prev

All Boxed In

This note was originally published at 8am on October 22, 2014 for Hedgeye subscribers.

“The Italian people are tired of this corruption. Because we have too many people that steal, too many people that put the money in his pocket. We have 40% of people who don’t pay tax. Can you imagine? 40%. It’s unbelievable.”

-Renzo Rosso

 

Renzo Rosso is an Italian and founder of the Diesel jeans brand. He appeared in a 60 Minutes segment on Sunday titled “Saving Italy’s History Becomes Fashionable” that showed how he along with a number of other prominent Italian fashion houses (Tod’s, Fendi, Bulgari) were donating millions to repair and improve the country’s historical landmarks, from the Colosseum and the Spanish Steps in Rome to the 400 year old Rialto Bridge over the Grand Canal in Venice.

 

Why? Because the government is too broke to allocate funds to maintain the country’s historic treasures.

 

While the issues of deep corruption and oversized bureaucracy in Italy remain nothing new, it’s both telling and remarkable to see these individuals and companies take a stand (now), rather than pointing fingers or pushing the problem on to somebody else further down the road.

All Boxed In - z. colosseum

 

Back to the Global Macro Grind

 

If only the Italian government could take a similar stand and unilaterally agree to reform itself… NOW.

 

As we’ve noted in previous work, Italy recently joined France as a standout in the camp of “Austerity Is Dead” in submitting 2015 budget plans that extend out its initial fiscal consolidation targets.

 

Specifically, Italian PM Matteo Renzi presented a budget last week that included cuts to labor taxes and personal income taxes worth €18 Billion, however some €11 Billion of it will be funded with extra borrowing that will raise the country’s deficit-to-GDP to 3% this year versus its previous target of 2.6% (with 2015 forecast as 2.9%).

 

And so for the first time in history, the European Commission may exercise its power to reject both Italy’s and France’s budgets and ask for new ones.  A formal resolution is expected to come on October 29th.

 

What’s clear is that the 39 year old young-gun and reform-minded Renzi has inherited a challenged position and the country is looking for leadership to pull itself out of what will be three years of negative growth:

  • He filled a power vacuum in February 2014 composed of splintered and diverse parties (that legacy continues and challenges reform)
  • Italy has a record high youth unemployment rate at 43% (3rd highest in the Eurozone behind Spain and Greece at 50%+) and an aggregate unemployment rate of 12.3% vs Eurozone 11.5%
  • Italy has put little dent in its record high debt of 133% (2nd highest to Greece’s in the Eurozone and 3rd highest of all countries in the developed world) vs Eurozone at 92% (that remains a persistent threat to raising debt/increasing interest rate costs)

Yet as we described in an Early Look note on 10/10 titled #EuropeSlowing – Austerity Is Dead? the main “rub” throughout the Eurozone is a leadership one. 

 

On one hand, we have the ECB and European Commission pointing its finger at the member states to do more country-level reforms. On the other hand, we have member states (like Italy and France) saying they’ve already done a significant level of reform and collectively pointing the finger back at the ECB for not doing more to inflect the lack of growth and deflation they’re experiencing.

 

To fuel the fire, tack on the indecision created by the fiscally conservative Germans calling into question the potential negative consequences that could result for the ECB’s newest policy toolkit, including the TLTROs, ABS and covered bond buying programs. Just in the last few days we’ve heard whispers (because the information is private) that the ECB bought French, Italian, and Spanish covered bonds, ahead of ABS purchases and the second round of the TLTRO program that are slated to begin/issued in December.

 

We’ve been clear in our research, including in our Q4 Macro theme of #EuropeSlowing, that we do not see Draghi’s Drugs arresting the low levels of inflation in the Eurozone (CPI currently is at 0.3% Y/Y) nor producing sustainable economic growth (recent programs baked in and with record low interest rates).

 

As we show in The Chart of the Day below, not only do we think that Draghi’s inflation policies will not work, but we expect deflation to hit Italy (CPI at -0.1% Y/Y) and the other countries across the periphery harder, which should only further push out growth expectations and limit business and consumer confidence. 

 

If Renzi’s Reform is to ever become a success, it will be counted in many years, not many months, and our opinion is that regaining competitiveness within the confines of the Eurozone structure is a sisyphean task.

 

Our bottom-up, qualitative analysis (e.g. our 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).

 

From an investment position we continue to recommend shorting Italian (EWI) and French (EWQ) equities (down -7.6% M/M and -8.1% M/M, respectively) and shorting the EUR/USD (FXE) (down -1.2% M/M).

 

Our immediate-term Global Macro Risk Ranges are now:

 

UST 10yr Yield 2.09-2.24%

SPX 1830-1947

RUT 1037-1115

DAX 8508-9103

USD 84.84-86.16

EUR/USD 1.26-1.28

 

Matthew Hedrick

Associate

All Boxed In - z. neu CPI


CHUY: Look Out Below

Takeaway: Significant downside ahead. Let us know if you'd like to review our recent slide deck supporting the short case.

CHUY remains on the Hedgeye Best Ideas list as a short.

 

The company reported disappointing 3Q14 results yesterday after the close, as revenues and earnings fell short by 36 bps and 594 bps, respectively.  Despite missing, the headline numbers were actually much stronger than the underlying fundamentals would suggest as food and labor cost pressures, in addition to select underperforming restaurants, drove restaurant level margins and operating margins lower year-over-year. 

 

The lack of leverage in the business model is something that the street has failed to come to grips with and something we thought was blatantly obvious.

 

Check out the street’s prior 3Q labor cost estimate below.  Estimates suggested that labor cost as a percentage of revenues would only increase 18 bps year-over-year in the quarter, after being up more than 167 bps year-over-year, on average, in the prior three quarters.

 

CHUY: Look Out Below - 1

 

As expected, these estimates proved to be woefully misguided, as labor actually deleveraged 110 bps year-over-year in the quarter, which can be seen below.

 

CHUY: Look Out Below - 2

 

While there was deleveraging throughout the entire P&L, labor costs were the primary reason Chuy’s missed the number in the quarter.  We wanted to make this point, because it is fundamental to what drives our idea generation process.  Find out where consensus is (sometimes blatantly) wrong, stress test the other line items, and then determine the ultimate impact this disconnect will have on earnings. 

 

It’s certainly not bullet proof, but it is something that has served us extremely well.  This also supports our case that Chuy’s has been the beneficiary of the Investment Banking Mafia.  Take what management tells you and blindly plug it into your models.

 

Another issue we had heading into the quarter was the fact that the street expected underperforming restaurants in new markets to suddenly improve.  This isn’t something that happens overnight.  In fact, half of the restaurants in the 2013 class (which comprises 33% of the total restaurant base) continue to struggle with inefficiencies from below average AUVs. 

 

Importantly, when you are operating a growth concept that is rapidly expanding into new markets, you need to make incremental investments in the business, meaning margins will be difficult to protect.  Management has been able to leverage operating & other and general & administrative expenses in the past, but will be hard pressed to continue this trend moving forward.

 

CHUY: Look Out Below - 3

 

CHUY: Look Out Below - 4

 

As a result of the aforementioned issues, management meaningfully guided down its full-year EPS range from $0.76-0.78 to $0.67-0.69.  This would imply a 4Q EPS range of $0.11-0.13, well below the street’s $0.15 estimate.  Backing out the approximate $0.04 full-year accretive effect of the depreciation change management made, and probably rightfully so, apples-to-apples 2014 EPS is expected to come in between $0.63-$0.65.  Chuy’s delivered $0.69 in earnings in 2013.

 

CHUY: Look Out Below - 5

 

Before we run through bullet points of the good and the bad from the quarter, we wanted to share with you our favorite quote from the earnings call which came from CEO Steve Hislop toward the end of his prepared remarks:

 

“…we are working diligently to tackle what we believe are near term challenges as well as taking a thoughtful look at the evolution of our new unique model as we grow our brand nationally.”

 

To hear this coming from the CEO of a company that is rapidly expanding nationally at a clip above 20% unit growth is concerning.  At face value, at least to us, it says “we’re not ready to grow,” and the financial results of this company suggest the same.  We still see significant downside to the stock and note that the company may struggle to deliver our base case $0.75 EPS next year.

 

CHUY: Look Out Below - 6

The Good

  • Comps +3.0% vs. +1.9% estimate; +1.3% increase in traffic; +1.7% increase in average check
  • Management believes they have pricing power and could take another increase in February 2015
  • Four new Chuy's restaurants opened in 3Q (2 in TX, GA, VA) and one additional in 4Q (VA); 2014 unit development is complete
  • Guided up full-year comp growth from +2.3-2.6% to +2.7-2.9%

The Bad

  • Guided to cost of sales as a percentage of revenue between 28.2-28.4% vs. 28.0% estimate
  • Food inflation 4.5-5% for the full-year; beef, dairy, chicken, produce (lettuce, tomatoes) have been issues in 2014; chicken beginning to subside; beef, dairy likely issues in 2015 as well; only contract 25-30% of base; food cost inflation will increase, though potentially at a lower rate than in 2014
  • Guided to labor costs as a percentage of revenue between 33.8-34.0% vs. 33.18% estimate
  • Ongoing inefficiencies at non-comparable restaurants; comprise 33% of open restaurants
  • Expect many new units to mature at lower AUVs
  • New unit volumes in new markets are difficult to predict
  • Guided down full-year EPS range from $0.76-0.78 to $0.67-0.69; implies a 4Q EPS range of $0.11-0.13, well below the street’s $0.15 estimate

 

Feel free to call, or email, with questions.

 

Howard Penney

Managing Director

 

Fred Masotta

Analyst


RHP: THE STRONGEST HORSE IN GROUP LODGING

CALL TO ACTION

RHP’s group business has never looked better as evidenced by the solid Q3 2014 results and strong Q4 2014 and 2015 outlooks. Estimates look like they are going higher aided in part by a too high share count embedded in Street estimates. The bears are grasping to the one negative datapoint – gross bookings declined sequentially. In this regard, however, RHP is a victim of its own success – Q2 was phenomenal and the Q4 pace is accelerating again. Besides, net bookings were still positive and at significantly higher rates. Bottom line: the number of nights on the books is a huge number. We recommend investors take advantage of today’s weakness.

 

Please see our note:  http://docs.hedgeye.com/HE_RHP_Outlook_11.4.14.pdf


Early Look

daily macro intelligence

Relied upon by big institutional and individual investors across the world, this granular morning newsletter distills the latest and most vital market developments and insures that you are always in the know.

BLMN: Notable Progress, Still Bullish

BLMN remains on our Investment Ideas list as a long.


Our bullish bias on BLMN centered on the following key points:

  • The largest shareholder, who also controls the board, could not sit around and let the stock languish.
  • Industry sales were improving.
  • The company could restructure its portfolio to better allocate capital.

 

Today, the company took an important first step in right-sizing the organization.  However, we still believe there is more to do.  Despite the moves announced today, we believe the company continues to operate an unsustainable business model comprised of a portfolio of (now) four different casual dining brands.

 

With that being said, an improvement in industry sales, current brand initiatives, and peak food costs (should become a tailwind in 2015) continue to provide plenty of reasons to be long the stock.

 

The important announcements made today included:

  • Restructuring the business in Korea.
  • Selling the Roy’s business.
  • Right-sizing the home office by selling off two company planes and trimming headcount.

 

While this is certainly a great start (and we commend management for this), we don’t think they went far enough.  In fact, we believe the rationale behind selling off Roy’s could be directly applied to Carrabba’s – at a minimum.  According to CEO Liz Smith, Roy’s is a small part of Bloomin’s portfolio and “not a priority for investment given competing opportunities.”

 

We believe the same could be said for Carrabba’s.  In our view, outperforming Knapp Track is hardly something to be proud of, particularly when considering you are in the process of rolling out weekday lunch.  Keeping a brand like Carrabba’s because it is better than bad doesn’t make it a compelling investment.  The chart below suggests the concept is far from fixed and should be sold off.

 

BLMN: Notable Progress, Still Bullish - 2

 

The company is hosting its analyst meeting in NYC in December, where we plan to learn more about 2015.

 

The Good

  • Restructuring the business in Korea; plan to close 34 underperforming restaurants; working toward optimal asset base; smaller fleet of stronger restaurants
  • Selling the Roy’s business
  • Right-sizing the home office team; eliminated a significant number of corporate positions; sold off two corporate planes
  • Outback comps +4.8%; all aspects of the business performed well; working to reclaim steak authority; focused on LTO’s, plate presentation and advertising
  • Bonefish comps +2.6%; introduced new core menu in 3Q; feedback has been encouraging; new platforms have been well-received; culinary forward brand; brought in executive chef from Seasons 52
  • Fleming’s comps +4.8%; high level of innovation; well-positioned within high-end steak category
  • 59% of Outback and 54% of Carrabba’s offering weekday lunch; lunch sales growing in restaurants that have had lunch for more than a year
  • Brazil continues to perform at a very high level; opening new restaurants as quickly as possible; 16 new Outback’s this year; plan to open first Carrabba’s next year
  • Opened 16 system-wide locations in 3Q
  • YTD total openings at 37 locations; 55-60 full-year unit growth guidance
  • Raised SSS guidance; full-year expectations now at 1-1.5%; plan to continue to meaningfully outperform the industry
  • Reaffirmed full-year EPS in the range of $1.05-1.10; hinted toward the higher-end of that range; could surprise if current sales environment continues

 

The Bad

  • Carrabba’s comps -1.2%; challenge is marketing and menu; working on next iteration of menu that will include lighter options and better value; using LTO’s and marketing to drive traffic in the meantime; management remains confident in the brand
  • Commodity inflation expected to be 3%
  • Aggressive new unit growth; capex expected to be between $215-235 million for the year; new guidance reflects fewer new stores and remodels than anticipated

 

Research Recap

09/25/14  BLMN: Same as it Ever Was

10/02/14  Bullish on Bloomin'

 

BLMN: Notable Progress, Still Bullish - 1

 

BLMN: Notable Progress, Still Bullish - 3

 

BLMN: Notable Progress, Still Bullish - 4

 

Feel free to call, or email, with questions.

 

Howard Penney

Managing Director

 

Fred Masotta

Analyst


4Q14 SENIOR LOAN OFFICER SURVEY: BROAD-BASED IMPROVEMENT WITH ONLY ONE EXCEPTION

Takeaway: The Fed's 4Q14 Senior Loan Officer Survey shows a healthy lending environment. The only exception is the multifamily channel of CRE.

Bullish Senior Loan Officer Survey in All but One Category

The Fed released its fourth quarter Senior Loan Officer Survey yesterday afternoon. The survey covers lending standards and loan demand and was conducted between September 30th and October 14th. 

 

Overall, the survey paints a very positive picture, though admittedly is somewhat backward looking given the survey period was 3-5 weeks ago. Across C&I and CRE loans, lending standards continued to ease while loan demand improved. On the consumer side, residential mortgage lending standards eased. Consumer non-mortgage loans saw lending standards ease again this quarter and demand strengthened again. Notably, banks willingness to make consumer loans is still increasing.  

 

This survey suggests that the reasonably strong loan growth trends we saw from banks in 3Q14 should persist in 4Q14 barring any sharp loss of confidence intra-quarter. 

 

Bottom Line:

The first chart below looks at the historical C&I lending standards question (LHS) juxtaposed against the price of the S&P 500 Financials subsector (RHS). C&I lending standards have historically turned tighter ahead of or coincident with peaks in Financials equity prices. We've highlighted in green the periods during which Financials stock prices are rising. in the 1 period it was clear that lending standards were tightening as early as late-1999 suggesting the top was near. In the 2003-2007 period standards were cooling steadily throughout 2006 and rolled into negative territory (i.e. standards were tightening on net) in mid-2007, about a quarter ahead of the peak in prices. As the chart shows, C&I standards are not showing any signs of rolling over through the most recent reading.

 

Takeaways:

There are two useful takeaways here. First, inflections in this series either lead or are coincident with turning points in Financials equity prices. Second, underwriting standards are autocorrelated, meaning they trend in the same direction for a long time before reversing. This means that once the turn begins you can ride the trend for a long time.

 

4Q14 SENIOR LOAN OFFICER SURVEY: BROAD-BASED IMPROVEMENT WITH ONLY ONE EXCEPTION  - C I vs prices

 

C&I Loan Tailwinds Persist: Easing Standards and Rising Demand

Demand for C&I loans continued to rise in the 4Q survey, spreads tightened, and standards continued to ease. 

 

Notably, a net 47% of banks reported not increasing spreads for large and mid-size firms, while a net 15% of banks reported stronger demand for C&I loans among large and mid-size borrowers. 

 

 

4Q14 SENIOR LOAN OFFICER SURVEY: BROAD-BASED IMPROVEMENT WITH ONLY ONE EXCEPTION  - C I standards

 

4Q14 SENIOR LOAN OFFICER SURVEY: BROAD-BASED IMPROVEMENT WITH ONLY ONE EXCEPTION  - C I spreads

 

4Q14 SENIOR LOAN OFFICER SURVEY: BROAD-BASED IMPROVEMENT WITH ONLY ONE EXCEPTION  - C I loan demand 

 

CRE Loan Demand Rises Further While Standards Continue to Ease

Commercial real estate loan demand improved in the quarter with a net 25% of banks reporting stronger demand for C&D and Nonfarm nonresidential loans. Meanwhile, a net 10.8% of banks reported easing C&D loan standards 4Q14 - the highest percentage recorded since the introduction of the C&D survey category.

 

Multifamily Issues

The one area of softness in the survey was that a small fraction of banks (+1.3%, net) reported tightening standards on Multifamily loans. While not a big deal in the face of all the other data, anytime a category rolls from positive to negative or the other way around we take note.

 

4Q14 SENIOR LOAN OFFICER SURVEY: BROAD-BASED IMPROVEMENT WITH ONLY ONE EXCEPTION  - CRE Standards

 

4Q14 SENIOR LOAN OFFICER SURVEY: BROAD-BASED IMPROVEMENT WITH ONLY ONE EXCEPTION  - CRE Demand

 

Residential Real Estate - A Mixed Picture

Residential mortgage loan standards were easier in 4Q for both prime and nontraditional borrowers. A net 11% of banks reported easing standards on prime borrowers, while a net 5% of banks reported easing standards on nontraditional borrowers. 

 

The demand side, however, saw negative trends across the board. We consider this less meaningful because there is built-in seasonality in the purchase market (Fall/Winter home sales always drop relative to Spring/Summer) and the refi market is a direct function of rates.  

 

4Q14 SENIOR LOAN OFFICER SURVEY: BROAD-BASED IMPROVEMENT WITH ONLY ONE EXCEPTION  - Resi Standards

 

4Q14 SENIOR LOAN OFFICER SURVEY: BROAD-BASED IMPROVEMENT WITH ONLY ONE EXCEPTION  - Resi Demand  2 

 

 

 

Consumer Loans - Cards, Cars & Installment

Banks reported a net easing of standards for credit cards, auto loans and installment credit. This survey was roughly in-line with that of recent surveys. On the demand front, auto loans are again hot. 25% of banks, net, reported an increase in demand for auto loans. Meanwhile, demand for card and installment loans remained positive on net, but slowed a bit sequentially. 

 

Finally, banks willingness to make consumer loans (non-mortgage loans) was a plus 8.7%, net in the fourth quarter. 

 

4Q14 SENIOR LOAN OFFICER SURVEY: BROAD-BASED IMPROVEMENT WITH ONLY ONE EXCEPTION  - consumer standards

 

4Q14 SENIOR LOAN OFFICER SURVEY: BROAD-BASED IMPROVEMENT WITH ONLY ONE EXCEPTION  - consumer demand

 

4Q14 SENIOR LOAN OFFICER SURVEY: BROAD-BASED IMPROVEMENT WITH ONLY ONE EXCEPTION  - consumer willingness

 

Joshua Steiner, CFA

 

Jonathan Casteleyn, CFA, CMT

 


Cartoon of the Day: Winnie the Putin

Takeaway: Deflation is pulverizing Vladimir Putin (and oil bulls). WTI crude is down another -2% to $77/barrel.

Cartoon of the Day: Winnie the Putin - Oil cartoon 11.03.2014


Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.

next