“If we lack emotional intelligence, whenever stress rises the human brain switches to autopilot and has an inherent tendency to do more of the same, only harder. This, more often than not, is precisely the wrong approach in today’s world.”
- Robert K. Cooper PhD
Robert Cooper is a neuroscientist and strategic advisor to CEOs and many Fortune 500 companies. Taking on the work that Dr. Cooper requires is certainly not easy. According to Cooper, your brain is organized to reflect everything you know in your life. Or, in other words, your brain is a record and an artifact of your past.
Consistent with this line of thought, Cooper poses the following question: Does your environment control your thinking or does your thinking control your environment?
To help you ponder, we ask the following questions:
- What does your daily routine look like?
- Did you wake up today and hop out of bed on the same side?
- Did you shut your alarm off with the same hand?
- Did you go to the bathroom like you always do?
- Did you shower and follow the same grooming routine?
- Did you dress the way your coworkers expect you to dress?
- Did you follow the same breakfast routine and do you get angry when the morning commute to work is just slightly off the normal pace?
I’m sure many of you will find that you often revert back to a routine in life you are comfortable with or, in Layman’s terms, the same-old, same-old life. This is considered living life inside your box and it is much more prevalent among us and our colleagues than we’d like to acknowledge.
Admittedly, this may be too much philosophical thinking for a Friday morning. But, the metaphor of switching to autopilot during rising levels of stress could be the norm for a CEO whose company you have invested hundreds of millions of dollars in and whose stock is underperforming. Isn’t this a scary thought? What if this routine keeps him/her in survival mode and prevents him/her from making the right decisions for the company he/she is running?
Back to the Global Macro Grind…
I often refer to this decision making process in the restaurant space as the “6 Stages of Grief.” This is a cycle that some companies tend to go through before they can see life outside the box. As I see it, today’s activist investors provide a version of neurological therapy for this grief.
Unfortunately, the news of an activist investor can actually provoke a series of decisions based on past experiences that might be inconsistent with what is appropriate for today’s environment. When an activist investor arrives on the scene, it’s only natural that “as stress rises, the human brain switches to autopilot and has an inherent tendency to do more of the same, only harder.”
Whether it’s a letter from Dan Loeb saying you’re an idiot or a letter that says “we look forward to maintaining an open dialogue and working with you to ensure that value is created for all shareholders,” either one could put management on the defensive and get them to react in ways that could potentially destroy shareholder value.
Sadly, this is precisely the path of destruction that the CEO of Darden Restaurants is headed down.
As I said earlier this week, the challenge for the Board members of Darden (or any Board) is to recognize the appropriate time to step up, break out of their box, and implement meaningful change. It is their challenge, their job, and their responsibility not to be more of the same.
When a Board works closely with a CEO for a number of years, the best interest of shareholders’ can become fuzzy. As an outsider, it appears that this is the case with the current Board and Chairman/CEO Clarence Otis. The operational performance of DRI has stagnated and it is, without question, time for a significant change.
As Keith said in yesterday’s Early Look, we are short a significant number of restaurant names. On yesterday’s earnings call, the CEO of Starbucks, Howard Schultz, went out of his way to emphasize the decline in bricks and mortar retailing. Starbucks was wisely in a position to win in this environment. Mr. Schultz is a great example of a CEO, at least in my space, that is willing to take on the difficult task of recognizing when and where he can strengthen his company.
To be honest, I welcome the commentary about bricks and mortar retailing as it relates to my short call on CAKE. My original thesis was shorter term, but his comments could make our bearish call on CAKE more secular in nature. In the short run, however, we believe the price spikes in the dairy complex are unaccounted for and suggest that EPS estimates are too aggressive for the company in 2014.
Moving on to a broader concept, the biggest risk to the consumer and restaurant space in 2014 is our MACRO theme of #InflationAccelerating. The CRB Index, milk, cheese, natural gas, cattle, hogs and coffee are all up more than the S&P 500, as gold continues to signal higher lows. With the Bloomberg Consumer Confidence Index flat week over week at -31, sluggish Per Capita Disposable Income, and a stagnant job market, it could be challenging for most companies to take price in order to offset inflation.
The irony of all this is that one of the few names I like on the long side is Darden Restaurants. The CEO’s tendency is to do more of the same, only harder. While I’m typically not a proponent of this line of action, it has indeed created a significant opportunity for a lot of money to be made.
It has also provided me with the material for a scathing attack on what has arguably been the largest case of value destruction in Casual Dining history. For the record, if you’re reading this Mr. Loeb, I have everything you could possibly need to write your best letter yet.
Function in disaster, finish in style.
TODAY’S S&P 500 SET-UP – January 24, 2014
As we look at today's setup for the S&P 500, the range is 28 points or 0.03% downside to 1828 and 1.51% upside to 1856.
*Levels as of 1/23/14
CREDIT/ECONOMIC MARKET LOOK:
- YIELD CURVE: 2.40 from 2.42
- VIX closed at 13.77 1 day percent change of 7.24%
MACRO DATA POINTS (Bloomberg Estimates):
- No major data releases
- 7:05am: BoE’s Carney speaks at Davos
- 12pm: ECB’s Draghi speaks at Davos
- 1pm: Baker Hughes rig count
- Sec. of State John Kerry attends talks on Syria in Montreux
- Treasury Sec. Jack Lew, Commerce Sec. Penny Pritzker attend Davos
- House not in session, Senate meets in pro forma session
- 10:30am Chairman Reince Priebus addresses Republican National Cmte winter meeting
- 11:30am Homeland Security Sec. Jeh Johnson speaks at U.S. Conference of Mayors winter meeting
- 1:30pm Gov. Rick Snyder, R-Mich.; former NYC Mayor/Bloomberg LP founder Michael Bloomberg discuss economic case for immigration reform
WHAT TO WATCH:
- Samsung profit growth slows as iPhones win sales, won gains
- Ziggo says talks to be taken over by Liberty making progress
- Starbucks sales trail estimates as U.S. growth decelerates
- McKesson to purchase Celesio in deal after earlier offer failed
- China bank regulator said to issue alert on coal mine loans
- Qualcomm acquires patents from Hewlett-Packard, including Palm
- JPMorgan’s Jamie Dimon said to get increased compensation: NYT
- Morgan Stanley gives Gorman $5.06m of shares for 2013
- Jana partners takes big stake in Juniper: Reuters
- Goldman may ban some person-to-person instant messaging: WSJ
- BofA may buy own stake held by Korea Investment Corp: Maeil
- Boeing to give ANA order discounts as 787 compensation: Nikkei
- CNN says some of its social media accounts were compromised
- AT&T unlikely to bid for Vodafone in near-term, Oriel says
- U.S. says no leeway in Iran oil exports based on inflated data
- FOMC, Yellen, Obama’s address, Egypt: Week Ahead Jan. 25-Feb. 1
- Bristol-Myers Squibb Co (BMY) 7:30am, $0.43 - Preview
- Covidien PLC (COV) 6am, $0.94 - Preview
- First Niagara Financial Group (FNFG) 7:15am, $0.20
- Honeywell International (HON) 7am, $1.21 - Preview
- Kansas City Southern (KSU) 8am, $1.10
- Kimberly-Clark (KMB) 7:30am, $1.39 - Preview
- Procter & Gamble Co/The (PG) 7am, $1.20 - Preview
- Stanley Black & Decker (SWK) 6am, $1.30
- State Street (STT) 7:30am, $1.19 - Preview
- WW Grainger (GWW) 8am, $2.62 - Preview
- Xerox (XRX) 7am, $0.29
COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)
- Natural Gas Set for Biggest Weekly Gain Since 2012 on U.S. Cold
- Brent Slumps as Premium to WTI Narrows to Least in Two Months
- Big Data From U.S. Cornfields Spurs Farmer Concerns: Commodities
- Copper Trades Near One-Month Low Amid China Credit-Risk Concern
- Wheat Snaps Seven-Week Slump as Freezing U.S. May Harm Crops
- Gold Extends Gains in London, Rising to Highest Since November
- Libya Oil Growth Crimped as Gunmen Block Eastern Port Hariga
- Cocoa Advances as Lower Reserves Add to Shortage; Coffee Falls
- Rebar Rises for First Week in Seven After China Money Rates Drop
- Platinum Talks Today Will Seek End to Pay Strike Crippling Mines
- Colder Weather Forecast for U.S. as Freeze Brings Texas Ice
- Vitol to Trafigura Chasing U.S. NGLs as Traders Cash In: Energy
- Curtailment, Trucks, Contracts Are Aluminum Themes: 2014 Outlook
- Super Bowl Fans Eat 1.25 Billion Wings as Corn Crop Lowers Costs
The Hedgeye Macro Team
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This note was originally published at 8am on January 10, 2014 for Hedgeye subscribers.
“One friend in a lifetime is much; two are many; three are hardly possible. Friendship needs a certain parallelism of life, a community of thought, a rivalry.”
As many of you may have noticed already, my colleagues and I have a bit of a fascination with the sport of hockey. In particular, Ivy League hockey, since many of us played at Yale (and our firebrand energy analyst Kevin Kaiser played at Princeton). So, if you will, please tolerate my enthusiasm for just a minute here as this weekend is effectively our Super Bowl.
Specifically, this Saturday at 8pm Yale will be playing Harvard at Madison Square Garden. In as much as I would like to wish my friends at Harvard good luck this weekend, I would, honestly, not really mean it. But I sincerely do hope the Crimson don’t totally embarrass themselves, or next year we will have to invite Cornell to play us on the world’s biggest hockey stage.
Now admittedly Harvard did once win a NCAA championship, albeit it was more than three decades ago. On the other hand, Yale is the defending NCAA champion and over the last five years has amassed a record of 111 – 53 – 12. Over the same period, Harvard hockey is 53 – 87 – 24. As if having Larry Summers on their team wasn’t bad enough... ;)
In Malcolm Gladwell’s new book, “David and Goliath”, he digs into the idea that underdogs do disproportionately well in competition. He cites a study from political scientists Ivan Arreguin-Toft that looked at all wars between small countries and much larger countries over the past two hundred years. He found that the much larger country only win 71.5% of the time. Further as Gladwell writes:
“What happens in wars between the strong and the weak when the weak side does as David did and refuses to fight the way the bigger side wants to fight, and instead uses unconventional or guerilla tactics. The answer: in those cases the weaker party’s winning percentage climbs from 28.5% to 63.6%. To put that in perspective, the United States population is ten times the size of Canada’s. If the two countries went to war and Canada chose to fight unconventionally, history would suggest you ought to put your money on Canada.”
So, who knows, if Harvard hockey were to do something totally unconventional, like say put their football team on skates, maybe they will have a chance this weekend!
Back to the Global Macro Grind...
Yesterday, Keith presented our top three global macro themes for Q1 2014. Like clockwork, we’ve been doing these themes for the last five years. Those three themes are as follows:
- #InflationAccelerating – CPI comparisons globally are easy and commodities are basing, as a result we are expecting a re-acceleration in reported inflation. From a sector perspective, the three sectors we like in this scenario are technology, healthcare and energy;
- #GrowthDivergences – This could be the year in which global growth divergences increasingly matter for stocks, especially as rates begin to normalize, and Europe looks set up to see accelerating economic growth. Conversely, we are starting to question whether Japan’s recovery is losing steam; and
- #FlowShow – In a world in which 75% of the global financing stock outstanding is in debt, there is a lot money that can flow out of bonds and into equities. In the Chart of the Day below, we again emphasize that the ratio of debt-to-equity was 50/50% in 1999.
One key supporting point for the idea that Europe could well be the global growth leader, at least on a percentage change basis, is the fact the European sovereign debt markets have all but recovered. Remember that sovereign debt crisis from a few years ago? Well, the European credit markets barely do.
This morning the Spanish 10-year yield is trading at 3.70%. This is a mere 74 basis points wider than the U.S. 10-year yield. In fact, last night Spain kicked off its funding program and raised $7.2 billion in five year debt, overshooting its target. Further, this debt was sold at 2.411%, which was the lowest funding rated of the Euro era for Spain.
Now in the long run, the Spanish economy still has excesses built up from the parabolic housing bubble it experienced. Nonetheless, in the short run as the likes of Spain, Italy, France and Portugal are able to sell debt at reasonable rates, this is both a real positive for their governments and their governments’ ability to spend, but more importantly for banks. As broad borrowing rates go down, this will eventually filter back to corporations who can then borrow at low rates to more aggressively fund capital expenditures and expand.
Since we are on the topic of housing, I should flag that the U.S. housing market is at the top of our list for worries as it relates to the U.S. economy. In fact, mortgage applications are down 22% from their 2014 peak reading.
Even if it’s not clear yet that housing headwinds will derail the U.S. economy, it is setting up for some interesting short ideas. In particular, our Financials team just added Nationstar Mortgage (NSM) to our Best Ideas list this week. Previously, this had been a top long idea for us, which played out well as our earnings estimates were higher than the consensus.
Conversely, our view is now that the consensus earnings estimate of north of $5 for 2014 could come in as low as $1.
Now, how’s that for a downside surprise?
We are doing a deep dive on the name and will outline the thesis this Monday at 11am EST. (Email email@example.com to subscribe for access.) NSM trades more than $30 million in volume per day, so there’s lots of stock out there to short, especially if you believe our Financials team that the best case scenario is that the stock will get cut in half.
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research
McDonald’s reported mediocre 4Q13 results this morning, as revenues ($7.093B) and global comp sales (-0.1%) missed expectations of $7.106B and +0.5%, respectively. EPS, however, surprised to the upside ($1.40) versus expectations of $1.39. 4Q was highlighted by disappointing performance across the board, save for Europe, which delivered respectable comp sale growth led by strength in France, the UK and Russia. December was the weakest month in 4Q, highlighted by disappointment in every region.
4Q Same-Store Sales
- Global: -0.1% vs +0.5% (consensus estimate)
- United States: -1.4% vs -0.2% (consensus estimate)
- Europe: +1.0% vs +1.1% (consensus estimate)
- APMEA: -2.4% vs -1.3% (consensus estimate)
Overall, 2013 proved to be another subpar year for MCD as the company only managed to grow EPS by 3% on 2% revenue growth. As management reiterated several times on the call, top line sales are critical to driving continual margin improvement and to the overall health of the business. This growth has been difficult to come by, however, as full year global comp sales (+0.2%) missed expectations of +0.5%. After a less than stellar two years, it is no surprise that global same-store sales continue to decline on a two-year basis.
We have been bearish on MCD for quite some time now and continue to believe the company has issues in its underlying, core business. While we believe management has realized they have problems, we have little faith that they have found the proper solutions.
To their credit, they have been proactive in their attempt to reverse the current downward momentum of the business. To this extent, they recently introduced a number of initiatives (Dollar Menu and More, new refrigerators, high density prep tables, additional drive thru windows) to operationally “enhance” the U.S. business. However, these initiatives are not guaranteed to improve operations and, in fact, could negatively impact the business.
Franchisees have voiced their discontent with the Dollar Menu and More, noting that it provokes customers to order multiple, smaller margin, products rather than a single, higher margin, product. This tends to slow service times. Another complaint is menu complexity. We have called for MCD to simplify their menu multiple times. This would not only help customers order meals quicker and help the kitchen deliver the food faster, but also improve speed of service, the guest experience and franchisee morale. Instead, MCD continues to try to be all things to all people. This desire has led to the manifestation of high density prep tables which are being put in place, at least hypothetically, to organize the kitchen, allow for additional customization, and speed service times. How those last two points correlate, however, is lost on us. We think this level of customization could in fact slow production times – a concern that has been shared by multiple franchisees. We questioned management on this point during the earnings call, to which they pointed out that the additional capacity would help organize the kitchen by keeping employees relatively stationary and eliminating cluster. Although we could be wrong, this response did not do much to allay our concerns.
We often hear the bulls refer to MCD’s structural advantages (global footprint, strong asset base, significant FCF generation, etc) in support of the stock. While these are important, they shouldn’t give anyone reason to ignore a slowing top line. The fact of the matter is, the street is still too bullish on McDonald’s in 2014. The company delivered 2% and 3% EPS growth on 2% and 2% revenue growth in 2012 and 2013, respectively. What would make anyone believe they will deliver 7% EPS growth on 5% revenue growth in 2014? Personally, we do not have enough confidence in the sales drivers management has in place to make this leap of faith.
When we look at the overall business, we see a challenged top line that has shown zero signs of improvement, declining traffic, shrinking margins, and a diminishing competitive advantage. With that being said, we believe 2014 expectations will be revised down over the course of the year and lead to multiple contraction.
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