Keith McCullough, chief executive officer of Hedgeye Risk Management and a Bloomberg Television contributing editor, talks about Federal Reserve Chairman Ben S. Bernanke's speech in Frankfurt today and the outlook for U.S.-China relations. McCullough speaks with Betty Liu on Bloomberg Television's "In the Loop."
Conclusion: The quadrant chart posted below portrays a clear picture of the current situation for restaurant stocks. A disproportionately large number of companies are operating in “Nirvana”; comparable restaurant sales are growing year-over-year and restaurant operating margins are expanding year-over-year. The valuation multiples in the chart are assigned by the Street and a clear relationship can be seen between valuation assigned and operational performance (different quadrants).
The following companies are currently operating in Nirvana as of the most recently reported quarter: CMG, BJRI, YUM, SBUX, MCD, PNRA, CAKE, DIN, TXRH, DRI, BWLD, RT, MRT, and PFCB. With the exception of DIN, DRI, BWDL, and PFCB, all of these companies were in the same quadrant as of the prior reported quarter also. On a NTM EV/EBITDA basis, the group is trading at an average of 9.4x. If we remove CMG from the list the multiple falls to 8.9x.
I would like to highlight several names that are, in my view, facing a possible move out of Nirvana in the next quarter or two. Yum China, TXRH, MRT, CAKE, BWLD, MCD, CMG, PNRA and RT are the primary names I am watching in this regard.
Yum China has performed will over the last number of quarters and exceeded my expectations. That said, I firmly believe that the company will find it difficult to extend their stay in Nirvana more than another quarter or two. As I posted earlier today in my note titled, “YUM – WATCH CHINA CONFIDENCE”, consumer confidence is a key driver of top line trends for Yum China and took a sharp turn down in the third quarter. Where that metric trends from here is a key question going forward. Additionally, McDonalds announced that the company has raised prices in China due to higher raw material costs. If Yum experiences the same pressure, it could either translate into margin pressure or, in the event of an ill-received price increase, additional drag on sales.
TXRH and MRT are obviously highly exposed to rising beef costs and many companies in the restaurant space, in the Casual Dining and Quick Service concepts, have highlighted elevated beef costs as a key concern going forward. Additionally, for Morton’s, layoffs (that many are expecting) in the financial sector could have an impact on sales trends. This is not helped by the fact that a sharp step up in comparable restaurant sales from 3Q09 to 4Q09 will present MRT with a far more difficult compare in the last quarter of 2010.
CAKE’s average check problem remains a concern and comps are more difficult to lap in 4Q than they were in 3Q when the company barely comped the restaurant operating margin from the year prior. Despite the implicit message embedded in the fact that customers are trading down to smaller plates and snacks, the company implemented a 1% menu price increase in August.
Food inflation could possible take CMG out of Nirvana. In line with its “food with integrity” mantra, the company purchases its food on the spot market and is therefore vulnerable to volatility in the foodstuffs markets. CMG is lapping declines in food costs of 218 and 207 basis points, respectively, in 4Q10 and 1Q11, respectively. I would consider it more likely that the company would leave the Nirvana quadrant in 1Q11 than in 4Q10. The same is true for MCD. The company has not yet discussed inflation trends in 2011, but they are likely to trend higher with beef prices. Like CMG, I see MCD likely falling out in 1Q11 due to year-over-year decline in restaurant operating margin.
I remain cautious, as I was a quarter ago, about RT’s ability to maintain its operating performance in Nirvana in 2QFY11. As I wrote in my note titled, “RT: IMPROVING BUT THINGS SHOULD SLOW”, momentum will likely slow after the first quarter of FY11 for RT. This could mean RT moving to the “Deep Hole” quadrant, negative comparable restaurant sales and contracting restaurant operating margins.
BWLD has been enjoying favorably commodity prices since chicken wing prices peaked in January and sales in the most recent quarter were an upside surprise to me. As the commodity tailwind goes away, it may be difficult for the company to maintain margins in positive territory on a year over year basis. Additionally, the company has many underperforming, lower volume stores to close down and this process of “right-sizing” may take some time.
The “Deep Hole” quadrant is populated by companies that are operating with negative comparable restaurant sales and negative year-over-year changes in restaurant operating margins. From a QSR perspective, MCD is causing a lot of pain for its competitors. Additionally, higher protein prices will begin to be felt on the bottom line in the upcoming quarter. This has been called out by several QSR management teams. The following companies are currently in that category: SONC, WEN, JACK, KONA, and RRGB. Emerging from this quadrant is quite difficult in that it requires patience; management teams cannot take short cuts or rely on short term fixes.
RRGB is one company that I believe has been taking the wrong approach for several quarters now. They have been under pressure from a check average perspective and management was recently moved to state on their 3Q earnings call that “competitive encroachment” and the concept not being “differentiated” enough is negatively impacting the business.
EAT, on the other hand, has emerged from the “Deep Hole” quadrant thanks to a measured plan on the part of management to increase restaurant operating margins and improve sales on a sustained basis. The former has already occurred; EAT is now in the “Life-line” quadrant and – per my recent notes on the name – I expect sales to pick up in the upcoming quarters (EAT – A BADGE OF HONOR, 11/14) and move into nirvana by FY3Q11.
Overall, a brief glance at the quadrant chart below is enough to tell anyone that restaurant stocks performed well over the last quarter. However, this can only persist for so long and I expect to see a more even distribution among the respective quadrants of this chart over the coming quarters.
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After an impressive start to the year MGM’s baccarat share is on the decline.
Strip Baccarat volume rose 52% in Q3. Juxtaposing those numbers with MGM’s reported 6% decline in baccarat volume for its wholly-owned properties would show that MGM (ex Aria) lost significant baccarat share in 3Q. With this year’s opening of 50% owned Aria, some cannibalization should be expected. However, MGM’s baccarat volume share with and without Aria has now declined for two straight quarters.
Our analysis indicates a 14% baccarat share loss from MGM’s share (ex Aria) of 38% in 2009. In our note, “STRIP BACCARAT TOOK A BIG BREATHER IN SEPTEMBER” (10/13/10), we wrongly concluded that September baccarat volume on the Strip declined, assuming MGM maintained its sequential share. What we didn’t realize is that MGM’s baccarat volume share (ex Aria) had fallen so much that it was not at all indicative of the overall Strip trend. In fact, Strip baccarat volume actually grew YoY in September. Moreover, the chart below shows MGM’s (including Aria) baccarat volume share fell below its share without Aria in 2009.
Aria’s baccarat volume share isn’t doing much better. Although management said on the conference call that Aria had exceptionally strong baccarat play, we believe Aria lost baccarat volume share in 3Q. Total table drop for Aria increased 48% in 3Q from 2Q. If we assume Aria’s baccarat % share of Aria’s total table volumes remained at 44%, Aria lost 3% baccarat volume share in 3Q. Since we know that on the Strip, baccarat % share of total table volume rose in 3Q, Aria’s share loss was probably not as steep.
Baccarat was the one lifeline that kept Vegas from falling into the abyss during the financial crisis. As seen in the following chart, baccarat volume has accounted for a higher % of total table volume over a two-year span. If MGM’s wholly-owned property baccarat volume continues to move in the opposite direction of higher Strip baccarat volume, then its wholly-owned performance will be as depressed as Nevada’s tax coffers.
Yet another solid result out of the athletic footwear/sporting goods industry this morning with HIBB confirming the breadth of industry strength coming in at $0.44 vs. the Street at $0.38 and our $0.40 estimate. Here are a few callouts ahead of the 10am call:
- Accelerated store growth is the clear callout in Hibbett’s Q3 results. With 17 net new stores openings in Q3, the company increased its year-end outlook for net additions by 50% with only one quarter left. We suspect the majority of incremental growth is coming from existing real estate opportunities at Movie Gallery and Blockbuster locations in addition to a more aggressive approach to expand into adjacent states – added first store in South Dakota during the quarter.
- Earnings upside was primarily driven by accelerating comp store sales of +12.5% improving sequentially on both a 1yr and 2yr basis. Similar to what we saw at DKS earlier in the week, top-line sales outperformed what management had suggested earlier in the quarter. Our read through via industry performance data suggests this strength has continued so far in Q4.
- Margin expansion continues with gross margins up +124bps in-line with our expectations and leverage on the SG&A line (-79bps) despite higher store opening expenses better than expected. Exceeding prior peak operating margins is looking increasingly likely next year.
- Inventories up +4% on 15% sales growth consistent with peers (FL & DKS). This is worth highlighting again as all three players are maintaining remarkable stability in the sales/inventory spread relative to what we’ve seen out of the vast majority of other retailers this quarter – positive for continued margin expansion into year-end as well.
- Raised FY outlook:
- Comp expectations up MSD in Q4. What’s notable is that the company would need 12%+ to keep comps flat on a sequential basis. Much like Ed Stack’s strategy at DKS, management is giving themselves a sizeable cushion in the face of potential consumer weakness. Preliminary Q4 sales will provide further color here on the call.
- FY EPS increase to $1.63-$1.66 from $1.45-$1.55 reflects additional upside to earnings in Q4 given just over half the difference is reflected in Q3 results.
In addition to more aggressive store growth plans, it appears the company’s bet to accelerate outerwear as a percent of total sales is also helping drive accelerating top-line results. With a clear commitment to reaccelerating square footage growth already underway, not only are earnings headed higher, but so too is the company’s multiple. More to follow after the call.
TODAY’S S&P 500 SET-UP - November 19, 2010
As we look at today’s set up for the S&P 500, the range is 11 points or -0.48% downside to 1191 and 0.44% upside to 1202. Equity futures are lower as easing worries about Ireland’s debt is offset by concern about tightening measures in China. No important economic data is expected today.
- Autodesk (ADSK) sees 4Q non-GAAP EPS 30c-33c vs est. 34c
- Blue Coat Systems (BCSI) forecast 3Q adj. EPS 33c-39c vs est. 40c
- Dell (DELL) reported 3Q EPS 45c vs est. 32c
- Foot Locker (FL) reported 3Q rev. $1.28b vs est. $1.2b
- Gap (GPS) reported 3Q EPS in line, said expects “choppy” sales in 4Q
- Intuit (INTU) forecast 2Q adj. EPS 36c-40c vs est. 45c
- KeyCorp (KEY) said CEO Henry L. Meyer will retire in May; Beth Mooney, currently vice chair, will replace him
- Salesforce.com (CRM) raised year adj. EPS forecast to $1.18-$1.19 from $1.15-$1.17, vs est. $1.17
- One day: Dow +1.57%, S&P +1.54%, Nasdaq +1.55%, Russell 2000 +1.85%
- Month-to-date: Dow +0.56%, S&P +1.13%, Nasdaq +0.28%, Russell +2.49%
- Quarter-to-date: Dow +3.79%, S&P +4.86%, Nasdaq +6.14%, Russell +6.61%
- Year-to-date: Dow +7.22%, S&P +7.32%, Nasdaq +10.81%, Russell +15.26%
- Sector Performance: Energy +2.20%, Materials +1.89%, Tech +1.68%, Industrials +2.03%, Financials +1.40%, Healthcare +1.41%, Consumer Spls +1.34%, Consumer Disc +0.87%, Utilities +0.60%
- ADVANCE/DECLINE LINE: 1894 (+1283)
- VOLUME: NYSE: 1198.94 (+27.13%)
- VIX: 18.75 -13.83% - YTD PERFORMANCE: (-13.51%)
- SPX PUT/CALL RATIO: 1.19 from 1.60 -25.29%
CREDIT/ECONOMIC MARKET LOOK:
- TED SPREAD: 15.35 0.203 (1.340%)
- 3-MONTH T-BILL YIELD: 0.15% +0.01%
- YIELD CURVE: 2.38 from 2.39
- CRB: 302.51 +2.40%
- Oil: 81.85 +1.75% - NEUTRAL
- COPPER: 383.85 +2.80% - BEARISH
- GOLD: 1,351.85 +1.09 - BEARISH
- EURO: 1.3615 +0.62% - NEUTRAL
- DOLLAR: 78.617 -0.59% - BULLISH
- FTSE 100: (0.54%); DAX +0.02%; CAC 40 (0.08%)
- Indices in the region trade flat to lower following a good show yesterday.
- Investors cautiously watch the progress in the Irish debt talks. Chemicals and Media are among the best performing sectors, while Basic Resources and Banks are in the red.
- Tech stocks are higher boosted by good Dell figures.
- Germany Oct PPI +4.3% y/y vs consensus +4.2% and prior +3.9%
- Germany Oct PPI +0.4% m/m vs consensus +0.2% and prior +0.3%
- Nikkei +0.1%; Hang Seng (0.1%); Shanghai Composite +0.8%
- Asian markets were mixed in a fairly tight range today.
- Worries about Ireland’s debt began to ease, and sentiment was boosted by a positive reaction to General Motors’s IPO.
- South Korea rose on expectations of a resolution of Ireland’s debt crisis. Tech issues supported the market, but shippers fell on a lower Baltic Dry Index.
- Tech stocks and carmakers gave Taiwan a slight rise after the island’s Q3 GDP growth beat estimates.
- Japan rose early, but shed most of its gains as the day went on, as concern rose about declines in China and Hong Kong.
- Australia slipped, with sentiment harmed when the QR National IPO was priced at the low end of its expected range.
- Coal, metals, and banking shares paced morning falls in Hong Kong and China, but the markets rebounded in the afternoon.
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