#EuropeSlowing: Some Ugly Charts

Takeaway: Here are a half-dozen charts that show just how poorly Europe's economies are faring.

This note was originally published October 14, 2014 at 10:29 in Macro

This market does not trust Draghi’s Drugs! (Draghi is European Central Bank President Mario Draghi.)


Below we show recent data points that are supportive our Q4 Macro Theme #EuropeSlowing.  Here’s an update on the latest Eurozone experiment:

  • Draghi’s policy to inflate has only resulted in deflation (France and Italy CPI in September fell 10bps to 0.4% Y/Y and -0.1% Y/Y, respectively)
  • BOTH the periphery and the core are contributing to the regional slowing
  • The gap between Germany’s fiscal policy stance and France and Italy is widening
  • There remains no singular voice from the ECB on the merits of its policy actions to produce sustainable economic growth

We’ll let the recent data from the region’s economic heavyweight speak for itself, #EuropeSlowing:

  • The German Government lowered its GDP forecast (leaked on Friday) to 1.2% in 2014 (vs 1.8% prior); and 1.3% in 2015 (vs 2.0% prior)
  • Germany ZEW Economic Growth Expectations in October hit a 2 year low
  • German Exports in August (down -5.8% M/M) largest fall in more than 5 years
  • German Factory Orders fell -1.3% in August Y/Y
  • German Industrial Production in August weakest reading in more than 5 years
  • German Bunds are making all time lows @ 0.855% and down 101 bps Y/Y

From an investment position, we are recommending shorting French (EWQ) and Italian (EWI) equities and the EUR/USD (FXE).

 #EuropeSlowing: Some Ugly Charts - z. ZEW Germany

 #EuropeSlowing: Some Ugly Charts - z. germnay exports imports

 #EuropeSlowing: Some Ugly Charts - zz. factorders

 #EuropeSlowing: Some Ugly Charts - zz. German Indust

 #EuropeSlowing: Some Ugly Charts - z. Germany 10YR yield

 #EuropeSlowing: Some Ugly Charts - z. cpi falling


WWW – Penalty Box

Takeaway: WWW is in our penalty box. We need to see better top line numbers in 1-2 quarters, else we’re out. But at this level, you’re paid to wait.

Conclusion: Despite the 5% pop in the stock, WWW is officially in the penalty box from where we sit. Our long thesis builds to 20%+ EPS growth, or a $45 stock in 12-18 months (70%+ upside). But we’re not seeing the revenue that we want to see to support a big call. We still think that a worst case top line is 200bp better than the consensus for next year, which should result in a minimum of 10-20% upside in the stock. But is that enough for WWW to remain on our Best Ideas list? Probably not. It’s not bad, but it wouldn’t be the kind of return Hedgeye Retail is playing for. We think we’re being paid to wait on this cheap, high quality, hated name. We have it on a 3-6 month leash.



Our patience is wearing thin for our bullish call on WWW. Yes, the headline was good -- $0.63 vs our $0.62 and the Street at $0.59. But revenue missed our estimate. We don’t care that sales were in line with WWW’s internal forecasts, and largely in-line with guidance. We need to see something bigger than guidance. And thus far it’s nowhere in sight.  The crux of our call is predicated on a meaningful growth acceleration in Sperry, Keds, Saucony and Stride Rite outside of the US – in markets that were largely ignored by the prior owner. Our math gets us to growth of 8-10% on the top line, 12-14% gross profit, 16-18% EBIT, and 20-22% EPS as the company’s cash flow is used to de-lever its balance sheet. That’s an algorithm we can get behind, especially for a company that has such a proven track record of consistently creating shareholder value over such a long period of time. That kind of sustainable growth is probably worth a high teens p/e, which implies a stock near $45 in 12-18 months (18x $2.50 in ’16).


This thesis is fine and good, but the reality is that the company is not delivering the revenue upside we need to see. Management talks about how revenue penetration for brands like Sperry has doubled in two years as a percent of total (5% in 2012 up to 10% of Brand revenue). But if consolidated revenue is flat does it really matter? The answer is no. We get their point that there are a lot of moving parts on the top line – like the Stride Rite realignment plan, decision to take Sperry out of bad channels of distribution, and the general hit we’ve seen all year with the Women’s Sperry business.  The strategic actions are temporary, and the Sperry business in the US appears to have stabilized. As such we should see a natural lift in sales next year.


That said, our point all along is that we needed to see a sequential acceleration to a mid-high-single digit growth rate by 4Q, which should set the company up to benefit meaningfully from significant depth on the international bench starting in 1Q15. Based on what the company says, at least the 4Q growth ramp is in the cards. But there’s no question that our conviction is waning in its ability to drive an incremental 800-1,000bp of growth starting in another 12 weeks. To be clear, this growth level is our goal – not the company’s. The money making call will be in management’s ability to deliver sales growth that is far in excess of what it is telling the Street. The good news there is that consensus sales growth expectations next year are only for 3.7%. We think that a worst case number is 5-6%.  


Is that enough for WWW to remain on our Best Ideas list? Probably not. Is it enough to make the stock work by 10-20% from here? Probably. But that’s not the kind of return Hedgeye Retail is playing for.


The good news is that the stock is trading at only 14x earnings, remains quite hated, and is facing a near term bump in its revenue – as evidenced by its order trends. We still think that there will be a more meaningful contribution from its non-US business in 2015, which does not appear to be represented by the consensus estimates. We’re not worried about this stock working, but based on the company’s top line success over three (six tops) months we’ll know whether we should fish or cut bait on WWW as one of our core long ideas.


Our Sentiment Monitor (which combines short interest and sell side ratings) shows just how bad WWW Sentiment is.

WWW – Penalty Box - WWW Sent


WWW – Penalty Box - WWW ET2



DRI: No Better Time for Focus and Simplicity

Takeaway: Naming an “interim” CEO is a logical move, with some negative implications.

"That's been one of my mantras - focus and simplicity.  Simple can be harder than complex: You have to work hard to get your thinking clean to make it simple.  But it's worth it in the end because once you get there, you can move mountains."  

-Steve Jobs


Key Takeaways:

  • Fixing Darden will take time and money.
  • The company is structurally inefficient in its current form, making it difficult for any CEO to run it and create value for shareholders.
  • The time is now to simplify the company and focus on running separate brands.
  • Olive Garden needs to be reinvented.
  • Naming an “interim” CEO is a logical move, with some negative implications.


The Interim CEO

Over the weekend, I spent some time writing a note called, “No Better Time for Focus and Simplicity.”  The note honed in on all the great possibilities that could come from the sweeping victory of Starboard on Friday.  I viewed Starboard’s 294 page presentation as the playbook for the future.  The only thing missing was who will be the next CEO.


My creative juices ran out, however, after reading the WSJ article hinting that Gene Lee is in line to become CEO of the company.  I immediately feared the board had voted him CEO last week.


Unfortunately, I needed to wait until today to see what the board had decided.  Well, we now have a new Chairman and CEO of Darden.  I’m grateful to see Jeff Smith as Chairman and comforted to see that Gene Lee is only the interim CEO.  I fully appreciate the need for an interim CEO and believe Gene is the logical choice.  Over the long-term, however, he is not the right person to run Darden. 


Mr. Lee still represents all that was wrong with Darden and he’s one of the reasons Starboard pushed for change in the first place.  Mr. Lee, who was COO at the time, publicly said that the spinoff of Red Lobster created shareholder value.  It pains me to think that shareholders voted for sweeping change at the board level, only to see the COO become CEO.


To be clear, fixing Olive Garden is the only thing that matters to shareholders now.  After taking 60 pages to tear apart the brand's current Renaissance Plan, why would Starboard name the man responsible for that plan the next CEO?  What has Mr. Lee accomplished since becoming the accidental COO in September 2013?  Will he become the accidental CEO in 2014?


If the status quo was unacceptable for shareholders with the old board, it should be even more unacceptable with the new board.  I’m going to hold out hope that more sweeping changes are on the way.  But, this first move by the new board looks suspect and inconsistent with the message shareholders are sending.


Darden and the casual dining industry need to be reinvented.  There is no better company to reinvent it than Darden and no better brand to reinvent it than Olive Garden.  The current Brand Renaissance plan for Olive Garden falls short on many levels, but the primary reason is food.  Fixing the food needs to be the company’s number one focus.  Until then, the benefit of any initiatives or upgrades will be miniscule. 


Reinventing Casual Dining

Two major reports emerged in the late 1980’s identifying dietary fat as the single largest impediment to improving health and diet.  Though the real hand at issue was saturated fat, the idea behind the reports was that people could simply improve their diets by cutting out the fat content.  While the science was ultimately proven wrong, it changed the way people ate for many years.


Moving forward to the present day, we are now in the midst of what we refer to as the natural and organic craze.  In fact, 2014 is the first year Gallup asked about organic foods in its annual Consumption Habits survey.  The results, while not necessarily surprising, were quite affirming:

  • 45% of respondents actively try to include organic foods in their diets
  • Another 38% of respondents “don’t think either way” about including or excluding organic foods in their diets


Kroger’s CFO, J. Michael Schlotman, had some interesting comments regarding organic on the most recent earnings call when he said:


“It appears to us that the natural/organic customer is changing and growing in numbers, and those that shop the grocery store are also crossing over, and the blurring of grocery and natural foods is becoming more and more difficult when you look around the store and you can see organic items on the regular grocery shelf.”


We posit that if an increasing number of consumers are eating natural/organic products at home, it is only natural that a greater number of people will seek this alternative when looking for food to eat away from home.


We believe we’ve reached a crossroads in the restaurant industry.  The marketplace is shifting and restaurant brands must now evolve to grow their customer case:

  • While organic is moving more mainstream, the majority of restaurants are not
  • Organic presents the only avenue of real growth in traditional supermarkets
  • The number of non-GMO product offerings has surged in the past three years
  • Well over half of Kroger’s customers would buy something organic
  • Kroger is seeing double-digit growth in Simple Truth and Simple Truth Organic products
  • Casual dining traffic has been declining for nine straight years, including the last three at an accelerating rate
  • Chipotle and small independent chains are the only “healthy” alternatives in the restaurant space
  • Chipotle’s traffic has surged since announcing its commitment to going 100% non-GMO on the 2Q13 earnings call


This shift in consumer behavior helps to explain the secular shift we are seeing away from the old school casual dining chains.  How else would you explain the secular decline in food away from home as measured by Knapp traffic trends?  We believe there is a high probability traffic continues to decelerate and, likely, at an accelerating rate.


Growth in the number of organic and fresh supermarkets is also a contributing factor.  Going into Whole Foods or Fresh Market is an exciting shopping experience for a foodie.  These chains have successfully created fun, high energy environments for consumers.  The abundance of healthful options enables us to be more creative and artistic in our food at home preparation.  Most importantly, however, it allows us to feel good about what we are feeding ourselves. 


This farm-to-table movement and the shift to non-GMO foods are two trends that can’t be ignored by the restaurant industry. 


No Better Time for Focus and Simplicity

With those thoughts in mind, it’s important to get back to the thought that Starboard’s 294 page presentation will be the playbook we’ll see unfold over the coming year.  The most significant part of this plan will be separating the company into separate brands.  We’ve been saying for years that multi-concept casual dining companies are structurally flawed, putting them at a disadvantage to their nimbler counterparts.  Although the restaurant industry is littered with examples, there is no better proof of this theory than the Old Darden.


If Darden doesn’t breakup into separate companies, it will continue to suffer from the same issues that prompted Starboard to claim all twelve board seats.  The biggest hindrance to success under its current structure is inefficient capital allocation. 


As it stands, Olive Garden is so much larger than all of the other brands that the 20th best idea for improving this business is likely more accretive to the bottom line than the number one idea for improving any of the other brands.


These inefficiencies aren’t always clear to outsiders, and we get that, but we guarantee they are clear to the brands’ Presidents.  Internal capital allocation discussions usually follow a similar pattern to this:

  • Olive Garden senior management: “Why are you focused on the smaller brands when there are so many opportunities at Olive Garden?”
  • LongHorn senior management: “All of your focus is on Olive Garden and we’re not getting the resources or attention we need to be successful.”


Now imagine this discussion revolving around seven different brands.  Mind-boggling, isn’t it?


Therefore, the decision to split Darden into at least two companies must be made quickly.  This split will help Olive Garden begin its journey to once again becoming a great casual dining brand.  Needless to say, we suspect that 

Darden, as we know it, will no longer be in existence a year from now.


History has proven that the most successful restaurant companies over the long-term are typically single-branded, with credible and focused management teams.  They also have CEOs with clear visions that strive to establish a cultural soul throughout the company.  Some examples of this immediately come to mind, including:

  • McDonald’s and Ray Kroc
  • Chili’s and Norm Brinker
  • Outback Steakhouse and Chris Sullivan
  • The Cheesecake Factory and David Overton
  • Starbucks and Howard Schultz
  • Chipotle and Steve Ells
  • Red Lobster and Joe Lee


As Starboard points out in its presentation, Darden had woefully lost its way under the guidance of Clarence Otis.  As we see it, the main issue with Clarence was that he wasn’t a restaurateur.  In fact, his limited experience as an operator, a stint as President of Smokey Bones, was nothing short of a disaster that ended up costing the company nearly $1 billion.


Moving forward, the slate of independent board nominees will have some very important decisions to make that will decide the future of Darden.  It is precisely these decisions that will determine how successful Starboard will be in its Darden investment.


The appointment of Gene Lee as interim CEO further suggests that difficult decisions are looming.  We agree with many aspects of Starboard’s 294 page presentation on Darden, but argue that the most underrated point is the need for restaurateurs to run the company.  Given that Gene Lee is a restaurateur that is familiar with the company, we respect the decision to name him interim CEO, but he is not the answer.  In fact, no one is the answer if they are tasked with managing seven different brands.


The Starboard playbook acknowledges this, and calls for a breakup of the company.  We agree this is in the best interest of shareholders.  Our plan always called for the company to be split into several smaller companies.  The concept behind our plan was simple – focus the company and the brands.  As we’ve said many times before, the best restaurant companies are focused on doing one thing right.  Steve Jobs’ mantra rings true: focus and simplicity.


Starboard has spent a considerable amount of time understanding Olive Garden and what must happen for the brand to regain its leadership position in the casual dining industry.  There is clearly a conflict between Starboard’s view of fixing Olive Garden and the Brand Renaissance plan put forward by Gene Lee.  We suspect we’ll see some refinements to the plan moving forward.


As we’ve said many times before, the biggest opportunity for the new board of Darden to create shareholder value is to isolate, and separate, its brands into consistent companies with proven restaurateurs, leaders and passionate CEOs.

Nothing is ever easy, but this is a rather simple solution that has proven to create value time and time again.


Call with questions.


Howard Penney

Managing Director


Fred Masotta



Early Look

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Just Ugly Charts #EuropeSlowing

This market does not trust Draghi’s Drugs!


Below we show recent data points that are supportive our Q4 Macro Theme #EuropeSlowing.  Here’s an update on the latest Eurozone experiment:

  • Draghi’s policy to inflate has only resulted in deflation (France and Italy CPI in September fell 10bps to 0.4% Y/Y and -0.1% Y/Y, respectively)
  • BOTH the periphery and the core are contributing to the regional slowing
  • The gap between Germany’s fiscal policy stance and France and Italy is widening
  • There remains no singular voice from the ECB on the merits of its policy actions to produce sustainable economic growth

We’ll let the recent data from the region’s economic heavyweight speak for itself, #EuropeSlowing:

  • The German Government lowered its GDP forecast (leaked on Friday) to 1.2% in 2014 (vs 1.8% prior); and 1.3% in 2015 (vs 2.0% prior)
  • Germany ZEW Economic Growth Expectations in October hit a 2 year low
  • German Exports in August (down -5.8% M/M) largest fall in more than 5 years
  • German Factory Orders fell -1.3% in August Y/Y
  • German Industrial Production in August weakest reading in more than 5 years
  • German Bunds are making all time lows @ 0.855% and down 101 bps Y/Y

For a comprehensive review of our outlook on the Eurozone, we encourage you to read #EuropeSlowing – Austerity Is Dead?  From an investment position, we are recommending shorting French (EWQ) and Italian (EWI) equities and the EUR/USD (FXE).

Just Ugly Charts #EuropeSlowing - z. ZEW Germany

Just Ugly Charts #EuropeSlowing - z. germnay exports imports

Just Ugly Charts #EuropeSlowing - zz. factorders

Just Ugly Charts #EuropeSlowing - zz. German Indust

Just Ugly Charts #EuropeSlowing - z. Germany 10YR yield

Just Ugly Charts #EuropeSlowing - z. cpi falling


Matthew Hedrick

Senior Analyst

Video | McCullough: Why Volume Matters

In this excerpt from today's Morning Macro Call  for institutional subscribers, Hedgeye CEO Keith McCullough explains why accelerating volume in a down move is a clear risk signal. He also has more details about volume in our Early Look and Morning Newsletter products.

LEISURE LETTER (10/14/2014)

Tickers: MGM, DRH, HLT, NCLH


  • Oct 15: LVS Q3 earnings 4:30 pm , pw 12611335
  • Oct 17: Hedgeye cruise pricing survey (mid-October)
  • Oct 23: PENN Q3 earnings 11 am
  • Oct 23: LHO Q3 earnings 11 am "La Salle Hotel Properties"
  • Oct 24: PEB Q3 earnings 9 am


MGM & 2282:HK (Bloomberg) MGM China has approached existing lenders to refinance HK$15.6b ($2.01b) 5 year facility signed in July 2012; considers increasing loan size.  Existing loan pays LIBOR +150 bps under current margin matrix.


DRH – announced that it amended its existing approximately $170.4 million mortgage loan secured by The Lexington New York City (the "Hotel"). The loan bears interest at an initial floating rate of LIBOR plus 275 basis points, but features a pricing grid that will further reduce the spread to as low as 175 basis points upon achieving certain hotel cash flow hurdles. The reduced borrowing costs are expected to save the Company between $1.5 million and $2.0 million in annual interest expense.  The amended loan also benefits the Company by extending the potential term of the loan by approximately 30 months to October 2019. 

Takeaway: Nice blend and extend.


HLT ( U.S. Government officials say that security issues are playing into their review of Hilton's sale of the New York Waldorf Astoria to Anbang Insurance Group, since a renovation could aid Chinese spying efforts, and the US Ambassador to the UN lives at the hotel. U.S. law allows the department to rent the ambassador's residence for a term of 10 years or less. The current lease expires next year with an option to renew it for one or two years. Kurtis Cooper, a spokesman for the U.S. Mission to the United Nations commented "We are currently in the process of reviewing the details of the sale and the company's long-term plans for the facility." He and other officials said decisions about the future of the U.S. relationship with the Waldorf would be made based on cost, Anbang's long-term plans for the hotel, and the government's needs and security concerns.

Takeaway: Time to start the process of finding a new home.


NCLH – announced that hospitality veteran Drew Madsen has joined as president and COO of NCLH.  Madsen has more than 30 years of leadership experience in the hospitality and consumer products industry, most recently as president and COO at Darden Restaurants.

Takeaway:  We're not big fans of this hire.  DRI has not been a well managed company. 


NCLH (Seatrade Insider) –The acquisition of Prestige Cruises International is moving forward and will likely close by mid-November, said CEO Kevin Sheehan.


Occupy Hong Kong Barricades Removed – Police with power tools tore down Occupy Central protesters' barricades on Queensway in Admiralty this morning, following a dawn operation to remove some barricades in Causeway Bay.

Takeaway: Still not a lot of protest spillover into Macau.


Chinese Officials Detail Occupy Hong Kong Protesters (Sinosphere) According to estimates by activists and foreign diplomats, between 50 and 100 people have been detained, some subsequently released but others held, in mainland China since the “Occupy Central" demonstrations began in Hong Kong in late September. 


China Corruption Crackdown

(China Daily) He Jiacheng, executive vice-president of the Chinese Academy of Governance, and Zhao Shaolin, former secretary-general of the Jiangsu provincial Party committee, are being investigated on suspicion of graft, the Central Commission for Discipline Inspection said on its website.


(Xinhua News) A former senior official of south China's Guangxi Zhuang Autonomous Region was sentenced to 15 years in prison for taking bribes by a local court in northeast China's Jilin Province on Monday.  Li Daqiu, former vice chairman of the Guangxi Zhuang Autonomous Regional Committee of the Chinese People's Political Consultative Conference, was stripped of political rights for four years by the Intermediate People's Court of Yanbian Korean Autonomous Prefecture in Jilin. His property, worth 2 million yuan (326,435 U.S. dollars), was also confiscated.

Takeaway: Crackdown activity notably increasing prior to the Fourth Plenary Session.


Atlantic City Mark to Market ( Philadelphia developer Bart Blatstein says he and casino architect Paul Steelman agreed to buy the four-story, 300,000 sq. ft., half-empty Caesars Pier shopping center in Atlantic City for a small fraction of its construction cost.  A person familiar with the deal said Blatstein and Steelman agreed to pay $2.8 million, less than 2% of the $200 million plus that developer Taubman Centers Inc., of suburban Detroit, and other investors plowed into the center in the mid-2000s, according to company filings. The partners hope to close the deal later this year.

Takeaway: The lower price on the property sale is a precursor to lower property real estate taxes which in turn will pressure Atlantic City's municipal budget.


Orlando Timeshare Property to be Auctioned– A vacant 890-unit resort in west Orange County, called the Grande Palisades, is set to be auctioned at 11 a.m. in Orlando today. Construction on the massive resort began in 2005 in an area of west Orange that was largely undeveloped but is about 6 miles from the entrance to Walt Disney World.  

Takeaway: Five years after the Global Financial Crisis, the final white elephant is about to find a new home. Will VAC or WYN step-up for this redevelopment opportunity?


Florida Keys Remain Hot – With the volume of tourist visits climbing by six percent annually—there are an anticipated 2.9 million visitors on the way this year—the Keys have taken their place among the best-performing tourism markets in the country. Hotels in the island chain have seen their revenue per available room (RevPAR) returns jump 15 percent in 2013 to $218 per room, nearly 20 percent stronger than Miami’s $183. Through June of this year, the Keys’ RevPAR climbed even further to $234.38.  Twenty-three properties, representing 27 percent of the market’s inventory, have changed hands since 2011. That produced $853 million in sales volume, or roughly $375,000 per key on average.

Takeaway: America's Caribbean - just a short drive from MIA or FLL airports.


Gonzalo scrambles half a dozen Caribbean itineraries Seatrade Insider

Hurricane Gonzalo, moving out over the Atlantic after passing through the Caribbean's northern Leeward Islands, is expected to continue strengthening into a major hurricane Tuesday. Carnival Cruise Lines and Royal Caribbean International have modified half a dozen itineraries between them.


Singapore GDP – expanded 2.4% in the third quarter from the year-ago period, a slower-than-expected, missing a forecast for a 2.8% expansion and following a increase of 2.4% during Q2 2014.

Takeaway:  From a macro standpoint, S'pore has been a mixed picture in Q3.  

German Economic Sentiment Falling – Oct ZEW Economic Sentiment Indicator (3.6) vs consensus 1.0 and prior 6.9, Germany Oct ZEW Current Situation 3.2 vs consensus 18.0 and prior 25.4, Eurozone Oct ZEW Economic Sentiment Indicator 4.1 vs consensus 7.1 and prior 14.2

Takeaway:  Negative German sentiment is not good. Keep an eye on AIDA (Carnival brand) pricing 


Hedgeye Macro Team remains negative on Europe, their bottom-up, qualitative analysis (Growth/Inflation/Policy framework) indicates that the Eurozone is setting up to enter the ugly Quad4 in Q4 (equating to growth decelerates and inflation decelerates) = Europe Slowing.

Takeaway:  We're seeing bottom-up slowing in European cruise pricing in our monthly survey.  Europe has been a tailwind for CCL and RCL but a negative pivot here looks increasingly likely. Following CCL's earnings release, we recently turned negative on those stocks based on the negative European thesis.  To a lesser extent, HOT and HLT are also exposed to European weakness.


Hedgeye Macro Team remains negative on consumer spending and believes in muted inflation, a Quad4 set-up.  Following  a great call on rising housing prices, the Hedgeye Macro/Financials team is decidedly less positive. 

Takeaway:  We’ve found housing prices to be the single most significant factor in driving gaming revenues over the past 20 years in virtually all gaming markets across the US.

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