermore that in the current "free money" vacuum it has the potential to expand at a rapid pace that will catch a lot of people unprepared.
  • We expect that treasury yields will start to rise on an absolute basis later this year DESPITE fed policy sentiment as investors factor concerns about ballooning debt and inflationary pressure into the equation. We think that this divergence between the target and the curve will be mirrored by expansion in the spread between treasuries and higher yielding corporate bonds.

As always, timing is everything, and we will be constantly looking for signals to test our thesis with. If the math doesn't support our thesis -or price action defies it, we WILL change our tactical risk management stance in response because that is the only way that we know how to invest -opportunistically.

Andrew Barber


Notable Confidence Divergence

My colleague Andrew Barber just floated me the following consumer confidence chart. These are Conference Board numbers, so they are not proprietary to us, but note 2 things... 1) Not only has confidence in aggregate popped since the market rally, but 2) it has disproportionately impacted higher incomes.

Thanks for stating the obvious McGough... not many people making $15k per year on stocks never mind feel more confident in the face of a market move. But obvious or not, a fact is a fact. We can't ignore it.


Notable Confidence Divergence - 6 25 2009 9 19 22 AM

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