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FLASHBACK | Hedgeye's Howard Penney Said Short $CHUY Last Week; The Stock Is Down Over -30% Today

Takeaway: Hedgeye restaurants sector head Howard Penney added Chuy's (CHUY) to our Best Ideas list as a short on 10/28. CHUY is down over -30% today.

Editor's note: This report was originally published October 28, 2014 at 06:09 in Restaurants. CHUY is down over -30% since Penney made this short call.

FLASHBACK | Hedgeye's Howard Penney Said Short $CHUY Last Week; The Stock Is Down Over -30% Today - hwp


We’ve covered the majority of our shorts in the casual dining space, but remain bearish on a select few stocks.  Today, we’re adding one of these names, CHUY, to the Hedgeye Best Ideas list as a short.


Three Key Points:

  1. In addition to being phonetically challenging, the Chuy’s brand is having difficult generating awareness is new markets.  The street is assuming that other states will be able to produce the same levels of revenues and returns generated in its core market (Texas) as it pursues its nationwide expansion plans.
  2. The issues associated with a disappointing 2013 class of restaurants are not a one quarter issue.  In fact, AUVs have declined every single quarter since 4Q12, a trend we believe will persist for the balance of 2015.  The concept has already proven it doesn’t travel well, suggesting growth expectations are being overvalued in the marketplace today.  Considering an onslaught of new, underperforming restaurants, the cost structure of the company is deleveraging.  This, coupled with increasing food and labor costs, likely means that more margin deterioration is on the way – precisely what the street is missing.
  3. Trading at 33x consensus NTM EPS, CHUY is currently one of the most expensive publicly traded casual dining stocks.  The company has maintained a premium valuation despite declining AUVs, returns and consensus EPS estimates.  Furthermore, we believe 2014 and 2015 earnings estimates are too high, which would imply this 33x multiple is closer to 39x by our estimates.  We see 30-40% downside in this name and believe 3Q14 earnings will be the catalyst the shorts are looking for.


CHUY has been on our Long Bench for the majority of 2014, until recently when we spotted several disconnects between the street’s expectations and reality.  For this reason, we believe the current issues the company faces will take longer to correct than most are giving them credit for.  At 39x NTM EPS, we believe there are too many risks in the current business, and the future of the business, to support such a multiple.  Importantly, we believe 3Q14 earnings will be the downside catalyst shorts are hoping for.


Our short thesis focuses on the following:

  • Disappointing new unit productivity
  • Cash burn necessitates the current new unit growth rate
  • Rampant support from the biased bulls (read: high expectations, aggressive estimates)
  • Significant insider selling
  • Strong sell-side sentiment and unjustified premium multiple
  • Significant food inflation (dairy, beef, avocados, produce)
  • Overly optimistic consensus food and labor cost assumptions in 2H14
  • A lack of leverage in the business model considering higher year-over-year G&A, D&A and pre-opening spend
  • Aggressive 2H14 and 2015 EPS estimates
  • Approximately 30-40% downside to the name


We’re in the early stages of this earnings season and, so far, we’ve seen bigger casual dining chains posting slightly stronger sales trends than a year ago.  While this trend is important to consider, some of this sales growth is coming at a significant cost to margins.  To that extent, Wyman Roberts, CEO of Brinker, recently said on the company’s earnings call: “If you look at NPD numbers 12 months rolling August, the category hit the highest deal rate that it’s ever hit, and some players in there are reaching some pretty aggressive numbers.”


So while gas prices may be helping the macro picture, it’s undoubtedly difficult to gauge the impact that increased discounting is having on several players in the industry.  What we do know, however, is that discounting is never good for margins.


Chuy’s looks to be one of the promising companies that can beat on the top-line, however, we suspect it will miss on margins and earnings.  The bulls on CHUY will likely point to stronger industry trends and the unexpected price increase management enacted sometime in September (we believe) to help mitigate the margin pressure the company is facing.  While both of these may likely occurred in the quarter, it will not be enough to save it. 


The underperformance of new units, in addition to lower margins, puts the company in a difficult spot, increasing the need for the company to tap the capital market in order to deliver on aggressive unit growth plans.  Over the past 12 months, capital spending has grown by 29%, while the cash burn has more than doubled to $12 million.


From a sentiment standpoint, one issue of concern on the short side is the 18% of short interest.  The average casual dining chain is running closer to 9.8%, so Chuy’s issues are fairly widely known.  Given the massive declines we’ve seen in restaurant stocks this year (with higher short interest) and the fact that insiders have been selling shares faster than gazelles, we believe the short side is a much better place to be.


We look forward to sharing more with you on the call.


Howard Penney

Managing Director


Fred Masotta


Keith's Macro Notebook 11/5: Japan | Sentiment | UST 10YR


Takeaway: Mass and VIP volume well below expectations. Premium Mass table conversions to Direct VIP only partly to blame for the Mass disappointment.

October numbers look much worse than previously thought.



Please see our note:  http://docs.hedgeye.com/HE_Macau_OctDetail_11.5.14.pdf

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CAT: 5 Reasons to Stay Bearish into 2015

There are more than five reasons, but we will start with these.



S.E.C. Subpoena:  In a Halloween 10-Q filing, CAT disclosed an S.E.C. subpoena from September 10, 2014 saying “…SEC issued to Caterpillar a subpoena seeking information concerning the Company’s accounting for the goodwill relating to its acquisition of Bucyrus International Inc. in 2011 and related matters. The Company is cooperating with the SEC regarding this subpoena and its ongoing investigation. We currently believe that this matter will not have a material adverse effect on the Company's consolidated results of operation, financial position or liquidity.”  We reviewed this accounting issue in the summer of 2013 CAT Short Review: Short Thesis, Long Tail: Replay: CLICK HEREMaterials: CLICK HEREInvestors love S.E.C. subpoenas and potential restatements.


CAT: 5 Reasons to Stay Bearish into 2015 - sfdsdfs



Oil Price Decline:  Oil & Gas is a large, high margin end-market for CAT.  After the collapse in mining equipment demand, CAT management directed attention away from Resource Industries and toward Energy & Transportation.  We continue to think that will prove an error.  On their earnings call, CAT commented that “the feedback we've been getting that say, mid-$80s - say $80 to $90, somewhere in there on a sustained basis, certainly will take the really agitated top off of it. …. I think if you'd see low $70s on a sustained basis there would be a chill across the market.   Markets are closer to the “chill” level now and time will tell if it is on a “sustained basis”.  Still, it sets up what are likely to be tough comps for E&T in 2015, which already had tough comps elsewhere.  Our recent call on tight oil suggests the chill may not thaw soon.  


CAT: 5 Reasons to Stay Bearish into 2015 - asdad2



Mining Can Get Worse:  Mining capital spending may be at or near a bottom, but results from Resource Industries can get worse.  We expect pricing pressure, which was mentioned in the 3Q 2014 earnings press release, to persist.  Orders in revenue likely reflect better pricing than those backlogged in today’s weaker market.  With mined commodity prices continuing to see pressure (e.g seaborne iron ore under $80/t) and MATS rules set to impact coal in 2015, idled equipment may well be parted out or resold/repurposed.  CAT Financial may be impacted if used equipment prices decline, potentially exposing the receivables portfolio to losses.  As we understand it, not all of CAT’s mining exposure is categorized under the “Mining” section of CAT Financials disclosures, as much of it is presented by geographic region.


Tier IV Pre-Buy:  While the locomotive pre-buy ahead of new emissions regulations was largely telegraphed and quantified at “less than 2% impact on Energy and Transportation” next year, the rest of the Tier IV impact was not.  We expect to see an impact on larger gensets and other very large engines in 2015.


Inflated 2015 Estimates:  CAT hasn’t guided revenues conservatively in recent years, with the 2014 top line mid-point staying constant since last October.  Given the evaporation of Resource Industries, likely pressure on Energy & Transportation (Tier IV, Lower Oil), and tough comps in Construction Industries (dealer inventory build, record margins), flat revenue growth seems reasonable, and perhaps aggressive, in 1H 2015.  The street lowered 2015 sales estimates a bit following the guidance, but remains above guidance (consensus at ~$56.9 bil vs. guide of ~$55 bil).  EPS are expected to grow to an adjusted $7.00 from an estimated $6.50 in 2014.  By our initial estimates, CAT would have to buy in a huge amount of stock to get there.  



CAT: 5 Reasons to Stay Bearish into 2015 - wrf3




PODCAST | McCullough: Panic Is Coming as ‘Policy to Inflate’ Experiment Ends In Tears

BKW: Quick Recap

We still have reservations about BKW, but the company as we know it is diminishing after this quarter.  Like WEN, JACK and SONC, BKW is a net beneficiary of the significant share losses that MCD is giving up.  Since MCD is far from getting its act together, further share losses are expected and will continue to benefit other sandwich/burger chains.


We recently expressed our reservations about the BKW/THI deal:

  • Levering up to pay a premium for a slow growth CDA company
  • The lack of synergies with the transaction; in fact, costs will accelerate to jumpstart unit growth
  • We doubt the merger will accelerate the growth of THI globally
  • The two companies have fundamentally different views on franchising
  • The Burger King franchisee base is weak and getting weaker by the day
  • BKW is likely to miss 3Q14 estimates
  • The social media backlash, on both ends of the spectrum, to this transaction cannot be underestimated
  • The conference call announcing the deal was far from impressive; in fact, it was rather discouraging
  • The transaction is dilutive to current shareholders
  • Current valuation is unwarranted


Trading at 18x EV/EBITDA, we simply can’t get behind this stock, but there were a few things to like about the quarter:

  • Global comparable sales increased 2.4%, primarily driven by growth in the U.S. and Canada
  • System-wide sales increased 8%
  • Adjusted EBITDA increased 12% to $194 million
  • Adjusted diluted EPS increased 18% to $0.27 per share
  • Net restaurant growth of 152, a 14% increase from the prior year


Investment Positives

BKW reported +3.6% same-store sales growth in the U.S. and Canada, making it the fourth consecutive quarter of positive same-store sales growth and the best rate of growth since early 2012.  BKW is launching fewer, more impactful high margin products, complemented by value offerings.  In 3Q14, they introduced the A1 Ultimate Bacon Cheeseburger and re-launched Chicken Fries.


Internationally, BKW expanded its brand presence around the world, opening 152 net new restaurants in the quarter.  The brand now has just under 14,000 restaurants worldwide.  November and December are typically the busiest months of the year for BKW and the company looks like it is on track to hit its target unit openings for the year.  At the end of FY15, the Burger King Brand will be in 100 countries.


BKW delivered 18% adjusted EPS growth and 12% organic adjusted EBITDA growth in the quarter.  To its credit, it has grown adjusted EBITDA and adjusted EPS every quarter since becoming a public company in mid-2012.


Reimaging continues to be a focus area and management expects to hit its stated target of 40% of the U.S. system on the modern image by the end of 2015.


EMEA was also strong, delivering its 15th consecutive quarter of comparable sales growth.  Performance was driven by strength in Turkey, the UK and Spain.


Year-to-date, BKW has generated $537 million in adjusted EBITDA and $366 million of free cash flow.  The company also paid down $57 million of debt and paid out nearly $77 million in dividends.  At quarter end, the company’s cash balances increased from approximately $790 million at year end 2013 to $1,014.


Investment Negatives

Despite strong same-store sales in the U.S. and Canada, organic adjusted EBITDA growth decreased 4.2%.  Although management expects North America to return to positive organic EBITDA growth in 4Q14, this is something we need to keep a keen eye on.   We have serious concerns over the health of Burger King’s franchisee base.


LAC was the most challenged region in 3Q14, as same-store sales declined due to weakness in Mexico and Puerto Rico.  Weakness in Mexico was the by-product of a sluggish eating out category and BKW’s ineffectiveness at driving value.


3Q14 marked the beginning of non-recurring (yet, recurring) expenses related to the THI transaction.  BKW incurred approximately $31 million of transaction and strategic realignment costs related to the transaction.


BKW also incurred $148 million of net losses on derivatives related to the transaction, as management was required to recognize a mark-to-market loss on transactions due to the weakening of the Canadian dollar.


BKW: Quick Recap - 1


BKW: Quick Recap - 2


BKW: Quick Recap - 3


BKW: Quick Recap - 4


Howard Penney

Managing Director


Fred Masotta


Early Look

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