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FLASH CALL: DISMANTLING DARDEN

Please join us for a flash call titled “Dismantling Darden” tomorrow, October 11th at 12:00pm EDT.  On the call we will discuss the opportunities we see to significantly increase shareholder value at Darden.  We have pursued this topic extensively and put together a 30 page Black Book, highlighting Darden’s inefficiencies and our vision for a potential turnaround.

 

 

TOPICS OF DISCUSSION INCLUDE:

  • Reshaping the enterprise
  • Operating trends among the worst in the casual dining industry
  • Darden’s bloated cost structure
  • Sum of the parts valuation
  • What are the implications of the Barington Capital news and what is next for the company?

 

 

CALL DETAILS

  • Toll Free Number:
  • Direct Dial Number:
  • Conference Code: 493295#
  • Materials: CLICK HERE (Will download one hour prior to the call)

 

 

If you have any questions, please email or call.

 

 

 

Howard Penney

Managing Director


 

 


INITIAL CLAIMS: DISTORTION REVERSAL

Takeaway: Despite the headline increase, today's claims data is very strong. Given the dearth of fundamental data, stick with the price signal here.

STICK WITH THE SIGNAL

Policy issues have dominated headlines and driven most of the equity and fixed income market price action over the last few weeks.  

 

The private sector data we have received for September has been largely equivocal with ISM Mfg and Consumer Credit marginally higher sequentially, Mortgage Applications and Small Business/Consumer confidence flat, and ISM services and Vehicle sales down marginally. 

 

The labor market strength, however, has not been equivocal.  Inclusive of today’s jump in Initial claims (which is still positive after adjusting for the CA computer system and government shutdown impacts) the trend in the labor market remains decidedly positive. More detail on this week's claims data below.  

 

From an Investment Management perspective, with the bulk of federal government sourced data releases embargoed or unavailable (ie. a dearth of fundamental data), our Prices Rule Risk Management model becomes an increasingly important signaling mechanism for driving portfolio decisions.   

 

So what are the key metrics and levels that matter right here?  The Dollar, VIX, and S&P500.

 

To reiterate the key levels of focus Keith highlighted in this morning’s Early Look. 

 

  1. U.S. Dollar:  The $USD long-term TAIL line of support = $79.21
  2. VIX:  VIX TREND Support sits at $18.98
  3. S&P500:  SPX TREND Resistance sits at $1663

 

In short, with the USD holding above its TAIL line, if the VIX can breach $18.98 on the downside and the SPX can hold 1663, the risk-reward to being long shifts positive and we cover more shorts and play for the 23 handles of immediate term upside in equities.  If the VIX and SPX fail to breach & hold their respective levels, we continue to keep gross exposure relatively low, net exposure tight and sit on our hands a bit longer. 

 

Dollar Up + Rates Up + Stocks Up remains the constellation of price factors we want to see persist to remain constructive beyond the positive, immediate term TRADE setup.   

 

Below is the breakdown of this morning's claims data, along with some Financial sector specific takeaways, from the Hedgeye Financials team.  If you would like to setup a call with Josh or Jonathan or trial their research, please contact 

 

 

- Hedgeye Macro  

 

INITIAL CLAIMS: DISTORTION REVERSAL - Dollar Up Rates Up Stocks Up

 

INITIAL CLAIMS: DISTORTION REVERSAL - Eco Summary Table

 

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INITIAL CLAIMS:  Not So Fast

We've been singing the praises of the initial jobless claims data for a while now, particularly as it showed noted divergence vs some of the other labor market data series. This morning we found out that at least a portion of the recent strength (since the start of September) was attributable to shenanigans in California new software for processing claims. For the last 4 weeks, since roughly the start of September, California has had a backlog of claims due to difficulties arising from their new software system. This past week, they finally got the bugs out of it and caught up. The effect was an increase of ~33k SA jobless claims. Total SA claims rose by 66k this week, and half that was attributable to CA, said a Labor Dept spokesperson. Beyond this, there was a further 15k increase this week from defense companies laying people off temporarily due to the government shutdown.

 

What we've done in the chart below is reconstruct the last five weeks of data to reflect CA's issues and the 15k temp layoffs from defense. The takeaway is that the trend is intact. Rolling NSA claims, adjusted for these issues, was lower by 14.1% in the latest week, which is almost right in line with the trendline since the start of the year, and only nominally weaker than the best print we've seen YTD of -14.9% 3 weeks ago.

 

The bottom line is that this morning's data looks terrible, but the underlying trends in the labor market remain exceptionally strong. We would reiterate our bullish stance on being levered to the ongoing jobs recovery. This morning we flagged Capital One (COF) in a note as being a great way to play this theme.

 

INITIAL CLAIMS: DISTORTION REVERSAL - JS 1

 

Nuts & Bolts

As there was no revision to the prior week's data, SA initial jobless claims rose 66k to 374k from 308k WoW. Meanwhile, the 4-week rolling average of seasonally-adjusted claims rose 20k WoW to 325k.

 

The 4-week rolling average of NSA claims, which we consider a more accurate representation of the underlying labor market trend, was -11.7% lower YoY, which is a sequential deterioration versus the previous week's YoY change of -18.2%, but this reflects the impact of the CA distortion.

 

INITIAL CLAIMS: DISTORTION REVERSAL - JS 2

 

INITIAL CLAIMS: DISTORTION REVERSAL - JS 3

 

INITIAL CLAIMS: DISTORTION REVERSAL - JS 4

 

INITIAL CLAIMS: DISTORTION REVERSAL - JS 5

 

 

Joshua Steiner, CFA

 

Jonathan Casteleyn, CFA, CMT

 


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INITIAL CLAIMS: TOO GOOD TO BE TRUE?

Takeaway: Our first impression of the labor market data this morning was that it looked terrible, but upon closer inspection it's actually great.

Not So Fast

We've been singing the praises of the initial jobless claims data for a while now, particularly as it showed noted divergence vs some of the other labor market data series. This morning we found out that at least a portion of the recent strength (since the start of September) was attributable to shenanigans in California new software for processing claims. For the last 4 weeks, since roughly the start of September, California has had a backlog of claims due to difficulties arising from their new software system. This past week, they finally got the bugs out of it and caught up. The effect was an increase of ~33k SA jobless claims. Total SA claims rose by 66k this week, and half that was attributable to CA, said a Labor Dept spokesperson. Beyond this, there was a further 15k increase this week from defense companies laying people off temporarily due to the government shutdown.

 

What we've done in the chart below is reconstruct the last five weeks of data to reflect CA's issues and the 15k temp layoffs from defense. The takeaway is that the trend is intact. Rolling NSA claims, adjusted for these issues, was lower by 14.1% in the latest week, which is almost right in line with the trendline since the start of the year, and only nominally weaker than the best print we've seen YTD of -14.9% 3 weeks ago.

 

The bottom line is that this morning's data looks terrible, but the underlying trends in the labor market remain exceptionally strong. We would reiterate our bullish stance on being levered to the ongoing jobs recovery. This morning we flagged Capital One (COF) in a note as being a great way to play this theme.

 

INITIAL CLAIMS: TOO GOOD TO BE TRUE? - 20 v2

 

Nuts & Bolts

As there was no revision to the prior week's data, SA initial jobless claims rose 66k to 374k from 308k WoW. Meanwhile, the 4-week rolling average of seasonally-adjusted claims rose 20k WoW to 325k.

 

The 4-week rolling average of NSA claims, which we consider a more accurate representation of the underlying labor market trend, was -11.7% lower YoY, which is a sequential deterioration versus the previous week's YoY change of -18.2%, but this reflects the impact of the CA distortion.

 

INITIAL CLAIMS: TOO GOOD TO BE TRUE? - 1

 

INITIAL CLAIMS: TOO GOOD TO BE TRUE? - 2

 

INITIAL CLAIMS: TOO GOOD TO BE TRUE? - 3

 

INITIAL CLAIMS: TOO GOOD TO BE TRUE? - 4

 

INITIAL CLAIMS: TOO GOOD TO BE TRUE? - 5

 

INITIAL CLAIMS: TOO GOOD TO BE TRUE? - 6

 

INITIAL CLAIMS: TOO GOOD TO BE TRUE? - 7

 

INITIAL CLAIMS: TOO GOOD TO BE TRUE? - 8

 

INITIAL CLAIMS: TOO GOOD TO BE TRUE? - 9

 

INITIAL CLAIMS: TOO GOOD TO BE TRUE? - 10

 

INITIAL CLAIMS: TOO GOOD TO BE TRUE? - 11

 

INITIAL CLAIMS: TOO GOOD TO BE TRUE? - 12

 

INITIAL CLAIMS: TOO GOOD TO BE TRUE? - 13

 

INITIAL CLAIMS: TOO GOOD TO BE TRUE? - 19

 

INITIAL CLAIMS: TOO GOOD TO BE TRUE? - 14

 

Yield Spreads

The 2-10 yield spread was unchanged at 229 bps in the past week. The third quarter average yield spread was 234 bps, a 63 bps increase vs the 2Q average of 171 bps. While the curve has come under some pressure of late with tapering speculation waning, the bottom line is that thus far 4Q is running at an average spread of 2.29%, or just 5 bps lower than the average for the third quarter. This 3Q lift will help alleviate some of the pressure on bank NIMs, but what it will really take ultimately will be the Fed lifting the short end of the curve.

 

INITIAL CLAIMS: TOO GOOD TO BE TRUE? - 15

 

INITIAL CLAIMS: TOO GOOD TO BE TRUE? - 16

 

Joshua Steiner, CFA

Jonathan Casteleyn, CFA, CMT



PODCAST: McCullough: Fade Fear

Hedgeye CEO Keith McCullough explains to clients on this morning's Macro Conference Call why this is the first morning since Bernanke decided not to taper (9/18) that he's advising people to buy-the-damn-dip.  

 


FLASHBACK: DISMANTLING DARDEN

This note was originally published September 12, 2013 at 06:40 in Restaurants

Editor's note: As many of you know, Darden Restaurants' (DRI) stock soared yesterday after the Wall Street Journal reported that a New York hedge fund took a stake in the company and will press it to break up. Barington Capital Group LP plans to push Darden to split into two companies: one with its high-growth chains such as Capital Grille and the other with established brands Red Lobster and Olive Garden.

 

As you may also know, Hedgeye Restaurants Sector Head Howard Penney was the first mover on this. About six months ago, Penney identified an opportunity at Darden that he believed could create significant value for shareholders.  His team has been diligent in their work on Darden since that time and has periodically released research notes on the topic. 

 

To rehash, Penney believes there is an opportunity to take full advantage of some low-hanging fruit and improve profitability.  As he has been saying for some time now, Darden is a strong, proven company that is in dire need of a major overhaul. Darden is being mismanaged, plain and simple.

 

We have pursued this topic extensively and have put together a 30 page Black Book, highlighting Darden’s inefficiencies and what our plan would be in order to turn the company around.  Please contact sales@hedgeye.com to access this research.

FLASHBACK: DISMANTLING DARDEN - darden 

DISMANTLING DARDEN

DRI is scheduled to report 1QFY14 earnings on 9/20 and expectations across the board have been reduced significantly for the quarter.  The only question that remains is: how bad is bad?  The current FY14 EPS consensus estimate is $2.99 on Bloomberg.  We could easily get our model down to $2.50.  And, unfortunately, the company needs to pay a $2.25 dividend, which makes earning anywhere near $2.50 a real problem.

 

FLASHBACK: DISMANTLING DARDEN - howard1

 

 

We continue to believe the sum of the parts is greater than the whole, at Darden, and we believe there is a striking opportunity for an activist to enter the fray, unlock value, and benefit holders of the company’s stock.

 

There have been four times in my career when I have seen a company in desperate need of a major overhaul.  In all four cases, I wrote extensively about the issues, much to the ire of management.  Darden and its problems are no different!

 

The following companies have undergone major corporate overhauls that have led to significant improvements in shareholder value:

  1. McDonald’s (2002): MCD formulated the “Plan to Win” in 2002, which later became a template for success at Brinker.
  2. Wendy’s (2004): The sum-of-the-parts were greater than the whole!
  3. Starbuck’s (2008): With Schultz back at the helm, SBUX focused on attacking the middle of the P&L and improving the guest experience.
  4. Brinker (2010): Facing an industry in the midst of a secular decline, senior management formulated a plan to win, which entailed attacking the middle of the P&L and driving traffic.
  5. Darden (2013): Will the current management team recognize the need for a major restructuring?

We are of the view that DRI is in a secular decline and, until management makes significant changes, we will continue to see erosion in the earnings power of the company.  We believe it is best to wait for these significant changes to occur before we get more aggressive on the LONG side.

 

 

Low-Hanging, Bountiful, Fruit

 

Looking at the four prior examples of past significant corporate action, it is clear that these companies had similar traits.  Specifically, each company had low-hanging fruit and the potential to create significant value for shareholders.  Many of these are similar to the opportunities we currently see in Darden:

  • Tremendous cash flow potential
  • Huge real estate value
  • Non-core, under-utilized assets that can be sold at rich valuation
  • Core assets represent a classic reorganization opportunity
  • Market’s valuation of the whole is far below what we believe the sum-of-the-parts would represent in a reorganization or breakup
  • G&A rationalization opportunities

 

DRI’s Biggest Problem – It’s Too Big, Too Complex, To Perform

  • This company has over 2,000 restaurants spread out among 8 separate concepts
  • Olive Garden and Red Lobster account for roughly 75% of total revenues

FLASHBACK: DISMANTLING DARDEN - DRI REVS BY CON

 

 

The Complexity Has Led To A Bloated Cost Structure


DRI management has contended for years that its multi-concept structure creates operational efficiencies.  But, a closer look at the numbers suggests the exact opposite.  The average unit volume of DRI’s big three brands is $3.68, which is 23% larger than the average unit volume of EAT’s core brand, Chili’s.

  • Restaurant level margins for DRI are 32% larger than EAT’s and 17% larger than the average of its casual dining peers

The math is quite simple.  If DRI generates more revenues per store and has higher margins per store than its competitors, then it should generate higher operating profit margins as well.  But, this isn’t the case.  The only real explanation we can find for DRI’s lower operating margins is a bloated G&A cost structure.

  • DRI’s operating margins over the TTM are 7.5%, which is 27.2% below EAT’s and 3.7% below the average of its casual dining peers
  • If DRI were to cut G&A by 200 bps, and achieve 9.5% in operating margins, the company would generate an additional $1.10 in earnings per share

FLASHBACK: DISMANTLING DARDEN - DRI EAT RLM

 

FLASHBACK: DISMANTLING DARDEN - DRI EAT OP MARGIN

 

 

Our Vision Of The New DRI

 

Below we offer our view of what the new Darden should look like.  We believe the company should be broken up into three segments – Seafood, Steak and Italian.  Yard House should be spun off and taken public and Bahama Breeze should be sold.  This would leave each of DRI’s three operating segments with a large brand, in addition to a smaller one in order to help, over time, improve the growth profile of the company.  Additionally, each company would finally be able to focus and zero in on their operations, which, we believe, would allow for a more streamlined operating structure.

 

FLASHBACK: DISMANTLING DARDEN - DRI VALU

 

FLASHBACK: DISMANTLING DARDEN - BREAKUP OF DRI

 

 

It’s Only A Matter Of Time – Restaurants Are An Attractive Sector For Activists

  • McDonald’s (2006): Real estate was the fulcrum of Bill Ackman’s thesis, but better operating performance, including new management, and capital allocations decisions were the real drivers of returns.  The company sold off non-core assets.
  • Wendy’s (2008): Real estate was, once again, the anchor of the thesis here, but the business was also undervalued.  The company, under the influence of Trian Fund Management’s Nelson Peltz, sold off non-core assets.
  • Applebee’s (2006): Breeden Capital Management threatened a proxy contest at the 2007 Annual Meeting of Stockholders, which ultimately was settled with two board seats being opened up for the activist entity.  The company was sold following a period of lackluster returns.
  • Cracker Barrel (2005): Nelson Peltz, again, held real estate central in his thinking on taking the company private.  In 1Q06, the company’s board authorized the use of proceeds from a sale of Logan’s Roadhouse to fund a modified “Dutch Auction” tender offer for $250mm of the company’s common stock (roughly 35% of common shares outstanding).
  • Cracker Barrel (2011): Biglari Holdings contested two proxy battles, but has failed to secure any board seats.  Pressure from Sardar Biglari led to the replacement of CBRL’s CEO and the stock price has appreciated significantly since BH first took a stake in October 2011, rising from $45 to over $100 a share today.
  • DineEquity (2012): Marcato Capital Management suggested a dividend payment in order to maximize its equity value.  The company announced a $0.75 quarterly dividend and a $100mm share repurchase, which amounted to 8% of equity value.  Richard “Mick” McGuire of Marcato was previously an analyst at Bill Ackman’s Pershing Square Capital Management.

 

Piecing It All Together

  • The current outlook for DRI is dire and we suspect that 1Q14 results will be a disaster
  • There is no cohesive plan to fix the asset base and address significant inefficiencies
  • As we have seen many times before, continuing deterioration will lead ultimately lead to intervention, in one form or the other
  • Given the current trends, the dividend, which was once an asset, could become a liability
  • We know how this is going to end, the only question is when?

 

 

Howard Penney

Managing Director

HPenney@hedgeye.com

862.217.9429

 


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