July 29, 2014

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“There’s a crack in everything.  That’s how the light gets in.”

-Leonard Cohen


Here is the good news: Clarence Otis is stepping down as Chairman and CEO of Darden Restaurants and the company will separate the Chairman and CEO roles.  Otis will continue to serve as CEO until his successor is appointed or by December 31st, 2014.  A search for his replacement will begin immediately.


In addition, Darden announced it will nominate up to nine of its independent directors for election at the Annual Meeting on September 30th, 2014, effectively giving Starboard three seats on the Board.  Darden continues to pursue a proxy settlement with Starboard, but the two sides have been unable to come to an agreement. 


Starboard needs to get control of this company – and they know it.


The joy of this news is tempered by the fact that Charles Ledsinger, Independent Lead Director, will become Non-Executive Chairman of the Board, effective immediately.  In our view, Ledsinger represents part of the old guard at Darden which oversaw substantial value destruction at the company, including the sale of Red Lobster.  Rewarding him this role should be temporary, because the company needs wholesale changes.


Mr. Otis and the current board were once considered the biggest obstacle to our long thesis.  The shift is beginning, but how far will the company go?  Mr. Otis dug his feet in to fight off the activists and leaves a lasting impression on the company, with the Red Lobster fiasco being his signature dish.  It will take time to fix the disaster he created.


But that’s the past.


Darden has essentially given Starboard three seats on the Board, but the activist wants more.  In fact, they've publicly shared their intentions to replace the entire Board.  This makes a settlement unlikely and while we doubt they'll gain all twelve seats, we'd be willing to bet they get the majority (at least seven) of them.  If this comes to fruition, we could see more wholesale changes on the way, including a new Chairman and management team.  As it stands, we think these three are strong potential candidates for the following roles:


Chairman of the Board: Jeffrey Smith (Managing Member, CEO and CIO of Starboard Value)


Chief Executive Officer: Brad Blum (former President of Olive Garden and Starboard consultant)


Chief Operating Officer: Bob Mock (former Executive VP of Olive Garden and Starboard consultant)


Restoring Olive Garden to the most respected brand in casual dining is the first thing any new management team must do.  While there are other things that need to be done as well, we suspect that bringing in two seasoned restaurant executives like Brad Blum and Bob Mock to reshape the company, specifically Olive Garden, would not only be well-received by the street, but also by current employees of Darden.


While there is still much uncertainty, today’s news is a significant step in the right direction.  This is the first crack to open up in Orlando and while there’s some light, we know the future can be much brighter.


More needs to be done.


Call with questions.


Howard Penney

Managing Director


Fred Masotta



We applaud the lower than consensus Q3 guidance but maintaining full year guidance risks a Q4 guide down.





NCLH reported 2Q numbers that met our estimate and company guidance despite lower revenues.  The NCL brand began discounting in the Caribbean in late January, rankling investors’ nerves but not the sell side.  Approximately 80% of sell-side analysts have maintained buy/outperform ratings (pending Genting stock sale?) even as the stock has fallen 10% this year.  Revenues were indeed disappointing and NCLH did provide lower than expected Q3 guidance.  With unchanged full year guidance, we’ve got to ask: where are they going to pull earnings from to make the higher implied Q4 guidance?


The stock looks to open down but we may see some more pin action today as a somber management team fields questions on the Caribbean and upcoming cost initiatives.  At the end of the day, investors may be tired of waiting for the inflection point.  We find it hard to disagree.




  1. What drove Q2 fuel price per metric ton down by $38 vs management guidance?  Lower fuel costs offset the revenue miss.
  2. Implied Q4 yield guidance looks aggressive.  What is driving that outlook – better pricing or load?
  3. Commissions/transportation costs as a % of ticket revenue has fallen in four out of the last five quarters and offset lower gross ticket yield. Is this an indication of being less reliant on the agent community, renegotiation of tour/shore pricing, or something else?  How sustainable is it?
  4. Why is cost guidance ex fuel going higher when there are a number of cost cutting initiatives are underway?  NEXT program?



We were surprised by the lower than expected 3Q yield guidance and very skeptical of the 4Q implied guidance of ~4% yield growth.  The Hedgeye proprietary cruise pricing survey suggests more difficult pricing conditions in Q4.  While Caribbean comps are easier in 4Q than 2Q and 3Q, more competition (e.g. Quantum) is on the way and NCL will have to deal with that in the New York market - quickly.  In our opinion, NCL has a better shot of exceeding yield expectations in Q3 than in Q4 or early 2015. 


We are not seeing any signs of a less promotional Caribbean pricing environment.  Could the low pricing in the Caribbean becoming a secular trend?  Perhaps.  Oversupply concerns have been understated and the initial hot booking demand cooled somewhat in the Caribbean this year.





Net yields met the low end of the company’s guidance at 3.0% as more cost reductions offset lower gross revenues.  

  • Net ticket yields rose 2.7% as lower commission/transportation/other costs offset the 1stdecline in gross ticket yield since 3Q 2012. 
    • Commission/transportation/other costs only accounted for 15% of ticket revenues, the lowest since IPO inception (an interesting trend…)
    • Gross ticket yield was likely hampered by a double digit decline in Caribbean yields despite the addition of Getaway and Breakaway
    • Ticket margins rose to 79%, a new high
  • Net onboard and other yield grew 4.8%
    • Gross onboard/other yields climbed 1.9%
    • Onboard/other expenses fell 2.1% points YoY to 24.3% of onboard/other revenues
  • Fuel expense was $6 million less than management’s guidance.



Q3:  2.25%-2.75% yield growth guidance came in below our estimate of +3.7% yield growth (Street: +3.5%).  Guidance was surprisingly conservative given the strength in Europe and its largest quarterly contribution at 32% of total capacity in 3Q.  We believe management is estimating Caribbean yields to be a couple % points lower than our projection of mid-single digit yield declines and a less stellar outlook for the Hawaii market.   


Q4:  Guidance suggests 3.8% yield growth to reach the midpoint of FY yield range.  That’s an aggressive forecast.  To achieve that yield target, one would need:  slightly lower European yields than that seen in Q3, flat yields in the Caribbean, slightly lower yields in Hawaii, and modest growth in the Canada/England/other segment.  Can the Caribbean hold its ground for the next couple of months for Q4 sailings even if Breakaway premiums shrink?  NCL seems to think so.

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TODAY’S S&P 500 SET-UP – July 29, 2014

As we look at today's setup for the S&P 500, the range is 26 points or 0.91% downside to 1961 and 0.41% upside to 1987.                                        













  • YIELD CURVE: 1.93 from 1.99
  • VIX closed at 12.56 1 day percent change of -1.02%


MACRO DATA POINTS (Bloomberg Estimates):

  • 7:45am: ICSC weekly sales
  • 8:55am: Redbook weekly sales
  • 9am: S&P/CS 20 City m/m, May, est. 0.3% (prior 0.19%)
  • 10am: Consumer Confidence Index, July, est. 85.4 (prior 85.2)
  • 4:30pm: API weekly oil inventories



    • 10am/2pm: Senate Foreign Relations Cmte Iran nuclear talks status hearing; House Foreign Affairs Cmte hearing on Iran
    • 10am: Senate Budget Cmte  hearing on climate change, with testimony from Ceres’s Lubber, GAO’s Gomez
    • 10am: U.S. Export-Import Bank President Fred Hochberg at House Oversight panel’s hearing on allegations of corruption
    • 10am: Senate Finance Cmte tobacco product tax evasion hearing
    • 10am: Citizenship and Immigration Svcs Director Leon Rodriguez at House Judiciary Cmte
    • 10:15am: House Foreign Affairs panel hearing on Malaysian flight shootdown
    • 2:30pm: House Armed Svcs Cmte mulls resolution on Obama’s release of Guantanamo prisoners w/out notifying Congress
    • U.S. ELECTION WRAP: Impeachment Talk Helps Fill Democrat Coffers



  • UBS 2Q net income beats estimates; German tax probe settled
  • UBS says SEC has been investigating its dark pool since 2012
  • Deutsche Bank debt trading beats estimates as 2Q pretax climbs
  • Nomura profit falls more than estimated on brokerage slump
  • U.S. bankers said stand to collect $1b in inversion fees: NYT
  • Democrats seek U.S. contract ban to limit corporate inversions
  • BP’s 2Q profit rises on U.S. oil output boost
  • Klepierre offers to buy Dutch competitor Corio for $5.6b
  • Pfizer may return for Astra, which may target Actelion: Citi
  • Pepe Jeans said to work With Morgan Stanley on sale of business
  • Motorola may double phone sales this year: The Information
  • Toyota should recall Camry to repair brakes: Consumer Reports
  • John Kerry meets with Ukrainian counterpart Pavlo Klimkin
  • Israel steps up Gaza attacks, warns of long campaign
  • Germany’s 10-yr Bund yield drops to record low



    • Aetna (AET) 6am, $1.60 - Preview
    • Affiliated Managers Group (AMG) 7:24am, $2.60
    • Agco (AGCO) 8am, $1.69
    • AK Steel Holding (AKS) 8:30am, ($0.03) - Preview
    • American Realty Capital (ARCP) 6am, ($0.01) -
    • Arch Coal (ACI) 7:45am, ($0.49)
    • Arrow Electronics (ARW) 8am, $1.42
    • Consol Energy (CNX) 6:45am, $0.25
    • Corning (GLW) 7:15am, $0.38
    • Eaton PLC (ETN) 6:30am, $1.12 - Preview
    • Ecolab (ECL) 8:20am, $1.02
    • Entergy (ETR) 7am, $1.11
    • Fidelity National Information (FIS) 7am, $0.74
    • George Weston (WN CN) 6:23am, C$1.16
    • GNC Holdings (GNC) 8am, $0.79 - Preview
    • GrafTech International (GTI) 9:01am, $0.01
    • Harris (HRS) 6:30am, $1.28
    • HCA Holdings (HCA) 8:29am, $1.37
    • Illinois Tool Works (ITW) 8am, $1.20
    • International Paper Co (IP) 7am, $0.83 - Preview
    • Level 3 Communications (LVLT) 8am, $0.33
    • Marsh & McLennan Cos (MMC) 7am, $0.74
    • Martin Marietta Materials (MLM) 8:17am, $1.29
    • McGraw Hill Financial (MHFI) 7:10am, $0.98
    • Merck & Co (MRK) 7am, $0.81 - Preview
    • National Oilwell Varco (NOV) 7am, $1.44 - Preview
    • New York Times (NYT) 8:30am, $0.08
    • NextEra Energy (NEE) 7:30am, $1.44
    • Nice Systems (NICE) 5:30am, $0.59 - Preview
    • Nielsen NV (NLSN) 7am, $0.61
    • Oshkosh (OSK) 7am, $1.37
    • Paccar (PCAR) 8am, $0.89
    • Pfizer (PFE) 7am, $0.57 - Preview
    • Rayonier (RYN) 8am, $0.49
    • Reynolds American (RAI) 6:58am, $0.87 - Preview
    • Sensata Technologies Holding (ST) 6am, $0.62
    • Sirius XM Holdings (SIRI) 7:01am, $0.02 - Preview
    • Spirit Airlines (SAVE) 6:30am, $0.90
    • TRW Automotive Holdings (TRW) 7am, $2.13
    • UDR (UDR) 8am, $0.03
    • United Parcel Service (UPS) 7:45am, $1.25
    • United Therapeutics (UTHR) 6am, $1.62
    • Vishay Intertechnology (VSH) 7:30am, $0.25
    • Waste Management (WM) 7:30am, $0.59
    • Xylem (XYL) 7am, $0.44
    • Yandex NV (YNDX) 6am, $9.73



    • Aflac (AFL) 4:10pm, $1.59
    • AGL Resources (GAS) 4:34pm, $0.43
    • American Express Co (AXP) 4:05pm, $1.38
    • AmeriGas Partners LP (APU) 4:29pm, ($0.39)
    • Ameriprise Financial (AMP) 4:05pm, $2.01
    • Amgen (AMGN) 4:03pm, $2.06
    • Anadarko Petroleum (APC) 4:05pm, $1.30
    • Arthur J Gallagher & Co (AJG) 4:09pm, $0.72
    • Axis Capital Holdings (AXS) 4:43pm, $1.19
    • CBRE Group (CBG) 4:05pm, $0.36
    • CH Robinson Worldwide (CHRW) 4:15pm, $0.77
    • Cincinnati Financial (CINF) 4:02pm, $0.46
    • Cloud Peak Energy (CLD) 4:10pm, ($0.01)
    • Compuware (CPWR) 4:10pm, $0.05
    • Covance (CVD) 4:02pm, $0.93
    • DreamWorks Animation SKG (DWA) 4:02pm, ($0.02)
    • Dyax (DYAX) 4:01pm, ($0.05)
    • Edwards Lifesciences (EW) 4:01pm, $0.77
    • Equity Residential (EQR) 4:29pm, $0.52
    • EXCO Resources (XCO) 4:03pm, $0.04
    • Express Scripts Holding Co (ESRX) 4:02pm, $1.22
    • Fiserv (FISV) 4:01pm, $0.81
    • Genworth Financial (GNW) 5:05pm, $0.35
    • Global Payments (GPN) 4:01pm, $1.07
    • International Game Technology (IGT) 4:05pm, $0.27
    • InvenSense (INVN) 4:06pm, $0.08
    • Kimco Realty (KIM) 4:19pm, $0.13
    • Marriott International (MAR) 5pm, $0.67
    • NCR (NCR) 4:02pm, $0.66
    • Newfield Exploration Co (NFX) 4:04pm, $0.53
    • Newmont Mining (NEM) Aft-mkt, $0.19
    • Owens-Illinois (OI) 4:04pm, $0.82
    • Panera Bread Co (PNRA) 4:05pm, $1.75
    • Qiagen NV (QGEN) 4:10pm, $0.25
    • RenaissanceRe Holdings (RNR) 4:15pm, $2.84
    • Rock-Tenn Co (RKT) 6:12pm, $1.80
    • SM Energy Co (SM) 5pm, $1.60
    • Trinity Industries (TRN) 4:05pm, $0.77
    • Twitter (TWTR) 4:03pm, ($0.01) - Preview
    • UGI (UGI) 4:29pm, $0.17
    • United States Steel (X) 5:15pm, ($0.31) - Preview
    • US Silica Holdings (SLCA) 4:30pm, $0.46
    • Verisk Analytics (VRSK) 4:10pm, $0.56
    • Vertex Pharmaceuticals (VRTX) 4:01pm, ($0.74)
    • Willis Group Holdings PLC (WSH) 4:30pm, $0.59
    • Wynn Resorts (WYNN) 4:05pm, $2.03



  • Goldman Sees Nickel Rising With Palladium as Iron Ore, Soy Drop
  • El Nino Chances Reduced by Australia as Tropical Pacific Cools
  • Norilsk Sees Two-Year Nickel Supply Deficit Supporting Prices
  • Beer Can Cost Rests on U.K. Court Aluminum Verdict: Commodities
  • Sugar Drops as Destination Markets Well-Supplied; Coffee Gains
  • WTI Oil Trades Near 2-Week Low Before Supply Data; Brent Steady
  • Copper Rises on Speculation Increasing Auto Sales Boost Demand
  • Steel Rebar Advances on Improved Economy in China, Stock Rally
  • Candy Crush-Like App Helps Engineers Target Tech Workers: Energy
  • IOC Offers 35-40kt of Naphtha for August Loading From Dahej
  • South African Unions Reach Accord on Wages to End Metal Strike
  • Westinghouse’s 1st AP1000 Reactor May Start in China Next Fall
  • Russia May Ban U.S. Chicken, European Fruit Amid Sanctions Push
  • Qingdao Port Disputes $108 Million Claim for Fraud-Linked Metals


























The Hedgeye Macro Team
















Flashback | Darden CEO Clarence Otis Is Bear Case and Needs to Go Says Hedgeye's Penney

In early March, Hedgeye Restaurants Sector Head Howard Penney sat down with CEO Keith McCullough to discuss embattled restaurant company Darden and why its CEO must go. This afternoon, it was announced that CEO and Chairman Clarence Otis is stepping down and that Darden is changing its corporate policies to split the chairman and CEO roles. Shares are up almost 5% after-hours on the news.

COPPER A SCARY SHORT: Where Would You Puke?

TREND Support: 3.17

TAIL Line: 3.19 (Previous resistance level and critical breakout line)

Copper ripped +1.8% Thursday after a big manufacturing PMI beat and sold off -83bps on Friday to finish the week +1.7% (up another +12bps today). We added it (ETF: JJC) to real-time alerts on 7/18 and booked the gain on an oversold signal last Friday. 


COPPER A SCARY SHORT: Where Would You Puke? - Levels Chart


On the move, copper broke out above its previous $3.13 intermediate-term TREND line of resistance last week and remains above its long-term TAIL Line (Refreshed TREND support now at $3.17).


Consensus macro leans on the strength of the Chinese economy as a leading indicator for base metal demand (as it should). China consumes over 40% of the world’s industrial metals (up from 5% in 1980).


2013 Consumption (% global demand):

  • Nickel: 47.4%
  • Aluminum: 46.1%
  • Zinc: 45.6%
  • Copper: 42.4%

An equally weighted index of Chinese GDP and industrial production to industrial metals prices (CRB metals index) is running an r-squared of 0.50 currently, down from a December 2011 peak. Although diverging from the 2011 highs, the relationship cannot be ignored as a market catalyst.

I have read the supporting research around the following data points from fundamentally focused sell-side research teams. Most of it supports the argument for the unsustainability, and thus bearish pressure, on Chinese base metal demand:

  • Copper and aluminum consumption has increased six-fold since 1999
  • China is 3x the size of the United States and, since 2011, base metal demand per capita is trending higher than the United States.
  • China’s consumption to investment ratio (consumer demand/cap-ex ) is at historical highs:
    • China: 0.7x
    • USA: 3.5x
    • UK: 4.6x
    • Eurozone: 3.3x
    • Chinese credit growth has manifest at incredibly rapid rates:
      • Aggregate debt level has reached 251% of GDP as of June which is a 20% increase from late 2013.

Note: The commodity-collateralization fueling this rapid increase in credit growth has been continuously highlighted as a bubble in base metal markets. Speculation as to how much commodity-backed financing has contributed to credit growth, along with an investigation into the Qingdao Port warehouse has continuously been labeled a catalyst for volatility in base metal prices. With the opaqueness in obtaining information as to whether multiple parties within the Chinese financial system have used the same metal stockpiles as collateral to access otherwise unavailable credit markets, we choose to focus on the observable. Goldman estimates that $160Bn has flowed into China through commodity-backed loans since 2010. Regardless, the argument that this scandal has helped fuel an unsustainable credit boom has been labeled a bearish signal for base metals.

  • Debt/GDP levels have increased 100% over the last five years
  • China’s $26 trillion of debt is more than the entire commercial banking system of the U.S. and Japan combined
  • On the supply side, an increase in late cycle mining cap-ex flooding the market requires an unsustainable amount of consumption from China

 COPPER A SCARY SHORT: Where Would You Puke? - Chinese Credit Growth


Although we must always look to reported numbers from China with caution, it’s difficult for me to make a fundamental case to buy copper more long-term.

Most of the sell-side research we have consumed points to the unlikelihood of a Chinese economy capable sustaining a rapid increase in base metal consumption. The statistics above may appear staggering, but without a contextual overlay and a market catalyst they fail to provide enough conviction for us to marry the story. Risk moves quickly, and we need to know that the market believes a research call before we would get in front of it. So far, this inflection point has not happened as reflected in base metal prices, especially in copper.

We continue to field mixed economic data out of China, but both the fundamental and quantitative picture turned more bullish late last week. For additional color, click on the link below to access the note:


Should You Chase the Rally in Chinese Equities?  


On one hand the Chinese property market remains a disaster…

  • JUN E-House Home Price Index (288 cities): 5.3% YoY from 5.8% prior
    • Prices of new homes in 288 cities fell -0.1% MoM in JUN, the third sequential decline in a row
  • JUN China Real Estate System Index (CREIS) Home Price Index (100 cities): 6.5% YoY from 7.8% prior
    • Average prices in the 100 biggest cities fell -0.5% MoM, the second consecutive sequential decline

 COPPER A SCARY SHORT: Where Would You Puke? - Hedgeye Chinese Property Monitor


With both housing prices and overall construction sequentially decelerating, the outlook for slowing demand of raw materials seems probable.

On the flip side of the coin, after digging into the various forms of stimulus out of local and municipal stimulus, we believe the Chinese government is directly targeting what has been a deteriorating real estate market with its recent stimulus measures which have proven a bullish catalyst for Chinese equities (and base metals):


Excerpt from the above note:


But perhaps the real reason Chinese policymakers were content to ease monetary and fiscal policy of late was to shore up the country’s crashing property market


Along those lines, many local governments have taken matters into their own hands by easing home purchase restrictions (27 of 46 cities did so yesterday). Moreover, last week’s statement out of the Ministry of Housing and Urban-Rural Development (MOHURD) would seem to suggest that such easing in property markets at the local level have the official blessing of Beijing as well”.


For now the flow-through from an unconventional mix of stimulus has proven more positive for the slope of Chinese growth than we previously expected. The easing-induced credit growth and positive manufacturing data support trading China with a bullish bias for now.


COPPER A SCARY SHORT: Where Would You Puke? - Chinese GIP Snapshot


COPPER A SCARY SHORT: Where Would You Puke? - China High Frequency GIP Data Monitor


The correlation between base metal prices and Chinese economic data remains intact. Because we have no other incentive other than to be on the correct side of inflection points across the globe, we absorb the data, and watch the market’s reaction:

  • HSBC Mfg. PMI: 52.0 July vs. 50.7 expected (huge blow-out).
  • Front-Month copper rips to the upside:1.84%.
    • We rode this move for a gain in real-time alerts (ETF: JJC) before selling Friday morning as the move was exhausted to the upside.

If my macro teammates asked my opinion as to whether or not we should go acquire some physical copper and throw it in a warehouse, I would have a tough time passing along a vote of confidence. We absorb, organize, and analyze a slew of economic and behavioral market data on a daily basis, and must be willing to change our opinion if it’ll put us in an alpha-generating position. For those of us who are price-sensitive near-term on both the entry and exit points, we have a few options in the commodity space: futures, derivatives, and ETFs.


Studying the volume, volatility, and critical capitulation levels of the market as a whole provides insight into the behavioral conviction behind a move. Enjoy the electronic trading or not humans and machines have levels, and a sharp directional move eventually becomes exhausted. At Hedgeye, we refer to these short-term TRADE exhaustion levels as OVERBOUGHT and OVERSOLD.


When we then utilize these levels (think of directional moves from a standard error perspective) with a directional bias from an intermediate-term TREND standpoint, the absolute price movements become second derivative changes. Therefore, absolute measures of risk may seem underpriced when multiple durations are observed (which is why we plot and model our perception of risk relative to the markets on multiple durations).


If copper is making a series of higher lows from a TREND perspective (critical observed capitulation levels moving higher) on aggregate futures volume (last Wednesday prior to the HSBC Mfg. PMI print) that is:

~35% below 1,3, and 6-month volume…




Volatility being sold for -3%,-10%, and -16% below 1, 3, and 6-month averages….


Shorting copper on a Chinese supply and demand call for physical copper is a risky position without a catalyst.


Open interest (Open, and un-closed positions both long and short) in the spot market for copper was just 2.3% of average daily trailing 6-month trading volume.


Because the front-month is now illiquid, those holding positions are probably stuck with a position, or intending to transact in physical copper. With so much speculation in commodity markets from both man and machine, a directional confirmation in observed trading activity remains the most important catalyst that must agree with a fundamental call. Feel free to ping us with any questions.


Ben Ryan




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