Takeaway: DTLR scraps IPO plans, Reebok opens FitHub in Paris, RSH refinances
EVENTS TO WATCH OVER THE NEXT 24 HOURS
COST - Earnings Call: Wednesday 12/11 11:00 am
LULU - Earnings Call: Thursday 12/12 9:00 am
MW - Earnings Call: Thursday 12/12 9:00 am
China’s Retail Sales Accelerate as Factory Output Slows
- "China’s retail sales unexpectedly accelerated in November while industrial output rose less than estimated, giving a mixed picture of growth as leaders gather in Beijing to set economic policies for the coming year."
- "Factory production rose 10 percent from a year earlier, the National Bureau of Statistics said in Beijing yesterday, compared with analysts’ median projection of 10.1 percent in a Bloomberg survey. Retail sales advanced 13.7 percent"
HD - The Home Depot Updates Strategic Priorities; Confirms Fiscal Year 2013 Sales And Diluted Earnings Per Share Guidance; Provides Fiscal Year 2014 Financial Outlook And Updates 2015 Financial Targets
- "The Company reaffirmed its sales and diluted earnings-per-share guidance for fiscal 2013. The Company expects sales to be up approximately 5.6 percent for the year and diluted earnings-per- share to be up approximately 24 percent to $3.72 for the year. Comparable store sales, on a 52-week like for like basis, are expected to be up approximately 7.0 percent for the year. The Company's fiscal 2013 sales and diluted earnings-per-share guidance is based on a 52-week year compared to fiscal 2012, a 53-week year."
DTLR - DTLR Scraps Plans for IPO
- "DTLR Holding, Inc. announced that due to a unspecified 'business development' the company has determined to not proceed with its planned initial public offering."
- "The company declined to comment beyond its one-sentence statement."
ADS - Reebok Opens First Fithub in Paris
- "Like the Reebok flagship opened a year ago in New York on 5th Avenue, Reebok is opening its first concept store (Fithub) and CrossFit Box at 31 Avenue de l'Opera, its first Fithub in Paris. The combined store and gym measures 8,600 square feet."
JWN - Jeffrey Kalinsky Shifting Role at Nordstrom
- "Jeffrey Kalinsky is taking a step back at Nordstrom Inc., where he has been executive vice president of designer merchandising for the last eight-and-a-half years."
- "Kalinsky, who wants to flex his creative muscles, is planning to focus part of his time on projects outside Nordstrom. He’ll also continue to operate his two namesake stores, Jeffrey New York and Jeffrey in Atlanta, which Nordstrom bought in 2005, naming Kalinsky director of designer merchandising while he remained president and chief executive officer of Jeffrey Inc."
Moncler - Moncler Said Likely to Price IPO at Top of Range on High Demand
- "Moncler...plans to price its initial public offering at 10.20 euros a share, the top of an indicated range, according to two people familiar with the transaction."
- "The sale was fully covered on the first day of the offer, said the people, who asked not to be named because the details aren’t public. The order book closes today and is more than 20 times subscribed, one person said."
RSH - RadioShack Closes New Five-Year Financing Totaling $835 Million
- "RadioShack Corporation announced today that it has completed a new financing totaling $835 million including a $585 million senior secured ABL credit facility led by GE Capital, Corporate Retail Finance and a $250 million secured term loan led by Salus Capital Partners, LLC. This comprehensive new financing will be used to refinance existing debt and provide approximately $200 million of incremental liquidity, all of which will further strengthen the Company's balance sheet as it continues to move forward with its operational turnaround."
- "The new $250 million secured term loan was led by Salus Capital. The terms of this loan include a five-year duration and a rate of LIBOR plus 11%. This term loan was drawn and funded at closing and is secured by a second lien on the assets securing the new ABL credit facility and a first lien on certain other assets of the Company."
Facebook Ranks as Top Platform in Social Media Survey
- "When it comes to product and service recommendations, Facebook scored highest as the most trusted platform, according to a new survey conducted by Social Media Link, an advocacy activation company.
- The survey found that 68 percent said they trusted Facebook over blogs (63 percent); retail Web sites (63 percent); Pinterest (56 percent); YouTube (51 percent); Twitter (41 percent), and Google+ (41 percent)."
- "According to the study, reviews by friends and family have the biggest impact (86 percent), followed by professionals (58 percent); Web site reviews (54 percent); acquaintances (42 percent); bloggers (39 percent), and celebrities (11 percent)."
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“Time destroys the speculation of men, but it confirms nature.”
Marcus Tullius Cicero was a Roman philosopher, politician, lawyer, orator, political theorist, and constitutionalist (no word on whether he played hockey). His impact on the Latin language was so deep that the history of prose in both Latin and European languages, up until the 19th century, is said to be either a reaction against or a return to his style. To use a sports analogy: he was an impact player.
Like many of you, I tend to tune out much of the main stream media, but I did catch myself watching a little bit of CNBC yesterday. Interestingly, it actually made me realize that the buy side, sell side, and media are arguing with many of the same platitudes on the topic of tapering. In short, no one has conviction or a strong insight. Or certainly, unlike Cicero, their views are not having an impact.
In the land of bonds, of course, Bill Gross from PIMCO is widely considered to be the impact player. And rightfully so, as PIMCO manages over $2 trillion in assets and is the world’s largest bond investor. Even if we don’t agree with PIMCO’s research or views, there can be no debate that the firm has the ability to impact asset prices in a meaningful reallocation.
So, what is the latest from the big bond boys on the taper? Well, this is what Gross wrote in his most recent monthly letter (which is usually a fun read by the way!):
“The taper will lead to the elimination of QE at some point in 2014, but the 25 basis point policy rate will continue until 6.5% unemployment and 2.0% inflation at a minimum have been achieved. If so, front-end Treasury, corporate and mortgage positions should provide low but attractively defensive returns.
We have positioned our bond wars portfolio – heavily front-end maturity loaded along with credit, volatility and curve steepening positions, with the aim of outperforming Vanguard as well as many other active managers.”
In part, especially given PIMCO’s sizeable position, Gross’s job is to influence and ensure the bond market doesn’t shake, rattle, or roll in any direction that isn’t beneficial to PIMCO. If you are Gross, you certainly want the incremental buyer to be focused on mortgage backed securities.
Currently, $40 billion of the Fed’s monthly purchases are in the MBS market. In aggregate, this is more than half a trillion in annual purchases of mortgage backed securities. The impact of multiple rounds of QE has been that the premium of Agency MBS over Treasuries has narrowed by some ~50 basis points from pre-QE to post-QE.
Given that 34% of PIMCO’s Total Return Fund are in agency MBS, there is some serious interest rate risk in that position. By our estimation, a 50 basis point move in the spread of Agency MBS has the potential to lead to 5% downside in price. To the extent that 34% of PIMCO’s “book” has the potential to be marked down 5%, that is a big deal for PIMCO and the associated market.
Reflexively, if PIMCO were to underperform, they would then be forced to liquidate MBS positions as investors exited their funds. In turn, this would amplify any move in price. A mass exit of PIMCO would be an “Aye Carumba” moment in the MBS market to be sure.
Back to the Global Macro Grind…
On the longer end of the curve, specifically 10-year yields, tapering is getting somewhat priced in. In the Chart of the Day, we show this graphically by comparing 10-year yields, to the Fed Funds rate, to the Federal Reserve balance sheet. As the chart below shows, 10-year yields are now back at a level not seen since early 2011, which pre-dated QE Infinity (i.e. the open ended purchases that began in September 2012).
In the hypothetical world where 10-year rates actually get priced based on economic fundamentals, the current spread of 2.6% between the 10-year yield and the Fed’s discount rate may not be far off reality. For context, the average spread between the two over the last decade was about 1.7% and since 1954 0.54%. Certainly, the 100 basis points widening of this spread over the last year is indicative of some level of tapering being priced in.
This all leads to an interesting question: will tapering be a ‘sell the news’ moment for 10-year yields? That’s a question I’ll leave to the speculators and those that need to protect their book to answer...
One point that many pundits don’t seem to be talking about is that a decline in tapering will be positive for the U.S. dollar. This is further supported by a point we have been highlighting consistently, which is that the Federal deficit has been narrowing. In the fiscal year ending 2013, the federal deficit was below $1 trillion for the first time since 2008.
This improvement continued into this fiscal year as the deficit in October was -$91.6 billion, an improvement of 24% year-over-year. The Treasury will release November’s budget numbers at 2pm and we would expect similar improvement. In addition to this budget improvement, the fact that Congress seems to actually be functioning should also bode well for the U.S. dollar.
In fact, last night the House and Senate announced a two year budget deal. Even if the deal isn’t ideal, thankfully our elected officials are at least getting out of the way and signaling to the world that they can functionally manage the country. From a deficit perspective, there will be $63 billion in increased spending (sequester relief) over the next two years, but that shouldn’t impact the continued narrowing of federal budgets. It’s amazing what our elected officials can accomplish when they get out of the way.
Just imagine what would happen if the un-elected officials at the Fed got out of the way, the strong dollar American growth story would be fully in play!
Our immediate-term Risk Ranges are now:
UST 10yr Yield 2.75-2.82%
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research
Takeaway: “Good morning, Mr. Otis. Your mission, should you choose to accept it, involves the recovery of lost customers from your core business"
“Turning around a failing restaurant is a daunting challenge under the best of circumstances.”
- Robert Irvine, Restaurant Impossible on the Food Network
To steal the structure of the opening line from Mission Impossible: “Good morning, Mr. Otis. Your mission, should you choose to accept it, involves the recovery of lost customers from your core business Olive Garden.”
Needless to say, fixing Olive Garden is going to be a daunting challenge. Will the introduction of a burger and fries to the menu make the challenge more or less daunting? In our opinion, it may very well be the final straw that breaks the camel’s back and drives shareholders to the tipping point.
In March 2013, our call was that an activist investor would get involved to make the necessary changes at Darden; many of which we’ve been chronicling. Since Barington filed on the company, nearly every research report written about Darden has focused on a breakup/real estate analysis and valuation.
None of these notes, however, focus on fixing the core business – Olive Garden. We believe the biggest upside in the stock today would come from the successful turnaround of Darden’s most important franchise in the portfolio. Yet, management has not even begun to outline a cohesive strategy to fix Olive Garden.
DRI will report 2QFY14 results on December 20th. This call will be the most important call of CEO Clarence Otis’ career. His choice of direction will determine if a dramatic shift in strategy is pursued at Darden to provide the necessary focus in order to achieve significant increases in shareholder value, or if the company will continue with the status quo. As we see it, the company could push forward in one of three different directions:
- Adopt the Hedgeye or Barington model of breaking up the company.
- This strategy is intended to significantly increase shareholder value.
- It would not be unlike what McDonald’s successfully accomplished over a decade ago by focusing on its flagship brand to build enormous value, and spinning off Chipotle, Pret a Manager and Boston Market, each of which also achieved significant increases in value due to a newfound focus.
- Brinker has also recently achieved strong success with Chili’s in the casual dining sector by focusing on this flagship brand, and spinning off several of its smaller brands.
- Throw shareholders a bone by making another small cut to its growth capital expenditures.
- Do nothing and push forward with the current flawed strategy.
On some level, we believe the case for significant change at Darden could be strengthened when the company reports 2QFY14 results. An earnings miss is very likely. The street currently expects EPS to come in around $0.22, but we are modeling somewhere between $0.12-$0.15. Despite the string of recent disappointments, we could see management digging their heels in and sticking with the “change nothing” philosophy.
Their overall strategy is uncertain. What appears certain, however, is that we may not hear a comprehensive nor compelling plan to fix Olive Garden on this earnings call.
Olive Garden is a brand with tremendous future value if it were in the right hands. Olive Garden is no longer the “Italian” brand that made it so successful. If you recall, the brand was on the brink of extinction back in 1994, before it experienced an Italian Renaissance. This revival led to 57 consecutive quarters of same-restaurant sales increases and consistent margin improvement, leading to accretive value creation and substantial incremental value for all Darden shareholders.
Unfortunately, the brand has gone so inexplicably and destructively off course since this "industry leading performance." Once again, Olive Garden has moved so far away from its core vision of “Genuine Italian Dining,” to the point where it now feels more like an “Italian Applebee’s.” And this was before Olive Garden introduced a burger and fries to the menu!
Olive Garden is out of touch with the consumer base in aggregate, but has particularly lost its relevance as it pertains to Millennials. Where is the vision for this brand? Is it reasonable to believe that Millennials want 1990’s style Americanized food that is fried, overly stuffed with cheeses, covered in cream sauce and served with overcooked pasta?
And now on the heels of a “Buy One, Get One Free to Take Home” promotional offer, the recent roll-out of hamburgers will most likely turn out to be an act of desperation, and ultimately yet another mistake in a series of ill-advised decisions. The idea that this will lead to incremental customers is nothing short of facile, a futile hope that a burger and fries will recoup the lost authenticity of the concept’s roots, and a hope that the shine of a hamburger will blind the customer to the fact that there is a lack of progressive thinking anywhere in the company. There is an overall sense of fear and confusion that has led to a significant decline in consumer acceptance.
Olive Garden needs a talented team that can bring innovation back to the company. It needs “fresh eyes” that are forward looking to create positive change. It needs improved, more authentically Italian food. It needs leadership that will ensure consistency of execution to deliver the required financial results on an on-going basis.
Olive Garden is still a large and well-known brand. It once had a crystal clear and compelling vision that was executed flawlessly to achieve the largest turnaround in casual dining history. This performance can be realized again with the right team in charge. Shareholders deserve better.
Restaurant impossible will be possible with the right vision, the right leadership, and a management team that can look ahead of the legacy issues plaguing the company!
Client Talking Points
Witness the broad-based selling in Asian Equities overnight (Hong Kong down -1.7%, China down -1.5%, KOSPI down -0.8%). Why? The world’s growth expectations are getting rightly concerned about importing inflation via a renewed USA Burning Buck strategy (“sequester relief!”). The US Dollar is down for FIVE straight weeks. Atta boy Bernanke. No-taper is killing whatever was left of Fed credibility.
It's back! After bottoming in mid-November, one proxy for global inflation (CRB Commodities Index) has put in a big +3% move off the year-to-date lows (the CRB Index was down -8% year-to-date on the lows, fueling real-consumption growth). Almost every major economic region (other than Europe because they have #StrongCurrency) will see inflation pickup sequentially in Q1 verses Q4.
Being long no-taper/inflation expectations is cool, but only to a price. After crashing this year, the price of Gold will take time to bottom. (Remember, it’s a process, not a point). We sold our trading position in Gold at the top-end of our immediate-term $1216-1261 risk range yesterday. We will buy it back if it confirms another higher-low on this pullback.
|FIXED INCOME||6%||INTL CURRENCIES||24%|
Top Long Ideas
Our bullish call on the British Pound was borne out of our Q4 Macro themes call. We believe the health of a nation’s economy is reflected in its currency. We remain bullish on the regime change at the BOE, replacing Governor Mervyn King with Mark Carney. In its October meeting, the Bank of England voted unanimously (9-0) to keep rates on hold and the asset purchase program unchanged. If we look at the GBP/USD cross, we believe the UK’s hawkish monetary and fiscal policy should appreciate the GBP, as Bernanke/Yellen continue to burn the USD via delaying the call to taper.
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.
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
TWEET OF THE DAY
COMMODITIES: Burning Buck continues to re-fuel the commodity inflation bubble @KeithMcCullough
QUOTE OF THE DAY
"Confidence comes not from always being right but from not fearing to be wrong." - Peter T. McIntyre
STAT OF THE DAY
Budget deal? The U.S. national debt is approaching $17,224,000,000,000.
Risk Managed Long Term Investing for Pros
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