Rear-View Progress

This note was originally published at 8am on December 06, 2013 for Hedgeye subscribers.

“All progress comes from the creative minority.”

-George Gilder


So, US GDP Growth goes from 0.14% (at this time last year) to 3.6% in Q3 of this year, and all I hear consensus whine about are “inventories.” I wonder if that slope of US #GrowthAccelerating’s line had anything to do with the long-end of the yield curve being up +127 basis points (or Gold crashing) year-over-year…


Newsflash: businesses build inventories when confidence is rising. These are called coincident indicators. Both the US Dollar and US interest rates peaked in Q3 – so did US consumer and business confidence. So the I (Investment) in C+ I + G = GDP, went up.


Would the 2013 growth bears have preferred Investment to go down (and G (government) spending to go up instead)? Who knows. And who actually cares what they think anyway? For them, it’s all rear-view. Mr. Macro Market looks forward.


Back to the Global Macro Grind


Now that Bond Yields ripped to a lower-high (vs the SEP 2013 high) on a lagging economic indicator (that was a Q3 GDP report; it’s the end of Q4), and the stock market had another little meth withdrawal on that (“taper-talk” drives them batty), what’s next?

  1. TREASURY YIELDS = immediate-term TRADE overbought at 2.88% on the UST 10yr
  2. US EQUITIES = immediate-term TRADE oversold at 1779 on the SP500
  3. US EQUITY VOLATILITY (VIX) = immediate-term TRADE overbought at 15.58

So, would a bad jobs report be good for stocks (and bad for bonds)? Would another good jobs report be bad for stocks (and good for bonds)? Inquiring “lower-class folks” who don’t get to play at the insider Fed Whale tables want to know…


We mince no words calling this a centrally-planned-casino at this point. And since some of us are pretty darn good at buying bubbles, we feel lucky when stocks and bonds hit the high and low-ends of our risk ranges. It’s all about playing the probabilities, baby!


That’s why, after 5 consecutive no-volume down days for the US stock market (a correction in the SP500 of -1.2%), we bought-the-damn-bubble #BTDB (again) yesterday, taking our Cash position (asset allocation model) down to 38% (started the wk at 58%).


Where do we think US Growth goes from here?

  1. Down

That might be the easiest question to answer since we said US growth would go UP (from 0.14%) 1-year ago.


What could happen if we’re right about that?

  1. 2014 #OldWall GDP and SP500 consensus will be wrong (again) because it’s taking “forecasts” UP (it’s called anchoring)
  2. Most rear-view macro investors will probably perpetuate one more series of US stock market tops
  3. #GrowthSlowing, sequentially (from 3.6%) starts to give the US stock market multiple compression by Q2 of 2014

As most of you know, I’m not a forensic-US-stock-market-multiple-analyst. In fact, I think picking an “earnings number” for the SP500, then licking your finger on what multiple to slap on that is one of the more laughable things I hear people say with a straight face.


I’m more of a market history, math, and behavioral mutt myself. And history tells you that the US stock market:

  1. Sees multiple expansion when A) GROWTH accelerates and B) INFLATION slows
  2. Sees multiple compression when A) GROWTH slows and B) INFLATION accelerates

In other words, US economic STAGFLATION periods (1970s, 2010-2012, etc.) saw the SP500 trade at 7-12x earnings and #StrongDollar (deflating the inflation) periods of US real-consumption GROWTH accelerating saw multiples trade anywhere from 17-35x earnings.


Therefore, in my own little mind, provided that I think I know where the slopes of the 2 lines (GROWTH and INFLATION) are going in the next 3-6 months, I can start to prepare the sails of change in my positioning. In Macro, mental flexibility is forward progress.


Our immediate-term Risk Ranges (with TREND bullish or bearish) are now:


UST 10yr Yield 2.77-2.88%

SPX 1779-1813 

DAX 9068-9288 

VIX 13.31-15.58 

USD 80.22-80.66

Pound 1.62-1.64 

EUR/USD 1.35-1.37 


Happy b-day to my brother Ryan and best of luck out there today,



Rear-View Progress - Chart of the Day


Rear-View Progress - Virtual Portfolio

NKE: Week-Old Sushi

Takeaway: We're going against the grain on this print - we thought it was a let down. Sales miss, inventory high, costs up. Futures the only positive.

Conclusion: We liked this Nike quarter about as much as we like week-old sushi.  Yeah, the quarter definitely had some redeeming qualities, like a solid 13% futures growth rate, a beat on the gross margin line, and really encouraging signs out of Western Europe. But the reality is that the company put up a less than impressive 8% top line growth rate, and managed to translate that into a whopping 4% EPS growth rate. It missed our estimate, and we were hardly aggressive in our assumptions. Maybe we're being a  little hard on Nike, as it has earned its spot as the dominant brand in this space, but the reality is that the company has put together such a fantastic string of results for so long (and has the multiple to match), and putting up a mere 4% growth rate is so….Adidas.  If Nike wants to maintain its standing as one of the preeminent global companies and brands, its going to have to push the envelope a bit more going forward. We wouldn't be buying it here, and might go the other way if it bounces.


Here are some key standouts in the quarter:

  1. Underwhelming EPS: Truth be told, we were looking for EPS of $0.65. Gross margin was right in line with our model, but sales were low, and SG&A was high. Not what we want to see. Our numbers were not wildly out of NKE's guidance range.

  2. Futures came in strong -- +13% Globally. That's up about 2-3 points sequentially, though it's worth noting that the 2-year stack is down by about 2 points on both a reported and constant-currency basis. There were a lot of regional callouts. Emerging markets and Western Europe both posted futures rates that doubled sequentially. Unfortunately, Central Europe's trend was as bad as Western Europe was good.  Japan is slightly less of a disaster, with futures down 10% vs -19% in 1Q (they're +1% ex FX -- unfortunately they can't exclude FX from results). China, unfortunately, is treading water in the low single digits. We have yet to see the rebound in China that Nike has been talking about for 12 months. US remains bullet-proof with 11% futures growth.

  3. ASP/Unit Less Balanced Than We Want: Of the 13% futures rate, 3% of it came from higher ASP, while 10% came from unit growth.  The good news is that they're both positive. But we generally like to see a more balanced split between ASP and units. Higher ASP often has positive implications for margin.

  4. Nike has been in a trend where futures have been solid, inventories have been trending lower, and raw material/labor costs have been easing.  Now that whole equation gets flipped to a certain extent. Futures are still solid, but inventories are growing faster than sales, and raw materials costs are going to turn from tailwind to headwind pretty much immediately. Nike is no stranger to finding ways to keep expectations low, but when Don Blair talks about input costs…he usually doesn't mess around.

  5. This Nike SIGMA chart is as bad as we've seen from Nike in years. Literally, it's so rare for NKE's SIGMA to trend down (bad inventory trend) and left (bad margin trend) at the same time.  The only realistic way to get out of that position is to take it on the chin on the margin line to clear inventories, or vice versa. Nike will likely go the 'clear inventory by way of lower margins' route. Statistically speaking, stocks like it when inventory gets cleared as opposed to when margins hold tight in hopes of clearing inventory. Either way, Nike is in a less-than-enviable position.

    NKE: Week-Old Sushi - nkeSIGMA

  6. Let's just think about something for a minute…what happens when US futures revert to a longer-term trend-line rate of 5-6%? That's when we'll need the portfolio to really work -- most notably we'll need to see China pick up in a massive way -- and we mean the current lsd rate going up by a factor of 10x -- not just by a few points here or there. We're not making a call that the US is on its way out…but we are convinced that the current US futures rate is not sustainable. We need a China fix.

  7. Here's a nit pick, but NKE spent $402mm to repo 5.5mm in stock, and yet the share count barely came down. Let's not forget how big options are as a percent of compensation at Nike. They company needs to repo well over $1bn in stock each year just to keep the share count even.


I can already see it...a dozen people are going to ping me tomorrow and say "aren't you being a little tough on the company" (and I welcome those conversations by the way)  My answer? "Yes, I am being tough." But a company as great as Nike needs to lead financially as much as it leads with product and in sports. It warrants greater scrutiny, not less -- because it can (and should) handle it. 

[video] Penney Has a Better Plan for Darden $DRI

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Takeaway: "Penney: A Better Plan for DRI" video to follow.


As expected, DRI reported 2QF14 results in which both top and bottom lines came in light.  Revenues of $2.05 billion and diluted EPS of $0.15 missed consensus estimates by -0.76% and -22.6%, respectively.  Resembling a company in dire need of revival, restaurant level margins and operating margins fell -143 and -140 bps, respectively, in the quarter.  Prior to the call, management released its plan to increase shareholder value.  This includes plans for a spin-off or sale of the Red Lobster brand.  We will hit on the details of the plan and our initial thoughts later in the note.








Management finally did what it was so reluctant to do last quarter and guided down their projections for FY14.  As it stands, the company expects FY14 diluted EPS to decline 15-20% year-over-year.  Blended same-restaurant sales for Olive Garden, Red Lobster, and LongHorn Steakhouse are also expected to be lower than initially anticipated.  Due to this, the company expects revenues to grow 4% to 5%, rather than the prior estimate of 6% to 8%.


Revised FY14 SRS Estimates

  • Olive Garden (1%) to (2%)
  • Red Lobster (4%) to (5%)
  • LongHorn +2% to +3%



2QF14 was another quarter of ugly same-restaurant sales and traffic trends, specifically at DRI’s two largest brands: Olive Garden and Red Lobster.  Clearly these two business models (the most important two) are broken.  Darden’s smaller brands fared much better in the quarter.  Same-restaurants sales were up at LongHorn (+5%), Capital Grille (+6.7%), Bahama Breeze (+5.7%), Eddie V’s (+5.7%), Yard House (+1.2%) and Seasons 52 (+1.2%) during the quarter.


DRI: NOT ENOUGH - saless


DRI: NOT ENOUGH - traffic



What Darden’s plan failed to address this morning, was how they are going to turn around Olive Garden and Red Lobster.  Same-restaurant sales and traffic trends have been anemic for the past several years.  We didn’t learn enough about the “Brand Renaissance" initiative at Olive Garden to conclude that it will have a material impact on sales.  After all, they just introduced a hamburger to the menu -- How authentically Italian can their vision be?  In regards to Red Lobster, management is simply pushing it to the side.  There is no real plan to fix it and, to be honest, we’re not even sure it can be fixed.









Separate the Red Lobster Business

The company plans to execute a tax-free spin-off of Red Lobster to shareholders that would close in early FY15.  They will also consider a sale of the Red Lobster business.  No final decision had been made on the form of separation. 


Per page 7 of the company’s investor presentation, the strategic focus of the New Darden and New Red Lobster will be:


New Darden

“Retaining core customers and expanding customer base to grow same-restaurant sales and market share.”

“Selective investment in expanding customer base and new unit growth to drive cash flow growth and growth in return of capital to shareholders.”


New Red Lobster

“Retaining core customers to maintain stable same-restaurant sales.”

“Consistent and stable cash flow generation to support stable return of capital to shareholders.”


THE HEDGEYE TAKE: This plan is a desperate, yet unfulfilling attempt to appease shareholders.  In fact, this separation doesn’t solve much other than removing an underperforming brand from the portfolio.  Fixing Olive Garden should be management’s number one priority.  Our vision of the New Darden properly aligns Darden’s brands and organizes the portfolio in a way that would be beneficial to each NewCo.





Reduce Unit Growth, Lower Capex, and Forgo Acquisitions

The reduced unit growth will come primarily from Olive Garden, where management plans to halt any new unit growth for at least a few years.  They also plan to slightly slow unit growth at LongHorn and expect unit growth at the Specialty Restaurant Group to be slightly lower next fiscal year.  This unit growth reduction is estimated to save approximately $100 million in capital expenditures per year.  In an effort to allay concerns over the company’s oversized portfolio, management also announced that it will forgo acquisitions of additional brands for the foreseeable future.


THE HEDGEYE TAKE: Similar to Darden’s plans to spin-off the Red Lobster business, these initiatives simply aren’t enough.  In our opinion, the company needs to stop growing altogether.  We believe management is cutting capital expenditures to cover their dividend this year.  In a sense, they aren’t slowing growth because they want to, they are slowing it because they have to.



Increase Cost Savings

Through support cost management, the team expects annual savings of $60 million beginning in FY15.  This is slightly up from the $50 million in annual savings the company announced last quarter.  They plan to continue the search for cost efficiencies.


THE HEDGEYE TAKE: There’s nothing new here.  We actually view this news as disappointing.  Darden’s business is riddled with excessive spending.  For management to only find an additional $10 million in annual cost savings is, at the very least, discouraging.



Increase Return of Capital to Shareholders

The company plans to use the reduction in capital expenditures and additional cash flow from savings to fund dividends, make opportunistic share repurchases, and strengthen its credit profile.  They intend to maintain their $0.55 quarterly dividend.


THE HEDGEYE TAKE: This is one of the only things Darden has been good for over the past several years.  As we stated earlier, we believe they were forced to cut costs in order to maintain the current quarterly dividend.



Refine Compensation and Incentive Programs

The company plans to refine compensation and incentive programs for senior management to more directly emphasize same-restaurant sales performance and free cash flow growth.  The company currently rewards management for growing sales and earnings.


THE HEDGEYE TAKE: There weren’t too many details provided with this, but it sounds like a step in the right direction.  Compensation and incentive programs, however, should be very far down the priority list if the team is serious about fixing the business and unlocking shareholder value.




A number of analysts appeared agitated on the call, particularly in regards to management’s loose projections for FY15.  Analysts appeared concerned with the authenticity of the strategic plan, the feeble cost cuts, the potential for a REIT or sale leaseback, and whether meaningful value would be created through the spin-off of Red Lobster.




We don’t believe the initiatives announced today are enough to unlock the true, underlying value of Darden.  Quite frankly, it seems as though these moves were made simply because management had to do something.  Spinning off Red Lobster, slightly slowing growth, and cutting capital expenditures to fund the dividend does very little to help fix the business.


The company’s number one priority should be turning around Olive Garden.  It is a strong, iconic brand that should be the leader in the casual dining category.  This starts with getting the right management team in place that will harness the brand’s authentic Italian heritage.


Following the call, we are as convinced as ever before that this is not the final step.  We expect to see more activist pressure in the coming months and believe that Darden will eventually be properly restructured; if this is the case, there will be significant shareholder value to be had.  As we've said before -- we know how this will end, we just don’t know when.



Recent Notes

12/17/13 – Best Idea Update: Long DRI

12/11/13 – Restaurant Impossible: Fixing Olive Garden

10/30/13 – DRI: Pending FY2Q14 Disaster?

10/18/13 – Dismantling Darden: Hedgeye vs. Barington

10/15/13 – DRI: A Generational Opportunity

 9/12/13 – Dismantling Darden

 8/21/13 – DRI: Restructuring Charge Looming?

 6/26/13 – DRI: Beware of False Narratives

 6/21/13 – DRI Comps Flatter to Deceive

 6/17/13 – DRI Remains a Win-Win

 5/23/13 – DRI’s Jamie Question



Let us know if you have any questions or would like to discuss anything in more detail.



Howard Penney

Managing Director


[video] McCullough: 3 Things You Need to Know Right Now


Takeaway: Today marks the first week of bona fide soft data in a long time. Confidence, meanwhile, remains resurgent.

This morning’s Initial jobless claims data reflected a second week of deterioration for the domestic labor market.  While the broader trend remains healthy and seasonality will continue to build as a tailwind, the recent softness is noteworthy in that there is no discrete, identifiable distortion other than the seasonal volatility that generally characterizes the peri-holiday period.  We wouldn’t read too much into the recent advance in claims, but it is worth a flag.   


Confidence, meanwhile, remains resurgent with bloomberg’s weekly read on consumer confidence recapturing the elusive 20-handle as the post-government shutdown hangover in populace sentiment continues to ebb.  We’ll get the final University of Michigan reading on Monday, but the preliminary data showed a positive inflection similar to that observed in the bloomberg survey.   


The U.S. dollar has moved in lockstep with monthly confidence over the past year and, now, with the taper announcement on the tape and the dollar recapturing the $80.15 TRADE line, we’re vapidly optimistic we could see a return to sustainable, #StrongDollar led growth into 2014.


Below is the breakdown of this morning's claims data from the Hedgeye Financials team along with some sector specific insight.  If you would like to setup a call with Josh or Jonathan or trial their research, please contact 


- Hedgeye Macro




 INITIAL CLAIMS: SPEED BUMP - USD Pheonix or forlorn 121613




INITIAL CLAIMS: Should We Be Concerned?

The labor data has softened now for two weeks in a row. The first week of weak data (two weeks ago) represented a seasonal mismatch and wasn't anything overly noteworthy. The second week - the most recent week - however, showed a more legitimate soft patch in the data.


Normally, we see a surge in claims following black Friday representing the seasonal layoff of retail workers. Then, in the following week we see claims drop sharply. For reference, the average increase in claims from post-Black Friday layoffs over the last six years has been 175,000 (NSA). The subsequent decline in claims has averaged 91,000. That works out to a 52% reduction in the post-black Friday surge. This year, we saw an increase of 147,000 post-black Friday followed by a decline of 48,000, or right around a decline of 1/3 - well below the normal retracement. We'll keep a close eye on the trends into year-end.


Separately, with the Fed finally tapering its bond purchases we think it's important to remind investors of the setup going into the new year. Remember that the labor market has a built in tailwind that strengthens steadily from September through February, peaking in February/March and then reversing, and, ultimately, troughing in August/September.


This should be supportive of rising rates through 1Q14. We've shown rate correlations across the Financials over the bulk of 2013 and we would expect that the playbook through the next 2-4 months should mirror that. For more information on how to position in that environment, see our note from 11/22/13 entitled #Rates-Rising: A Current Look at Rate Sensitivity Across Financials.


The Data

Prior to revision, initial jobless claims rose 11k to 379k from 368k WoW, as the prior week's number was revised up by 1k to 369k.


The headline (unrevised) number shows claims were higher by 10k WoW. Meanwhile, the 4-week rolling average of seasonally-adjusted claims rose 13.25k WoW to 342.25k.


The 4-week rolling average of NSA claims, which we consider a more accurate representation of the underlying labor market trend, was -7.7% lower YoY, which is a sequential deterioration versus the previous week's YoY change of -13.0%











Joshua Steiner, CFA


Jonathan Casteleyn, CFA, CMT


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