It’s difficult being bearish on a stock when the stock has been moving in a bullish trend with major indices hitting three-year highs and speculative growth stocks catching a bid.
U.S. spending habits seem to be positive for consumer stocks currently but elevated gas prices are impacting confidence. Last Friday we saw the University Of Michigan Index Of Consumer Sentiment unexpectedly fell in March, coming in at 74.3 versus 75.3 in the month prior expectations of 76. Looking at the price action of stocks of consumer facing companies, it is clear that certain segments of retail are doing very well. Preliminary reports of AAPL’s new iPad sales are positive and the company’s stock is now up 45% for the year. Homebuilder stocks are hitting highs not seen since 2008 and high-end retailers from Lululemon (LULU) to Harley Davidson (HOG) are hitting multi-year highs. Restaurants, too, are seeing their stock prices surge. YUM, MCD, CMG, and SBUX are some of the strongest stocks in the space. BWLD can be included in that group but stands alone in that none of the other restaurant companies are facing protein cost inflation of 50% or more in 2012.
Looking at the recently filed 10-K, we see that BWLD offers the following statement on chicken wing prices’ impact on the company’s P&L: “A 10% increase in the chicken wing costs for 2011 would have increased restaurant cost of sales by approximately $3.8 million”. The 2010 10-K had a similar statement except the impact was $3.9 million. If we assume a similar sensitivity in 2012, a tax rate of 34%, and shares out of 18.5m, then the table below offers us an idea of what kind of an impact wing price inflation may have on BWLD EPS in 2012. Assuming that 2012 wing price inflation will be +50%, which is certainly in play if not conservative, implies a $0.68 impact to BWLD’s EPS.
Another potential cost headwind is labor. Given the minimum wage hikes that were brought through Arizona, Colorado, Florida, Ohio, and Washington, we believe that a significant increase in labor costs could further impact the company’s P&L. 18.2% of the company-owned Buffalo Wild Wing restaurants are in those markets.
Despite impressive same-store sales trends over the past month and favorable weather conditions in Buffalo Wild Wing’s markets, EPS estimates have not increased for the full year and have even declined for 3Q12.
In order to avoid wing price inflation having a significant impact on wing price inflation, three things need to happen:
- The company needs to raise prices without hurting demand (higher gas prices are not helping)
- Management needs to cut G&A without impeding growth in the future
- High single-digit same-store sales are needed for the remainder of the year
In our view, the probability of all three of these factors working out in the company’s favor is not high. Expectations for the company’s same-store sales trends are extremely high with 1Q consensus at 10% for 1Q and 6.5% for FY12.
In short, BWLD’s stock price now anchors largely on one factor: the top line. How rapidly and sustainably the company can grow the top line is going to be crucial for BWLD this year. The new TV and radio spots, along with the digital advertising campaign and increased presence during March madness will help in the near-term.
Those in the know cannot get out of this stock fast enough. The sequence of events since this company went public does little to inspire confidence that Dunkin’ Brand is the best growth story around.
The CEO of Hedgeye, Keith McCullough, often repeats this phrase: “Watch what people do, not what they say”. When thinking about Dunkin’ Brands’ stock at this point, we feel that his advice is highly apropos. Here is a timeline of events that have occurred since the company went public.
- 7/27/11: Dunkin’ Brands’ shares have a successful IPO; the stock rises ~38% on the first day of trading.
- 11/01/11: Dunkin’ Brands announces a secondary offering of 22 million shares of common stock.
- 11/14/11: Dunkin’ Brands says lead book-running managers are waiving the lock up restriction for certain officers and directors.
- 1/04/12: Dunkin’ Brands signs an exclusive procurement and distribution agreement with Dunkin’ Donuts franchisee-owned cooperative.
- 3/06/12: Dunkin’ Brands begins dividend at $0.15 per share.
- 3/16/12: Dunkin’ Brands announces secondary offering of 22 million shares of common stock.
- 3/16/12: Discloses in a regulatory filing that 1Q12 same-store sales are tracking between 6.7% and 7% at Dunkin’ Donuts U.S. stores, which is a sequential slowdown in two-year average trends.
Does this timeline suggest to anyone that the people in the know are excited about the growth prospects of the company?
The most significant omission from management’s disclosure continues to be the backlog of contracted new unit openings for Dunkin’ Donuts stores in the U.S. Dunkin’ Donuts is, by far, the primary driver of growth for Dunkin’ Brands over the next few years and the U.S. market is the “white space” opportunity that has been so heavily touted to investors. Where is the disclosure on the most pertinent factor for the Dunkin’ growth story? Last Friday, the company disclosed that Dunkin’ Donuts comparable store sales growth was expected to come in at 6.7-7.0% for 1Q12, which implies a sequential slowdown in two-year average trends and is disappointing in that it also raises a concern about the sustained success, or lack thereof, that the company has had with K-Cup sales versus expectations. In addition, we would be surprised if many other restaurant companies - particularly those with strong prospects - are seeing a sequential slowdown in two-year average trends with the weather benefit that is helping industry sales this quarter.
The question at this point is; if that sales data point is what the company was willing to disclose, how disappointing is the mysterious backlog number?
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THE HEDGEYE BREAKFAST MONITOR
Commentary from CEO Keith McCullough
I’m on the road seeing clients in Minneapolis – this melt-down in the Japanese Yen remains our top new risk mgt topic:
- CHINA – got Growth Slowing yet? Interestingly, but not surprisingly, the Hang Seng (-1.1%) snapped its immediate-term TRADE line of 21,255 overnight, joining India’s Sensex as the 2nd major Asian Equity market to break a significant line of momentum.
- US Dollar – my intermediate-term TREND line of support of $79.33 is once again under assault by central planners who are absolutely hooked on the inflation policy born out of it (Obama’s % chance of winning the election just shot up to another new high of 60.5% in the Hedgeye Election Indicator (+200bps wk/wk) - stock market inflation is a big factor in our back-test).
- GOLD – rising UST yields is bad for Gold on the margin. Period. Gold’s intermediate-term TREND line of $1691 remains broken as 10yr yields remain comfortably above my intermediate-term TREND line of 2.03%.
DPZ: Domino’s was downgraded to underperform at BofA. The PT was lowered to $34 from $41. BofA believes that the catalyst (special dividend) has passed. This seems like a good move to us by BofA but we are waiting for further data points to gain conviction that DPZ is going to underperform.
DPZ: Domino’s announced the completion of its recapitalization yesterday, along with a special dividend of $3 per share.
SBUX: Starbucks was reiterated Buy at UBS and the PT was hiked to $61 from $52.
SBUX: Starbucks has opened the first Evolution Fresh-branded stores in Washington State.
YUM: Yum Brands was initiated Outperform at Oppenheimer with a PT of $82.
YUM: Yum Brands’ KFC South Africa division is doubling stores in its delivery stable by the end of this year.
DNKN: Dunkin’ Brands is projecting comparable-store sales at its U.S. Dunkin’ Donuts chain will grow 6.7% to 7% for 1Q12. We still believe that the company needs to disclose its backlog of new units. The company’s future profitability is far more levered to new unit openings than comps and our contention, going on the information we have, is that the backlog is declining and not growing.
NOTABLE PERFORMANCE ON ACCELERATING VOLUME:
DPZ: Domino’s gained 3.4% on accelerating volume yesterday on news of the completion of its refinancing and special dividend announcements.
DNKN: Dunkin’ Brands declined -1.3% on accelerating volume.
CBOU: Caribou declined -3.9% on accelerating volume.
NOTABLE PERFORMANCE ON ACCELERATING VOLUME:
RUTH: Ruth’s Chris gained 3.4% on accelerating volume.
“Risk appears to be at its greatest when measures of it are at its lowest.”
Keith and I have been on the road meeting with subscribers this week and spent the first part of the week in Winnipeg, so it seemed appropriate to start the Early Look this morning with a quote from Mark Carney, the current Governor of the Bank of Canada.
Setting aside the fact that Carney played hockey at Harvard, which raises some character questions in our minds, he has had a respectable tenure as the Governor of the Bank of Canada. In fact, even though we at times question too much government involvement, his actions are rightfully credited for getting the Canadian economy back to normal levels of output and employment quicker than the G-7 following the 2008 meltdown.
Personally, after reading the above quote from Carney, I was almost ready to forgive him for wearing the crimson colors of Harvard. To me that quote shows perhaps the most appropriate understanding of risk, which is that risk in the market is greatest when we least expect it. For us, a key measure of risk is volatility. As it relates to equities, a key measure of this is the VIX, or volatility index of the SP500.
Like much of modern risk management, the VIX is a relatively new creation. In fact, it was developed by Professor Robert Whaley in 1993 (courtesy of Wikipedia). The VIX is a weighted blend for a range of options on the SP500. More specifically, the VIX is the square root of the par variance swap rate for a 30-day term initiated on the current day. So, in layman’s terms, it is the expected movement of the SP500 over the next thirty days on an annualized basis.
As an example if the VIX is at 15, the expected return for the next twelve months is 15%. Over the next thirty days, the range of return is calculated by dividing the VIX by the square root of 12. Therefore with the VIX at 15%, there is 68% likelihood, or one standard deviation, that the SP500’s move, up or down over the next thirty days, will be 4.3%, or less.
In the Chart of the Day, we show the chart of the VIX going back five years. The takeaway of this chart, a point we have been hammering home as of late, is that when the VIX reaches levels around 15, it has been a contrarian signal to shift out of risk assets. In the course of the last two years, this signal has been reached three times – April 2010, May / June 2011, and now. (Incidentally, we are long the VIX, via the etf VXX, in our Virtual Portfolio.)
In our meetings with subscribers, the push back we often receive on the VIX discussion is that in the 2003 – 2007 period, or thereabouts, the VIX reached lower levels and stayed at these levels for sustained periods, which buoyed equity market returns. So, what’s different this time?
This is certainly a fair question. Our retort is that the economy itself is more volatile than it was in that period. This is due to the active management of the economy by Keynesian central planners, but also accelerating debt burdens of the economy. Think of the economy like a highly levered company, with more debt on the balance sheet a company’s earnings become much more volatile, so equity returns are inherently more volatile. (Not to mention, the “awash with liquidity” period of 2003 – 2007 was far from normal.)
In part, this is why we are long Canada in the Virtual Portfolio via the etf EWC and, if you think about, long Mark Carney policy. Canada’s debt-to-GDP is 83% (per the CIA Factbook), which while higher than we would like, is below the critical 90% bound which historically leads to slowing economic growth, and less than the United States’ ratio that is north of 100%. In Canada, the deficit is actually now in decline, which will lead to lower debt-to-GDP ratios in the future. This compares to the United States, which had the largest monthly deficit of any nation in history in February.
Another key discussion or debate point in our recent meetings with subscribers has been the outlook for economic growth, both in the United States and abroad. As we’ve stated repeatedly, we expect lower growth than many Wall Street 1.0 prognosticators. This is primarily driven by the math of our predictive algorithms and further supported by incremental data points.
For us, the price of oil is a critical data point when contemplating economic growth. As I wrote two weeks ago:
“Charles Hall, Steven Balogh, and David Murphy did an analysis of the connection between the price of oil and when recession can be expected, examining the Minimum Energy Return on Investment (EROI). In their assessment, recession is likely to occur when oil amounts to more than 5.5% of GDP. Logically, this makes sense. Even based on the very tainted calculation of CPI, the average U.S. consumer spends 9% of his or her income directly on energy, with the majority allocated to gasoline. This obviously also excludes the derivative impact of increasing energy costs, such, as we noted above, the increasing costs of food.”
Incidentally, Brent oil at $116 per barrel is equivalent to 5.5% of U.S. GDP based on current usage patterns. Brent is trading at $124 per barrel this morning.
The most recent data point supporting lower global economic growth came from the mining giant BHP Billiton this morning who said they are seeing signs of “flattening” of iron ore demand from China. It seems when China tells you they are going to gear down economic growth, they actually will.
T.S. Eliot once wrote:
“Only those who will risk going too far can possibly find out how far one can go.”
From a personal perspective, I’d agree with Eliot, from a portfolio risk management perspective, not so much.
Our immediate-term support and resistance ranges for Gold, Oil (Brent), US Dollar Index, and the SP500 are now $1, $122.96-127.19, $79.33-79.88, and 1, respectively.
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research
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