Cartoon of the Day: The 4 Most Dangerous Words

Takeaway: Our advice? If you hear somebody utter the following four words ... run.

Cartoon of the Day: The 4 Most Dangerous Words - Bull goes... 07.11.2014

Riding Out the LO Gravy Train!

The big news overnight and into this morning is that all parties that may be involved in a deal to acquire LO (directly or not) acknowledged through press releases that in fact the parties are underway in discussions yet noted that there is “no certainty that any deal will take place”.  This not-so-new-news (rumors have persisted since March of this year of a deal between RAI and LO), is bolting LO as high as 5%+ intraday (to $66) as of this writing.


We are riding out our long position in LO, which we initiated as a Best Idea Long on 2/26/14 at $47.74, to a price target of $80. We expect to see RAI and LO work closely to get this deal done, and attach an 85% probability that a deal in fact gets done.  Assuming yesterday’s (7/10) closing price of $63.09, we assume there’s an additional 26% upside to our target, and ~ 8% of downside to $58 should a deal not get done.


Facts Around a Deal:

  • British American Tobacco (BAT) owns 42% of RAI and would have to approve any merger. The company has indicated it wishes to maintain its existing stake
  • Imperial Tobacco Group may be a key buyer of select RAI brands to assuage any U.S. antitrust concerns.  As is, RAI+LO would command 67% of U.S. menthol market – definitely an antitrust flag, so we expect divestiture from RAI’s menthol properties
  • Imperial targets from RAI’s menthol brands could include Kool, Winston and Salem, or ~5% of its business. [For more on Imperial’s Positioning see Imperial Sweetens Potential RAI-LO Deal]
  • Whispers are Imperial may have $7B to spend – it’s interested in building out a U.S. business
  • We suspect that RAI’s new CEO Susan Cameron (announced in late April) was positioned by the board to get a deal done (and transform the company) rather than simply accept a buy-out from BAT



  • RAI+LO would have annual sales of $13B and market cap of $56B, or 42% share of U.S. tobacco, second to #1 MO at 51%
  • Per the chart below we expect LO’s blu business to propel the entire business to a higher growth rate over the next 5 years
  • The tobacco group (PM, MO, LO, RAI) is currently trading at a forward P/E of 16.8x vs 13.2x 5-YR historical average
  • Superior fundamentals of LO’s menthol business, leading share of e-cigarette category in blu (45% across all channels), and the synergies involved in a combined RAI+LO (estimated ~ $500-$600M) should command/propel a higher P/E multiple as tobacco moves into an even more tightly consolidate industry = additional pricing power to defend declining volume trends
  • We suggest LO should command a P/E of 17x to 18x
  • We expect LO to command at least $80/share. Below is a sensitivity chart to assess various ranges based on 5-yr forward EPS estimates and discount rate applied

Riding Out the LO Gravy Train! - z4


Howard Penney

Managing Director


Matt Hedrick



Fred Masotta


June: The Ugly Duck of 2Q

We were recently given a look at June sales and traffic trends from Black Box Intelligence which were, in aggregate, disappointing for casual dining industry.  Both same-store sales and traffic declined during the month.  Before we delve further into the details of the release, we thought it'd be useful to highlight the changes in same-store sales estimates from the beginning of 2Q (April 2nd) to today (July 11th).


The street took up 2QC14 SSS estimates over the course of the quarter for the following companies: BWLD, CAKE, CHUY, DFRG, KONA, RRGB, RT, TXRH.


The street took down 2QC14 SSS estimates over the course of the quarter for the following companies: BBRG, BJRI, BLMN, BOBE, CBRL, DIN, DRI, EAT IRG, RUTH.


The street left 2QC14 SSS estimates unchanged over the course of the quarter for DENN.


We continue to like DFRG on the short side and believe same-store sales estimates, which have risen over the course of the quarter, are too aggressive.  In particular, we have serious doubts that Grille and Sullivan's will post a +3.4% and a +0.1% comp, respectively.


Despite a rather disappointing quarter, revisions to same-store sales estimates were fairly mixed leading us to believe that expectations are too high for several companies.  Casual dining stocks have underperformed both the SPX and XLY, in aggregate, over a 1YR, 6M, 3M, 1M and 1W duration.


June: The Ugly Duck of 2Q - ch1


June: The Ugly Duck of 2Q - 5


June was the worst month of the quarter, with same-store sales and traffic down -0.10% and -1.7%, respectively.  The underlying trends were similarly concerning, with two-year same-store sales and traffic down -0.1% and -2.1%, respectively.  Notably, each month in the quarter was worse than the prior.  This is consistent with the discounting trends we've seen in the industry.  As food cost pressures continued to build throughout the quarter, casual dining companies decreased their level of discounting in order to protect margins.  In turn, traffic suffered which leads us to believe it's a "pick your poison" environment for casual dining operators right now.


June: The Ugly Duck of 2Q - chart2


June: The Ugly Duck of 2Q - 44


Weather, which was the scapegoat in 1Q14, can no longer be used as an excuse.  Rather, we point to a number of issues including stagnant wages, rising gasoline prices and what we've deemed "casual dining's secular decline."  Overall, 2Q14 was a disappointing quarter as same-store sales increased +0.3%, while traffic declined -1.4%.  These results are, however, an improvement over a tumultuous 1Q14.


Black Box also noted that the best performing region was Mountain Plains (SSS +2.1%; traffic -0.6%) and the worst performing region was NY/NJ (SSS -2.6%; traffic -3.5%).


Trends in the casual dining industry have been rather unsettling to us.  While the bulls blamed weather in 1Q and predicted a strong 2Q, that clearly didn't materialize.  In fact, we'd argue that looking at our proprietary Casual Dining Index, same-store sales estimates of +1.4% in 2Q14 are far too high.  Unless estimates come down further, this should make for some interesting earnings releases!


June: The Ugly Duck of 2Q - chart4


Call with questions.


Howard Penney

Managing Director


Fred Masotta



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RH Black Book: Real Estate Deep Dive

Takeaway: Join us for a call to debate the key issue today facing RH – real estate. Our deep dive will show why we think this story is far from over.

Please join us on Thursday, July 17th at 11:00 am ET for a call titled RH: Real Estate Deep Dive. We’ll be releasing our 2nd  Black Book on Restoration Hardware, specifically outlining the key issues that we think are critical to the investment thesis and the stock at this point in the company’s growth trajectory.  The reality is that some of the key factors to this story deserve greater scrutiny today than they did just $30 ago. 


We’ll hit on several topics, but the key focus on Thursday will be real estate. The crux of our commentary will focus on the likelihood of success in RH’s build-out of its large format Full Line Design Galleries. We’ll outline the biggest opportunities, potential risks, and whether or not the company is set up to execute on this opportunity. Ultimately, we’re going to flush out the real estate profile and potential store growth in the same way and using the same tools many retailers use to analyze their own store growth opportunity.



1) What does RH’s addressable market look like, and how will that evolve over the next 5 years?

2) How many markets in the US can support a Full Line Design Gallery at the sales productivity standards that RH is setting for its’ new stores?

  1. We’ll drill down on specific markets that have been announced, but will also analyze in great detail other markets that we think are likely candidates that the company has not yet announced.
  2. We’ll look quantitatively at the underlying economics of each FLDG market.
  3. We’ll break out ‘fill in’ markets versus new markets.
  4. The costs of the properties is evolving. How this is impacting RH’s ROIC?

3) A look at trends we’re seeing in anchor tenant space, and why we’re seeing more premium space available than most people might think.

4) Category expansion, and which categories present the biggest opportunities (and potential risks) at retail.

5) How much of a risk is a housing downturn to the RH story?


Participant Dialing Instructions

Toll Free Number:

Direct Dial Number:

Conference Code: 275779#

Materials: CLICK HERE

Retail Callouts (7/11): FL, LULU

Takeaway: FL - Lorna Jane may help fix womens/apparel issues at FL, but we're not overly excited



FL, LULU - Australia's Lorna Jane Attracts Some Big-Name Suitors



  • "Lorna Jane, an Australian maker and seller of women's workout clothing that is up for sale, has attracted buyer interest from Foot Locker Inc. and private-equity firms, according to people familiar with the matter."
  • "Manhattan-based Foot Locker and private-equity firms Advent International and Bain Capital are among potential buyers submitting first-round bids for Lorna Jane, some of the people said. Lorna Jane hired investment bankers Credit Suisse  to sell itself, the people said."


Takeaway: FL has a lot of cash to play with and Lorna Jane could help reinvigorate two of FL's biggest issues womens and apparel. If a deal were to go through, it's likely that Lorna Jane would function as a stand alone banner - we can't justify $90 yoga pants on Foot Locker shelves. Adding the brand's 169 stores into the fold would account for 5% unit growth to a base that has been shrinking organically for the last 8 years, and 3 percentage points of growth to the top line. But, it's hard for us to get overly excited about a brand that did under $1mil per store in 2013 (150 Stores, $138mm in sales) when LULU is pumping out $5mil plus through its box. Yes, the brand has limited awareness in the US and the Yoga market shows no signs of slowing so there is some runway for growth, but not enough for us to get overly excited about this potential deal.




EBAY, AMZN - ChannelAdvisor Reports June Comp Sales


Retail Callouts (7/11): FL, LULU - Chart1 7 11 2014


GPS - Gap Inc. Reports June Sales



  • "Gap Inc.’s comparable sales for June 2014 were down 2 percent versus a 7 percent increase last year. Comparable sales by global brand for June 2014 were as follows:
    • Gap Global: negative 7 percent versus positive 5 percent last year
    • Banana Republic Global: negative 7 percent versus negative 1 percent last year
    • Old Navy Global: positive 7 percent versus positive 13 percent last year"

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