DRI: The Big Miss

Darden is due to report 4QF14 EPS tomorrow before the open and we’re confident that the news coming out of the quarter will be nothing short of a disaster.


With that in mind, we’d like to offer up some key thoughts:

  1. The 4QF14 consensus EPS estimate of $0.94 is $0.05 to $0.10 too high.
  2. The current FY15 consensus EPS estimate of $2.54 is $0.30 to $0.40 too high.
  3. The earnings implications are that the company will be unable to sustain its $2.20 dividend in FY15.
  4. There will be little, if any, legitimate visibility in regards to the attempted turnaround of the Olive Garden.
  5. Management will give guidance that will be too optimistic.


We suspect that very few analysts have updated the earnings power of the company to properly reflect the recent sale of Red Lobster to Golden Gate Capital for $2.1 billion ($1.6 billion net).  Additionally, we believe that analysts are currently too optimistic about current trends and what the future holds for FY15.  As we see it, changes to the Street’s models should include lower revenues, continued restaurant margin erosion, modest G&A reductions, lower interest expense and a lower share count from the use of proceeds.


As you can see in the charts below, the Street generally believes that Olive Garden is fixed and should see improved trends next quarter.  We’d note, however, that this has been the case for the last five years.  As such, it has become typical to hear something along the lines of “Don’t worry; the turnaround at Olive Garden is just one quarter away!”


We’ve repeatedly stated our view that current management headlines the bear case for DRI as they continue to destroy shareholder value.  Their actions during this past quarter simply reinforce our belief.  While there is a core group of shareholders that are working diligently to correct the issues, there is little that can be done between now and the annual meeting.


In the short-run, we have little reason to believe the stock will outperform.  Further out, we believe Darden’s cavalier attitude toward shareholders will result in wholesale changes at the company when the annual meeting comes around later this year.


DRI: The Big Miss - chart2


DRI: The Big Miss - chart1


Call with questions.


Howard Penney

Managing Director


Fred Masotta



The trend in the high frequency labor market data remains solid and a supportive factor in the static policy course reiterated by the FOMC again yesterday  - although the expectation of lower growth, higher inflation and higher rates seems internally/mandate inconsistent.   


Of course, there’s two inputs into the net Hires equation (hirings less firings) and with employment still middling at the ~200K/mo level in the face of ongoing improvement in the claims data, we continue to largely fire on one cylinder. 


We’ve profiled the positive, employment & wage inflationary dynamics percolating under the hood a number of times and with Job Openings (JOLTS) and Small Business Jobs-Hard-to-Fill making higher highs, extra-large corporations leading the employment charge, and short-term employed figures strong, the “less-slack-than-there-appears” argument will continue to bubble. 






INITIAL CLAIMS: 1.5 CYLINDERS - Employment by Size



The prevailing trend in the above factors could have supported an accelerating employment thesis and pro-growth, consumption centric positioning for the better part of the last year+, however (note: Utes outperformed the SPX by 3X yesterday and are +15% YTD vs. -0.2% for the XLY). 


Wage inflation is a lagging indicator and whether internal tightness and rising mobility (more renters, less houses underwater) can finally catalyze a transition to a 2-cylinder labor market driven by the demand side remains a waiting game. 


And as we’ve remarked previously, patience probably remains the most prudent prescription:


The frustration and impatience on the pace of the recovery that pervades media reports and pundit commentary offers an interesting juxtaposition against the almost universal acknowledgement that balance sheet crises and the back end of long-term credit cycles invariably augur protracted periods of sub-trend growth.  


Passivity doesn’t sell advertising and generally doesn’t drive AUM, but a little more patience and little less manic punditry is probably the right prescription 




NSA:  Non-seasonally adjusted initial claims, our preferred read on the underlying trend  in the labor market, posted another solid print at -10.9% YoY.  This takes the 4-wk rolling average to -10.2% YoY from -8.8% prior, and back near the best levels of year


SA:  Headline claims improved -6K to +312K WoW with rolling claims (+312K) moving back to the best levels YTD and the best levels since august 2007


In isolation, the initial claims numbers again remain supportive a good NFP print this month.  








Christian B. Drake



Retail Callouts (6/19): RH, TGT, APP, LULU

Takeaway: RH prices convertible notes, de-risks growth strategy. TGT CEO search. APP terminates Charney.






  • "Restoration Hardware Holdings, Inc. today announced the pricing of $300 million of 0% convertible senior notes due 2019 at a 35% conversion premium to today’s closing stock price of $85.99. Restoration Hardware also granted the initial purchasers of the notes a 13-day option to purchase up to an additional $50 million of the notes on the same terms and conditions, for a total potential offering size of up to $350 million. Additionally, the Company entered into convertible note hedge and warrant transactions in order to prevent dilution up to a 100% premium to today’s closing stock price. Under the terms of these transactions, the Company’s shareholders are not expected to experience dilution until the Company’s stock price is above approximately $172…"
  • "The immediate use of proceeds from the offering will be to pay the net cost of the convertible note hedge transactions and general corporate purposes, including repayment of all of the outstanding indebtedness under the Company’s credit facility. The sale of the notes to the initial purchasers is expected to settle on June 24, 2014, subject to customary closing conditions."


Takeaway: The punchline on this financing deal is that it de-risked the growth strategy, and took out one of the key bear arguments on this stock. If there’s any bad news, it’s that that there will be dilution at some point over the next few years – because we think that RH trades through $170.


TGT - Target Faces Difficult CEO Search



  • "Target is reportedly speaking to traditional retail leaders such as Roger Farah, former vice chairman of Ralph Lauren Corp.; Ken Hicks, chairman, president and ceo of Foot Locker Inc.; Matt Rubel, a senior adviser at TPG Capital; Sharen Jester Turney, president and ceo of Victoria’s Secret, and Sharon McCollam, cfo of Best Buy Co. Inc."
  • "Target’s short list also is said to include Rosalind Brewer, president and ceo of Sam’s Club; Glenn Murphy, chairman and ceo of Gap Inc., Angela Ahrendts, senior vice president of retail and online stores at Apple Inc., and Mindy Grossman, ceo of HSN Inc. But Ahrendts just joined Apple, so she’s unlikely to leave; Grossman is said not to be interested, and Murphy probably wouldn’t want to leave Gap Inc., still in the midst of a turnaround, to go to another turnaround situation."


Takeaway: Farah, Murphy, or an Amazon exec make the most sense to us. This company needs a ‘rock-star’ CEO who is properly incentivized to make big changes in the organization. It’ll be tough for the company to attract that type of candidate unless they know that they have both the capital and board’s authority to make the changes necessary to fix what’s broken. That likely won’t be a quick process. And, it won’ t be cheap.


APP - American Apparel Board Suspends Dov Charney as CEO and Declares Intent to Terminate Him for Cause; Names John Luttrell as Interim CEO



  • "The Board of Directors of American Apparel, Inc. today voted to replace Dov Charney as Chairman and notified him of its intent to terminate his employment as President and CEO for cause. It is expected that the termination will be effective following a 30-day cure period required under the terms of Mr. Charney's employment agreement."
  • "'We take no joy in this, but the Board felt it was the right thing to do,' Mr. Mayer said. 'Dov Charney created American Apparel, but the Company has grown much larger than any one individual and we are confident that its greatest days are still ahead.'"


Takeaway: While it comes as no surprise that Charney was pushed out due to issues with his personal conduct and poor judgment, we find it hard to believe that this had absolutely nothing to do with the company’s performance. If this was a $100 stock, or even a $10 stock, and probably even a $5 stock, the Board would tolerate a lot more than if it were trading at $0.64. The key takeaway from where we sit is that Charney owns 27% of this company and the board, acting in the best interest of its shareholders, made the decision to disconnect the founder from the company. One other situation comes to mind. Chip Wilson at LULU who also owns 27%.




MW, JOSB - Men's Wearhouse, Jos. A. Bank Merger Complete



  • "On the day of The Men’s Wearhouse Inc.’s annual meeting at the Fairmont Hotel here Wednesday morning, the company completed the long-awaited acquisition of its competitor, Jos. A. Bank Clothiers Inc."


AMZN - unveils the Fire Phone, its first smartphone



  • " has officially launched the Fire Phone, its first smartphone, after years of rumors.
  • Chief Executive Jeff Bezos took to the stage in Seattle shortly after 10:30 a.m. PDT to unveil the smartphone, which boasts a 4.7-inch screen, 13-megapixel rear-facing camera and five front-facing cameras."
  • "The smartphone costs $200 for a 32-gigabyte version and $300 for a 64GB version, both with a two-year contract -- a higher-than-expected price tag given Amazon's history of pricing its hardware relatively cheap. AT&T will be the exclusive carrier for the phone."


Client Talking Points


U.S. Dollar Down hard on the latest central plan (down another -0.5% this morning) and everything asset price inflation loves it (including a short squeeze in SPX); Oil up, Gold up – up, up, and up, in devalued Dollar terms.


Down 6 basis points in a straight line off the Fed’s “dovish” news; bonds (and anything that looks like a bond) up with Utilities leading the rally yesterday (XLU = +15.2% YTD); stay with energy inflation (XLE) + slow-growth #YieldChasing equity sector styles vs consumer discretionary (XLY) short.


10 handle again (it’s never held below 10, and never is a long time) and the immediate-term risk range for VIX is 10.14-12.15 now, so there’s no reason why this massive (-115,000) SPX Index + Emini net short position in futures and options contracts can’t capitulate (like it already is) to the upside.

Asset Allocation


Top Long Ideas

Company Ticker Sector Duration

Hologic is emerging from an extremely tough period which has left investors wary of further missteps. In our view, Hologic and its new management are set to show solid growth over the next several years. We have built two survey tools to track and forecast the two critical elements that will drive this acceleration.  The first survey tool measures 3-D Mammography placements every month.  Recently we have detected acceleration in month over month placements.  When Hologic finally receives a reimbursement code from Medicare, placements will accelerate further, perhaps even sooner.  With our survey, we'll see it real time. In addition to our mammography survey. We've been running a monthly survey of OB/GYNs asking them questions to help us forecast the rest of Hologic's businesses, some of which have been faced with significant headwinds. Based on our survey, we think those headwinds are fading. If the Affordable Care Act actually manages to reduce the number of uninsured, Hologic is one of the best positioned companies.


Construction activity remains cyclically depressed, but has likely begun the long process of recovery.  A large multi-year rebound in construction should provide a tailwind to OC shares that the market appears to be underestimating.  Both residential and nonresidential construction in the U.S. would need to roughly double to reach post-war demographic norms.  As credit returns to the market and government funded construction begins to rebound, construction markets should make steady gains in coming years, quarterly weather aside, supporting OC’s revenue and capacity utilization.


Legg Mason reported its month ending asset-under-management for April at the beginning of the week with a very positive result in its fixed income segment. The firm cited “significant” bond inflows for the month which we calculated to be over $2.3 billion. To contextualize this inflow amount we note that the entire U.S. mutual fund industry had total bond fund inflows of just $8.4 billion in April according to the Investment Company Institute, which provides an indication of the strong win rate for Legg alone last month. We also point out on a forward looking basis that the emerging trends in the mutual fund marketplace are starting to favor fixed income which should translate into accelerating positive trends at leading bond fund managers. Fixed income inflow is outpacing equities thus far in the second quarter of 2014 for the first time in 9 months which reflects the emerging defensive nature of global markets which is a good environment for leading fixed income houses including Legg Mason.

Three for the Road


After being bullish on rates in 2013, we continue to be bearish on US rates in 2014



“Education is the most powerful weapon you can choose to change the world.”

-Nelson Mandela


U.S. share buybacks and dividend payments climbed to a record level in the first quarter of 2014, as companies chose to boost shareholder returns in the absence of robust revenue growth. (Financial Times)

ICI Fund Flow Survey - Bonds Are Running - Above Average Week for Fixed Income

Takeaway: Taxable bonds have just put up their 18 consecutive week of inflow assisted by tax-free inflows at 22 consecutive weeks.

Investment Company Institute Mutual Fund Data and ETF Money Flow:


In the most recent 5 day period, bond fund flows in both taxable and tax-free products had solid production producing inflows last week over the year-to-date running averages. This intermediate term trend for fixed income is highlighted by 18 consecutive weeks of inflow into taxable bonds assisted by 22 consecutive weeks of inflow into tax-free fixed income funds. Conversely, equity funds had another choppy week with domestic stock fund outflows, the 7th consecutive week, offset by international stock fund inflows.


Total equity mutual funds put up a modest inflow in the most recent 5 day period ending June 11th with $2.2 billion coming into the all stock category as reported by the Investment Company Institute. The composition of the $2.2 billion subscription continued to be weighted towards international equity funds with $3.7 billion coming into international stock funds which was offset by a $1.4 billion outflow in domestic products. This outflow within domestic equity funds has become an intermediate term trend with now the seventh consecutive week of outflow in the category. The aggregate subscription of $2.2 billion for the recent five day period was below the year-to-date average for equity funds of a $2.6 billion inflow, which is now running below the $3.0 billion weekly average inflow from 2013. 


Fixed income mutual fund flows had a solid week of production with the aggregate $2.3 billion that came into the asset class besting the 2014 running year-to-date average inflow of $2.0 billion. The inflow into taxable products of $1.8 billion was the 18th consecutive week of positive flow and the inflow into municipal or tax-free products of $527 million was the 22nd consecutive week of positive subscriptions. The 2014 weekly average for fixed income mutual funds now stands at a $2.0 billion weekly inflow, an improvement from 2013's weekly average outflow of $1.5 billion, but still a far cry from the $5.8 billion weekly average inflow from 2012 (our view of the blow off top in bond fund inflow). 


ETFs had a mixed showing versus mutual funds last week with equity ETFs putting up a strong week of production offset by weak passive bond flows. Equity ETFs experienced a robust $8.6 billion inflow, while fixed income ETFs put up a meager $137 million subscription. The 2014 weekly averages are now a $1.1 billion weekly inflow for equity ETFs and a $1.2 billion weekly inflow for fixed income ETFs. 


The net of total equity mutual fund and ETF trends against total bond mutual fund and ETF flows totaled a positive $8.3 billion spread for the week ($10.8 billion of total equity inflow versus the $2.4 billion inflow within fixed income; positive numbers imply greater money flow to stocks; negative numbers imply greater money flow to bonds). The 52 week moving average has been $6.9 billion (more positive money flow to equities), with a 52 week high of $31.0 billion (more positive money flow to equities) and a 52 week low of -$37.5 billion (negative numbers imply more positive money flow to bonds for the week). 


Mutual fund flow data is collected weekly from the Investment Company Institute (ICI) and represents a survey of 95% of the investment management industry's mutual fund assets. Mutual fund data largely reflects the actions of retail investors. Exchange traded fund (ETF) information is extracted from Bloomberg and is matched to the same weekly reporting schedule as the ICI mutual fund data. According to industry leader Blackrock (BLK), U.S. ETF participation is 60% institutional investors and 40% retail investors.   


ICI Fund Flow Survey - Bonds Are Running - Above Average Week for Fixed Income - ICI chart1



Most Recent 12 Week Flow in Millions by Mutual Fund Product:


ICI Fund Flow Survey - Bonds Are Running - Above Average Week for Fixed Income - ICI chart2


ICI Fund Flow Survey - Bonds Are Running - Above Average Week for Fixed Income - ICI chart3


ICI Fund Flow Survey - Bonds Are Running - Above Average Week for Fixed Income - ICI chart4


ICI Fund Flow Survey - Bonds Are Running - Above Average Week for Fixed Income - ICI chart5


ICI Fund Flow Survey - Bonds Are Running - Above Average Week for Fixed Income - ICI chart6



Most Recent 12 Week Flow Within Equity and Fixed Income Exchange Traded Funds:


ICI Fund Flow Survey - Bonds Are Running - Above Average Week for Fixed Income - ICI chart7


ICI Fund Flow Survey - Bonds Are Running - Above Average Week for Fixed Income - ICI chart8



Net Results:


The net of total equity mutual fund and ETF trends against total bond mutual fund and ETF flows totaled a positive $8.3 billion spread for the week ($10.8 billion of total equity inflow versus the $2.4 billion inflow within fixed income; positive numbers imply greater money flow to stocks; negative numbers imply greater money flow to bonds). The 52 week moving average has been $6.9 billion (more positive money flow to equities), with a 52 week high of $31.0 billion (more positive money flow to equities) and a 52 week low of -$37.5 billion (negative numbers imply more positive money flow to bonds for the week). 


ICI Fund Flow Survey - Bonds Are Running - Above Average Week for Fixed Income - ICI chart9 




Jonathan Casteleyn, CFA, CMT 




Joshua Steiner, CFA

CHART OF THE DAY: The Truth About Real Wages

Takeaway: U.S. real-wages (what you get paid in terms of wage growth minus made-up gov't inflation) just went negative for the 1st time in 2 years.


CHART OF THE DAY: The Truth About Real Wages - RWG

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