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Investment Ideas: Shorts

The Cheesecake Factory Incorporated (CAKE)

Details: We’ve been bullish on CAKE for the better part of the past two years, but we believe margin pressure is building and the bar is set too high for FY14.  To be clear, this is not a structural short.  CAKE is a strong company with a good management team, so we will be disciplined with our call.

 

Traffic: Traffic has declined for the past five quarters at CAKE and the macro backdrop hasn’t been encouraging.  We believe the casual dining industry is in secular decline as it continues to lose market share to select fast casual and quick service players.  Mall traffic has also been weak as consumers are increasingly shopping online.  CAKE has significant exposure to malls, but management has denied a link between mall and restaurant traffic.  We contend that this dynamic presents a headwind for CAKE, not matter how minimal it presently is. 

 

Margin Pressure: CAKE needs to drive positive traffic soon.  As a result, we expect them to reinvest in labor and other expenses in order to attract more visits and increase frequency.  Minimum wage increases and the looming ACA are also expected to pressure margins.  Our biggest concern, however, is on the cost of sales line as food inflation has accelerated meaningfully in 2014.  Management guided to 3-4% food inflation in FY14, due in large part to rising shrimp and salmon prices which are up +60.8% and +10.4% YoY, respectively.  We believe dairy prices are causing incremental pressure on the COGS line, as the surge in milk and cheese prices has been more resilient than most anticipated.  These two commodities are up +36.6% and +17.5% YoY, respectively.  Management previously noted that they only have 40% of dairy needs locked in for FY14.  The street only estimates cost of sales as a % of revenue to increase 8 bps for the full year.  We believe this is very unlikely.

 

Guidance: Management guided down 1Q14 numbers on the 4Q13 earnings call, but maintained full-year guidance.  As such, the stock has been quite resilient.  We believe the bar is too high and expect management to guide down FY14 numbers on the 1Q14 earnings call.  FY14 EPS estimates have come down slightly, from $2.38 to $2.36, only to reflect a disappointing first quarter.  Full-year estimates look achievable if commodities ease in the back half of 2014, but we’ve seen no signs of this happening.  FY15 estimates for 16% EPS growth on 8% sales growth continue to look aggressive.

 

Valuation: CAKE trades at 20.07x P/E and 9.08x EV/EBITDA on a NTM basis.

 

Investment Ideas: Shorts - chart1

 

Investment Ideas: Shorts - chart2

 

Bloomin’ Brands

Details: It’s difficult to find a compelling company in the casual dining industry that has a large, complex portfolio of brands.  We believe the casual dining industry is in secular decline.  According to Malcolm Knapp, 2013 marked the eighth consecutive year of same-restaurant traffic declines.  In the new age of casual dining, the brands that focus on doing one thing right are the most successful.  Companies with large, diverse portfolios are at greater risk of missing the numbers than smaller, more nimble players.

 

Sales Trends: Two-year same-store sales trends across all four of BLMN’s main concepts are deteriorating.  As a result, management has been rolling out weekday lunch at Outback and Carrabba’s.  We contend this is to mask a decline in the core dinner business.  As a result of the lunch rollout, we expect same-store sales trends to outperform the Knapp Track Index.  We believe BLMN will run into trouble at some point in 2H14 and beyond as they begin to lap the lunch rollout.  Bonefish Grill, the portfolio's “growth vehicle,” has had same-store sales decline on a two-year basis since 1Q12.

 

Margins: BLMN has some of the worst operating margins in the restaurant industry.  Despite the efficiencies management has claimed to achieve, operating margins as a % of sales have mostly remained flat since 1Q11.  We believe this is a primary reason why BLMN opted to acquire its Brazilian JV late last year.  We expect food costs in FY14 to pressure margins more than the street expects and believe the street is too aggressive in its labor cost leverage assumption.  We believe margins will be pressured for the majority of 2014.  FY14 consensus estimates have been cut in half to 10% EPS growth on 8% sales growth.  The real disconnect comes in FY15, with the street expecting 20% EPS growth on 7% sales growth.  These estimates are far too aggressive – in fact, we don’t think BLMN will ever grow EPS by 20% in a given year.

 

Valuation: BLMN trades at 18.59x P/E and 8.61x EV/EBITDA on a NTM basis.

 

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Panera Bread Company (PNRA)


Details: PNRA has secular and well-publicized operational issues working against it.  This has led to the vision for Panera 2.0, in which management aims to thrive in a digital future.  We are on board with management’s plans, we just happen to think they will take longer to materialize than consensus.

 

Increased Competition: PNRA has secular forces working against it that didn’t exist a few years ago.  There are more fast casual players than ever before, QSR chains have upgraded looks and menus, and casual dining companies have resorted to discounting.  These chains market their products heavily and offer them at cheaper price points than Panera’s core offerings.  As a result, PNRA has little pricing power and a value equation that is out of sync.

 

Operational Issues: Capacity and throughout issues plagued PNRA in 2013.  As a result, 2014 and 2015 will be heavy investment years.  PNRA must invest to improve its café operating experience by reconfiguring product lines, streamlining menu offerings, offering lower priced items, delivering product consistency and improving speed of service.  We believe Panera 2.0 will address these issues, but it will take significant investment and time to materialize.  PNRA also plans to ramp up its advertising spend in 2H14 with a national cable TV launch.  Will the system be ready to handle incremental traffic as a result?

 

Concerns: We are concerned by a lack of visibility around earnings and the reality is PNRA 2.0 won’t be fully rolled out until the end of FY15.  Management would not commit to higher margins post-rollout, because they don’t know if this is possible.  They also spoke of conscious cannibalization during the Investor Day in late March.  To us, this signals market maturity and indicates that the majority of future growth will be at lower returns as cannibalization and the significant investment (labor and training, IT fees, etc.) that comes with Panera 2.0 take hold.  We expect FY14 and FY15 to be margin compressing years.  FY14 could get a bump from the national advertising rollout, but FY15 estimates of 15% EPS growth on 10% sales growth look aggressive.

 

Valuation: PNRA is trading at 24.6x P/E and 10.76x EV/EBITDA on a NTM basis.

 

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Potbelly Corporation (PBPB)


Details: We’ve been bearish on PBPB since it closed its first day as a public company at $30.77 a share.  We believe Potbelly is a solid company, with a respected management team, but it’s been difficult to justify its valuation considering it competes in the most competitive segment in the restaurant industry.  At its core, PBPB is a single daypart, low margin, low return, local sandwich chain with declining traffic and little competitive advantage over its most basic peers.

 

Fundamentals: Same-store sales and traffic trends continue to be discouraging for a company flagged as a growth chain.  Weather is partly to blame for recent weakness, but the truth it will continue to be a headwind until management diversifies its unit base.  PBPB’s operating model requires sales leverage in order to drive further upside.  We believe 1Q14 will mark the fifth consecutive quarter of traffic declines and another quarter of lower YoY average unit volumes. 

 

Takeaway: We believe PBPB can be a feasible, financially robust company over the long haul, but we continue to see downside in the stock.  Current fundamentals continue to suggest it is overvalued and the FY14 outlook is under pressure.  We’d be tempted to like PBPB at a much lower price, but we need to see the company begin to generate some sustainable same-store sales momentum.

 

Valuation: PBPB is trading at 50.18x P/E and 20.92x EV/EBITDA on a NTM basis.

 

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Howard Penney

Managing Director

 

Fred Masotta

Analyst



Consumer Staples Marginally Outperforms S&P 500

Takeaway: U.S. consumption growth is slowing as inflation rises.

Consumer Staples Marginally Outperforms S&P 500 - wallstreet

Consumer Staples (XLP) outperformed the broader market last week, falling -0.5% versus the S&P 500 at -2.6%. XLP is down -0.5% year-to-date vs the SPX at -1.8%.

 

For a sixth straight week, XLP is bullish on immediate term TRADE and intermediate term TREND durations from a quantitative set-up. This is a material shift as the sector traded bearish TRADE and TREND for the majority of the year-to-date.

 

Consumer Staples Marginally Outperforms S&P 500 - 2

 

Despite the bullish quantitative set-up for the sector, we continue to believe that the group is facing numerous headwinds, including:

 

  • U.S. consumption growth is slowing as inflation rises, in-line with the Macro team’s 2014 Q1 theme of #InflationAccelerating, and Q2 theme of #ConsumerSlowing.
     
  • The economies and currencies of the emerging market – once the sector’s greatest growth engine – remain weak with the prospect of higher inflation in 2014 eroding real growth.
     
  • The sector is loaded with a premium valuation (P/E of 18.8x).
     
  • Less sector Yield Chasing as Fed continues its tapering program.
     
  • The high frequency Bloomberg weekly U.S. Consumer Comfort Index has not seen any real improvement over the past 6 months, and declined to -31.9 versus -30.0 in the prior week.

Consumer Staples Marginally Outperforms S&P 500 - 4

Consumer Staples Marginally Outperforms S&P 500 - 5

Consumer Staples Marginally Outperforms S&P 500 - 6

 

*   *   *   *   *   *   *

 

Editor's Note: This is an excerpt of a research note that was originally provided to subscribers on April 14, 2014 by Hedgeye Consumer Staples Analyst Matt Hedrick. Follow Hedgeye's Consumer Staples sector @HedgeyeStaples.

 

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Relied upon by big institutional and individual investors across the world, this granular morning newsletter distills the latest and most vital market developments and insures that you are always in the know.

CHARTED: A TALE OF TWO CONTINENTS

Aristocrat vs IGT

 

  • IGT’s problems are well documented and discounted in the stock
  • Some were out of the company’s control:  soft North American demand (replacements and new casino) and weak US gaming revenues
  • Meanwhile, Asian focused ALL’s business is much stronger combined with a little bit of a North American resurgence

CHARTED: A TALE OF TWO CONTINENTS - ya

 

Source: Yahoo Finance!


European Banking Monitor: Greek Credit Risk Tightens | $NBG

Editor's Note: This is a complimentary research note from Hedgeye Analyst Matt Hedrick originally provided to subscribers on April 14, 2014 at 11:20 a.m. 

Below are key European banking risk monitors, which are included as part of Hedgeye Financials team's Monday Morning Risk Monitor.  If you'd like to receive the work of the Financials team or request a trial please email sales@hedgeye.com. And, for more information on our services, click here.

 

European Banking Monitor: Greek Credit Risk Tightens | $NBG - greece

 

European Financial CDS –  Swaps across Europe's banking system were little changed (median change = 0 bps), but the Greek banks continue to tighten notably, dropping an average of 40 bps in the past week and 185 bps in the past month. The news that GS & MS will be leading a secondary offering for National Bank of Greece doesn't hurt either.

 

European Banking Monitor: Greek Credit Risk Tightens | $NBG - European Financials CDS  1

 

Sovereign CDS – Sovereign swaps mostly widened over last week. Irish sovereign swaps tightened by -2.7% (-2 bps to 71 ) and Spanish sovereign swaps widened by 7.1% (6 bps to 93).

 

European Banking Monitor: Greek Credit Risk Tightens | $NBG - Sovereign CDS  2

 

European Banking Monitor: Greek Credit Risk Tightens | $NBG - sovereign cds chart  3

 

European Banking Monitor: Greek Credit Risk Tightens | $NBG - sovereign cds chart  4

 

Euribor-OIS Spread – The Euribor-OIS spread was unchanged week-over-week at 13 bps. The Euribor-OIS spread (the difference between the euro interbank lending rate and overnight indexed swaps) measures bank counterparty risk in the Eurozone. The OIS is analogous to the effective Fed Funds rate in the United States.  Banks lending at the OIS do not swap principal, so counterparty risk in the OIS is minimal.  By contrast, the Euribor rate is the rate offered for unsecured interbank lending.  Thus, the spread between the two isolates counterparty risk. 

 

European Banking Monitor: Greek Credit Risk Tightens | $NBG - euribor ois spread  5

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Retail Callouts (4/16): KORS, NKE & ADDY, BBY, GPS

Takeaway: KORS inks new eyewear deal with LUX. NKE & ADDY factory shutdown. BBY retail chief retires after 1yr on the job.

EVENTS TO WATCH

 

WEDNESDAY

  • GPS - Investor Meeting: Wednesday 4/16, 1:00 pm

 

THURSDAY

  • LULU - Analyst Day: Thursday 4/17, 12:00 pm

 

COMPANY NEWS

 

KORS, LUX - MICHAEL KORS ANNOUNCES EYEWEAR LICENSE WITH LUXOTTICA

(http://phx.corporate-ir.net/phoenix.zhtml?c=235654&p=irol-newsArticle&ID=1918813&highlight=)

 

  • "Michael Kors Holdings Limited and Luxottica Group  announced today that they have signed a new and exclusive eyewear license agreement for the Michael Kors Collection and MICHAEL Michael Kors eyewear. The first collection produced with Luxottica will launch in January 2015."
  • "The partnership with Luxottica...will last 10 years. It will allow Michael Kors...to continue the global expansion of the brand’s eyewear business. Luxottica will produce eyewear for both the Michael Kors Collection and MICHAEL Michael Kors lines, beginning with Spring 2015. The brand’s two luxury eyewear collections will be carried around the world in Michael Kors stores, department stores, select travel retail locations, independent optical locations and Luxottica’s retail stores."

 

Takeaway: The deal with LUX partners KORS with the dominant player in the eyewear segment and will give the company a much more prominent place inside Luxottica's retail network. Nice upgrade here for KORS with the Marchon deal set to expire.

 

NKE, ADDYY - China Shoe Plant Strike Disrupts Output at Nike, Adidas Supplier

(http://www.bloomberg.com/news/2014-04-15/nike-shoemaker-yue-yuen-says-over-1-000-china-workers-on-strike.html)

 

  • "Workers at Nike Inc. and Adidas AG shoe supplier Yue Yuen Industrial Holdings Ltd. in Dongguan, China struck for a third day seeking a 30 percent pay increase and better benefits, disrupting output."
  • "The number of striking workers increased today, a spokesman for Hong Kong-based Yue Yuen said, without estimating the number of strikers or affect on production. He asked not to be identified because of company policy. New York-based China Labor Watch estimated strikers at 30,000."
  • "Adidas is 'closely monitoring the situation' at the factory, Katja Schreiber, spokeswoman for the company, said by e-mail today."
  • "Nike 'is concerned by the events' and is monitoring production and the dialog between factory management and workers, Greg Rossiter, a spokesman for the Beaverton, Oregon-based sporting goods company, said in an e-mail."

 

Takeaway: Regardless of the outcome here, its clear that input costs, both material and labor, are headed higher. With Gross Margin turning from a tailwind to a headwind and an incremental $400mm in SG&A we're looking at 9% decline in EPS with the top line growing at 10%. If NKE can't grow EPS at a Nike-esque 20% rate when futures are six months into a DD growth rate, then when will it happen?

 

OTHER NEWS

 

BBY - Best Buy's top U.S. store executive departs

(http://www.startribune.com/business/255243381.html)

 

  • "Seven months after getting a new title, Best Buy Inc.’s president of U.S. retail stores retired and is being succeeded by the retailer’s chief human resources officer."
  • "Shawn Score, a 29-year veteran of the Richfield-based company, was put in charge of its 1,400 U.S. stores in January 2013. He was named president of the unit, the biggest in the company, last October. Best Buy on Monday confirmed the departure of Score, 48, but declined further comment."
  • "Shari Ballard, the human resources chief, will take on Score’s duties. ­Ballard, a 21-year employee, will retain the human resources job, which she got last August after leading Best Buy’s approximately 450-store international unit. She previously was executive vice president of retail channel management. Best Buy said Ballard is a permanent replacement for Score, rather than an interim choice."

 

GPS - Gap Inc. Announces Marissa Webb as Creative Director and Executive Vice President of Design for Banana Republic

(http://www.gapinc.com/content/gapinc/html/media/pressrelease/2014/med_pr_MarissaWebb_CreativeDirector_BananaRepublic.html)

 

  • "Gap Inc. today announced that Banana Republic has named Marissa Webb as Creative Director and Executive Vice President of Design, effective April 28. She will be responsible for guiding the brand’s overall creative direction, as well as leading global product design for Banana Republic Women’s, Men’s, and Accessories.  Marissa will report to Global President of Banana Republic, Jack Calhoun."
  • "...Marissa Webb is most recently known for her eponymous upper contemporary label. Prior to branching out on her own during 2011, she spent time at Polo, Club Monaco and over a decade at J. Crew Group Inc., where she served in various design roles, including Head of Womenswear and Accessories Design.  Webb will retain her role as President and Creative Director at Marissa Webb, in addition to her newly appointed role at Banana Republic. Webb’s first collection for Banana Republic is expected in the summer of 2015."

 

ANN, DXL, DEST - Private equity and retailers court each other

(http://www.thedeal.com/content/consumer-retail/private-equity-and-retailers-court-each-other.php)

 

  • "One of the easier deals, at least on paper, likely to get done this year is a leveraged buyout of Ann Taylor parent Ann Inc., according to industry sources. Leading the line of potential buyers would be San Francisco's Golden Gate Capital, which already took a 9.5% stake in the women's apparel retailer in March. Ann is already working with a financial adviser, a source said."
  • "Two other retailers available for tie-ups with private equity are Destination Maternity Corp. and Destination XL Group Inc., according to industry sources. Those sources said the retailers are often on bankers' lists and have been circulated as potential acquisition targets over the past few years. Either could be targeted…"

 

ADDYY - Adidas Links With Mary Katrantzou

(http://www.wwd.com/markets-news/intimates-activewear/adidas-links-with-mary-katrantzou-7645297)

 

  • "Come November, London-based designer Mary Katrantzou will collaborate with Adidas Originals on a long-term partnership that will consist of a women’s-focused apparel and footwear line."
  • "The designer follows in the footsteps of names like Yohji Yamamoto, Raf Simons and Rick Owens, among others, and will be the first women’s-focused collaboration line since Stella McCartney’s."

 


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