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Stock Report: Bob Evans Farms, Inc. (BOBE)

Stock Report: Bob Evans Farms, Inc. (BOBE) - HE II BOBE table 7 17 14


BOBE is a stodgy, old company that has flown under the radar for far too long. 


For those unfamiliar, Bob Evans was founded in 1948, when the company’s namesake began making sausages on his farm in southeastern Ohio.  The business was incorporated in Ohio in 1957 and became publicly traded in 1963.  Bob Evans Farms operates in two primary businesses: Bob Evans Restaurants and Bob Evans Farms Foods.  Bob Evans Restaurants owns and operates 562 full-service restaurants in 19 states across the U.S., primarily in the Midwest, mid-Atlantic and Southeast.  BEF Foods produces and distributes a variety of refrigerated and frozen food items to more than 30,000 retail locations across the U.S. and Mexico. 


We’ve followed BOBE on and off over the years, but have never really gotten behind the story – until now.  The level of activism in the restaurant industry has never been more rampant.  In the past year alone, we’ve seen CBRL, DAVE, DRI, BJRI and BOBE attract largely uninvited attention from these investors.  In the case of BOBE, we believe Sandell Asset Management’s attention was warranted.  All told, BOBE has a long history of mismanagement, evidenced by flawed strategic rationale, an excessively bloated cost structure and severe underperformance relative to peers.  Fortunately, its poor operating performance presents a tremendous opportunity.


We believe Sandell has identified significant, largely feasible, opportunities to enhance shareholder value.  Particularly, we see tremendous upside value in selling the foods business, transitioning to an asset light model and refocusing capital allocation.


INTERMEDIATE TERM (TREND) (the next 3 months or more)

Don’t get us wrong – it was a disastrous year for Bob Evans Farms and its management team, but that precisely the point.  We don’t like the company for what it is, we like it for what it could be.  Sandell has been working tirelessly to unlock significant value and if BOBE reports another quarter similar to the one it just did, we won’t have to wait much longer.  We believe BOBE’s inherent value and the upcoming proxy fight should keep the stock afloat over an intermediate-term duration.  BOBE holds its Annual General Meeting on August 20th.  This will be a monumental moment for the company and its shareholders.


LONG-TERM (TAIL) (the next 3 years or less)

We have a ton of respect for Sandell and the work they’ve done.  In fact, we believe that, over time, they have uncovered far more than they originally set out to.  As a result, there is now an opportunity for them to capture bountiful, low hanging fruit that will immediately change the business for the better.  We believe in Sandell’s resolve and while the street is seemingly betting against them, we’ll gladly take the other side of the trade.  If Sandell is successful in their efforts to effect change, we see at least 65% upside to BOBE shares over the next two years.


Stock Report: Bob Evans Farms, Inc. (BOBE) - HE II BOBE chart 7 17 14


YUM reported 2Q14 earnings AMC yesterday, missing top line estimates by 110 bps while beating bottom line estimates by 19 bps.  Strength in China and KFC were largely offset by weakness at Pizza Hut and Taco Bell.  In aggregate, system-wide restaurant margin increased 300 bps to 15.5%.  We cautioned coming out of 1Q that we believed a China recovery was baked-in and that the Street was looking to Taco Bell for any incremental upside.  Unfortunately, Taco Bell delivered another disappointing performance in 2Q in which it failed to meet high expectations surrounding its national breakfast launch.


Management reiterated guidance for 20%+ adjusted EPS growth and 40% operating profit growth in China, but indicated full-year China SSS would come in at the low end of its initial guidance range or in the high-single digits.  All told, there remains a lack of quarter-to-quarter visibility in the China segment and we believe management guided cautiously with this in mind.  With that being said, we believe investors can finally put any China fears behind them - the recovery is well underway.  Management also indicated that full-year results for the Pizza Hut Division will fall far below initial expectations.


While the stock has reacted negatively to the print and subsequent earnings call, we continue to believe YUM is a strong long-term investment with limited downside over the intermediate-term.  We believe YUM is best positioned to capitalize upon a material emerging market opportunity.  As noted on the call, YUM currently has two restaurants per million people in emerging markets compared to 58 restaurant per million people in the U.S.  In addition to its enormous growth potential, YUM is a largely franchised business (~90% of stores outside of China are franchised) that generates more than $2 billion in franchise fees.  With this diversified revenue stream, YUM is able to strategically invest in its growth and enhance its earnings growth by returning all excess cash (after investments, ~2% dividend payout) to shareholders through share repurchases.


Below, we provide brief updates on each operating Division.


China Division system-wide sales increased 21%, including same-store sales growth of 15%.  Restaurant margin increased 620 bps to 16.8%.  New unit returns are outstanding and the company is well-positioned to capitalize upon China's growing consumer class, particularly in higher return tier 3-6 cities.  KFC same-store sales grew 21%, benefitting from an easy comp as well as its Brand Relaunch which included 15 new products, redesigned packaging, new uniforms, new menu boards and a new marketing plan that leveraged four local popular celebrities.  Value scores improved despite average check rising.  The company remains focused on premium innovation and superior customer service.  With that in mind, it has begun rolling out free Wi-Fi and is working on a new mobile app with payment capabilities.  Pizza Hut same-store sales were flat in the quarter, after lapping 7% growth in 2Q13.  The business model is as strong as ever, with two-year cash paybacks on new Pizza Hut casual dining restaurants.  They continue to aggressively expand into lower tier cities, with plans to have over 1,200 units by year-end.  Pizza Hut home service continues to be an exciting opportunity with room for substantial upside.


KFC Division delivered 2% same-store sales growth, led by international strength and offset by a struggling U.S. business.  Restaurant margin and operating margin increased 30 and 10 bps, respectively.  While the domestic KFC business was weak, 90% of the division's operating profits come from outside the U.S.  KFC is well-positioned to capitalize on emerging markets, with plans to build 650 new units outside of the U.S. this year.


Pizza Hut Division same-store sales declined 3%, in part due to flat same-store sales in emerging markets and a 4% decline in the U.S.  Restaurant margin and operating margin decreased 640 bps apiece.  Full-year operating profit is expected to fall well short of prior expectations.  Management plans to launch a number of initiatives to reignite sales in 4Q, aimed at developing a stronger value proposition (more competitive offers).  They also appeared excited about the digital opportunity here and set the goal of surpassing competitors in this space in 2015.  YUM expects to build 450 new international units this year.


Taco Bell Division same-store sales increased 2%, falling well short of 6% estimates.  Although restaurant margin decreased 270 bps due to incremental food and labor costs, operating margin increased 10 bps.  The comp was particularly disappointing, considering 2Q14 marked the launch of Taco Bell's national breakfast.  We believe the marketing aimed solely at breakfast in the first two months of the year, along with a disappointing product launch, negatively affected the lunch and dinner dayparts.  Breakfast comprised 7% of sales in the quarter and added approximately $70,000 to $120,000 in sales per unit.  Management, and franchisees, appear genuinely excited about the breakfast daypart (plan to broaden the offerings) and intend to leverage innovation across all dayparts in the coming quarters.  YUM reiterated its long-term goal of having 8,000 Taco Bell restaurants in the U.S.


India Division same-store sales decreased 2%.  Management is committed to moving ahead of the growth curve and is targeting 2,000 units by 2020 (up from ~700 today).






Call with questions.


Howard Penney

Managing Director


Fred Masotta


Cartoon of the Day: Escar-No-Go

Takeaway: We expect consensus economic optimism to be marked to [a more dour] reality as we progress through 3Q.

Cartoon of the Day: Escar-No-Go - escargot 07.17.2014

Early Look

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VIDEO | #DollarDevaluation: 3Q14 Macro Themes Call Excerpt

In this excerpt from Hedgeye's 3Q14 Macro Themes Call with institutional investors on July 11, CEO Keith McCullough outlines why we remain outside consensus and expect to see continued #DollarDevaluation, as well as how to front-run the Fed's predictable behavior.

PM – Strong Q2; Rich Valuation Supported Over Long Term

PM beat Q2 top and bottom line estimates (EPS $1.41 ex-items vs consensus $1.24 and Revenue $7.80B vs consensus $7.52B) on better than expected volume trends. However, tougher EPS comps in the back half of the year on persistent macro challenges, especially from the Asia region, could drive 2014 performance to the lower end of the company's 6% to 8% guidance, or $4.87-$4.97 that was reaffirmed today. Over the longer term we’d warm to the stock. We're bullish on the Marlboro 2.0 architecture to attain new global customers from higher margin products and we believe PM is ahead of the curve on R&D behind its non-combustible Risk Reduce Product (RRP) category, which we see as a natural progression to meet and grow new product demand given declining global combustible cigarette trends. 


We expect the stock to be bid up today on a marked improvement in sales at -1.5% Y/Y vs last quarter at -8.8%, however the set-up is largely as anticipated by the company due to timing dynamics and a considerably easier comp of-2.5% in Q2 2013 vs +1.8 in Q1 2013. The company boosted its OCI margin +1.2% to 44.3% despite taking a $489M charge for impairment and exit costs related to the closure of a production facility in the Netherlands and additional costs to shutter a factory in Australia.


PM offers a healthy dividend yield of 4.4% and a generous stock buyback program ($1.75B remains on a $4B 2014 repurchase target for the year), however given the aforementioned near to medium term headwinds, we’ll wait for its rich valuation to depress before we’re buyers.  For now, we like its U.S. peers that do not have PM’s geographical headwinds.  Further, we expect the news on 7/15 that RAI intends to buy LO to further spur investment interest in the U.S. manufacturers.

PM – Strong Q2; Rich Valuation Supported Over Long Term - z.. cig pe


Notable geographic performance in Q2 and Outlook

Asia:  Volumes fell -6.1% and operating income plunged -20.2% on the back of weakness in Australia and Japan. In Australia the main factors contributing to the decline remain down trading from the issuance of plain packaging, excise tax hikes, and heavy discounting from competitors.  Japan also remained weak in the quarter with volume down -14.4% (reflecting de-stocking of trade inventories) and share fell -0.5 points to 26.4%. Unfavorable hand-rolled trends in Indonesia was partially offset by better trends in machine made. Philippines volume down 13.4%, as the Co. begins to take share from competitor Mighty Corporation as it is increasingly pressured from the government to appropriate pay excise tax (vs previously reporting half of its revenue for tax purposes).


EEMA:  Russia market share up +0.9% to 26.8%, volume down -10%, with price increases up 25% Y/Y. The 4 Ruble per pack increase in May 2014 may impact consumption along with June smoking restrictions.  Turkey volume increased 2.5%, with stable underlying trends.


EU:  Cigarette volume was much stronger than expected, down -1.2%. Total share increased +0.9 points to 40.4%. The EU region is now expected to see FY volume declines of -5%, an improvement over the previous range of -5% to -6%. The Co. announced price increases in Germany (~20 cents per pack avg.), Portugal and Spain, which will helped to offset weakness in Italy due to VAT increases. The Co. cited Poland’s volume (-7%) was impacted by the growth in e-vapor products. 


After we get past more difficult comps in 2H of this year we’re bullish over the longer-term on Marlboro 2.0, the company’s architecture to modernize the brand, and with it expand into new population and smoker segments, catering towards trends of consumers seeking smoother tastes, even within the full-flavor category. 


We’re positive on the company’s push to trade up consumers to the premium and above premium categories that enjoy higher margins with combustible cigarettes, and bullish on PM’s future portfolio of Risk Reduce Products to meet consumer trends shifting away from combustible. We believe PM can carry out its strategy over the longer term, leveraging strong marketing and sales teams across the globe, and leverage the growth in aspirational consumers seeking the strong brand identities of the PM portfolio.


PM – Strong Q2; Rich Valuation Supported Over Long Term - z. pm


Howard Penney

Managing Director


Matt Hedrick



Fred Masotta



Takeaway: The labor data is strong, no question, but we're also getting late in the cycle. We reflect on how late in the note below.

Below is the detailed breakdown of this morning's initial claims data from the Hedgeye Financials team led by Joshua Steiner. If you would like to setup a call with Josh or Jonathan or trial their research, please contact 



You Know, the Jungian Thing

The first chart below summarizes where we are in the labor market from a historical context. Allow me to suggest something akin to the duality of man. On the one hand, we're seemingly in a great place. Claims are near their historic lows at 309k (rolling SA). Look back at the last three periods in time when claims were comparably low. You'd be looking at the periods of December, 2005, April, 1999 and August, 1987. All those periods were auspicious as they were accompanied by a rapidly rising stock market and an ongoing economic expansion. On the other hand, they were also all in relatively close proximity to major market corrections: 2 months away in the case of August, 1987, ~2 years away in December, 2005 and ~1 year away in April, 1999. Such is the dilemma of where we stand today. We're standing on the tracks and we know the train is coming, but we don't know if it's 2 months or 2 years away. #Conundrum.




[HEDGEYE MACRO]:  An alternate approach to the “where are we in the cycle” question is examining how long, after having reached their frictional lower bound, have claims tracked at a level generally considered (by the market) to be “good”.


On average, over the last three cycles, claims have held below the 330K level for ~33 months.  The present streak currently stands at 5 months.    




The chart below speaks to just how strong the data is at the moment. By the way, it's important to remember that seasonal auto manufacturing furloughs occur at this point every year, but last year, due to strong demand, they went largely unutilized. Furloughed autoworkers are eligible to file for claims. As such, seeing the NSA Y/Y prints come in as strongly as they are suggests things really are quite good (at the moment).





The Data 

Prior to revision, initial jobless claims fell 2k to 302k from 304k WoW, as the prior week's number was revised up by 1k to 305k.


The headline (unrevised) number shows claims were lower by 3k WoW. Meanwhile, the 4-week rolling average of seasonally-adjusted claims fell -3k WoW to 309k.


The 4-week rolling average of NSA claims, which we consider a more accurate representation of the underlying labor market trend, was -11.2% lower YoY, which is a sequential deterioration versus the previous week's YoY change of -11.4%







Joshua Steiner, CFA


Jonathan Casteleyn, CFA, CMT






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