POSITION: Short SPY
In the Hedgeye Portfolio, I shorted the SP500 on Tuesday at 3:14PM at 1297. We maintain that short position as 1297 remains immediate-term TRADE resistance. Across durations, within the framework of our TRADE/TREND/TAIL Risk Management Process, here’s the setup:
- TRADE resistance = 1297
- TREND resistance = 1320
- TAIL resistance = 1377
That’s what we call a Bearish Formation – when all 3 of our core risk management durations are bearish.
Is consensus Bearish Enough on growth yet? I’m not sure – but consensus may be too bullish on earnings expectations. Micron and Oracle certainly didn’t bode well for Tech earnings today – and I don’t think the Financials are baking upside surprises to the 1st week of earnings season in mid-July either. At least not yet.
All that said, I’m not a blind bear. Short-and-hold isn’t what I do. So I just tightened up my net exposure in the Hedgeye Portfolio (LONGS minus SHORTS) back to neutral (10 LONGS, 10 SHORTS) from net short on today’s US market open.
Enjoy your weekend,
Keith R. McCullough
Chief Executive Officer
Positions in Europe: Long Germany (EWG); Short Spain (EWP)
In sizing up our macro position in Germany, which we’re long in the Hedgeye Virtual Portfolio via the etf EWG, we want to emphasize that the high frequency data has slowed in recent months. While Germany continues to reflect a strong growth profile for 2011, especially when compared to many of its neighbors handcuffed by gross fiscal imbalances, high unemployment, government indecision and unruly populous’ over austerity measures, the charts below show that German consumer and business confidence have waned over the last four months, as forward-looking Services and Manufacturing PMI surveys have also tailed off—Manufacturing has declined for the last two months as Services has been mixed and off ytd highs established in Q1 (see charts below).
While we still like Germany’s fiscal discipline and ability to find demand for its goods and services, the risk that Germany does not meet its growth forecasts given the pressing macro climate makes us more cautious on the position. GDP forecasts include:
German Government: 2.6% in 2011. (Chancellor Merkel indicated in late May that GDP will probably be above 3% in 2011)
German-based Institute for the World Economy: 3.6% in 2011; 1.6% in 2012
Bundesbank: 3.1% in 2011; 1.8% in 2012
Contagion from the periphery remains a glaring threat. While the Troika (EU, IMF, ECB) appears poised to step in to save Greece at every step with additional funds and more favorable terms on its debt, great uncertainty exists on how long the Greek state will be subsidized by Big Brother, and the impact of similar issues for larger countries like Spain and Italy. The obvious spill-over risk could dent not only the German equity market, but also the common currency. Certainly while a weaker EUR is to Germany’s advantage, we’re certain that if a real currency crisis emerged, the advantage of “cheap” German exports wouldn’t be of note.
For now we’re managing our exposure to Germany real-time. The DAX is trading just above its intermediate term TREND support line of 7,106 (third chart below). Stay tuned.
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The trends at JACK are getting better “on the margin” but the company is not in the clear just yet. As I see it, the current risk/reward is favorable. JACK is the last QSR company with a market capitalization over a billion that is trading below 6.0x EV/EBITDA. By comparison, the average multiple for the QSR sector is now at 9.8X EV/EBITDA. However, excluding CMG and GMCR, the QSR average multiple drops to 8.6X EV/EBITDA.
If JACK’s fundamental were to continue improving “on the margin” and the street were to reward the company with a higher multiple, I believe there could be over $10 of upside in the stock, or +40% from current levels.
The case for investors to revalue the stock over the next twelve months is as follows:
- 70% to 80% franchise mix by the end of fiscal year 2013 (just 18 months out) in line with other in the QSR space (the company needs to sell approximately 300 restaurants between now and the end of 2013.)
- 16% restaurant level margins by 2013
- Slowing franchise remodel incentive payments in FY2012
- “Deflating the Inflation” into FY2012
THE TOP-LINE AT A GLANCE
I see FY3Q11 same-store sales growth guidance of +2-4% for Jack in the Box company units is reasonable, given the sequential improvement in two-year average trends during fiscal 2Q11 and the stable/improving QSR MACRO environment.
The full-year guidance of +1-3%, though not completely out of reach, seems to be a bit more of a stretch given that the company would have to achieve a nearly 150 bp improvement in two-year average trends during the fourth quarter to hit the low end of the range, assuming 3Q11 same-store sales come in at 2%. I would note that SONC showed a 645 basis point improvement in 2-yr trends at company-owned restaurants between 2QFY11 and 3QFY11 (quarters ended February and May, respectively). For Jack in the Box, the YOY comparison gets increasingly more difficult during fiscal 4Q11 as the company is lapping a -4.0% comp from 4Q10 relative to -9.4% in 3Q10.
The Qdoba same-store sales growth target of +4-6% for both fiscal 3Q11 and the full year seem easily achievable given recent two-year average trends.
MARGIN TRENDS AT A GLANCE
The company’s commodity inflation guidance of up 6-7% in fiscal 3Q11 and +4.5-5.5% for the full year implies commodities are up about 5-8% during the fourth quarter, which will continue to put pressure on restaurant level margins. There is some risk to this commodity guidance as management has been incorrect in its prior guidance of these costs, initially guiding to inflation of +1-2% and then +3-4%. And, given recent commodity trends, I would expect the company’s commodity costs, particularly, its beef costs (guided to a 14% increase in full-year beef costs), to exceed the company’s current expectations.
JACK’s full-year restaurant level margin guidance of 12.5% to 13.5% implies the YOY margin declines moderate during the second half of the year. It is important to remember that following the first quarter’s 170 bp decline in restaurant level margins, management guided to a significant improvement in YOY trends for the remaining three quarters. Fiscal 2Q11 margins, however, declined nearly 290 bps, largely as a result of the larger-than-expected increase in commodity costs. Margins have also been negatively impacted YOY by the company’s investment in guest service initiatives, which at least is a high quality problem.
JACK has posted margin declines for the last seven quarters. I would expect margins to continue to contract YOY during the second half of the year, but the magnitude of these declines should moderate significantly from fiscal 1H11, with the fourth quarter being less bad than the third on a YOY bp change basis. Obviously, if same-store sales growth surprises to the upside, stronger margin trends could result.
JACK has not yet turned the corner, but same-store sales trends have stabilized and turned positive during 1H11. Trends are still fairly negative on a two-year average basis but are improving nonetheless. Margin improvements should slowly follow with margins beginning to stabilize in 2H11. That being said, current commodity pressure will only slow this process.
OTHER THING TO CONSIDER:
- The company is lapping its 53rd week from fiscal 2010 in fiscal 4Q11.
- JACK increased its share repurchases during fiscal 1H11 to $75 million from $50 million during 1H10.
- The company’s diluted share count decreased 8.6% YOY during 2Q11. Full-year earnings will continue to benefit from this lower YOY share count and continued share repurchases.
Raising estimates but leaving price target intact is stinky analysis. What happens when they have to raise estimates again?
Yesterday, BMO raised 2011 and 2012 estimates to $1.65 and $2.09, respectively. We have two issues with this. First, the analyst left his price target at $21 and rating at Neutral despite the higher estimates. With ASCA almost at $23, wouldn't that make the stock a Sell and not a Neutral? He's been raising estimates fairly consistently on the name but that Neutral rating has been sticky. Second, his estimates are still way too low. We think $2 for 2011 is likely. The only way ASCA does $1.65 is if the economy tanks. If that's what he is projecting, he should have a Sell on the entire gaming sector which has become synonymous with the term cyclical.
ASCA is not a Wall Street favorite. Maybe it's because they aren't in Asia. Maybe it's because they aren't spending a ton of money to drive growth. Maybe it's just not an exciting story. So what? These guys are great operators who are focused on ROI. Free cash flow is growing faster than EBITDA and it won't be long before the company returns more capital to shareholders above the current 2% dividend yield. ASCA is one of only a few gaming companies that actually pays a dividend.
At some point, these analysts will have to raise ratings and price targets as estimates continue to go higher.
Notable news items and price action from the restaurant space including our fundamental view on select names.
Gas prices were highlighted by DRI CEO Clarence Otis on the company’s most recent earnings call (March 25) as being a significant headwind for traffic. Gas prices are down almost 7% since then and 16% since the peak on April 30th. If gas prices continue to fall or, simply, not go up during the summer months, casual dining may continue to perform strongly. As gas prices declined in May, the Knapp Track casual dining same-store sales index accelerated sequentially on a one- and two-year basis.
Cattle futures continue to rise as shorter supplies loom on the horizon, according to cattlenetwork.com.
Unrelenting rainfall may have slashed U.S. planting of durum wheat to the lowest level in more than 50 years, fueling a surge in the price of pasta and noodles as mills scramble for supply of the grain. Grain elevators in North Dakota are paying farmers about $14.40 a bushel for durum up from $9.50 a month ago; the peak was $23 reached in February 2008.
The outlook for the consumer - more Americans filed first-time jobless claims last week and consumer confidence fell according to the Bloomberg Consumer comfort index.
- THI was mentioned in a list of names that Goldman expects to drive EPS growth via buybacks. EAT was not on the list.
- MCD is planning its second Yuan-denominated bond issue, HKET says. MCD spokeswoman Vivian Zhang has denied the claim.
- SONC estimates were raised by Piper Jaffray. FY11 revenue and EPS are now expected to come in at $546.8 million and $0.56 per share, respectively.
- WEN opened its flagship restaurant in Moscow, Russia Thursday. The restaurant in Moscow’s historic Arbat District, was opened with festivities to celebrate the quick-service burger brand’s entry into the Russian Federation this month. The Russian Wendy - instead of the wholesome freckle-faced redhead in old-fashioned pantaloons, wears a short dress, bright red-striped stockings and stilettos.
HEDGEYE: For years WEN has been trying to cultivate an “international” growth story. On the marketing front, upgrading “Wendy” to a sexier look can’t hurt sales…
- Dunkin’ Brands is teaming up with Marvel Studios to promote “Captain America: The First Avenger.” The tie in — which marks the first time the parent of Dunkin’ Donuts and Baskin-Robins has partnered with a motion picture studio — includes themed menu items, a website where participants can win prizes, and a Facebook promotion.
HEDGEYE: The S1 filing for the IPO shows some of the slowest same-store sales trends in the breakfast category. I know they are hoping this will give them a boost. Not likely, movie tie-ins are a relic of the past.
- When KFC Corporation filed a lawsuit in late April seeking to terminate the agreements of 10 stores owned by John R. Neal, one of its biggest operators, some critics charged that the system was getting back at Neal over his leadership in franchisees' successful lawsuit to secure more control over advertising. Late yesterday, Neal's attorneys filed court documents alleging exactly that - Restaurant Finance Monitor
HEDGEYE: YUM’S issues in the USA are not isolated to KFC franchisees the company has many problems with a number of franchisees across all its USA brands.
- SBUX - Starbucks celebrated the opening of its 100th outlet in Indonesia on Friday, promising a more aggressive expansion plan in the future. Jakarta-based retailer Mitra Adi Perkasa, which holds the license for Starbucks in Indonesia, said it planned to open 15 more branches throughout Indonesia by the end of 2011.
HEDGEYE: SBUX remains in the Hedgeye virtual portfolio.
- DRI’s Red Lobster concept has seen an improvement in performance due to the four-course menu promotion, according to Wells Fargo. The company’s outlook on DRI has strengthened as a result.
- DRI could be facing higher food costs on top of the double-digit inflation being seen in seafood. Bloomberg reports that pasta prices may surge on curbed durum supply.
- EAT franchisee ERJ Dining LLC, which runs 122 Chili’s units, has deployed wireless, on-table touch-screen technology at 30 of its restaurants in advance of a full rollout by the company later this summer.
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