Restaurants - Earnings Fatigue

Continuing the theme from Q1, restaurant companies are beating Q2 EPS expectations by cutting costs. Unlike Q1, a significant earnings beat is no longer driving stocks appreciably higher.  The cost cutting theme is becoming the consensus and not an investable theme that moves stocks. 

Restaurants - Earnings Fatigue - Q2 thus far stock price performance

Here is the drill from a typical company.

The good news:

“We’ve also identified other cost savings opportunities”

“The lower capital spending will go towards boosting our cash balance, further strengthening our balance sheet and increasing our future flexibility. And we will have even more time and resources to focus on operations and execution at our existing base of restaurants.”


“Despite a continued low level of visibility for the rest of the year due to both last year’s volatility and the ongoing economic uncertainty it’s very difficult to know where same-store sales will come in”

So far this earnings season, the stocks are not reacting to the better than expected earnings news.  Stocks performed well post calendar Q1 numbers because for most FSR companies it was the first quarter of operating margin growth in at least two years.  In Q1, restaurant operators proved they could cut costs to offset sales weakness and boost margins.  In Q2, investors seem to be expecting these cost savings and even when a company increases its cost saving projections, like CAKE did yesterday, it is not enough to get the stock moving higher. 

The bulk of the fat has been cut from these companies’ operating models so the obvious question is where do we go from here.  It will be impossible for these companies to continue to grow margins once they start to lap these savings initiatives if sales don’t pick up.  They can’t cut costs forever without hurting the customer experience and eroding their brands.  And, as I already pointed out, most companies are saying they have limited visibility about when sales might turn positive. 

This thought can best be shown by the chart below, which looks at FSR same-store sales growth trends, as reported by Malcolm Knapp, relative to the average YOY bp change in EBIT margin for DRI, RT, CAKE, PFCB and BJRI (FSR companies that have reported calendar 2Q earnings so far). 

Restaurants - Earnings Fatigue - Q2 thus far SSS vs EBIT Margins

Clearly this trend is not sustainable – these companies cannot continue to grow margins with negative same-store sales growth.  CAKE’s CFO Doug Benn highlighted this point in response to a question about if and when the company would recapture the margin level of yesteryear:

“Internally, the way that we are looking at it, we’re taking it one step at a time. If you go back to 2007 margins, operating margins they were around 8.5%, which is somewhere in the neighborhood of 250 to 300 basis points better than where we expect to end this year. And the scenario to get back there, some of it is going to be this cost-cutting and the cost initiatives and we’ve made some great progress there but the real avenue to get back is we have to have a plus sign in front of comparable store sales. And until we do that, we’re not going to be able to get all the way back.”

We all know that comparisons get very easy in 2H, particularly in Q4.  What if easy comparisons are not that easy? Minimum wage is now higher for the balance of 2009 and the benefits of lower commodity costs will diminish over the next six months. 

I don’t want to paint a bearish picture because nearly all the companies I follow are financially strong cash generators.  And, with little to no development plans in the near-term, their cash positions are only building.  What I’m struggling with is deciphering the catalyst (positive or negative) that will get these stocks moving in either direction.    




PNK just put out an 8K regarding a credit amendment that they entered into on July 21, 2009.  They got an increase of the leverage ratio / decrease of the interest coverage ratio to account for a later opening of River City.  In return the facility size was reduced by 15%, the spread was increased by 50bps and a LIBOR floor of 1% was introduced

Below are the details of the Fourth Amendment to its Credit Facility:

Increased the maximum permitted Consolidated Leverage Ratio to take into account the opening of River City which was originally expected to open earlier.


The new maximum leverage ratios are as follows, for the period ended:

June 30, 2009 to 6.5x (was 6.0x)

Sept 30, 2009 to 6.5x (was 5.5x)

Dec 31, 2009 to 6.75x (was 5.5x)

March 31, 2010 to 6.5x (was 5.0x)

June 30, 2010 to 6.0x (was 5.0x)

Thereafter to 5.0x (was 5.0x)

  • Decreased the minimum Consolidated Interest Coverage for the March & June 2010 ended periods to 1.75x from 2.0x
  • Increased the applicable Margin on the R/C by 50 bps
  • Company was permitted to issue senior unsecured notes, subject to covenant compliance
  • Retained permission to request an extension of its Credit Facility beyond the Dec 10, 2010 maturity
  • Broadened the definition of “Defaulting Lender” to include any lender which fails to fund its portion of the Loan required under the Credit Agreement, as well as any Lender who becomes subject to bankruptcy or insolvency or takeover by a regulatory authority. By broadening this definition it makes it easier to assign a lender’s interests, rights and obligations (at par) under the Credit Agreement - I’ve never seen this one before – interesting in light of the bank environment
  • Definition of Base Rate was changed to include a one-month LIBOR floor of 1%
  • Each Lender’s commitment was reduced by 15% so that the Aggregate commitment was downsized to $531.25MM from $625MM



24 JULY 2009



Irony can be so ironic. I got out of a meeting yesterday talking about Payless, and my last comment before the elevator door closed was how I am lobbying for Matt Rubell at Payless to hire Gene McCarthy – who is the best free agent (and one of the best all around players) in footwear today. Not 30 minutes later, it hit the tape that Kevin Plank just hired McCarthy to head up UA’s footwear business. This is big folks. Why?

  1. The guy ‘gets it’ when it comes to branding. He’s a 17-year Nike veteran who was instrumental in growing Brand Jordan from a shoe to a generation-transcending brand.
  2. The guy understands that one person alone can't change a brand’s perception and direction. It takes capital, heads, common goals and inspirational leadership.  Even at TBL, he only took the job if Jeff Schwartz agreed to give him latitude to build a new organization around ‘Authentic Youth’ (ie the yellow boot business). Gene built a 90-person organization within six months. This would have worked if TBL let him be good at what he does. Instead, at the first sign of success, they promoted him to co-President and in typical TBL fashion they began to take resources away from his original effort.
  3. Is there a risk that UA begins to beef up its footwear organization and takes up SG&A accordingly? Yep. Call this a risk if you’d like, but I think a greater risk is if UA does NOT do this.
  4. Do you think that current investors (who overwhelmingly own it for the big growth opportunity ahead) are going to fault this company for investing in growth and putting capital behind the key point of controversy out there in the market?  I know my answer…

The bottom line is that if you were to ask me for my short list of 5 people that can successfully see UA through this stage of its transition into a great footwear company, Gene would definitely make the cut. If you’re one of the 91% of sell side analysts who are negative, or 30%+ of the float that is short, you should be careful here.



Some Notable Call Outs

- Safeway’s 2Q results were disappointing and the underlying trends are noteworthy. On the company’s conference call, CEO Steve Burd highlighted that the company is experiencing the greatest deflation in 17 years! Some examples of y/y price declines include: milk down 27%, eggs down 15%, cheese down 17%, butter down 14%, apples down 23%, tomatoes down 13%, citrus down 16%, and cherries down 42%. Additionally, Burd highlighted an accelerated trend in customers trading down to lower or opening price points. The trading down behavior is now impacting all categories, ranging from floral to wine.

- Contrary to trends from other footwear wholesalers that are seeing customers order closer to need, Deckers reported that they are pulling shipments forward to meet demand for early fall orders and customer demands requesting earlier deliveries. Despite this commentary on current trends and its impact on current inventory levels, the company is conservatively forecasting a deceleration in topline growth over the back half of the year.



- China's textile and garment exports is expected to recover in the back half of 2009 - China's textile and garment exports is expected to recover for the rest of the year as figures have shown that the global economy has hit the bottom. Textile and garment exports dropped 8.33% to $72.79 billion in H1, with textile exports decreasing by 16.99% to $26.94 billion and garment exports edging down 2.35% to $45.86 billion, according to the government's customs statistics. However, textile exports in June alone were slightly increased by 0.35% but garment exports posted a strong growth of 22.06%. Local financial analysts foresaw an acceleration of textile and garment export growth in H2 due to the forthcoming economic recovery in the US and EU. <>

- U.S. to urge China in talks to develop a non export driven economic growth model - The U.S. will encourage China to move away from an export-driven growth model during talks between officials from the two countries here, set for next week. China’s currency policy also will be up for discussion, officials said. The trade deficit the U.S. has with China decreased significantly in the last year, primarily driven by plummeting consumer demand in the U.S. For the first five months of this year, the U.S. trade deficit with China was $84.6 billion, down from $96.8 billion for the same period in 2008. For the 12-month period through May, the goods trade deficit with China was $255.8 billion, down from the $258.6 billion deficit in the same period a year earlier. <>

- The largest clothing retailer in Central and Eastern Europe met with Greater China suppliers - LPP, the largest clothing retailer in Central and Eastern Europe, met 31 pre-screened Greater China suppliers at Global Sources' Custom Private Sourcing Event in Shanghai on July 16, 2009. Global Sources' Chairman and CEO, Merle A. Hinrichs, said: "Though the global economy remains weak, we are helping our suppliers offset lost sales by providing unmatched opportunities to diversify their export markets. "Rather than focus on a few markets, suppliers today need to look for opportunities around the world. Moreover, to expand to new markets, they need to find the right buyers. "LPP is another example of the kind of quality-focused companies that participate regularly in Private Sourcing Events. Representing five of the top fashion brands in the region, it can offer suppliers a deeper understanding of local trends, while helping them move up the value chain." Joanna Krakowska, Senior Buyer of LPP S.A., said: "We pride ourselves on offering high quality, high fashion clothing at reasonable prices. It is difficult to find suppliers who can meet our requirements, but we were impressed with the suppliers we met at the event. Private Sourcing Events offer an efficient channel to discover new sources in far less time than we could previously." <>

- The Indian retail sector's expected annual growth of 9% to reach $521 billion by 2012 will be driven by apparel - Apparel and FMCG segments will be the driving forces for the Indian retail sector, which is likely to grow annually by 9% to reach $521 billion by 2012. "FMCG and apparel sectors contribute the maximum to the growth of the retail market in India," Bharti Retail President and COO Vinod Sawhny said during a FICCI event.  "FMCG in particular has a huge potential to grow... and this will ensure a growth rate of nine per cent year-on-year for the retail sector, which is likely to touch $521 billion by 2012," Sawhny added. He said the Indian retail market is estimated to be around $350 billion, of which modern retail or the organised segment has only four per cent share. "Modern retail will grow much faster, at the rate of 30-35 per cent annually, than the traditional one in the coming years and will be at the size of $54 billion in the next three years," he said. Sawhny said the growth can be attributed to the evolving consumer behaviour, changing market dynamics as well as to easier access to capital by both the retailers and consumers. <>

- Retailers brace for the impact of the increase in federal minimum wage - Retailers are bracing for another financial hit to payroll costs and profits as the last increase in the federal minimum wage rate takes effect today, while advocates maintain it will serve as a big boost to the livelihood of workers, the economy and businesses. The hourly wage rate will increase to $7.25 from $6.55, the third increase in two years, stemming from legislation enacted in 2007. The change will give a boost to workers in 30 states, Washington, D.C., and Puerto Rico, where the state wage rate is currently lower. Facing mounting bankruptcies and consolidations due to the recession, many retailers, particularly in the teen retail segment, will feel the spike in wage pressure with the increase. The impact will vary depending on the size and location of a retailer. “The record shows that labor-intensive industries such as retailers, restaurants and other small businesses are disproportionately impacted by minimum wage increases,” said Green.  <>

- Outdoor Retailer Show highlights women's sandals and hiking category as growth vehicles - Women’s sandals, hikers and performance travel-oriented sandals were the standouts for spring ’10 at the Outdoor Retailer Show, held here this week. Denise Friend, head women’s footwear buyer at Bothell, Wash.-based REI, said flip-flops of “any color, any style, for any price,” as well as road-running shoes and casual sandals with a dressier feel would be key for spring. She also flagged hiking as an area in which the brand had seen a lot of growth — possibly, she said, due to families planning local outdoor treks for lower-cost vacations. “People are rethinking how they recreate,” she said, identifying lightweight and often low-cut styles from Merrell, Vasque and Keen as key looks. <>

- Finish Line Inc. amended and restated its Restated Articles of Incorporation - First, the Restated Articles provide for the conversion of all outstanding high voting Class B Common Shares into Class A Common Shares as of the day after the Company's annual shareholders' meeting to be held in 2012, and eliminate the prior provision in the Company's restated articles of incorporation which automatically converted all Class B Common Shares into Class A Common Shares on a one-to-one basis only once they constituted less than 5% of the total common shares outstanding as of a record date for an annual meeting. Second, the Restated Articles also contain an amendment limiting the aggregate voting power of the Company's Class B Common Shares. Under this provision, if at any time the holders of all Class B Common Shares hold greater than 41% of the total voting power of the Company's shares as of the record date for any shareholders' meeting, then the number of votes per share of each holder of Class B Common Shares will automatically be reduced (on a proportionate basis) so that the holders of Class B Common Shares hold in the aggregate no more than 41% of the Company's total voting power. <>

- Kellwood secures funding, avoids chapter 11 - Kellwood Co. ended weeks of tense negotiations by completing a $140 million exchange offer with Deutsche Bank and other bondholders. The agreement exchanges old notes that expired on July 15 for new senior secured notes due in 2014. The deal, closed on Thursday, allowed the firm to avoid a bankruptcy filing. As reported, jitters about Kellwood’s solvency arose earlier this month when Deutsche Bank unexpectedly elected not to accept a proposed note swap, even though it played a key role in negotiating its terms. The parties have been in talks for two weeks trying to resolve the matter amicably. “I am very pleased that Deutsche Bank and the other bondholders accepted Kellwood’s exchange offer,” said Michael W. Kramer, Kellwood’s president and chief executive officer. “This will let us continue to build on the operational improvements we have made to date and take advantage of opportunities to grow our brands and our business.” According to Kramer, there are no notes due until the ones just exchanged mature in 2014. “We’re looking forward to taking advantage of [the work we’ve done so far] and move forward,” the ceo told WWD.  <>

- Hibbett Sports hires new VP of merchandising - Hibbett Sports Inc. announced on Thursday that Rebecca Jones will join the company as VP of merchandising in August. Jones is currently VP and GMM of crafts at Jo-Ann Fabric & Craft stores, a position she’s held since 2003. She was previously VP and DMM at Wal-Mart stores and VP and DMM at Fred Meyer Stores. “Becky Jones complements [the Hibbett] team well with a wealth of successful merchandising experience for large, growing retail organizations operating in markets similar to ours,” CEO Mickey Newsome said in a statement. “We look forward to her contributions to our continued success.” <>

- Coldwater Creek hired a new executive vice president and creative director - Coldwater Creek on Thursday tapped Jerome Jessup as executive vice president and creative director as it continues to seek a product formula that will return it to the growth path. Jessup, an industry veteran who worked at Ann Taylor and Gap, will be responsible for brand management, creative services and visual merchandising. The retailer also said it is maintaining its second-quarter loss forecast of 5 cents to 7 cents a share; its prior guidance was a quarterly loss of less than 8 cents a share. <>

- De Beers Diamond Sales Fall 57% as Global Recession Cuts Demand for Gems - De Beers, the world’s largest diamond company, said first-half rough gem sales fell 57 percent on lower demand after the U.S., Europe and Japan slid into recession. <>

- French retailers will now be open on Sunday - The French senate narrowly passed a law that will allow more stores to open for business on Sundays, relaxing a ban that has been in place since 1906. The law, which was passed 165 to 159, is far from being applied, however. The opposition Socialist party has asked the Constitutional Council to examine whether the law, which has been backed by President Nicolas Sarkozy, is constitutionally sound.  If introduced, the law would allow all stores in certain designated areas - for example, in large cities like Paris, Lille and Marseille - to open on Sundays, marking a major cultural shift in a country where Sundays traditionally have been dedicated to rest and family activities. French shops are currently required by law to stay closed on Sundays, unless they sell food or are located in tourist areas and are deemed to have “recreational” or “cultural” value, such as bookstores. <>

- Moody's downgrades Barneys New York - Barneys New York was downgraded by Moody’s Investors Service late Thursday due to liquidity concerns, but the retailer quickly responded by stating it has taken several measures to put itself in a “stronger financial condition.” “Barneys has responded aggressively in the midst of these challenging conditions in the luxury retail market,” a company spokeswoman said. “Controllable operating expenses have been reduced by approximately 10% to 15% on an annualized basis, and capital spending has been reduced by 50% in comparison to last year. Inventory purchases have been reduced for fall 2009 and spring 2010 by over 20%. These measures will put Barneys in a stronger financial position, with anticipated better margins,” she continued. “Our sales trend is improving and we expect a stronger performance in the second half of 2009.”Barneys said Moody’s action is primarily a reflection of its financial performance in the fourth quarter of 2008 and first quarter of 2009. <>

- Nike Inc. is committed to new leather sourcing guidelines aimed at saving the Amazon rainforest - Nike Inc. announced on Wednesday new leather sourcing guidelines aimed at reducing deforestation in Brazil’s Amazon rainforest. The policy comes in reaction to a Greenpeace report that identified cattle grazing for meat production — and for leather — as contributors to the destruction of the rainforest. In a press release, Nike reported that none of its leather comes from the Amazon basin. However, to ensure that it avoids using leather sourced in the Amazon basin, Nike will require suppliers of Brazilian leather to certify in writing that all cattle come from outside the area in question. Nike will also require all its suppliers to join the Leather Working Group by December 2009 and create an ongoing, traceable and transparent system to ensure by July 1, 2010, that the leather they use comes from outside the Amazon basin.  <>

- Austrian high-end hoisery, lingerie, and swimwear company reports weak results in Europe - Wolford AG, the Austrian maker of high-end hosiery, lingerie and swimwear, reported full-year losses and declining sales and forecast difficult markets throughout the current fiscal year. But the company, hit by the ongoing economic downturn, cast a more optimistic outlook for next year. It anticipates moderate growth in the 2010-11 fiscal year. “We can assume that the crisis is only of a temporary nature,” chief executive Holger Dahmen said Friday in a statement. <>

- Summit Entertainment and Nordstrom have paired to launch an exclusive fashion and jewelry collection this October based on the Nov. 27 release of The Twilight Saga: New Moon - The line, created by Awake, will feature fitted screen-printed tees, tanks and hoodies, as well as T-shirts with film-related lines and imagery. The collection is also rounded out with plaid tunics and jackets. The New Moon collection, retailing from $32 to $58, will be available at Nordstrom's BP. junior department and The jewelry offering will include silver and gold-plated necklaces, bracelets, earrings and key fobs with film-inspired charms. "We hope to bring the Twilight experience into our stores through fashion for our customers," says Loretta Soffe, Nordstrom executive vice president and general merchandise manager for women's apparel. "The line allows customers to show their love for the film by creating a whole look with pieces from the collection or combining with other merchandise to create a unique look of their own." Nordstrom also plans to host kick-off events in November, including advance-screening parties.  <>


RESEARCH EDGE PORTFOLIO: (Comments by Keith McCullough): TGT

07/23/2009 12:21 PM


Solid entry point here on the short side if you dont have any on. I was early shorting Bill Ackman, and here again - but I'm cool with that. Short green. KM




  • Steven Temares, CEO, sold ~480,000shs ($16.1mm) after exercising the right to buy 600,000shs more than 50% of common holdings.
  • Eugene Castagna, CFO and Treasurer, sold ~45,000shs ($1.5mm) most of which came from exercising the right to buy 45,000shs roughly 30% of common holdings. 

CTR: John Howe, EVP & CFO, sold 2,000shs ($40k) after exercising the right to buy 4,500shs less than 10% of common holdings.

KSS: John Herma, Director, purchased 2,800shs ($118k) a modest incremental addition to total common holdings.

FINL: David Klapper, Director, sold 60,000shs ($497k) after converting Class B shares representing entire common holdings.






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Dodging Responsibility

"It is easy to dodge our responsibilities, but we cannot dodge the consequences of dodging our responsibilities."-  Sir Josiah Stamp

After watching the SP500 hold my 954 line and close there for two days, yesterday Mr. Market blew it right out of the water. That makes me wrong.
I could dance around the math, make excuses, and hide - but I will not. That's what losers do. My vision of creating this real-time research firm is shaped by a profound belief that we need to re-establish that there is responsibility in recommendation on Wall Street again.
Importantly, yesterday's critical US market breakout was confirmed by volume. With US market volumes in structural decline, the best I can do right now is measure the market volumetrically on a day-over-day and month-over-month basis. Yesterday's volume spiked +28% versus Wednesday's volume. That matters - big time.
I have a lot of macro models. One simple three factor model that I use studies price/volume/volatility. As of now, we have the confluence of these three quantitative factors signaling very bullish outputs. With the Volatility Index (VIX) absolutely crushing the Depressionistas who look at every 1% down move as the signal of the next "crash", this should be no surprise. The VIX remains broken across all 3 of my durations (TRADE, TREND, and TAIL) and continues to make a series of lower lows.
As volume accelerates into higher stock market highs, no matter where you go this morning, there you are. I, for one, didn't wake up hoping for the futures to be down because "Microsoft and Amazon missed." Hope is not an investment process.
So what is the refreshed immediate term TRADE setup for the US stock market from here?
1.      SP500 support 939, resistance 984

2.      Nasdaq support 1883, resistance 1993

3.      Dow support 8719, resistance 9188

My macro models update every 90 minutes of marked-to-market trading. No, I don't have a "side pocket" or "level 3" accounting plug in my models. As prices and other dynamic market factors change, I do. That's not new. The only thing that is new is my waking up to being wrong on my SP500 levels ahead of this morning's open.
I don't intend on being wrong for Monday's US market open, so I will continue to keep proactively moving exposures in both the Asset Allocation Model and our virtual hedge fund portfolio ( <> ). I currently have 17 longs and 15 shorts (including short MCD, which Howard Penney nailed yesterday).
While the top side of my Range Rover SP500 level missed the mark, that doesn't mean I was short that line. I simply missed the beta of associated with a big +2.3% US market move. In so far as I wasn't interested in chasing the 200-day Moving Monkeys over the cliff on July 10th's Q3 closing low of 879, I am not looking to clang symbols and clamor for levered long bananas here at 976.
The New Reality is this: a lot of people missed the -57% crash in the US stock market and now a lot of people are missing the +44% REFLATION from the March 9th low. Until Wall Street changes, career risk is at stake for those who don't freak out at bottoms and chase tops. That's the constrained US Financial System that this country has built.
What's the number one driver of the top end of this rally? That's simple - a US Government sponsored Burning of The Buck. As Bernanke provided Washington/Wall Street with another "Misguided" outlook, those who understand carry trading are sucking the last gasps of air that free moneys will give them. As they rightly should.
The dollar is down on the week, again, and has lost -13% of it's value since March. By the time Q4 hits, this won't be about DEFLATION anymore. INFLATION, inspired by US Dollar DEVALUATION, will be coming off my fingertips in t-minus 3 months. Prepare your risk management setup and portfolios accordingly.
History is not written on a one-day or one-year duration. Ask Alan Greenspan about that. The ex-Limitless Credit Creation Chairman himself recently stated that "there was a flaw in the model that I perceived as the critical functioning structure that defines how the world works."
Amen, Mr. Greenspan. Amen. Please forward your memo to Chairman Bernanke because "we cannot dodge the consequences of dodging our responsibilities."
Best of luck out there today. Have a wonderful weekend with your families,


CYB - WisdomTree Dreyfus Chinese Yuan
- The Yuan is a managed floating currency that trades inside a 0.5% band around the official PBOC mark versus a FX basket. Not quite pegged, not truly floating; the speculative interest in the Yuan/USD forward market has increased dramatically in recent years. We trade the ETN CYB to take exposure to this managed currency in a managed economy hoping to manage our risk as the stimulus led recovery in China dominates global trade.

COW - iPath Livestock
- This ETN tracks an index comprised of two thirds Live Cattle futures, one third Lean Hogs futures. We initially began looking at these commodities because of recession inspired capacity reductions combined with seasonal inflections. A series of macro factors including the swine flu scare, a major dairy cattle cull in response to collapsing milk prices and the collapse of the Argentine agricultural complex due to misguided policy provided us with additional supporting fundamental data points for the quantitative set up in price action.  

TIP- iShares TIPS
- The iShares etf, TIP, which is 90% invested in the inflation protected sector of the US Treasury Market currently offers a compelling yield on TTM basis of 5.89%. We believe that future inflation expectations are currently mispriced and that TIPS are a compelling way to own yield on an inflation protected basis, especially in the context of our re-flation thesis.

- Buying back the GLD that we sold higher earlier in June on 6/30. In an equity market that is losing its bullish momentum, we expect the masses to rotate back to Gold.  We also think the glittery metal will benefit in the intermediate term as inflation concerns accelerate into Q4.

XLI - SPDR Industrials
- We don't want to be long financial leverage, which is baked into Industrials.

EWI - iShares Italy - Italian Prime Minister Silvio Berlusconi has made headlines for his private escapades, and not for his leadership in turning around the struggling economy. Like its European peers, Italian unemployment is on the rise and despite improved confidence indices, industrial production is depressed and there are faint signs, at best, that the consumer is spending. From a quantitative set-up, the Italian ETF holds a substantial amount of Financials (43.10%), leverage we don't want to be long of.

DIA  - Diamonds Trust- We shorted the financial geared Dow on 7/10, which is breaking down across durations.

EWJ - iShares Japan -We're short the Japanese equity market via EWJ on 5/20. We view Japan as something of a Ponzi Economy -with a population maintaining very high savings rate whose nest eggs allow the government to borrow at ultra low interest levels in order to execute stimulus programs designed to encourage people to save less. This cycle of internal public debt accumulation (now hovering at close to 200% of GDP) is anchored to a vicious demographic curve that leaves the Japanese economy in the long-term position of a man treading water with a bowling ball in his hands.

XLY - SPDR Consumer Discretionary
- As Reflation morphs into inflation, the US Consumer Discretionary rally will run out of its short squeeze steam. We shorted XLY on 7/9 and again on 7/22.

SHY- iShares 1-3 Year Treasury Bonds- If you pull up a three year chart of 2-Year Treasuries you'll see the massive macro Trend of interest rates starting to move in the opposite direction. We call this chart the "Queen Mary" and its new-found positive slope means that America's cost of capital will start to go up, implying that access to capital will tighten. Yields are going to continue to make higher-highs and higher lows until consensus gets realistic.


In Q209, MCD’s U.S. margins held up despite the sequential slowdown in comparable sales growth.  Margins improved 50 bps during the quarter following 50 bps of expansion in Q1.  These two quarters of growth show a marked improvement from the prior two years of decline.  Moderating commodity costs helped to offset weaker sales as the company’s overall basket of commodities increased 4.4% in Q2 relative to the 6.7% increase in Q1.  MCD expects this favorable cost environment to continue and even improve in the back half of the year with commodity costs forecast to grow only 1%.  Management revised its U.S. commodity costs outlook for the full-year to up 3%-3.5% from its prior 5%-5.5% range. 

MCD is going to need this increased cost favorability to offset continued softness in top-line numbers as July same-store sales are expected to be “similar or better” than June’s reported 1.8% increase.  Management very clearly stated that Europe and APMEA July sales trends are running better than June, which leaves me to believe that the U.S. is the segment that is currently running similar to June. 

Despite the sequentially slower sales in the U.S., MCD still grew market share on a year-to-date basis, gaining 50 bps of the formal eating out category, according to the company.  For reference, the overall formal eating out category was negative in June. 

MCD is experiencing some pressure on its average check.  Specifically, management stated that average check accounted for about 65%-70% of sales in some quarters last year, but has come down to 50% and could move below that level as we move into 2010.  Management attributed the increased pressure on average check to some trading down by consumers and the decreased level of promotion from the company around its higher priced products.  Management expects operating margins to be stronger in the latter half of the year, but increased trading down could offset some of the company’s expected commodity benefit, particularly with the company saying it is less likely to take as much pricing as it has in prior years. 

Regarding the recently launched Angus burger, the company has not yet launched a national advertising campaign around the product and admitted that the “timing’s not perfect on Angus.”  I have communicated my concerns around the direction of MCD’s recent product launches, primarily the Angus burger and McCafe, which don’t focus on the company’s core consumers, so it was encouraging to hear that management recognizes as well that the timing is off for the Angus burger.  Additionally, management said that due to lower media costs this year and a slight increase in the company’s level of investment in advertising, MCD has been able to advertise behind its core menu, largely the Big Mac, while also promoting the McCafe launch.  This continued focus on the company’s core menu is necessary in this environment and alleviates some of my concerns about the Angus burger; though I do not think it will do much to benefit average check or margins in the near-term.

That being said, I am still not convinced that McCafe will provide the lift to sales that investors are expecting.  Even with management saying that McCafe results are exceeding expectations and that the national advertising launch in May drove significant incremental unit movement, I am not yet a believer.  June same-store sales numbers (and similar trends thus far in July) are not making me feel any better about McCafe.  In response to a question, management said yes, it is on track to achieving $125K in incremental revenues per restaurant with its entire new beverage platform.  This statement does not provide any real evidence of the success of McCafe, however, because the $125K goal includes fruit smoothies, crushed ice drinks and frappes, which have not even been launched yet.  The fact that MCD is moving forward on reaching that $125K goal does not really quantify the current performance of McCafe.  I know it is still early, but it’s important to remember that implementing McCafe into the entire MCD system required a high level of investment (about $100K per restaurant).  I do not yet have the proof that McCafe is yielding the necessary returns.


MCD – FOCUSED ON THE USA - mcdusmargins

Data for Oil and Dr. Copper Continues to Send Mixed Signals

While oil and copper continue to compete for first place in the global commodity race for performance year-to-date (at least in US$ terms), the date points we have been following continue to suggest a mixed picture on the supply and demand side.  Ultimately, the US$ is as fundamental for these two commodities as any supply and demand data points.  That said, it is worth reviewing some recent data points for each commodity:


  • The DOE announced that oil supplies fell by 1.8MM barrels domestically, which was slightly less than the consensus estimate of 2.1MM barrels.  Currently, inventories in the U.S. are 7.3% higher than the five-year average;
  • In contrast to the DOE report from yesterday, the API signaled a much more bearish build of oil.  The American Petroleum Institute indicated that inventories had increased by 3.1MM barrels week-over-week;
  • On the demand side, U.S. daily fuel demand has average 18.6MM barrels over the past four weeks, which is down 4.8% year-over-year; and
  • In Nigeria, the Movement for the Emancipation of the Niger Delta declared a 60-day ceasefire in attacks on the oil and gas installations.


  • BHP Billiton reported a 21% decline in copper output last quarter, which is significant given its place as one of the world’s largest copper miners;
  • China in the first half of 2009 has consume 3.7MM tonnes of copper, up 12.4% from a year ago;
  • Nippon Mining and Metals recently indicated that they believe that they expect copper demand from China to ramp into October as a result of increased stimulus spending;
  • Copper inventories on the LME rose to a 1-month high on July 23rd to 271,725 tonnes.

Generally, both copper and oil data points seem to be suggesting a buildup on the inventory side, though both supply and demand for copper appear quite favorable versus oil.  The US$ seems likely to prevail as the key driving factor for the price of oil and copper.  As the dollar goes down, these commodities are inherently cheaper and, all else equal, will re-flate.  If and when the dollar stabilizes, global supply and demand points will likely become the primary fundamental drivers for price.

Daryl G. Jones
Managing Director

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