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.
CREDIT/ECONOMIC MARKET LOOK:
MACRO DATA POINTS (Bloomberg Estimates):
WHAT TO WATCH:
COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)
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).
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.
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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.
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.
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.
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.
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