This note was originally published at 8am on April 04, 2014 for Hedgeye subscribers.
“He is striking at everything. I am afraid of this man.”
-Thomas Gibbons, 1822
That’s the opening line to Part One (titled “Captain” – 1794-1847) in the latest brick I’ve cracked open, The First Tycoon – The Epic Life of Cornelius Vanderbilt, by T.J. Stiles. If you’re into hard core capitalism, this is where it’s at.
That’s not to say I’m not into Grubhub.com (GRUB) going public this morning (I couldn’t make that up if I tried)… or any company that doesn’t make any money for that matter. If the public is dumb enough to pay 15-20x revenues for companies with no earnings, there is a precedent for that. #1999
There’s also a longstanding history in America of hard core capitalists making hard core profits. Admittedly, I have a confirmation bias towards them. As William Gibbs McNeil said about Vanderbilt in 1840, “I’d sooner have him with us, than against us.” Amen to that.
Back to the Global Macro Grind…
As the European Central Bank (ECB) reduces the size of its balance sheet, Yellen’s Federal Reserve continues to ramp up the size of hers. At $4.2 TRILLION, I was perusing the Fed’s balance sheet last night. It was up another +$9.5B wk-over-wk, and +$1 TRILLION year-over-year. Socialism, baby!
Is that a bad word?
Or should we use statism? What else would you call an un-elected agency (the Federal Reserve), whose mandate is to get tighter as inflation accelerates and the economy expands, getting looser for the sake of the 1%-10% of the population that benefits from asset price inflation?
- The US economic expansion is now going into its 59th month!
- Pardon? Yes. Take out all the spew politicians have been whining about since missing the buying opp of a lifetime in 2009.
- And focus on what actually happened. In gravity speak, this is called a cycle (see #history table in today’s Chart of The Day)
Oh, and what you’ll note in the historical data is that the average US economic expansion following a recession is also … drum-roll… 59 months!
In other words, during this epic expansion, the Fed:
- Didn’t see any inflation, at the all-time-highs in US energy, food, education, rent, etc. inflation – so it didn’t see a need to tighten
- Won’t ever see inflation, until we have another inflation crisis
- And is now tapering (late) into what will likely be a US consumption growth slowdown
Yep, that last part is the least consensus of everything else I wrote, primarily because my conclusion is embedded in a forecast that isn’t consensus – i.e. that US #InflationAccelerating is finally slowing US consumption growth.
Hard core Keynesianism, this view is not. And what do you do if you share it? Do more of what you’ve been doing for 3 months:
- Buy Inflation (Short US Dollars, and Buy Commodities and/or anything with pricing power)
- Buy Bonds (because the Fed has 0% credibility and/or intention to fight inflation)
- Buy Foreign Currencies who has monetary policies that are building credibility
That’s why I feel pretty good about selling US Buy-The-Damn-Bubble #BTDB Growth Equities (everything we liked last year), booking those gains and plowing them back into the former Bernanke Bubbles (Food, Gold, Utilities, REITS, Bonds, Emerging Markets, etc.) that blew up in 2013.
The inflation topic drives people who take the Fed’s word for it (that there is no inflation) squirrel. But those are mostly people who are educated with a serious level of Western Academic Groupthink and don’t think for themselves. If you ask objective people, they know the government is lying to them.
We did a poll @Hedgeye.com yesterday (powered by Polstir, here) that asked a very basic question: Do you trust the government’s inflation numbers?
87.5% responded no.
Yes Mr. and Mrs. Big-Government-Made-Up-Data, Hedgeye is 6 years older (with much wider distribution) than when we called you out on the last inflation-slows-growth cycle reality (our US consumer recession call in early 2008). We’ll be striking at everything you say going forward. Be afraid of the common man.
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 2.66-2.82%
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
Takeaway: We remain bullish on CMG, as it continues to take share in an ultra-competitive environment. Recent comp & traffic numbers are unheard of.
Comps: CMG delivered +13.4% comp growth in the quarter, beating estimates of +8.8%. Management upped its FY14 comp guidance from low to mid-single digit growth up to high-single digit growth. Revenues of $904.163mm came in 3.5% higher than consensus estimates.
Margins: Despite accelerating top line trends, margin pressure continues to squeeze profits. Food costs accounted for 34.5% of revenue, up nearly 150 bps YoY, due to higher beef, steak, avocado and cheese prices. Restaurant level margins came in at 25.9%, down 40 bps YoY. G&A expenses accounted for 7.4% of revenue in the quarter, up 130 bps YoY due primarily to higher non-cash compensation exp. and litigation costs. Operating margins came in at 15%, down nearly 150 bps YoY.
Earnings: EPS of $2.64 came in light, missing consensus estimates by approximately 8% as the aforementioned margin pressure weighed on profits.
Analysis: While the majority of the restaurant industry continues to blame poor weather for disappointing comps, Chipotle delivered +13.4% comp growth primarily on the back of traffic gains. Chipotle continues to take market share in an increasingly competitive environment.
Declining margins are a concern, but are not insurmountable. Food inflation is weighing heavily on the cost of sales line, as beef, steak, avocado and cheese prices continue to surge. In order to combat this pressure, management announced they will take a mid-single digit price increase in 2H14. This should help mitigate food costs, which are expected to run above 36% of revenues (excl. any price increase) for the full-year. Management indicated they have ample pricing power and we tend to agree. In our view, Chipotle’s loyal and growing customer base will be willing to look past a $0.24-0.40 increase in the price of a burrito. People are willing to pay for a premium product.
Even with this margin pressure, Chipotle still operates a best in class business model and the demand for the product appears as strong as ever before. Faster throughput contributed meaningfully to the quarter, as restaurant saw an average increase of seven transactions at both peak hour lunch and peak hour dinner times. A unique and differentiated marketing/advertising approach helps keep CMG top of mind and continues to drive incremental traffic. Catering, though immaterial, continues to be a potential sales driver. We expect this to pick up steam in 2Q as graduation season commences.
CMG typically trades up on strong comps post-earnings, even when EPS misses, but an uncertain margin outlook has weighed down the stock. We believe same-store sales momentum and a price increase will effectively mitigate oncoming pressure, leading CMG to deliver +20% EPS growth over the next two years. Longer-term, international, ShopHouse and Pizzeria Locale continue to provide CMG with a strong growth runway.
- CMG continues to poach market share from competitors as same-store sales and same-store traffic momentum persists.
- Marketing/advertising drives incremental traffic as the “Better Ingredients” campaign rolls out to 30 different markets in 2Q.
- Catering ramps up.
- Management accelerates its share buyback program.
- Increasingly difficult comps for the remainder of the year.
- Food costs continue to surge.
- Consumers aren’t as receptive to a price increase as anticipated.
- Margin pressure erodes earnings.
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Takeaway: 80% responding YES; 20% NO.
It can’t be denied that the medical marijuana market is escalating. In states that have recently legalized marijuana, tax revenues have soared into the millions, exceeding expectations. And, to the extent that this legalizing expands, it is likely that tobacco companies will enter the field.
But, before we put together our own conclusions, we wanted to hear your view. We asked in today’s poll: Would you invest in a company that produces medical marijuana?
At the time of this post, the clear majority favored 80% responding YES; 20% NO.
Many voters who chose YES agreed that as long as the product was legal, they’d be comfortable investing in it. Additionally, several noted that marijuana has proven and obvious benefits in the medical field.
Other noteworthy YES comments included:
- “It's a business like any other. Like tobacco, I think people are nuts to use it heavily but they're all grownups. If the company can make consistent, superior returns and is priced attractively one should own it.”
- “It'd probably be better than investing [in] pharmaceuticals, which are crap-shoots with the FDA.”
- “It is obvious that marijuana use will become fully legal, probably with the same kind of controls now applied to alcohol and tobacco. There’s too much social acceptance, opportunity for tax revenue, and by the way, serious political pressure from Latin American countries that have paid the price in hundreds of thousands killed because US drug users won't give up their habit.”
- "It's a burgeoning market with extensive pent up demand and a virtually undeniable medium-term growth trend... And it's green, man.”
- “I think it’s a dope idea...I would invest in any company that was well-managed with a competitive advantage or a disruptive product.”
One responder over in the NO group, however, put it this way: “I wouldn't invest in these stocks for the same reason I wouldn’t invest in tobacco or alcohol stocks. I just think that, on balance, all of these products aren't good for people. That said, I'm not casting any moral aspersions on legalizing or using marijuana. In fact, I agree with the decision to make it legal. I just wouldn't personally invest in these types of companies.”
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We are removing T. Rowe Price (TROW) from Investing Ideas.
TROW shares have held up well in the volatile equity market year-to-date but we think the stock will be too cyclical for more challenging broader economic results as we move into the middle part of the year. Mutual fund trends are starting to reflect this slowing growth with bond trends starting to improve with stock fund trends starting to slow over the most recent 12 week period. We do not think it is a rush for the exits on TROW shares and are still expecting a good earnings result upcoming this week on April 24. We are getting ahead of this catalyst however and recommend that investors use any stock strength to sell or reduce their TROW position.
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