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July 22, 2014

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CHART OF THE DAY: Leading vs. Lagging Indicators: You Choose


CHART OF THE DAY: Leading vs. Lagging Indicators: You Choose - Chart of the Day


Risk managing macro rarely has anything to do with “valuation” or even reported supply and demand metrics. Most of the big moves in macro happen on the margin when there is a phase transition in price momentum, volume, and volatility.

Cyclical Times

“In cyclical time, a society always evolves.”

-The Fourth Turning


Are you long Millenial evolution? “From the Arthurian Generation through today’s Millenial Generation, there have been twenty-four generations in the Anglo-American lineage. The first six were purely English. Millenials are the fourteenth in the American line.” (The Fourth Turning, pg 95)


So get in the burrito line. With +17% same store sales and +29% year-over-year revenue growth, evidently Millenials are eating lots of Chipotle (CMG). They are texting, tindering, and talking about things baby boomers don’t talk about too.


Being long new patterns of consumption and short old ones is a profitable way to look at the world. Having been on the long/short side of consumer stocks for almost my entire career, this is where I’ve seen some of the biggest moves – and they go both ways!


Cyclical Times - millenials


Back to the Global Macro Grind


BREAKING: US Orange Juice Sales Fall To Record Low –Wall Street Journal


Yep. Damn Millenials are drinking the fruitier and frumpier stuff that costs 10x more. But, no worries, there’s no inflation in food/beverages – ask the Fed. With Orange Juice prices up another +0.4% in a down US Equity tape yesterday to +12.3% YTD, there’s deflation in whoever is short OJ demand.


As we age in this business (I’m a 13th gen dude and will be 40 within the next 6 months) we learn that most things we learned early on were in some way, shape, or storytelling form, false.


Risk managing macro, for example, rarely has anything to do with “valuation” or even reported supply and demand metrics. Most of the big moves in macro happen on the margin when there is a phase transition in price momentum, volume, and volatility.


How about long Copper (JJC)?


  1. Worldwide supply is hitting all-time highs
  2. But prices are starting to breakout from a TREND signal perspective


Or are they?


I’m not wed to a Millenial or Copper. I am happily married with three children and a risk management process that will hopefully allow me to be less wrong than I have been over the course of the last 15 years.


But in Real-Time Alerts I issued a buy signal in Copper on last week’s pullback. This morning I am getting buy signals for both the Shanghai Composite Index (China) and the Hang Seng. Both broke out above my intermediate-term TREND signal. We don’t have a research call to support that signal (yet), but do you always need one? Or is Mr. Macro Market telling you that you are going to get one?


What is a phase transition?  


A phase transition is the transformation of a thermodynamic system from one phase or state of matter to another by heat transfer.” –Wikipedia


And, in modern macro times, the heat transfer of price, volume, and volatility is measurable.


So why don’t more investors care about multi-duration, multi-factor, risk analytics. Why do so many still hinge on some gospel like “valuation” for direction, when reality is that market multiples expand and contract much more on economic and/or market phase transitions than anything else?


If you can answer all these questions, let me know. Because I can’t.


What are the most interesting big macro time/price cycles (for asset classes) that have gone from bearish to bullish from 2013 to 2014?


  1. US Treasuries
  2. Commodities
  3. Gold
  4. Emerging Market Equities
  5. Chinese Equities?


That last one I won’t buy until Darius Dale gives me the green light. But there’s no reason to sit in 50% cash when very liquid asset classes like this are getting people paid. On the bear side, we’re all about shorting USA baby-boom #ConsumerSlowing patterns:


  1. US Housing
  2. US Casual Dining Stocks
  3. Broadline Retailers


In macro investing, it’s important to contextualize where you are in the cycle. Almost every single short idea we have that isn’t purely bottom-up is what we call an “early cycle” call. Plenty of the mid-to-late-cycle ideas out there (like being long inflation) will eventually run their course. It’s our job to always evolve our process and try to signal when they do.


Our immediate-term Global Macro Risk Ranges are now:


UST 10yr Yield 2.46-2.56%


RUT 1132-1155

VIX 11.94-14.99

Gold 1

Copper 3.18-3.24


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Cyclical Times - Chart of the Day

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CMG continues to be one of our core longs.




Comps: CMG delivered +17.3% comp growth in the quarter, beating estimates of +10.2%, led by traffic and, to a lesser extent, a +5% increase in average check (+2.5% price; +2.5% benefit from catering/side orders).  Management upped its FY14 comp guidance once again, from high-single digit growth to mid-teens growth.  Revenues of $1,050 billion (+29% YoY growth) beat consensus estimates by 6.10%.


Margins: Despite an accelerating topline trend, cost of sales inflation (beef, avocado, cheese) squeezed profits in the quarter – albeit to a much lesser extent than expected.  Management was able to leverage other lines, including labor and other restaurant expenses, in order to offset some of this pressure.  All told, Chipotle absolutely blew away expectations and the margin structure of the company moving forward looks quite rosy, particularly with a full price impact hitting in 2H14.




Earnings: Adjusted EPS of $3.50 (+24% YoY growth) beat expectations of $3.09 by 13.34%.


Brief Analysis: As the title says, this was simply an incredible quarter.  Coming into the print, we were slightly cautious regarding food cost inflation and the one-month effect of a price increase.  We didn’t know CMG was going to deliver +17.3% comp growth, but neither did anyone else.  Declining margins are no longer a concern, because this will end next quarter.


Chipotle has rolled out a 6.25-6.50% price increase system-wide, which should, by our calculation more than offset any food cost inflation.  In fact, management indicated this price increase could lead to 30%+ restaurant level margins in a best case scenario.  This hinges on several assumptions: 1) consumers continue to be receptive to price increases 2) food costs don’t increase from here and 3) consumers don’t trade down any more than they already have.  Regardless, if Chipotle can run their restaurants anywhere close to 30% margins, we’ll consider it a major feat.  We’ve always preached that Chipotle has pricing power, but finally confirmed it with today’s release of our Hedgeye Consumer Survey.  What struck us most about the results is that younger consumers, Chipotle’s core target market, are least resistant to price increases.


Chipotle’s unique marketing message and ability to connect with consumers isn’t the only thing driving traffic.  They also continually deliver faster throughput, increasing peak hour transactions at lunch and dinner by eight customers a piece.  Catering comprised 1.6% of sales in the quarter and reached 2% of sales in established markets.  We continue to believe this can be a meaningful driver to sales and average check over the longer-term.


On Friday, we also reiterated our view that Street estimates for 2H14 were too low.  With that being said, and considering management’s new SSS guidance, we expect estimates to be revised up drastically over the next several weeks. 


What We Liked:

  • +17.3% same-store sales growth; +11.5% two-year average
  • Management upped its FY14 comp guidance once again, from high-single digit growth to mid-teens growth
  • Revenues of $1,050 billion (+29% YoY growth) beat consensus estimates by 6.10%
  • Adjusted EPS of $3.50 (+24% YoY growth) beat expectations of $3.09 by 13.34%
  • Performance speaks to the strength of leadership teams and operating crews
  • Unparalleled food culture
  • Have begun sourcing grass fed beef from Australia in order to uphold integrity
  • Marketing efforts are really resonating; establishing emotional connections with consumers
  • Throughput continues to improve; this quarter by 8 transactions at peak hour lunch and 8 transactions at peak hour dinner
  • AUVs for restaurants in the comparable base have surpassed $2.3 million for the first time
  • Catering hit 2% of sales in established markets
  • Expect opening sales volumes in the $1.7-1.8 million range; up from prior $1.6-1.7 million
  • Underlying economic earnings growth is stronger than implied
  • Repurchased over $37 million of stock in the quarter
  • Have $140 million remaining on current share buyback program
  • Saw frequency improve in the teen market across all different economic backgrounds
  • Considering building out smaller box units with much less seating (2/3 of customers takeout)


What We Didn’t Like:

  • Expect steak inflation to be considerable for the foreseeable future
  • Have seen some customers trade down from steak to chicken




Call with questions.


Howard Penney

Managing Director


Fred Masotta



Q2 and Q3 look like beats although we’re not sure management will raise guidance when they report company earnings on Thursday




RCL will report Q2 earnings this Thursday morning.  We expect a Q2 beat and while Q3 guidance could match consensus estimates, our proprietary pricing survey is suggesting another beat in Q3.  Thus, we remain above the Street for 2014 as a much stronger Europe offsets a still struggling Caribbean market.



We expect Q2 net yields (constant-currency) and EPS to be 2.8% and $0.54, respectively, above the consensus EPS estimate of $0.52.  Given what we’ve seen out of Europe on pricing and bookings, we expect Q3 yield guidance of +4-5%, which should be enough to placate the bears.  For Q3, we’re forecasting 4.9% net yield growth and $2.19 in EPS versus the Street EPS estimate of $2.11. 



We usually prefer to focus on sequential pricing trends as YoY pricing indicators are highly volatile and weak in their predicative power in signaling price pivots.  However, we feel it is worthwhile to highlight the rapid ascent RCL has seen in European YoY pricing as this year has progressed.


As seen in the chart from our mid-July pricing survey below, we believe European pricing (as weighted by brand) have averaged 15% YoY growth for Q2 sailings and averaged 10% YoY growth for Q3 sailings.  Q4 pricing is trending close to double digits YoY as well.  Given the strength in bookings, particularly for the RC brand, European yields could be +20% for Q2 and +15% for Q3.  Europe will play a prominent role in Q3 as it accounts for 44% of all RCL sailings, compared with 22% in Q2.  





This ‘transformational’ ship is getting quite a lot of positive buzz.  In fact, it’s one of the few bright spots in the overcrowded, fiercely competitive Caribbean market.  Agents continue to rave about Quantum, which has held pricing for its winter itineraries since we started tracking in February.  We believe Quantum will easily take over the NJ/NY market for Winter 2014/Spring 2015 Caribbean sailings, at the expense of Norwegian Gem and Breakaway



As we look out to 2015, Quantum’s sister Anthem of the Seas is seeing increased demand for its summer 2015 sailings out of Southhampton.  RCL will need this surge as the company deals with some of the toughest comps and higher capacity in Europe.  China, while an exciting opportunity, will certainly be a wild card in the 2H of 2015.



We are encouraged by the sticky pricing driven partially by easy comps in Europe for the RCL brands.  Given the persistently weak pricing in the overcrowded Caribbean market, to which RCL is not immune, we do not believe RCL will raise its previously disclosed FY 2014 net yield guidance of 2-3%. However, RCL will receive a big lift in Q4 Caribbean when Quantum of the Seas hits the market in November 2014.  As we’ve seen multiple times, investors are giddy whenever a media-happy new ship is about to be deployed.




DFRG reports on Tuesday, July 22nd BMO.


Takeaway: DFRG remains on the Hedgeye Best Ideas list as a short.  We expect weak casual dining trends and cost of sales inflation (beef, shrimp, milk, cheese) to pressure margins in the Q.  While Del Frisco's may have pricing power at the Double Eagle concept, we doubt they have any at the other two concepts.  That said, same-store sales estimates at Grille (+2.9%) and Sullivan's (-0.1%) continue to look aggressive.


Investment Thesis

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.  We believe 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're confident the stock is dislocated from its intrinsic value as our sum-of-the-parts analysis suggests notable downside.  You can review our full thesis here.


Earnings Expectations

For 2Q14, the Street expects revenues of $69.10 million (+14% YoY), adjusted EPS of $21.00 (+4% YoY), and system-wide same-store sales of +2.3% (led by +3.6% growth at Del Frisco's Double Eagle).  We see downside to earnings driven by disappointing comps at Grille and Sullivan's as well as margin pressure due to significant food inflation.


Same-Store Sales Trends

Two-year same-store sales trends are plain ugly, but the Street is baking in a recovery in 2Q14.  We're slightly less optimistic.  Grille is still defining its target market and Sullivan's hasn't yet proven its capable of a turnaround.  We believe any potential upside will be driven by the Double Eagle concept, in which case management would need to be able to take ample pricing in the Q.  Certainly a risky proposition given the discounting trends we're seeing across the industry.









The Street expects slight restaurant level and operating margin deterioration in the quarter, mostly due to food cost pressures.  The real disconnect, however, comes in back half of the year with the Street assuming restaurant level margin expansion in 3Q14 and operating margin expansion in 4Q14.  We continue to expect restaurant level and operating margin deleverage as Grille (lower margin concept) becomes a larger percentage of the portfolio.  Recall that DFRG plans to build 5 new Grille's this year and only 1 new Del Frisco's.







DFRG is currently trading at 24.96x P/E and 11.58x EV/EBITDA on a NTM basis.  This is well ahead of its casual dining peers which, on average, trade at 17.1x P/E and 9.4x EV/EBITDA on a NTM basis.






77.8% of analysts rate DFRG a buy, 11.1% a hold and 11.1% a sell.  Furthermore, short interest comprises 6.59% of the float.





Immediate-term risks to the bear case include strong same-store sales trends across the board and management's ability to take ample pricing to protect margins.  Longer-term risks to the bear case include continued strength in the high-end dining category, system-wide same-store sales acceleration, a quicker than expected turnaround at Sullivan's and Grille's ability to prove itself as a legitimate growth concept in 2014. 


Howard Penney

Managing Director


Fred Masotta


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