Takeaway: We believe we’ve identified one of Wall Street’s current darlings and recently added it to the Hedgeye Best Ideas list as a short.
“Dreams of castles in the air, of getting rich quick, do play a role – at times a dominant one – in determining actual stock prices.”
-Burton G. Malkiel
For the past several days, I’ve been reading a gem of a book recommended by my colleague, Howard Penney. Malkiel’s “A Random Walk Down Wall Street” is a timeless, thought provoking piece that most curious investors would enjoy reading poolside on a beautiful summer day. I certainly did. After all, restaurant research isn’t limited to cheeseburgers and fries. In fact, a large part of our job pertains to understanding both human and market psychology. The castle-in-the-air theory, which concentrates on the psychic values of investors, serves as a constant reminder of this fact.
For those unfamiliar with its origin, the castle-in-the-air theory was popularized by John Maynard Keynes in 1936. While we tend to disagree with Keynes’ and his disciples on a number of economic issues, the notion that stocks trade off of mass psychology is widely appealing. Accordingly, some investors attempt to front run this onslaught of groupthink, not by identifying mispriced stocks, but rather by identifying stocks that are likely to become Wall Street’s next darling. All told, this can be a profitable strategy – until it’s not.
Back to the Global Macro Grind...
We believe we’ve identified one of Wall Street’s current darlings and recently added it to the Hedgeye Best Ideas list as a short. Del Frisco’s Restaurant Group (DFRG) owns and operates three distinctly different high-end steak chains. After coming public in July 2012, the stock has gained over 114%; quite impressive, by any measure. More importantly, however, we believe cheerleading analysts and the subsequent madness of the crowd have propelled the stock during this time. Is it reasonable to call a company whose adjusted EPS declined 7% in 2013 one of the greatest growth stories in the restaurant industry? We think not.
As Malkiel goes on to say:
“Beware of very high multiple stocks in which future growth is already discounted, if growth doesn’t materialize, losses are doubly heavy – both the earnings and the multiples drop.”
The truth is, the company currently screens as one of the most expensive stocks on both a Price-to-Sales and EV-to-EBITDA basis in the casual dining industry. While we’re not insinuating DFRG is the beneficiary of a “get-rich quick speculative binge,” we are confident the stock is severely dislocated from its intrinsic value.
Part of the hype has been driven by the company’s positioning within the restaurant industry. Del Frisco’s caters to the high-end consumer; a cohort that the stock market would suggest is doing quite well. While this may be true, we believe the high-end consumer has been slowing on the margin as inflation in the things that matter (food, energy, rent, etc.) continues to accelerate. Contrary to popular belief, high-end consumers can feel the pinch too and two-year trends at the company’s hallmark concept, Del Frisco’s Double Eagle Steakhouse, would suggest the same.
Admittedly, the Double Eagle Steakhouse, though slowing, is a healthy concept. But it’s only 25% of the overall portfolio. The other 75% consists of a fundamentally broken concept (Sullivan’s) and an unproven growth concept (Grille). Naturally, the Street is discounting an immediate turnaround at Sullivan’s and a flawless rollout of the Grille, neither of which we see materializing. In fact, we continue to expect restaurant level and operating margin deterioration throughout 2014. This has less to do with all-time high beef prices (32.8% of Del Frisco’s 2013 cost of sales) and the recent wave of minimum wage increases (25% of Del Frisco’s restaurants have exposure), than it does with the fact that the company is systematically growing at lower margins and, consequently, returns.
More broadly, there are a number of red flags that the Street is unwilling to acknowledge right now including decelerating same-store sales and traffic trends, declining margins, declining returns, increasing cost pressures, expensive operating leases, peak valuation, positive sentiment and high expectations. We simply refuse to give the company credit for what it has not proven and while we can’t hit on all the minutiae of our thesis in this note, we do have a 67-page slide deck that does precisely that (email for more info). In short, our sum-of-the-parts analysis suggests significant downside.
You can delay gravity, but you can’t deny it. Needless to say, we don’t expect this particular castle-in-the-air to stay there much longer.
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 2.50-2.59%
Brent Oil 111.51-115.43
This note was originally published at 8am on June 18, 2014 for Hedgeye subscribers.
“Measure what is measurable, and make measurable what is not.”
According to legendary theoretical physicist Stephen Hawking, Galileo likely bears more responsibility for the birth and development of modern science than anyone. This is a heady compliment from one of the most prominent physicists of the modern era. In terms of measuring accomplishments, Hawking is probably right.
While he was well versed in physics and mathematics, Galileo (like the artist Banksy, Galileo was known mononymously) was best known for his work in astronomy. Among other things, he confirmed the phases of Venus, discovered the four largest satellites of Jupiter, and discovered sunspots. Galileo could literally see in the stars things that his contemporaries could not.
As insinuated in the quote at the beginning of this note, Galileo was truly one of the first modern thinkers to establish and vigorously defend the idea that laws of nature are governed by mathematics. In other words, if it could be measured, Galileo measured it. And if it could be counted, Galileo counted it.
This lesson of measuring and counting can also be applied very directly to a less scientific profession, that of investing. The more we can quantify any investment, the better decisions makers we become. Anecdotes are convenient shortcut for the less informed. Math doesn’t lie, people do. As Galileo also advised:
“If I were again beginning my studies, I would follow the advice of Plato and start with mathematics.”
Wise advice, indeed
Back to the Global Macro Grind...
Speaking of outer space, an increasing macro risk we see, especially heading into the summer driving season, is that oil prices are potentially “going to the moon” due to the heightened conflict in Iraq. Iraq currently produces about 3.3 million barrels per day, but it is the second largest exporter after Saudi Arabia in OPEC.
On a percentage basis, over the next five years Iraqi is projected to see the most production growth globally. Net-net, Iraq is the key global swing producer and also has the fifth largest reserves. In the world of commodities, what happens on the margin matters and the Iraq oil industry plays squarely on that margin.
Of course, to the punditry that is arguing commodity inflation is temporary in nature, this adds fuel to the fire. The heightened tensions in Iraq are clearly “temporary” in nature. Currently, the CRB index is up +10.5% in the year-to-date and 16 of 19 of its key components are up as well. For those of us that, like Galileo, like to count things, that means that 84% of componentry of the CRB index is up on a “temporary” basis this year.
As well, for those of us that work in the hallowed halls of Wall Street, or for those that eat iPhones, this might not matter much. But for the median American consumer who has pre-tax income of $47,000, you can be damn skippy it does matter. Assuming those consumers also drive, then accelerating oil prices are only going to accelerate the vise like grip that commodity inflation has on their pocket books.
Coincident with accelerating commodity prices domestically is the fact that real weekly earnings, released yesterday morning, turned back to negative in May. At down -0.10% year-over, this is the worst reading, assuming you believe negative earnings growth is bad, since January of 2013. Food, energy and shelter prices are inflating and real income is turning negative. Clearly, this is an elixir for a strong economy (#SarcasmAlert).
Luckily enough, given the high correlation between many commodities and the U.S. dollar, our policy makers do have a choice, which is to implement strong dollar policy. Seemingly, this has worked for the United Kingdom, where its rational, and Canadian, central banker Mark Carney has protected the currency and the pound is now up 8% year-over-year versus the U.S. dollar. Subsequently, the U.K. economy has outperformed.
Sadly, about the only meaningful move we can expect out of the Federal Reserve later today is that they will once again have to take down their U.S. GDP estimates. Nothing new there though as the Federal Reserve’s economic projection have been about the best lagging, or some instances just wrong, economic projections that devalued U.S. dollars can buy.
Clearly, though, any concerns we may have are misplaced. In fact, this morning, Portugal is selling 12-month t-bills at 0.364% versus the prior level of 0.617% and 3-month t-bills at an average yield of 0.18% versus the prior yield of 0.432%. The Spanish government even got a better deal, selling five year paper at a yield of 1.402% with a bid-to-cover of, are you ready for this, 2.32x! Aye carumba!
Meanwhile, in the most recent U.S. Investor’s Intelligence poll, a mere 22.3% of respondents expect a correction in U.S. equity markets . . . but, hey, the Utility subsector of the SP500 is up +12.7% on the year-to-date, that must be healthy for the U.S. economy. Right? Or maybe the hockey heads at Hedgeye are just seeing stars.
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 2.44-2.66%
Brent Oil 110.23-113.98
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research
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TODAY’S S&P 500 SET-UP – July 2, 2014
As we look at today's setup for the S&P 500, the range is 27 points or 1.23% downside to 1949 and 0.14% upside to 1976.
CREDIT/ECONOMIC MARKET LOOK:
- YIELD CURVE: 2.10 from 2.10
- VIX closed at 11.15 1 day percent change of -3.63%
MACRO DATA POINTS (Bloomberg Estimates):
- 7am: MBA Mortgage Applications, June 27 (prior -1.0%)
- 7:30am: Challenger Job Cuts y/y, June (prior 45.5%)
- 7:30am: RBC Consumer Outlook Index, July (prior 51)
- 8:15am: ADP Employment Change, June., est. 205k (prior 179k)
- 9:45am: ISM New York, June (prior 55.3)
- 10am: Factory Orders, May, est. -0.3% (prior 0.7%)
- 10:30am: DOE Energy Inventories
- 11am: Fed’s Yellen speaks in Washington
- 2pm: Fed board discusses semiannual monetary policy report to Congress, board oversight and assessment of reserve bank
- House, Senate on recess until July 8
- 6am: Quinnipiac releases survey on public opinion of Obama, best and worst presidents since WWII
- U.S. ELECTION WRAP: Rand Paul’s Hedge Fund Ties; Repub. Ads
WHAT TO WATCH:
- JPMorgan CEO Dimon will undergo treatment for throat cancer
- Facebook’s news feed experiment probed by U.K. data regulators
- Motorola Mobility gets second chance at antitrust appeal
- SolarWorld seeks U.S. investigation of China cyber-hacking
- Goldman ‘Boy’s Club’ accused of mocking, underpaying women
- Fastest hiring since 1999 in U.S. as companies’ confidence rises
- GM judge to review rules for multibillion-dollar recall fight
- Dow approaches 17,000 as record transports join small-cap rally
- Apartment rents climb at faster pace as U.S. demand tops supply
- U.S. sale to Iraq of 4,000 Lockheed missiles said to be readied
- Nestle sells Juicy Juice brand to buyout firm Brynwood, WSJ says
- Fed Chair Janet Yellen speaks at International Monetary Fund
- Constellation Brands (STZ) 7:30am, $0.93; preview
- Greenbrier Cos/The (GBX) 6am, $0.74
- SYNNEX (SNX) 4:05pm, $1.36
- UniFirst/MA (UNF) 8am, $1.42
COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)
- Vanishing Coal-Mine Jobs Squeeze Pension at Risk of U.S. Rescue
- Brent Falls to Three-Week Low as Libya Rebels Say Ports Reopen
- More South African Strikes Erupt After Mining Gains: Commodities
- Platinum Reaches 10-Month High as Gold Near Highest Since March
- Corn Falls to Near 5-Month Low as Record U.S. Crop Predicted
- Coffee Gains as Investors Await Brazil Crop Details; Cocoa Falls
- Electronic Devices Waste $80 Billion of Power a Year, IEA Says
- Citigroup Says Growing Commodity Market Share as Rivals Retreat
- Gold’s Rally Will Reverse as Recovery Quickens, Says OCBC’s Gan
- Euromar Slows Cocoa-Bean Processing on Struggle to Sell Powder
- Oil Risk Flares in Iran Nuclear Talks Amid Iraqi Unrest: Energy
- Storm Arthur to Threaten North Carolina by Fourth of July
- Komatsu CEO Flags China Slump as Mining Market Nears Bottom
- Copper Trades Near 16-Week High Before U.S. Employment Report
The Hedgeye Macro Team
Takeaway: 58% voted NO, 42% voted YES
If you follow Hedgeye, you know that one of Keith’s key themes has been #InflationAccelerating. That’s very evident when it comes to oil prices, which have been climbing.
In the video below Macro Senior Analyst Darius Dale discusses the Fed’s monetary policy and geopolitical risks that are impacting on oil prices and the energy sector.
Now, as the summer driving season gets into full swing ahead of the July 4 holiday, we want to know: Will gas prices hit $5 a gallon in your area this year?
At the time of this post, 58% voted NO, 42% voted YES.
Those who voted NO gas prices will not hit $5 a gallon in their area this year reasoned:
- I think we'll ramp slightly this summer, but not too much -- don't think we'll hit $5 a gallon. I also think that Middle East pressure on prices will recede, and those worries already are priced into the market.
Voters who said YES gas prices will reach $5 had this to say:
- Things look perilous in the Middle East, which will pressure prices. The weaker dollar and the Fed's policy to inflate won't help matters. This has $5 gas written all over it.
- At about $5.xx we reach the tipping point for e-vehicles adoption. Many are pushing for this price level. Plus, who would dare add more gas tax with prices at this level.
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