Takeaway: A quick look at some stories trending on our radar screen.
Daryl Jones - Macro
All Is Fair in Love and Twitter (via New York Times)
Keith McCullough - CEO
German consumer confidence up as economy brightens (via AP)
Russell 2000 hits all-time high (via CNBC)
UK eases rules for Chinese trading (via BBC)
Look at this 1932 editorial from the NY Times backing fascism > May 22, 1932: Fascism for America (via NY Times)
Brian McGough – Retail
Walmart shelves in Springhill, Mansfield, cleared in EBT glitch (via KSLA)
Apple Hires Burberry CEO as Retail Chief (via WSJ)
Keds Debuts Retail Shop (via WWD)
Jay Van Sciver - Industrials
FedEx Announces 32 Million Share Repurchase Program (via BusinessWeek)
Josh Steiner – Financials
2 'ghost' banks run credit card scam (via SunSentinel)
Corzine makes moves to lift $30M defense-fund cap (via NY Post)
Tom Tobin – Healthcare
Johnson & Johnson Profits Rise on Drug Sales; Beats Estimates (JNJ) (via Dividend.com)
Jonathan Casteleyn - Financials
Citi Profit Misses Estimates on Bond Trading, Mortgages (via Bloomberg)
Client Talking Points
European stocks nailed this move on the upside inasmuch as Gold did on the downside. Take a look at Germany and Italy. Both the DAX and Italy’s MIB index are hitting new highs this morning. We are long Germany via the EWG with our Q413 #EuroBulls Theme. See our Macro deck from this past Friday for details. Ping email@example.com if you need assistance.
Both the U.S. Dollar holding its long-term TAIL risk line of $79.21 support and the 10-year U.S. Treasury TREND line of 2.58% holding are critical in terms of the quant signals in my model that matter. Don’t forget. The sovereign debt bubble is as glaring as Gold’s was.
We have had $1271 as our mean reversion downside target since December 2012. It's good to be lucky, but we didn’t lick the finger on that – it was all math. Gold and Silver? Yup, they're down again this morning. Fear fades @ VIX TREND line of 18.98. Thankfully.
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Top Long Ideas
WWW is one of the best managed and most consistent companies in retail. We’re rarely fans of acquisitions, but the recent addition of Sperry, Saucony, Keds and Stride Rite (known as PLG) gives WWW a multi-year platform from which to grow. We think that the prevailing bearish view is very backward looking and leaves out a big piece of the WWW story, which is that integration of these brands into the WWW portfolio will allow the former PLG group to achieve what it could not under its former owner (most notably – international growth, and leverage a more diverse selling infrastructure in the US). Furthermore it will grow without needing to add the capital we’d otherwise expect as a stand-alone company – especially given WWW’s consolidation from four divisions into three -- which improves asset turns and financial returns.
Health Care sector head Tom Tobin has identified a number of tailwinds in the near and longer term that act as tailwinds to the hospital industry, and HCA in particular. This includes: Utilization, Maternity Trends as well as Pent-Up Demand and Acuity. The demographic shift towards more health care – driven by a gradually improving economy, improving employment trends, and accelerating new household formation and births – is a meaningful Macro factor and likely to lead to improving revenue and volume trends moving forward. Near-term market mayhem should not hamper this trend, even if it means slightly higher borrowing costs for hospitals down the road.
Financials sector senior analyst Jonathan Casteleyn continues to carry T. Rowe Price as his highest-conviction long call, based on the long-range reallocation out of bonds with investors continuing to move into stocks. T Rowe is one of the fastest growing equity asset managers and has consistently had the best performing stock funds over the past ten years.
Three for the Road
QUOTE OF THE DAY
There is a strong tendency to get used to and accept very bad things that would be shocking if seen with fresh eyes. -Ray Dalio
STAT OF THE DAY
U.S. national debt is now more than 23 times larger than it was when Jimmy Carter became president.
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Takeaway: We continue to believe there is significant upside in DRI. The main question is: Who will unlock the potential?
We contend that buying DRI today represents a generational opportunity in the Restaurant space, as the stock is currently trading at a significant discount to its underlying asset value. In our view, there remains the potential for tremendous upside if the core company can improve its operational execution.
We understand that DRI is different from the companies below, but the point we are trying to make is that they have all been in similar situations, and have once felt the pressure, that DRI is feeling today. We believe part of the upside in DRI is significant, but unquantifiable and could be realized if management is ousted (or they adopt our operating beliefs), and the company returns to a more streamlined operating structure.
In our opinion, Darden needs a forward-thinking, seasoned restaurant operator, with public company experience, to deliver an effective turnaround plan that is focuses on restoring Olive Garden profitability. In this regard, the current Chairman and CEO, Clarence Otis, has proven his incompetence. His lack of restaurant operating experience is a major reason the current management team has been decidedly unsuccessful.
The plan of action for DRI should be comprehensive, clear, and must offer a compelling solution that would help Darden, and specifically the Olive Garden, regain its stature as one of the premier casual dining chains in the business.
The most important pillar for the new Darden, is the formation of a closely aligned and well-functioning team of qualified, talented, experienced, and motivated personnel, that would come together to execute on the following business philosophy:
- Superior financial results come from inspired, principled leadership
- A clear, focused vision
- A consumer-driven culture
- Measurable operational excellence
- Distinctive brand consistency
- Appropriate cost controls
Darden’s current business plan has done nothing but destroy shareholder value over the past five years. Our recent Black Book, “Dismantling Darden”, describes, in detail, why DRI is having such a difficult time.
The company finds itself in an eerily similar position as MCD, SBUX, and EAT, not too long ago, when these companies tried appealing to the masses and began growing units too fast. Not surprisingly, the road to recovery for each company was essentially the same, barring some obvious nuances.
McDonald’s (2002-2007): MCD formulated the “Plan to Win” in 2002, which later became a template for success at Brinker.
- MCD cut capital spending from $2.0 billion in FY02 to $1.3 billion in FY03
- EBITDA bottomed at $3.2 billion in 2002 and increased 117% over the next five years
- The stock bottomed in March 2003 at $12 and rose to $57 by the end of 2007
Starbucks (2007-2012): With Schultz back at the helm, SBUX focused on attacking the middle of the P&L and improving the guest experience.
- SBUX cut capital spending from $985 million in FY08 to $446 million in FY09
- EBITDA bottomed at $1.3 billion in 2008 and increased 88% over the next four years
- By 2QFY09 (June) the fundamentals had improved; the stock was traded at $14 and rose to $78 five years later
Brinker (2008-2013): 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.
- EAT cut capital spending from $431 million in FY07 to $273 million in FY08; the company further reduced capital spending to $88 million in FY09
- EBITDA bottomed at $248 million in 2009 and increased 64% over the next four years
- By 2QFY09 (January) the fundamentals had improved; the stock traded at $10 and rose to $40 five years later
We don’t know exactly where DRI will shake out in the process, but we do know the company finds itself in a hole that MCD, SBUX, and EAT all managed to climb their way out of.
“The most dangerous leadership myth is that leaders are born - that there is a genetic factor to leadership. That’s nonsense; in fact, the opposite is true. Leaders are made rather than born.”
We’ve started our work for our October 31st IPO Blackbook on Twitter and digging into a company that was founded in 2006 and already has 215 million monthly users. Talking about going viral in a hurry!
Similar to Facebook, Twitter has that little problem of how to make money. That attribute aside, the companies are very different, even if much of the conventional media puts them in the same category. Facebook is a true social network and, as such, is largely closed and limited in terms of how large a network it can become. On the other hand, Twitter is open, transparent, real-time and has scale.
Twitter is actually a true network in that it creates the network effect. As an example, when President Obama announce his victory in the 2012 election on Twitter, that Tweet was re-tweeted more than 25 million times. The most I’ve ever had a tweet re-tweeted was a couple of hundred times, but even there you get the point. Twitter amplifies your communication.
Analyzing Twitter has also made me consider the importance of leadership in corporate America. This weekend The New York Times Magazine had an article written by Nick Bilton that was titled, “All Is Fair in Love and Twitter.” It is one version of the power and leadership struggles that have occurred within Twitter.
Twitter is also a little bit about the American dream. Take this excerpt from the article for example:
“In 2005, Jack Dorsey was a 29-year-old New York University dropout who sometimes wore a T-shirt with his phone number on the front and a nose ring. After a three-month stint writing code for an Alcatraz boat-tour outfit, he was living in a tiny San Francisco apartment. He had recently been turned down for a job at Camper, the shoe store.”
Dorsey and his co-founders have been largely pushed out of Twitter, though many of them will obviously profit handsomely on the IPO. Time will tell whether current CEO Dick Costolo is the right man to monetize the Twitter network, but his experience at Andersen Consulting, founding and running Feed Burner (among other start-ups), and working at Google have allowed him to acquire learned leadership assets, to Bennis’ point, that will be critical for Twitter’s future.
Now, from Silicon Valley back to the global macro grind . . .
Front and center this morning is once again the U.S. debt ceiling. Thankfully, Bloomberg is no longer alluding to a Nazi Germany like default this morning and the reality is, as we’ve been predicting, that a deal gets done is becoming increasingly accepted. If the deal that is purportedly on the table gets done, then the government will get funded through January 15th and the debt ceiling will get pushed to early February.
Setting aside an actual default, which was of course always highly unlikely, a short term deal is actually one of the worse scenarios. As we show in the Chart of the Day today, economic confidence, according to the Gallup Daily tracking poll has fallen off a cliff in the last month due to the government shutdown and looming debt ceiling. Delaying an outcome by three or four months is unlikely to be much of a catalyst to improve confidence in the short run.
We are certainly seeing these trends reflected in the real economy. One example is the casual dining sector where weakness has been pervasive. While certainly there are some sector specific trends at play, with the majority of the stocks missing estimates and comparable same-store-sales declining -1.9% in September according to Black Box, the decline in consumer confidence is having its impact.
All is not bad for the consumer, though, and one positive to highlight is the price of gasoline. Even as oil remains stubbornly above the $100 bound for WTI and $110 for Brent, the price of gasoline in the U.S. is actually down. According to the Energy Information Administration, a government agency that is still open, the price of gas in the U.S. is $3.37 per gallon, which is down $0.48 from a year ago and down $0.06 from last week. Maybe consumers are spending more time on Twitter and less time driving?
Speaking of Twitter, for those of you that answered no to the question in the title, one great reason to join Twitter is the intellectual exchange that comes from meeting new people in your expanded network. One example of a person that I’ve met on Twitter is a gentleman named Doug Kass, who is a financial blogger for the Street.com and works out of his basement in Florida.
Even if not always correct, Kass certainly makes us think. One example was that last night he went old school on us and sent an email indicating that based on his analysis over the long run of twenty years, the U.S. dollar has no identifiable correlation to U.S. equities. While an interesting point, we would certainly caution any of you to invest on 20-year historical correlations. But if you want to, we also have a bridge in Brooklyn for sale . . .
The fact is correlations influence our intermediate term view of markets. Correlations aren’t perpetual, and correlation strength builds and decays. At times and price levels they matter and at others they do not. We get that. But over the last three years the correlation between the U.S. dollar and SP500 has been 0.60. But as Maynard Keynes said, when the facts change, we will.
Our immediate-term Risk Ranges are now:
UST 10yr yield 2.66-2.73%
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research
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