TODAY’S S&P 500 SET-UP - July 20, 2011
Yesterday, volume and Volatility (2 of our 3 core risk management factors) didn't confirm the PRICE move today, but 2 or 3 more days of follow through on this PRICE strength should do it and could easily carry this market towards 1352 SPX. If today's Tech move (+2.3% XLK) was a head-fake (doubtful given AAPL at the close), it would need to be confirmed by a TREND line breakdown of SPX 1319.
As we look at today’s set up for the S&P 500, the range is 33 points or -0.58% downside to 1319 and 1.90% upside to 1352.
SECTOR AND GLOBAL PERFORMANCE
- ADVANCE/DECLINE LINE: +1749 (+3888)
- VOLUME: NYSE 870.65 (-0.41%)
- VIX: 19.21 -8.31% YTD PERFORMANCE: +11.5%
- SPX PUT/CALL RATIO: 1.63 from 1.99 (-18.19%)
CREDIT/ECONOMIC MARKET LOOK:
- TED SPREAD: 23.68
- 3-MONTH T-BILL YIELD: 0.03% +0.01%
- 10-Year: 2.91 from 2.94
- YIELD CURVE: 2.57 from 2.57
MACRO DATA POINTS:
- 7 a.m.: MBA Mortgage Applications, prior (-5.1%)
- 9 a.m.: Moody’s U.S. commercial property prices
- 10 a.m. Existing home sales, est. 1.9% to 4.9m, prior (- 3.8%)
- 10:30 a.m.: DoE inventories
- 6:15 p.m.: Fed’s Sack to speak to money marketers in NY
WHAT TO WATCH:
- President Obama will renew talks at the White House this week, praised bipartisan Senate proposal for a $3.7t debt- cutting plan that emerged yesterday; House Republicans passed their own version yesterday
- Greek Prime Minister George Papandreou to meet with EU leaders in Brussels tomorrow as officials struggle to agree on measures to restore confidence in region’s creditworthiness
- WSJ is cautious on Cheerios (GIS), Frosted Flakes (K), Grape-Nuts (RAH)
COMMODITY HEADLINES FROM BLOOMBERG:
- Oil Climbs for Second Day on Shrinking Crude Stockpiles, Stronger Economy
- Copper Declines for First Day in Four as Three-Month High Spurs Selling
- Corn Gains for a Second Day as Hot Weather in U.S. Midwest May Hurt Yields
- Gold May Decline on Optimism Solution Is Nearer for Sovereign-Finance Woes
- Coffee Falls as Supplies May Be Adequate to Meet Demand; Sugar Advances
- Gold Price at Record Fails to Deter Purchasing in India as Demand Advances
- Milk Powder Slumps to Eight-Month Low After Fonterra’s Call Proves Correct
- Japan Won't Rule Out Possibility Radioactive Fukushima Beef Was Exported
- Zinc Trades Near the Highest Price Since April as Supplies May Be Limited
- Rice Exports From India at $400 a Ton May Lower Global Prices, Group Says
- Rubber Supply Tightness Lasting Until 2018 May Raise Costs for Tiremakers
- Ethanol Rebounds on Tax Credit, Price Discount to Gasoline: Energy Markets
- Russia Arctic Route to Rival Suez May Aid Sovcomflot IPO: Freight Markets
- EUROPE: ominous bounce to lower-highs; Italy fading here and Greece about to go negative on day; Sold my Germany yesterday; shorting Italy with impunity
- Germany Jun PPI +5.6% vs consensus +5.5% and prior +6.1%
- BOE MPC Committee minutes say recent developments had reduced the likelihood that a tightening in policy would be warranted in the near term
- ASIA: surprisingly mixed give the Apple of everyone's American eye - India down -0.8%; China down -0.1% w/ Korea/Japan/Aus all up over 1%
Chipotle misses EPS expectations but with strong top line numbers it is not cut and dried.
The EPS miss definitely spooked the street with the stock trading down as low as $313 post-market from the $333 close. Looking at the overall picture, Chipotle’s top line metrics are very healthy but the margin side of the story is less stellar with restaurant-level margins now declining for the second consecutive quarter. This is primarily as a result of high levels of food cost inflation. The reaction of the Chipotle customer to the price increase being taken by the company to protect margins in the face of these costs is going to dictate the overall direction of the stock.
Same-restaurant sales for CMG came in at 10%, well in excess of already-high expectations of 8.6% according to StreetAccount. Two-year average trends for 2Q11 came in at 9.4%, a 100 basis-point sequential acceleration from 1Q. Management attributed this strong performance to awareness being raised around the company’s Food With Integrity mantra as well as continuing loyalty to Chipotle. Initiatives such as the new affinity program that is being rolled out currently, and will anchor off social media from a participation perspective, are designed to retain and grow customer loyalty going forward.
New unit volume was another driver of revenue growth during the quarter, increasing by 20% year-over-year versus 16% year-over-year growth in 1Q. A-models are also a medium through which the company is looking to grow; during today’s earnings call the company, for the first time, indicated that the A-model is now proven enough to develop in developing (rather than solely established) markets.
From here, the company is implementing a price increase, the customer’s reaction to which will be crucial for comps as we transition through the second half of the year. During the second quarter, Chipotle took 1.5% which mostly pertained to the Pacific region. The broader price increase, across the system, will be fully rolled out during August and will affect all markets. The average magnitude of the hike will be 4.5%. This is the first price increase Chipotle has taken in three years and management will be hoping that traffic doesn’t react as severely to this price increase as it did in 2008.
Restaurant level margins were down again, year-over-year, for the second consecutive quarter. As a percentage of sales, Food, Beverage, and Packaging costs increased 250 basis points year-over-year. Management expects the impact of the price increase being taken in the current quarter to offset most if not all of the inflation impact on margins. Labor as a percentage of sales decreased 50 basis year-over-year despite an increase in worker’s comp claims and an increase in employee turnover. The company stressed several times that there is more fat to be trimmed on the labor line. Occupancy costs were down approximately 50 basis points from last year due to sales leverage. Marketing as a percentage of sales was 1.7% versus 2.1% a year ago which accounted for the 40 basis point decrease in other operating costs.
Protecting margin is critical for Chipotle, particularly given their practice of not locking in commodity costs.
The current (third) quarter is highly significant for Chipotle and there are several factors that we will be monitoring closely.
- The last time Chipotle took price was in 2008 and the consumer did not react well at all. One would hope that management will have learned from that experience and will have completed all of the necessary research to ascertain the optimal magnitude of the price increase for profitability. Ultimately, the result won’t be known by us until the next quarterly earnings report is released.
- The increase in employee turnover that management highlighted is an interesting data point. Rising from an average of 100% to 120% during 2Q hardly constitutes a crisis for a company in an industry where the norm is closer to 160%, but if the trend continues it will certainly catch our attention. Training new people increases labor costs, newer employees are generally slower which impacts throughput, and if manager turnover is increasing, it may signal deeper issues than just low job satisfaction. The situation is clearly not there yet, but we will be watching this closely.
- Any new information about the ICE investigation into CMG’s hiring practices will obviously be important to the extent that it may impact labor costs or EPS via a one-time charge. However, to be frank, hiring 12,000 people since March must surely have improved CMG’s image in the eyes of the government!
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Below Josh Steiner and Allison Kaptur of our Financials Team quantify the 40 most exposed European banks (among the 91 tested) to the PIIGS based on the results of the EBA’s EU Stress Test. While the team notes that this data is “stale”, with the data and risk assumptions based on year-end 2010 figures, the exposures are nevertheless valuable reference points as European sovereign debt contagion risks persist:
Moving Beyond EBA Conclusions That All is Well
Our view of the European bank stress tests released last Friday is rather dim. We criticized the leniency of the "adverse scenario" assumptions, noting in particular that the actual deterioration since year-end 2010 is already worse than the "adverse" assumptions in some cases. (Contact us if you want to see our full note.)
While we consider the loss assumptions to be balderdash, the stress tests were valuable in that they disclose a wealth of bank-specific data around sovereign and commercial exposures by country. Clearly, the greatest default risk is currently in Greece, Portugal and Ireland. Italy and Spain, while on slightly more stable ground, are rapidly deteriorating as well.
In the tables below, we show the exposure to sovereign debt and commercial loans by bank to each PIIGS country. Specifically, we show the top 40 most exposed European banks (among the 91 stress-tested), ranked by gross loans and sovereign debt holdings as a percentage of their Core Tier 1 Capital. Bear in mind that this data is as of December 31, 2010. In addition to showing which banks hold the greatest exposure on a country by country basis, we also show which banks hold the greatest exposure to Greece, Portugal and Ireland collectively, as we view those countries as being at greatest risk for default. Further, we show total exposure to all five PIIGS countries.
We highlight in red those banks with 100% or more of their Core Tier 1 Capital in the form of sovereign debt holdings and/or commercial loans to a given country or group of countries. The total exposure groups (all PIIGS) are presented two ways. First, we show exposure sorted by RWA. In other words we show the PIIGS exposure by bank for the 40 largest European banks. Second, we show exposure sorted by % of Core Tier 1 Capital at risk regardless of the size of RWA.
Summary Conclusions: 14 of the Top 40 EU Banks Hold Over 200% of their Capital in PIIGS Exposure
We find that there are numerous European banks with over 100% of their Core Tier 1 Capital committed to either PIIGS commercial loans or PIIGS sovereign debt holdings. For example, we found that 18 of the 40 largest European banks held 100% or more of their Core Tier 1 Capital in PIIGS sovereign debt or commercial loans. In 14 of these cases, the banks held more than 200% of their Core Tier 1 Capital in PIIGS sovereign debt or commercial loans.
As a general rule we found that the Nordic banks are the least exposed to PIIGS debt, typically holding less than 20% of their Core Tier 1 Capital, putting them at considerably less risk than the group as a whole.
Joshua Steiner, CFA
A recap of commentary from the last earnings call and our thoughts heading into 4QFY11 earnings on Thursday.
The biggest event for RT this quarter was that Steven Becker and Matthew Drapkin have been appointed to the board of directors at Ruby Tuesday shortly after Becker, Drapkin and Carlson Capital began agitating the company. Sandy said "Steve, Matt and I recently met in person, and have subsequently worked quickly and cordially to reach a win/win scenario which we believe is in the best interests of our shareholders.”
HEDGEYE - Why did Sandy cave so quickly? My guess is that the fundamental performance of the company did not offer him the opportunity to fight. Yes, it’s going to be another bad quarter. That being said, look for changes in the strategic direction of the company (i.e. new ways to create shareholder value). The stock has been outperforming of late.
BIG PICTURE COMMENTS FROM LAST QUARTER
SALES TRENDS - “Absent the snow-related impact during the quarter, which we estimate at 1.5-2.0% on top of last year's negative weather impact, we would have had our fourth quarter in a row of positive same restaurant sales.” The weather dilution impact estimated at $0.03 to $0.04 per share in the third quarter
“We have seen sales in bar grill lag casual dining overall and have recently seen some non-weather related issues in some of our markets, more so in the south, which is most likely due to the gas prices being significantly higher year-over-year and tracking a bit like we saw in 2008. We are actively responding with sales building programs to drive traffic in these markets, which we hope will offset this behavior over time.”
HEDGEYE – Actually, we have learned that sales in the bar & grill category have not been disappointing. The two largest players Chili’s and Applebee’s are showing accelerating trends: yet another indication of a bad 4Q from RT.
INVESTMENTS FOR THE FUTURE - “We will have invested approximately $9 million of loan in our fresh bread program and our new marketing/brand research initiatives by the end of fiscal year '11 and with some offsetting costs, but basically a big investment year. Just need to translate into sales. “We've recently strengthened our real-estate and development team as we get back into trying to move into the investment of this excess capital and start growing a bit again.”
HEDGEYE - Defensive move or competitive advantage. Not sure giving away bread is a big deal to anyone.
THREE YEAR STRATEGIC PLAN - “First and foremost, we continue to stay focused on getting more out of Ruby Tuesday, continue to enhance the sales, margins, and overall strength of that great brand. We need to maintain that cash flow and create even more cash flow from Ruby Tuesday, the cash cow, so that we can reinvest it in other areas, and if we can't, return it to shareholders in whichever way is appropriate.”
“Our second strategy is focused on increasing shareholder returns through new concept conversions. We believe that converting our low volume Ruby Tuesday restaurants that are in good site locations to other high-quality casual dining concepts.”
“Whatever is best suited for that local marketplace is what we're focused on. Actually, we're trying to run our entire company in almost in every respect on what's right for that market instead of being a national brand is more of a roll-up or collection of communities in our company.”
“Our third strategy is to create value by increasing revenue and EBITDA through franchise partner acquisitions. We pretty well have this complete. We'll have it complete by the end of the year”
HEDGEYE - First, it was two years ago that a national advertising campaign was going to save the day and drive traffic. Since that failed, they are now going in the opposite direction “roll-up or collection of communities in our company”. Second, they want to convert Ruby’s Tuesdays in to other concepts and at the same time increase exposure to the brand by buying franchise partners. I’m not sure that’s likely to produce an outcome in line with the company’s ultimate goal.
COMMODITY EXPOSURE - While we currently could have some food cost exposure in the back half of fiscal 2012, we also have plans for savings, which on a net basis we currently estimate to approximate a 20 to 30 basis point increase in food costs for fiscal 2012.
HEDGEYE – The final impact of food inflation will likely be higher than 20-30 basis points, in our view.
PROMOTIONS - “We hope to continue shifting our promotional dollars away from coupons and incentives and towards LTO product offerings and frequency-building programs”
“From a promotional and advertising perspective, we continue to have success with our RT Athletics program, which is a part of our So Connected e-mail club The investments we've made in the bar program to create a more sophisticated sports viewing experience where guests can come and have fun with friends, watch great sporting events, and enjoy handcrafted beverages and unique bar fare have resulted in improved bar sales and are helping to support our goal of moving alcohol sales from 9% to our goal of 12%.”
“We're investing approximately $4 million in order to better understand consumer and guest behavior this year, and anticipate these investments will continue to positively impact sales and brand strategy throughout fiscal 2012”
HEDGEYE - Coupons are a big driver of consumer behavior. The transition could cause a hiccup in sales trends.
DEVELOPMENT - “We are still researching and negotiating potential sites for restaurant development and are on track to open our first Lime Restaurant in the first quarter of fiscal 2012 and should have six to eight open by the end of the calendar year. We're targeting three regions for development including Washington, D.C., the Midwest and Ohio Valley area, and the core South East.”
“Our next planned conversion will be a Marlin and Ray's slated for the northern Virginia area early this summer. Now our site selections for our planned conversions over the next 12 to 15 months are largely complete and over the next nine to 12 months we should have a better of idea of which brands represent the best conversion growth opportunity in each individual market.”
GUIDANCE FOR 2011 IS AS FOLLOWS:
- Same-restaurant sales for company-owned restaurants to be in the range of flat to positive 1% for the year
- We do not expect to open any inline restaurants in fiscal '11, anticipate closing eight to 10 company-owned restaurants, these closures obviously exclude our conversions, and converting four to six lower performing company-owned restaurants to other high-end casual dining concepts. Our franchisees expect to open between six to eight restaurants in the year, up to three of which will be international.
- We plan to buy back the remaining 13 franchise partnership restaurants during the fourth quarter.
- We expect restaurant operating margins to be relatively flat, primarily reflecting the impact of our continued investment in higher-quality menu items and new product offerings, such as our complimentary bread program, as well as investments in service to enhance our guest experience and drive sales, all offset by lower promotional levels.
- Our core food costs are expected to remain relatively stable compared to the prior year.
- Depreciation and amortization is estimated to be $62 million to $64 million.
- SG&A is targeted to be up approximately 18% to 20% year-to-year, primarily reflecting a shift in spending from promotional initiatives to advertising expense, higher marketing brand research, higher training expense, and the loss of fee income from acquired franchise partnerships which has historically offset our selling, general, and administrative expenses.
- Interest expense is estimated to be in the $12 million to $13 million range. The tax rate is estimated to be 10% to 15% as we continue to benefit from FICA Tip and other employment-related tax credits.
- Diluted earnings per share in fiscal 2011 are estimated to be in the range of $0.74 to $0.82.
Positions in Europe: Short UK (EWU); Short EUR-USD (FXE); Short Italy (EWI); Sold Germany today
Germany Confidence Dips, Selling EWG
German expectations of economic growth over the next 6 months according to ZEW declined for the 5th straight month to -15.1 in July versus -9 in June, its lowest level since January 2009 (see chart below). While but one sentiment indicator, it confirms with high frequency data that has slowed in Germany in recent months, which prompted us to sell our long Germany position via the etf EWG in the Hedgeye Portfolio today.
According to GfK, another sentiment survey provider, German consumer sentiment will rise for the first time in four months in July, citing that “Good general conditions” have become “more influential than detrimental factors, such as the state of affairs in Greece.” We’re however not convinced.
While the intermediate term TREND line in the DAX has held up above the 7,100 line, it danced dangerously around this level for most of June and recently pulling back squarely to the line (see chart below). We think that despite Germany’s strong fiscal position and leadership in the debate on solutions to the region’s peripheral ails, it is not immune to broader contagion.
UK’s Sticky Stagflation, Shorting EWU
UK CPI has held at or above the 4% for the last 5 months, currently at 4.2% in June year-over-year, with no indication that the BoE will move off its 0.50% benchmark interest rate to quell it. We’ll take the other side of BoE Governor King who expects CPI to return to the target of 2% over the intermediate term. With inflation pushing at these elevated levels and growth prospects anemic, we’re bearish on the UK’s sticky stagflation. Below we show a chart of the FTSE, which is clearly broken below our intermediate term TREND line at 5,926.
IBEX and MIB Level to Watch
Spain’s IBEX at the 9,984 resistance line, down -15.0% since 2/17
Italy’s MIB at the 19,559 resistance line, down -21.1% since 2/17
-For both indices we’d initiate short positions provided the resistance TREND lines were not violated to the upside.
Italy’s Spotlight Day-over-Day, Short EWI
Day-over-day we’re seeing a reduction in risk in Italy. The 10YR government bond yield came in 26bps to 5.73%, after flirting around the 6% level in the last days, a level proven to be a significant breakout level for yields in Greece, Ireland, and Portugal in the past. Equally, Italian 5YR CDS spread dropped 17bps d/d to 302bps today.
We’d caution that this is but one day of improvement. Spain’s bond auction of 12 and 18 month bills today showed a significant boost in yields to entice investors, with the 12M pegged at 3.7% versus 2.7% in a similar auction in June and the 18M pushing 3.9% versus 3.3% in June. We’d expect a similar trend of higher yields to continue for the rest of the periphery over the intermediate term.
The next calendar catalyst to watch is the upcoming EU Summit, scheduled for this Thursday, however speculated to be pushed to tomorrow. The main agenda is to address a new rescue plan for Greece, pegged around €115 Billion. Over the weekend Germany Chancellor Angela Merkel told the FT that she will only attend “if there is going to be an agreement on a new rescue plan for Greece”, a marked inflection from recent discourse suggesting a plan would come in mid-September. Merkel said “she wished to avoid any Greek debt rescheduling, but underlined that the key to a deal would be substantial voluntary involvement of private creditors in easing the Greek debt burden.”
While it’s anyone’s guess what may come out of the meeting given the competing ideologies and politicking, the fire was further stoked today with comments from Austria’s Central Banker and ECB Governing Council member Ewald Nowotny who said there’s “a full range of options and definitions, from a clear-cut default, selective default, credit event and so on.”
The meeting will be front and center on our screens including how it relates to the EUR-USD, which we’re short in the Hedgeye Portfolio via the etf FXE. Our immediate term TRADE levels are $1.39 to $1.41 and the intermediate term TREND is decidedly broken at $1.43. This is THE key trade our team is watching!
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