In the May 27th issues of the Hedgeye Edge I included BWLD as one of my top ideas. While it’s still a name I like, we need to start looking at taking some of the chips off the table.
Within the Casual Dining names, year-to-date, BWLD is the third-best performing name after RRGB and BJRI, up 52.7%. This outperformance has been driven by the company being revalued in the marketplace; over the past 6 months BWLD has seen consensus EPS rise 7.5% (RRGB, MRT, DIN and EAT all had even better revision trends than BWLD) and its forward NTM P/E multiple 45%. At the very least, the performance of BWLD is telling you that the NFL lockout will end soon and not disrupt sales trends in 4Q11.
The sell-side sentiment monitor still stands at a bullish reading of 58.8% buys (was 55.6% in January 2011; while the buy-side sentiment reading (Bloomberg short-interest ratio) has decline from 8.47 in January to 7.29 currently (was 12.44 last August).
Year-to-date the stock has worked with very little support from the sell-side and the shorts have been covering on the back of better-than-expected sales and earnings driven in part by lower food coast, among other things. Trading at 9.1x EV/EBITDA, there is about $7.06 (10.7%) of upside if the market revalues the stock to 10.1X EV/EBITDA (and there is no more upward revisions to EPS).
We have been pointing out recently that the top-line is, by far, the most important metric investors are considering at the moment and, with respect to this view, we believe BWLD will report a strong 2Q11. Depending on how strong comparable restaurant sales are for 2Q, 3Q could see a sequential deceleration on one- and two-year average trends.
Regarding food costs, BWLD will be lapping the benefit of lower chicken wing prices in approximately six months. Below, I discuss more in depth the sales and margin trends.
BWLD same-store sales trends:
Although April same-store sales trends were up an impressive +5.3%, it is important to remember that the company was lapping an easy comparison from April 2010, when comparable sales declined -3.7%. This +5.3% growth implies a 120 bp slowdown in two-year average trends from two-year average trends in the first quarter. I would expect to see two-year trends slow somewhat during the second quarter, given the slower start to the quarter and the decreased level of pricing during 2Q11 of 1.9% relative to 2.4% in 1Q11.
Management also stated that incremental gift card redemptions benefited same-store sales growth by about 60 bps during the first quarter, which will likely not be as beneficial going forward. That being said, the same-store sales growth comparison gets easier in 2Q11, so comparable sales growth should continue to be strong on a one-year basis. I am currently modeling a +3.0% comp for the second quarter.
The year-over-year comparison gets increasingly more difficult come the third quarter and if the company does not implement another price increase (management said it has not yet decided whether it will take any further menu price increases), pricing will decrease to +1.3% in the second half of the year. Assuming no disruption to the NFL season, I am currently modeling a 1.5% comp for the third quarter and +4% growth during 4Q11.
During the first quarter, average weekly sales at company units outpaced same-store sales growth by 390 bps. I would expect company average weekly sales to continue to outpace comparable sales growth as management continues to close underperforming restaurants (the company said it will close or relocate 8 older units) and new unit performance is strong.
BWLD Restaurant-level Operating Margins:
Restaurant-level margins improved about 360 bps YOY during the first quarter. The bulk of that YOY growth was driven by lower traditional wing prices (traditional wings accounted for 20% of sales), which were down 36% YOY during the quarter. Accelerated same-store sales growth on both a one-year and two-year average basis also contributed to the company’s increased operating leverage.
Given that traditional wing prices averaged $1.02 per pound during the first two months of the second quarter (down 33% YOY from 2Q10’s $1.51 per pound cost and down nearly 22% on a two-year average basis), BWLD should continue to see significant favorability on the COGS line for the remainder of the year. As a percentage of sales, the YOY favorability should moderate, however, as traditional wing prices peaked during 1Q10.
Partially offsetting the COGS benefit, BWLD experienced higher labor expenses during the first quarter which management attributed to higher training costs related to its new menu rollout and increased hourly wages as the company invested in speed of service initiatives. The incremental training costs will roll off during the second quarter but management still expects to experience higher hourly expenses; though it said continued leverage of management wages should result in flat YOY labor expenses as a percentage of sales. I am modeling some slight deleveraging of the labor expense line during the second quarter given my assumption that same-store sales trends will moderate slightly from the first quarter on a two-year average basis.
All in, I think restaurant level margins will continue to improve for the remainder of the year; though 1Q11 should prove to be the high point from a YOY basis point growth standpoint. Management’s full-year EPS target of more than 18% growth should be easily achieved, assuming no major NFL disruptions (I currently forecasting full-year EPS growth of nearly 22%). I would not be surprised to see 2Q and 3Q11 earnings fall short of that annual goal, however, largely as a result of the expected significant YOY jump in preopening expenses during those quarters.
POSITION: covered SPY
On this morning’s opening market weakness, I decided to cover my SP500 short position. There is no emotion in the process – or at least there shouldn’t be. And having made enough mistakes in my risk management career, I’d rather not stay the course with another predictable one.
I don’t think this short squeeze is over, primarily because that’s what the math is telling me. What was intermediate-term TREND resistance at 1314 is now intermediate-term support – and now the bulls have every opportunity to squeeze a 1 out of this thing before The Pain Trade subsides (the Pain Trade is higher, not lower – with pain being the move that will hurt the most people).
When the world was complacent about US Growth and Bullish Sentiment was raging (Q1), The Pain Trade was lower. But -7% draw-downs have a funny way of changing both expectations and sentiment. In the last 6 months, the Street has cut their US GDP Growth estimates almost in half and the spread between Bulls and Bears in the II Survey has narrowed by 2,000 basis points from peak perma-bull to fear and frustration.
Across our 3 core risk management durations, we’ve outlined the lines that matter in the chart below:
- Long-term TAIL resistance remains 1377 (I’ve been using a level in that area code for 6 months and don’t see it being violated, for now)
- Intermediate term TREND support = 1314
- Immediate-term TRADE resistance = 1350
These are the kinds of markets that can drive you right batty, if you let them. So don’t. If something isn’t working – get it off your sheets, have a coffee, and roll on. A Risk Manager’s role is to be a realist – not dogmatic.
Keith R. McCullough
Chief Executive Officer
Conclusion: While Secretary Geithner's strategy of using the Fourteenth Amendment in defending an extension of the debt ceiling appears to have legal precedent, the potential for a Supreme Court showdown between Democrats and Republicans may make the strategy not worth the gamble.
Secretary of the Treasury Timothy Geithner has heightened the debate over the debt ceiling extension in recent weeks by implying that the President could simply push through an extension of the debt ceiling based on an interpretation of the Fourteenth Amendment of the United States Constitution. While rumors of this defense have been circulating for the last 8 weeks or so, the idea was more officially circulated at a May 25th Politico Playbook breakfast at which Mike Allen was hosting Geithner.
At that breakfast, Allen asked Geithner about a potential default and the debt ceiling debate and Geithner responded with the following:
“I think there are some people who are pretending not to understand it, who think there's leverage for them in threatening a default. I don't understand it as a negotiating position. I mean really think about it, you're going to say that-- can I read you the Fourteenth Amendment?"
Even as President Obama as late as last week has avoided opining or interpreting the Fourteenth Amendment, Geithner, who presumably is speaking as a representative of the administration, has made it very clear that he believes that Fourteenth Amendment gives a President the legal right to extend the debt ceiling.
As noted, in the same breakfast Geithner then read the following excerpt, Section 4, from the Fourteenth Amendment:
“The validity of the public debt of the United States, authorized by law, including debts incurred for payment of pensions and bounties for services in suppressing insurrection or rebellion, shall not be questioned. But neither the United States nor any State shall assume or pay any debt or obligation incurred in aid of insurrection or rebellion against the United States, or any claim for the loss or emancipation of any slave; but all such debts, obligations and claims shall be held illegal and void.”
In fact, the U.S. Supreme Court has actually ruled on the Fourteenth Amendment in Perry v United States (1935). This case was part of a series of cases brought before the United States Supreme Court that were known as the Gold Clause Cases. The gist of these cases was to question whether the U.S. Congress could change the form by, or terms under which, U.S. debts could be repaid.
The ruling by the Supreme Court in Perry v United States specifically referenced Section 4 in the following excerpt:
“Section 4 of the Fourteenth Amendment, declaring that "The validity of the public debt of the United States, authorized by law, . . . shall not be questioned," is confirmatory of a fundamental principle, applying as well to bonds issued after, as to those issued before, the adoption of the Amendment, and the expression "validity of the public debt" embraces whatever concerns the integrity of the public obligations.”
So, in effect, it would appear that there is some precedent for Geither’s statements as it seems that the United States Supreme Court has previously ruled that voiding a U.S. government debt is beyond the power of Congress. Since we are far from legal scholars, we have attached below a link to the ruling:
As is outlined in the following chart, the credit default swap markets on U.S. government debt are signaling that a default on U.S. government is highly unlikely and the odds of such haven’t increased much over the last six months, which perhaps also gives credence to Geither’s view. Currently, CDS on 10-year U.S. treasuries are trading at 58bps, which is well off its highs for the year. By way of comparison, German 10-year CDS are trading at 59bps, Greek CDS are trading at 1,550bps, and Spanish CDS are trading at 268bps.
Even if we accept that President Obama has the legal authority to make a unilateral decision on extending the debt ceiling as Geithner has been suggesting and legal precedent appears to support, the question is really whether it is the most practical or best political path to take. Regarding the latter point, it would seem that while President Obama would get a clear win by trumping the Republican Congress with the Fourteenth Amendment, the downside risk to this strategy is a potentially increased credit risk associated with U.S. sovereign debt and a potential Supreme Court showdown between Republicans and Democrats.
So, would the President and the Democratic rank and file actually pursue the Fourteenth Amendment option? While he doesn’t necessarily speak for all Democrats, Senator Schumer said on a call to reporters on July 1st when asked about the Fourteenth Amendment responded, “It is certainly worth exploring.”
Daryl G. Jones
Director of Research
Positions in Europe: Long Germany (EWG); Short Spain (EWP)
With the Greek Confidence vote won, austerity approved, confirmation over the weekend that the country will receive its next €12 Billion tranche on July 15th (from its original €110 billion bailout package), and talk that Greece’s second bailout package (est. €70-120 Billion) will be announced in mid-September, the intense spotlight on Greece may dim in the coming days and weeks. Yet, the debate will now turn to recent proposals from France and Germany that its banks would voluntarily “restructure” Greek debt holdings by extending repayment on shorter term paper (5 years or less) to 30 year maturities. However, the specific terms, including the interest rate commanded, remains uncertain and as they say, the devil is in the details.
Importantly, under such a plan, great friction will develop with the main ratings agencies, which technically rate any form of restructuring (or re-profiling) as default. We, however, expect some sort of back-door dealings between Troika (EU, ECB, IMF, and institutional banks) and the ratings agencies to modify debt repayments schedules without the mark of “default”, or else some other proposal may be drafted altogether.
Our European Risk Monitor signals that risk has mitigated week-over-week following the insurance from PM Papandreou’s confidence vote and confirmation that Greece will receive its next bailout tranche from the EU/IMF. This is represented in the charts below of sovereign CDS spreads and peripheral government 10YR bond yields.
A similar trend is seen in our European Financials CDS Monitor, in which bank swaps across Europe were wider for only 11 of the 39 referenced banks week-over-week, while 28 were tighter.
While uncertainty surrounds potential restructuring of Greek debt held by public and private institutions, we expect the common currency to hold support with implicit guarantees from Big Brother Troika to prevent default of any member nation, and into the ECB’s interest rate announcement this Thursday (7/7). Trichet has indicated in recent weeks that the Bank is “strongly vigilant” and ready to act against rising inflation that remains above its target of 2% (Eurozone CPI currently stands at 2.7% in May Y/Y). We expect the ECB to raise rates 25bps on Thursday to 1.50%, and remain at that level for the remainder of the year.
In the EUR-USD cross, $1.43 remains a critical short-term support trading level we’re managing risk around. Our TRADE resistance stands at $1.45.
An important catalyst to keep on your sheets is the announcement of the second round of European Bank Stress Tests, expected on July 13th. Rumors swirl that up to 15 of 91 banks could fail the tests, but the number could be a token figure to convey that the tests were "stringent" enough.
Services PMI figures out today showed contracting to slowing figures month-over-month (see table below). Much like Manufacturing PMI figures out last week (for more see our post on 7/1 titled “European Manufacturing Cools in June”), both surveys point to slowing growth expectations ahead as inflation remains elevated and sovereign debt contagion presses. Italian Services is a notable underperformer in the June survey, with a reading under 50 representing contraction.
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