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TODAY’S S&P 500 SET-UP – July 18, 2014

As we look at today's setup for the S&P 500, the range is 21 points or 0.47% downside to 1949 and 0.61% upside to 1970.                                               













  • YIELD CURVE: 2.01 from 2.00
  • VIX closed at 14.54 1 day percent change of 32.18%


MACRO DATA POINTS (Bloomberg Estimates):

  • 9:55am: UofMich Consumer Sentiment Index, July prelim., est. 83 (prior 82.5)
  • 10am: Leading Economic Indicators, June, est. 0.5% (prior 0.5%)
  • 1pm: Baker Hughes rig count



    • House, Senate out
    • 12pm: Congressional Internet Caucus Advisory Cmte holds panel discussion on NSA surveillance programs
    • UN Security Council holds emergency meeting on MH17 crash, may take place at 3pm
    • U.S. Election Wrap: Colo. Dead Heat; Immigration Concerns



  • Ukraine, Russia point fingers over downed Malaysia plane
  • United Nations Security Council to discuss MH17 crash
  • Israeli forces carry out Gaza entry via land, sea
  • AbbVie to buy Shire Pharmaceutical for $55b in cash, stock
  • Line said to seek U.S. IPO with confidential SEC filing
  • McDonald’s workers claim co. fired them for union activity
  • American Apparel investor said to be close to buying loan
  • DoJ alleges FedEx role in delivering misbranded drugs
  • SEC looking at 10 firms in probe of high-speed trading
  • Microsoft job cuts provoke Finnish demands of worker support
  • Energy Future lenders gang up to force talks on rival plan
  • Amazon considering subscription service for e-books: NYPost
  • Union plans more strikes at 9 German Amazon sites: Bild
  • Petsmart talking with investment banks amid activism: WSJ
  • Twitter to roll out 4 new metrics with earnings: WSJ
  • CBS interested in CNN purchase if channel becomes available
  • DirecTV offering NFL package via web at 10 universities
  • IMF, Home Sales, Apple, Facebook, Ifo: Week Ahead July 19-26



    • Bank of New York Mellon (BK) 6:30am, $0.57
    • First Horizon National (FHN) 7am, $0.16
    • General Electric (GE) 6:30am, $0.39 - Preview
    • Honeywell Intl (HON) 7am, $1.36 - Preview
    • Huntington Bancshares (HBAN) 5:55am, $0.18
    • Interpublic Group (IPG) 7am, $0.25
    • Johnson Controls (JCI) 7am, $0.83
    • Kansas City Southern (KSU) 8am, $1.17
    • Laboratory of America (LH) 7:03am, $1.77 - Preview
    • VF Corp. (VFC) 7am, $0.35 - Preview



  • WTI, Brent Set for First Weekly Gain in a Month on Ukraine, Gaza
  • Gold Declines as Investors Weigh Dollar Against Global Tensions
  • Cocoa Grinding in Asia Climbs as Demand for Chocolate Increases
  • Glencore’s Woman Director Marks Progress for Mining: Commodities
  • ANZ Tightened China Commodity Financing Processes ‘A Little’
  • WTI Crude Seen Rising in Survey on Falling U.S. Supplies
  • MORE: Shanghai Exchange Copper Stockpiles Rise 29% to 108,851 Mt
  • Ban on U.S. Oil Exports Seen Dying One Ruling at a Time: Energy
  • Corn Volatility Rises as Options Traders Bet on Price Rally
  • Wheat Set for Weekly Climb as Investors Assess Black Sea Outlook
  • Buzzard Field Power Restored After July 13 Outage, Nexen Says
  • Colorado Governor Says He Opposes Measures Restricting Drilling
  • Kurdish Oil Grab Fuels Independence Dream as Iraq Unravels
  • Copper Traders Bearish for a Second Week as Supplies Seen Ample


























The Hedgeye Macro Team



















CMG reports on Monday, July 21st AMC.


Takeaway: CMG has been the best performer in the restaurant space over the past year (+57.1%) and is a name we continue to prefer on the long side.  We are cautious, however, about the upcoming quarter given notable inflation in avocado, beef and cheese prices.  Recall that Chipotle only began taking ~6% of menu price in early June (~1,000 units), with the system-wide rollout likely completed by the end of 2Q.  Therefore, we question the extent to which management was able to protect margins in the quarter in the face of pressing inflationary pressures.  Looking out into 2H14, same-store sales momentum and the full impact of pricing suggests estimates are too low.  We'd therefore be buying on any post-earnings weakness.


Investment Thesis Overview

Chipotle continues to be one of our favorite longs in the big cap QSR space, highlighted by a best in class operating model and recent same-store sales momentum.  Traffic grew 13.4% in 1Q and management has several drivers in place (faster throughput, non-traditional marketing, GMO-removal, sofritas, catering) to help capitalize on this and enable them to deliver +15% revenue growth and +20% EPS growth for the next few years. 


Food inflation driven by high beef, avocado and cheese prices continues to be a cause for concern, but a MSD price increase should mitigate these pressures in 2H14 and 1H15.  We believe Chipotle has ample pricing power which should allow them to raise prices with little resistance and give another leg up to margins.


Chipotle also continues to attract investors with two potential growth drivers (ShopHouse, Pizzeria Locale) and a strong balance sheet (room to accelerate buybacks).


Earnings Expectations

For 2Q14, the street expects revenues of $989.1 million (+21% YoY), adjusted EPS of $3.09 (+9% YoY), and company owned same-store sales of +10.2% (incl. +2% price).  We’re cautious on earnings given food inflation and little impact on the Q from June price increases.


Same-Store Sales Trends

Given recent momentum and menu pricing of ~6%, we expect two-year same-store sales to accelerate throughout 2H14 and into 1H15.











The 2Q margin outlook is dicey given food cost pressures.  As such, we expect to see notable restaurant level and operating margin contraction.  However, this trend should turn moving forward, as we expect price increases in 2H14 and 1H15 to drive restaurant level and operating margin expansion for the next several quarters.









CMG is currently trading at 43.34x P/E and 21.92x EV/EBITDA on a NTM basis.



This quarter depends on the company’s ability to maintain prior same-store sales momentum and mitigate food cost pressure by leveraging labor and other operating expenses.  2H14 performance will also depend on these factors, but will have the full benefit of ample price increases, which should give restaurant and operating margins another leg up.  Any pushback to these price increases (though unlikely), would be a significant blow to our bullish thesis.  Highly promotional QSRs are trying their best to make this happen.  A decline in new unit productivity would also raise a red flag, as CMG begins moving into smaller markets.


Call with questions.


Howard Penney

Managing Director


Fred Masotta


Replay Ballantyne Brands Expert Call - Are Vaporizers Stealing Share from Big Tobacco

Yesterday (7/16) we continued our “Speaker Series” on e-cigarettes and e-vapor with John J. Wiesehan, Jr., CEO of the Charlotte based company, Ballantyne Brands, the maker of Mistic Electronic Cigarettes.  Mistic is the No. 2 brand in the xAOC category, in 60,000 brick and mortar stores including Walmart, Dollar General, 7-Eleven, and Walgreens (to name a few).


We had a chance to put on a similar call with John in June of last year as part of a series of talks we’ve held with industry experts (previous speakers included CEOs of NJOY, LOGIC, Victory, and VMR Products) to help update and define shifts and trends within the e-cigarette/e-vapor industry. 


Here are the links to the presentation and video replay of the call.


John substantiated many trends we are seeing across the industry, perhaps the largest one being vaporizers taking share from cig-alike (or mini) e-cigarettes, which mostly make up the current non-combustible portfolio of Big Tobacco.  Alongside the consolidation we are seeing in the industry (with Lorillard’s e-cig business blu expected to be sold to Imperial as a part of Reynolds’ acquisition of Lorillard), and persistent questions about the regulatory environment around the category, below are our key takeaways from John’s prepared remarks and a robust Q&A session:


How will the FDA come down on flavors, online sales, and advertising?John expects the FDA to take a science based approaching in evaluating e-cigarettes. To this end the FDA recently announced it would spend $270M on future research. On advertising, he says U.S. legislators (see U.S. Senator Committee on E-Cigs Lobs Harsh Criticism Yet Science Inconclusive) are very concerned about advertising targeting children and the Co. has a policy to target only current combustible smokers in its marketing. Hedgeye’s view agrees with a science based approach, which we expect to be counted in years, and we suspect that over time flavors, online sales and advertising will be banned/restricted in similar fashion to combustible cigarettes.


Is there a broader industry trend to bring liquid, filling and manufacturing of e-cigs/e-vapor products to the U.S. (from China)?  John believes that the consumer will increasingly demand that liquids are USA sourced and filled. He also believes U.S. based manufacturers will be better able to facilitate FDA regulation. In 2012/13 Ballantyne Brands was ahead of most of its peers in deciding to source and fill its e-liquid products in the U.S. (the Co. still sources hardware, including batteries, from China).  We expect Big Tobacco and independent manufacturers to increasingly move to U.S. shores. For competitive (pricing) reasons this is yet to make economic sense to most major players, however increasingly it seems prudent from a regulatory perspective.


How do we contextualize the weakness in E-cig sales trends? How long will this persist?   John says there are clear signs that the consumers is shifting to a vapor product. Indicators include the proliferation of vapor products in easily accessible retail channels (including the company’s Haus personal vaporizer) and the rise in vapor shops across the U.S. (estimated at 6,000-10,000). He estimates that the vapor category is worth between 30% to 50% of the entire e-cig/e-vapor industry.  He confirmed many of the opinions we’ve heard in our “Speaker Series” that the customer is looking for an experience closer to combustible cigarettes and he rank ordered current products (from the best consumer product experience to worst) as: 1) e-vapor (tanks, mods, etc.); 2) rechargable cig-alike; and 3) disposable cig-alike. He thinks disposables could eventually go away. We continue to see that the shift toward e-vapor (which is largely not counted by measures channels) as a major contributing factor to the decline in e-cigarette sales data across measured channels. Added to the decline is also a heavily promotional environment as both MO and RAI begin national campaigns to promote their e-cig brands in MarkTen and VUSE, respectively. 


How do the product offerings of MarkTen and Vuse differ from blu’s offering and how might this impact overall market share figures?  John expects that once all of Big Tobacco is marketing products nationwide the dollar share should go back up, despite an initial period of discounting and promotion to get consumers to try the products.  In terms of technology he says VUSE is a product strictly made in the USA (out of Kansas) and doesn’t expect the experience to be much different from blu.  Regarding MarkTen, which is made in China, he does not see innovation that will create much surprise (if any) for the industry. We have no data to size up VUSE or MarkTen, however we suspect that Big Tobacco’s offering may underwhelm the consumer, accelerating sales of alternative e-vapor products. Although there’s initial rumblings of Big Tobacco’s awareness of this shifting landscape and in some cases plans/development for superior non-combustible offerings, we expect in the near-term no great catalyst to arrest falling (measured) e-cig trends.


Is there future M&A in sight for Big Tobacco or will they fund their non-combustible brands internally? (Ex. Lorillard purchased blu and SKYCIG; Altria bought Green Smoke; PM acquired Nicocigs).  John believes there will be much more M&A over the next year. He thinks Big Tobacco will need to pay attention to independents like Mistic Electronic Cigarettes (and NJOY and LOGIC), that and nimble and can create a product category quickly, because he believes Big Tobacco is missing half of the U.S. market.  We expect the e-cigarette/e-vapor market to remain highly fragmented (especially given the FDA’s mild proposed regulatory stance that allows online sales and flavors). We see a handful of private players (like Ballantyne Brands, NJOY, LOGIC, and Victory) that stand to compete with Big Tobacco in retail (despite ever limited shelf space), and therefore are posed as attractive buyouts for Big Tobacco given their potential as established brands with complementary product offerings. 


Howard Penney

Managing Director


Matt Hedrick



Fred Masotta


Early Look

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Poll of the Day Recap: 71% Are Bearish on Housing

U.S. housing starts unexpectedly fell 9.3% to a nine-month low to an 893,000 annualized rate in June, versus a 985,000 pace in May which was weaker than initially estimated. For the record, Hedgeye has been bearish on housing since the spring. “Today’s number wasn’t pretty, it confirms our negative outlook,” said analyst Josh Steiner who co-heads Hedgeye's financials and housing sectors.


In our Real Conversations video below Chris Whalen, Senior Managing Director and Head of Research at Kroll Bond Rating Agency and Hedgeye Financials Sector Head Josh Steiner discuss the structural issues within the housing market and how demand peaked in Summer 2013.



In the today’s poll we asked: Are you bullish or bearish on housing over the next year?


At the time of this post, 71% are bearish, 29% are bullish.


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


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