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SBUX: Why We Think It's a Short

We first laid out our bearish thesis on a conference call back in September 2014.  Let us know if you’d like a copy of the slide deck.

 

This note is accompanied by an updated, condensed slide deck that visually runs through the bear case.  CLICK HERE for access.  We encourage you to read the note prior to running through the deck.

 

 

Point #1: ‘Big Bets’ Carry Risk

As we see it, the “biggest bet” the company is making is on its food strategy and the implications for overall performance of breakfast and lunch.  SBUX is investing a substantial amount of time and effort into building food sales, without the benefit of having equipment or a process that allows them to produce the food fresh.  Food is the biggest risk to the DNA of the company because, in our view, it will never be on-par with the quality of beverages consumers have come to expect from Starbucks.  Handcrafted beverages and food served wrapped in plastic are not complimentary.  It’s also difficult to imagine that other QSRs and fast casual restaurants will idly sit by and let SBUX scoop up incremental market share.

 

Point #2: Signs of Domestic Maturation

There’s no two ways about it.  The business is steadily decelerating in the U.S.  Two-year average same-store sales have decelerated 250 bps from the recent highs of 4Q11.  Even more concerning, two-year average traffic has decelerated 300 bps from the recent highs of 3Q13 and, last quarter, was up a measly +1%.  The recent composition of comps has been weak, yet the street expects the company to produce 5%+ comps throughout 2015.  If comps come in below cheery estimates, Starbucks will not hit its earnings numbers. 

 

SBUX: Why We Think It's a Short - sbux chart 1

 

Point #3: Menu Proliferation Rearing Its Ugly Head

Our short call argues that the proliferation of new menu items is in fact slowing service times and traffic trends.  Management was hard pressed on this issue on the 4Q14 earnings call and was in complete denial about the possibility of a throughput issue.  In fact, they attributed the entire slowdown to the macro environment and a shift in consumer shopping patterns.

 

SBUX: Why We Think It's a Short - chart2

 

Point #4: CAP & EMEA Are Irrelevant

We often hear pushback from bulls that Starbucks has an enormous growth opportunity in CAP and that EMEA has turned the corner.  Look, we get it – the company has plenty of international expansion ahead.  But, the fact of the matter is, this is irrelevant to the business today.  EMEA only contributed ~3% to operating profits in Fiscal 2014.  CAP, where same-store sales and traffic trends have been in freefall, only contributed ~10%.  This business, for now, is about the U.S. – a market which is undoubtedly showing signs of maturation.

 

SBUX: Why We Think It's a Short - chart 3

 

Point #5: Japan Acquisition Reeked Of Desperation

Shortly following our bearish conference call back in September 2014, Starbucks announced its intentions to acquire the remaining 60.5% share of Starbucks Japan in a two-step tender offer process that should be fully completed in the first half of this year.  To be frank, this acquisition makes strategic sense over the long-term as it will allow the company to capture the significant growth opportunity left in that region.  It’s a large market for Starbucks ($1.2 billion in revenues), boasts high store-level profit margins (20-25%), and should be immediately accretive to EPS. 

 

The timing of the deal, however, is what really raised some eyebrows.  In our view, this transaction was completed, at this specific point in time, in attempt to mask a slowing core business.  The company could've done this deal at any time in the past three years, but did not need to given strong sales trends and a significant commodity tailwind.  With these trends reversing, expectations for 17% EPS growth in FY15 still look aggressive, despite the transaction.

 

Point #6: DNKN Debacle & Parallels

Mid-December, Dunkin’ guided to disappointing full-year 2014 comps of +1.4%, below the +1.8% consensus estimate.  The read-through was quite discouraging, as it implied 4Q comps in the range of +0.5-0.8%, well below the +2.2% consensus estimate.  The company also guided down full-year 2015 EPS by $0.11-0.14 to $1.88-1.91.  This made us consider whether or not Starbucks is seeing similar pressure in their business.

 

While it pains many people to compare Starbucks to Dunkin’ Donuts, the reality is that the correlation between the two company’s same-store sales is an alarming 0.75 since the beginning of calendar 2011.  It’s difficult for us to sit here and pretend Starbucks is fully immune to the softness Dunkin’ is facing.

 

SBUX: Why We Think It's a Short - 4

 

Point #7: Hyped Up Holiday Season

Let’s face it – Starbucks 4Q14 print was not a pretty one, resulting in multiple downward revisions in 2015 EPS estimates.  Despite this, it’s been clear to us that the street has given management “a pass,” for now, opting instead to wager that holiday promotions and “Starbucks for Life” will drive accelerated traffic in 1Q15.  If there’s one thing we’ve learned over the years, it’s that the holiday season is almost always overhyped – and, this year, we’re not buying it.

 

Point #8: Operating Leverage Is Gone

The core of our thesis is playing out exactly as expected.  This is a business model that is completely lacking incremental leverage.  If sales and traffic continue to surprise to the downside, Starbucks will continue to miss its numbers.  Management is currently struggling to find additional leverage in the model in order to offset a reversing sales trends and a commodity headwind.  Efforts to pull labor from stores come with the massive risk of exacerbating recent comp and traffic deceleration.  With the cadence of comps already weak (fueled by unsustainable average check growth), management has suddenly found itself between a rock and a hard place.

 

SBUX: Why We Think It's a Short - 5

SBUX: Why We Think It's a Short - 6

 

Point #9: Sentiment Is Shifting

We’ve been the lone bear on Starbucks since our initial call back in September.  Even with the overwhelmingly majority of the street bullish (80.6% Buys; 1.62% Short Interest), we feel the tide is slowly turning.  In fact, last week a competitor downgraded the stock to Neutral in a note which cited multiple factors, including concerns about near-term comp trends.  Analysts are hesitant to take on an unfavorable view of the restaurant industry’s darling, and we get that, but the good news is sentiment can only get worse from here.

 

Point #10: Fundamental Disconnect

While our thesis is playing out to a tee, the stock has yet to move in our favor.  Consider this:  since the end of October, FY15 EPS estimates have been revised down by $0.04 while the stock has traded up nearly 7% to $81.18 per share.  While these aren’t substantial moves on either account, they are notable – and they certainly shouldn’t be ignored.  If comps come in below the street’s estimates at all in 2015, there will almost certainly be another leg down in the red line below.

 

SBUX: Why We Think It's a Short - 7 


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Cartoon of the Day: It's All Greek to Me - Greek cartoon 01.07.2015

Greece's crumbling economy and its potential impact on the EU is roiling global markets. Again.


"Draghi Has No Plan": McCullough Talks Europe, Japan, and U.S. Dollar

 

In this excerpt from today’s Morning Macro Call, Keith answers questions about today’s $SPX trading ranges and describes the different durations.

Keith also discusses the likelihood of a dovish Fed and what impact that will have on the three main currency players (Yen, USD and Euro).

Subscribe to Hedgeye's Daily Trading Ranges product to receive Keith's proprietary ranges for the S&P 500, U.S. Dollar, Euro, and more every morning before the market opens: 


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Keith's Macro Notebook 1/7: #EuropeSlowing | UST 10YR | SPY

Hedgeye CEO Keith McCullough shares the top three things in his macro notebook this morning.


Retail Callouts (1/7): JCP, KSS, M, PVH, NKE, UA

Takeaway: JCP Nov/Dec sales - marketshare gains from KSS to continue. CK adding the Biebs, far cry from Marky Mark. NKE e-mail promos.

EVENTS TO WATCH

 

Thursday (1/8)

FDO - Earnings Call: 10:00am

BBBY - Earnings Call: 5:00pm

 

COMPANY HIGHLIGHTS

 

JCP - November/December period up 3.7 percent

(http://ir.jcpenney.com/phoenix.zhtml?c=70528&p=irol-newsCompanyArticle&ID=2004446)

 

Takeaway: Optically the number looks solid for JCP, though we could argue that a 3.7% comp isn't good enough for a retailer who ceded $5bil in sales and has productivity levels 45% below peak. But in light of the expectations it was enough to get the stock moving +20% after hours. The only other point of contention we'd flag here is the lack of commentary on gross margins - though for JCP it's less of an issue with GM 1000bps below historical levels. Any way you slice it, it's a big improvement from the "pleased with its performance for the holiday period" press release from LY.

This marks 5 quarters now where JCP comps have been better than negative and it also is the first quarter where it laps market share gains from both M & KSS. Over the past 4, JCP has outperformed M and KSS on the comp line by an average of 0.7% and 3.4% respectively (see chart below). Our research, which includes a number of surveys on the topic, shows that KSS was the biggest beneficiary of JCP's lost market share gaining over $1bil in sales. JCP is just starting to take that back – they’ll either earn it, or they’ll buy it (through discounting). Either way it’s bad for KSS.

Lastly on January - we did that math to see what the implied comps looked like for each of the three retailers during the month and there is no question comps look easy. The scorecard looks like this: JCP -3.8%, KSS -7.8%, and M -10.2%. But it's important not to lose sight of 1) the month represents ~15% of the top line in the quarter and 2) M & KSS were comping against 11.7% and 13.3% comps respectivley in January of FY12.

Retail Callouts (1/7): JCP, KSS, M, PVH, NKE, UA - 1 7 chart1

 

PVH - Calvin Klein Signs Justin Bieber, Baby

(https://www.pvh.com/investor_relations_press_release_article.aspx?reqid=2004511)

 

Takeaway: The 2 or 3 Bieber fans left out there that The Bieb did not alienate and/or offend can sleep well knowing that he'll be synonymous with the CK Brand. Seriously, what is PVH thinking? There is very likely a large number of potential male CK Underwear consumers that won't touch the brand given Bieb's affiliation. The teeny-bopper crowd has grown out of him. Adult women generally don't find him appealing. Men hardly view him as being 'masculine' or fashion-forward. And his music is no longer relevant.  We hope that PVH did a lot of market analysis on this one and has enough data to prove us wrong. But this sounds like a really bad idea. If all else fails, maybe CK can sell a lot of underwear and jeans in Canada.

Retail Callouts (1/7): JCP, KSS, M, PVH, NKE, UA - 1 7 chart2

 

NKE - Rare Email Promo

 

An extremely rare promotional email directly from Nike with many items on the site on sale. The company is in the process of transitioning out of Holiday and into Winter, so this makes sense. But the point is it previously used its outlets as the primary clearance channel. For what it's worth, Nike's promo emails look tight and brand-relevant -- which is a far cry from the emails of its wholesale partners.

 

Retail Callouts (1/7): JCP, KSS, M, PVH, NKE, UA - 1 7 chart3

 

 

OTHER NEWS

 

UA - Under Armour Launches UA Record™, the Latest Addition to the Definitive Digital Health and Fitness Network

(http://investor.underarmour.com/news/releasedetail.cfm?ReleaseID=889649)

 

Chris Burch Shutters C. Wonder Operation

(http://www.wwd.com/retail-news/specialty-stores/c-wonder-shutters-stores-8090623?module=hp-topstories)

 

Federal mediators join West Coast ports dispute

(http://www.chainstoreage.com/article/federal-mediators-join-west-coast-ports-dispute)

 

GME - GameStop swaps customer gift cards

(http://www.chainstoreage.com/article/gamestop-swaps-customer-gift-cards>

 

SWY - Safeway to pay $9.87 million for environmental violations

(http://www.chainstoreage.com/article/safeway-pay-987-million-environmental-violations)


THE HEDGEYE MACRO PLAYBOOK

Takeaway: In today's edition of the Macro Playbook, we revisit our bearish bias on the Japanese yen and bullish bias on Japanese equities.

THEMATIC INVESTMENT CONCLUSIONS

Long Ideas/Overweight Recommendations

  1. Health Care Select Sector SPDR Fund (XLV)
  2. Consumer Staples Select Sector SPDR Fund (XLP)
  3. iShares National AMT-Free Muni Bond ETF (MUB)
  4. Vanguard Extended Duration Treasury ETF (EDV)
  5. iShares 20+ Year Treasury Bond ETF (TLT)

Short Ideas/Underweight Recommendations

  1. iShares TIPS Bond ETF (TIP)
  2. SPDR S&P Regional Banking ETF (KRE)
  3. SPDR S&P Oil & Gas Exploration & Production ETF (XOP)
  4. iShares MSCI European Monetary Union ETF (EZU)
  5. iShares MSCI France ETF (EWQ)

 

QUANT SIGNALS & RESEARCH CONTEXT

Revisiting Our Thoughts on Japan: In yesterday’s edition of the Macro Playbook, we updated our bearish thesis on emerging markets (CLICK HERE to review). The long and short of it was that we continue to anticipate considerable downside for EM asset prices over the intermediate term.

 

In that note, we also took a victory lap of sorts, as EM asset prices have been in some version of free-fall since we introduced the bearish thesis back in late September.

 

Don’t short them down here, though! With the U.S. Dollar Index, the VIX and long-term Treasury bonds nearing immediate-term TRADE overbought, we think EM asset prices are likely to experience another low-volume bear market bounce in the coming days. We still believe the directional trend remains lower with respect to the intermediate term, however.

 

THE HEDGEYE MACRO PLAYBOOK - DXY vs. JPM EM FX Index

 

THE HEDGEYE MACRO PLAYBOOK - VIX vs. MSCI EM Index

 

THE HEDGEYE MACRO PLAYBOOK - UST 10Y vs. EM OAS

 

In the spirit of accountability, let us turn our attention to a call that has not worked out as well thus far – specifically our bearish bias on the Japanese yen (FXY) and bullish bias on Japanese equities (DXJ).

 

Since we re-introduced the thesis back on 12/15, the FXY has moved +68bps against us, contributing to a -1019bps decline in the DXJ.

 

THE HEDGEYE MACRO PLAYBOOK - DM Idea Flow Monitor

 

The latter move is not at all surprising in the context of the crowded net LONG lean in non-commercial yen-denominated futures and options contracts. Recall that immediate-term counter-trend rallies tend to be epic once the net length approaches/exceeds 2 SIGMA in either direction.

 

THE HEDGEYE MACRO PLAYBOOK - EXTREME SENTIMENT MONITOR

 

The recent correction in Japanese equities and the dollar/yen cross has likely wiped out a healthy degree of LONG positions (we’ll get confirming data this Friday afternoon) in Japanese equities, so we’d expect them to bounce through this week and next.

 

Beyond that, we still need to see Abenomics continue to deliver the bacon on reform and monetary base expansion for the Nikkei 225 to approach the ~18% upside from today’s closing prices by year-end 2015 expected by consensus among Japanese money managers. Recall that we anticipate ~50% upside from today’s closing prices if the USD/JPY tests its August ’98 highs over the intermediate-to-long term.

 

These policy catalysts will be instrumental in perpetuating foreign inflows into Japanese equities, at the margins, and we think such capital flows will be instrumental in perpetuating a rally in the Nikkei.

 

On that note, with the exception of a few weeks in/around the BoJ’s surprise QQE expansion net foreign inflows into Japanese equities were negative in 2014. Recall that this is coming off a monster year in 2013 when net foreign inflows of ~$132.5B perpetuated a +56.7% melt-up in the Nikkei. 2014’s paltry net inflows of $23.1B perpetuated a commensurately paltry +7.1% advance in the Nikkei in 2014. We think 2015 is likely to resemble 2013 when it’s all said and done.

 

THE HEDGEYE MACRO PLAYBOOK - Net Foreign Inflows into Japanese Equities

 

All told, the next few weeks will be critical in testing our conviction in our thesis on Japan. Stay tuned for further commentary.

 

***CLICK HERE to download the full TACRM presentation.***

 

TRACKING OUR ACTIVE MACRO THEMES

#Quad4 (introduced 10/2/14): Our models are forecasting a continued slowing in the pace of domestic economic growth, as well as a further deceleration in inflation here in Q4. The confluence of these two events is likely to perpetuate a rise in volatility across asset classes as broad-based expectations for a robust economic recovery and tighter monetary policy are met with bearish data that is counter to the consensus narrative.

 

Captain Obvious: December ISM (1/6)

 

#EuropeSlowing (introduced 10/2/14): Is ECB President Mario Draghi Europe's savior? Despite his ability to wield a QE fire hose, our view is that inflation via currency debasement does not produce sustainable economic growth. We believe select member states will struggle to implement appropriate structural reforms and fiscal management to induce real growth.

 

Grexit? Not So Fast (1/6)

 

#Bubbles (introduced 10/2/14): The current economic cycle is cresting and the confluence of policy-induced yield-chasing and late-cycle speculation is inflating spread risk across asset classes. The clock is ticking on the value proposition of the latest policy to inflate as the prices many investors are paying for financial assets is significantly higher than the value they are receiving in return.

 

#Bubbles: “Hedge Fund Hotel” Edition (Part II) (12/8)

 

Best of luck out there,

 

DD

 

Darius Dale

Associate: Macro Team

 

About the Hedgeye Macro Playbook

The Hedgeye Macro Playbook aspires to present investors with the robust quantitative signals, well-researched investment themes and actionable ETF recommendations required to dynamically allocate assets and front-run regime changes across global financial markets. The securities highlighted above represent our top ten investment recommendations based on our active macro themes, which themselves stem from our proprietary four-quadrant Growth/Inflation/Policy (GIP) framework. The securities are ranked according to our calculus of the immediate-term risk/reward of going long or short at the prior closing price, which itself is based on our proprietary analysis of price, volume and volatility trends. Effectively, it is a dynamic ranking of the order in which we’d buy or sell the securities today – keeping in mind that we have equal conviction in each security from an intermediate-term absolute return perspective.     


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