TODAY’S S&P 500 SET-UP – November 5, 2014
As we look at today's setup for the S&P 500, the range is 66 points or 2.24% downside to 1967 and 1.04% upside to 2033.
CREDIT/ECONOMIC MARKET LOOK:
MACRO DATA POINTS (Bloomberg Estimates):
WHAT TO WATCH:
COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)
The Hedgeye Macro Team
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 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.
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:
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%
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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.
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.
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.
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.
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.
Feel free to call, or email, with questions.
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
BLMN remains on our Investment Ideas list as a long.
Our bullish bias on BLMN centered on the following key points:
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:
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.
The company is hosting its analyst meeting in NYC in December, where we plan to learn more about 2015.
09/25/14 BLMN: Same as it Ever Was
10/02/14 Bullish on Bloomin'
Feel free to call, or email, with questions.
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