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CAKE: RISK PROFILE RISING

Takeaway: From Bull to Bear, we briefly run through our short thesis following our conference call.

We added CAKE to the Hedgeye Best Ideas list as a SHORT yesterday at $47.51 per share.

 

Click here to access the presentation: NEW BEST IDEA: SHORT CAKE

 

 

IT’S BEEN A GOOD RUN

We have been bullish on CAKE for the better part of the past two years, but in this industry nothing lasts forever.  In full disclosure, CAKE is a strong company with a good management team, so we will be disciplined with this short call.

 

The bottom line is that 2014 is setting up to be a difficult year for the company.  To summarize our thesis, we believe the company’s three year run in improving margins is coming to an end.  Specifically, we believe the declines in food costs, labor costs, and other costs have run their course.

 

Traffic has declined for four straight quarters, a trend that management must address soon.  This suggests that 2014 could see an increase in labor and other costs as the company reinvests in store operations.  Factor in the minimum wage increases and the ACA, and it is clear that incremental pressure is beginning to build.

 

 

LOOKING AHEAD TO 4Q13 EARNINGS

CAKE is scheduled to report 4Q13 EPS on 2/12.  Current consensus estimates suggest the company will report 2.0% same-store sales at the Cheesecake brand and 1.9% on a consolidated basis.  This would represent a slight slowdown in 2-year same-store sales trends of 30 bps.  We believe that those estimates are aggressive and have not been adjusted lower during the quarter despite sluggish industry sales trends.

 

On the 3Q13 earnings call, the company gave fairly aggressive guidance for 4Q13, due to the easy comparisons from a year ago.  The 0.9% comp from last year was the lowest of the 2012 and was impacted by the Presidential debate, Election Day, and Hurricane Sandy. 

 

Management commented on the 3Q13 call: “The housing market continues to recover, the stock market is up, there really doesn’t appear to be any negative calendar issues or holiday shifts that are impacting the fourth quarter.  I think that Thanksgiving and Christmas, there’s one less week between Thanksgiving and Christmas.  We don’t really think that’s going to impact us.”

 

However, one less week seemed to have an impact on a number of retailers this holiday season.  We are unsure why CAKE would be immune to these trends.

 

Consolidated revenues are expected to grow 4.1% in 4Q13 vs 3.5% in 3Q13, but we believe these numbers may also be aggressive given slower than anticipated 4Q13 trends.

 

Furthermore, the company is guiding to EPS of $0.57-$0.60 in 4Q13, based on a range of same-store sales between 1.5-2.5%.  The street is assuming the company delivers at the high end of the EPS range, currently registering at $0.59.  The current guidance for 2014 is for EPS of $2.29-$2.41, based on a range of same-store sales growth between 1-2%. 

 

 

FOOD COST INFLATION WILL BE AN ISSUE IN 2014

In our opinion, the largest issues the company will face in 2014 is food inflation.  This becomes an even bigger issue considering management has limited pricing flexibility given the decline in traffic over the past four quarters.  Can they protect margins without perpetuating the recent decline in traffic?

 

Management is guiding to food cost inflation of 4-5% in 2014, driven primarily by shrimp and, to a lesser extent, salmon.  The company estimates this could impact 2014 by as much as $0.07-$0.10. 

 

As management stated on the 3Q13 earnings call: “We believe that we will be able to offset some of this pressure with slightly higher pricing, balancing our need to protect guest traffic and protecting our margins.  As a result, we factored in a net of about $0.04 to $0.07 into our 2014 earnings per share sensitivity.”

 

However, management failed to account for the spike in milk and cheese prices we are seeing early on in 2014.  In our opinion, this will add significant incremental pressure to the food cost line and will force management to lower their 2014 earnings guidance.  We run through this thesis in our presentation, including more thoughts on the topics, our earnings sensitivity analysis and the notion that management will be “in a box” in 2014.

 

If you haven’t already, we encourage you to read through the slide deck.  As always, we are available to talk.  Please feel free to call any questions. 

 

CAKE: RISK PROFILE RISING - 1

 

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CAKE: RISK PROFILE RISING - 5

 

 

Howard Penney

Managing Director



SHORT CAKE: CONFERENCE CALL TODAY 1PM

We’re hosting a quick conference call TODAY at 1pm EST to hit on the key points of our thesis and field questions. Please send any questions over to .

 

We added CAKE to our Best Ideas list as a high conviction SHORT yesterday.

 

After being the bull on CAKE for the majority of 2013, we have reversed course and turned bearish heading into the 4Q13 print and throughout 2014 for several reasons including, but not limited to:

  • The secular decline of the casual dining industry
  • The end of the road for CAKE’s margin story
  • Growing complacency on the street

Trading at a peak multiple, we see 20-30% downside to the stock in 2014 as full-year earnings estimates and expectations are revised down.

 

Click here for the full report: CAKE: BEST IDEA SHORT

 

Call Details:

Toll Free Number:

Direct Dial Number:

Conference Code: 331331#

 

 

Howard Penney

Managing Director


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[podcast] McCullough: What's Working (And What's Not)

Hedgeye's Keith McCullough discusses #GrowthDivergences (a Q1 Hedgeye Macro Theme) on this morning's Macro Conference Call, what countries and S&P sectors are winning (and losing), and where investors should be focusing their attention.

 


Contrasting Winners & Losers

Client Talking Points

ASIA

That smell you’re smelling? It’s Asia from an equity market perspective. It stinks.  All the majors have major issues. Despite what’s been a pretty decent week for US stocks, Asian stocks evidently did not care. Just go down the Asian line for 2014 year-to-date. China is down -5.3%, Japan is down -3.4% and South Korea is down -3.3%. 

UK

UK economic data looks nothing short of fantastic. Check out the retail sales number ripping +5.3% year-over-year in December; that’s versus 2% in November (which itself was a good number). Note to Keynesians who burn currency: Strong pound? It’s a good thing. Strong purchasing power? Good thing.  Incidentally, European stocks continue to crush it year-to-date. Check out Spain, up another +0.3% this morning to +6.4% year-to-date. Yes, we stand by our #EuroBulls Macro Theme. Bottom line is it’s been a fantastic start of the year in Europe. 

S&P 500

Look at Consumer Discretionary (XLY) and even Consumer Staples for that matter. Both of them are broken now from an immediate-term trade perspective in our Hedgeye model. This is A) new news and B) bad news. The XLY is down -2%. That stands in stark contrast to Healthcare which is up 3%. 

Asset Allocation

CASH 27% US EQUITIES 18%
INTL EQUITIES 20% COMMODITIES 8%
FIXED INCOME 0% INTL CURRENCIES 27%

Top Long Ideas

Company Ticker Sector Duration
DRI

Darden is the world’s largest full service restaurant company. The company operates +2000 restaurants in the U.S. and Canada, including Olive Garden, Red Lobster, LongHorn and Capital Grille. Management has been under a firestorm of criticism for poor performance. Hedgeye's Howard Penney has been at the forefront of this activist movement since early 2013, when he first identified the potential for unleashing significant value creation for Darden shareholders. Less than a year later, it looks like Penney’s plan is coming to fruition. Penney (who thinks DRI is grossly mismanaged and in need of a major overhaul) believes activists will drive material change at Darden. This would obviously be extremely bullish for shareholders and could happen fairly soon driving shares materially higher.

GHL

Hedgeye's detailed and constructive view on the improving fundamentals in the M&A market with a longer term perspective is a contrarian idea at odds with the rest of the Street which is overly focused on short-term results. From an intermediate term perspective, M&A is poised to break out in 2014. We are witnessing record amounts of cash on corporate balance sheets, continued low borrowing costs and the first positive fund raising round for Private Equity in four years. Moreover, a VIX in secular decline (this has historically benefited M&A), recent incrementally positive data points from leading M&A firms that dialogue has improved, and an improving deal tally from Greenhill & Company (GHL) themselves coming out of the summer all bode favorably for GHL. So is a budding European economic recovery that would assist a global M&A market that has been range bound over the past three years. GHL stands out as a leading beneficiary of these developments.

FXB

We remain bullish on the British Pound versus the US Dollar, a position supported over the intermediate term TREND by prudent management of interest rate policy from Mark Carney at the BOE (oriented towards hiking rather than cutting as conditions improve) and the Bank maintaining its existing asset purchase program (QE). UK high frequency data continues to offer evidence of emergent strength in the economy, and in many cases the data is outperforming that of its western European peers, which should provide further strength to the currency. In short, we believe a strengthening UK economy coupled with the comparative hawkishness of the BOE (vs. Yellen et al.) will further perpetuate #StrongPound over the intermediate term.

Three for the Road

TWEET OF THE DAY

In hindsight, this $RH selloff will prove to be one of the best buying oppties this year in retail. Liked it a lot at $28. Love it at $57. @HedgeyeRetail

QUOTE OF THE DAY

"I know where I'm going and I know the truth, and I don't have to be what you want me to be. I'm free to be what I want." -Muhammad Ali

STAT OF THE DAY

Sochi is preparing to host the most expensive Olympic Games ever at a cost of about $50 billion. The staggering price tag, which includes a major upgrade to Sochi's infrastructure, outstrips the $40 billion China is thought to have spent on the Beijing Summer Games. And it's more than three times the cost of London 2012. (CNN)


January 17, 2014

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BULLISH TRENDS

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BEARISH TRENDS

January 17, 2014 - Slide10

January 17, 2014 - Slide11
January 17, 2014 - Slide12

 


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