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NDLS: GOING IN SHORT

Last week we elevated a number of troubled growth stocks to our Investment Ideas list as shorts.  Among these was NDLS, a name we see approximately 35-45% downside in with a fair value of $14-16 per share.

 

NDLS is a small cap stock that has been the recipient of an unwarranted premium growth multiple.  With only ~440 Noodles & Company restaurants system-wide, management maintains that they have a tremendous runway of growth ahead of them that calls for “at least” 2,500 restaurants nationwide.  This is a lofty goal, by any measure, particularly when considering the recent surge of competitors claiming similar domestic growth profiles.  We’ve already seen signs of how difficult this will be to achieve in NDLS’ infancy as a public company.  As the company has accelerated unit growth and ventured into new markets, system-wide sales and margins have suffered.

 

While this is to be expected, the company believes it is facing a brand awareness issue and thinks it will solve this issue through increased marketing spend and its catering initiative.  In our view, NDLS' brand awareness problem shouldn’t be management’s top priority.  In fact, elevating brand awareness will not be the panacea most hope.  Execution and site selection are the real deterrents to the business, and these can’t simply be fixed by plowing more cash into advertising.

 

Despite bullish consensus estimates, we believe NDLS is facing a difficult 2015 for the following reasons:

  • Cost of sales inflation: management is only estimating 2% food inflation, but durum wheat prices are under pressure and food cost estimates could head higher as we move into the back half of the year
  • Geographic concentration: the company has a notable number of stores in the DC metro area, which is an extremely competitive market
  • Rising labor costs: 52% of company operated restaurants are in markets that are facing minimum wage increases in 2015 or 2016 (or both), the majority of which are coming this year
  • The Affordable Care Act: will add about 30-50 bps of pressure on margins in 2H15
  • Estimates are high: the street is looking for 27% EPS growth in 2015, after an essentially flat year in 2014

Management is currently guiding to between 20-25% EPS growth in 2015.  With very little flow through from same-store sales, NDLS needs to drive 3-4% comp growth in order to keep margins flat versus last year – a task we feel will be difficult to achieve. 

 

The biggest factor working against us on the short side is the amount of short interest in the name (~25%).  The analyst community is rather divided, with a 60%/40% split on buys vs holds, respectively.

 

Consensus Estimates for 4Q14 Look Aggressive As Well

As a part of our process we continually monitor consensus estimates for each of the major line items on the P&L for the vast majority of companies in our space.

 

In regards to NDLS, we have a difficult time understanding the rationale behind the street's estimates for COGS and, subsequently, restaurant level margins in 4Q14.  

 

Consensus expects cost of sales to decrease 41 bps on a YoY basis in the quarter, after increasing 51, 67, and 64 bps in 1Q14, 2Q14, and 3Q14, respectively. We've tried, numerous ways, to reconcile the extent of this sudden reversal - but to no avail.  Predictably, this leverage is expected to flow through to restaurant level margins which consensus expects to be down 36 bps YoY, after decreasing 127, 200, and 230 bps in 1Q14, 2Q14, and 3Q14, respectively.  

 

We think there is a material disconnect here which will become readily apparent if NDLS does not put up a well-above consensus comp.

 

NDLS: GOING IN SHORT - 1

NDLS: GOING IN SHORT - 2

Data: Company Filings, Consensus Metrix Estimates

 

NDLS: GOING IN SHORT - 3


HLT 4Q 2014 CONFERENCE CALL NOTES

Takeaway: Delivers solid 2015 guidance (ex Fx) and outlook. Best in class stock (in our opinion) no longer cheap but should be a grinder.

CONF CALL OPENING REMARKS

 

  • Q4 2014
    • Led by Europe and US REVPAR  (6.9%, 6.8%, respectively)
    • Strong balanced growth in group and transient segment
    • Drive leisure demand in non-peak periods
    • Government grew 7% 
    • Transient grew 7%
  • Americas/owned group segment: up mid single digits for 2015
    • 50/50 (volume/rate) contribution
    • Pace has been very strong - up 57% YoY in 1Q.  
    • Middle quarters doing well
  • HLT as STR leader:  global rooms under construction, pipeline size and system rooms
  • HLT:  REVPAR index premium of 15%
  • HLT: Rooms under construction make up 19% of global share
  • Americas:  signed on average one deal/day
  • 400 Hamptons in the pipeline.  Will have hundreds of Hamptons in China
  • Doubletree:  doubled in size since 2007. REVPAR index increased over 700bps since 2007
  • 2 new brands in 2014:  Curio (5 hotels opened with 23 hotels in pipeline); Canopy (15 hotels in pipeline; expect to open 1st Canopy within the year)
  • Waldorf sale 1030 exchange:  screened for high-quality properties in urban/resort markets
  • 2015
    • >75% of Adjusted EBITDA comes from US.  Some disruption from weather....sees mid-to-high single digit REVPAR growth in US (strength in San Francisco, Florida, Boston, Washington, offset by ongoing challenges in NY)
    • Mid-single digit REVPAR growth in Europe; strong group business in Southern region.  Russia pressuring Eastern Europe. France underperforming.
    • Mid-to-high single digit REVPAR growth in Middle East
    • China:  6-8% REVPAR growth.  Overall Asia:  high single digit REVPAR growth in 2015
  • Effective franchise rates continue to increase: 4.65%
  • Timeshare: Lower SG&A, higher transient rentals, and lower club charges
    • Continue to transition to capital-light business
    • 60% of sales from new timeshare intervals (different from competitors)
  • Calendar shifts somewhat tempered growth in November
  • Some markets saw group revenue increase 15-25%
  • Hawaii Q4 REVPAR: 10%
  • Strong transient business in DC
  • Transient strength in Brazil and Argentina offset softness in Puerto Rico
  • Europe:  strong group business in UK and Rome 
  • China:  weakness in Mainland group business
  • Paid down $300m in term loans.  Leverage ratio currently at: 4.2x
  • Leverage target: 3-4x
  • Will start returning capital to shareholders via dividend when they reach leverage goals
  • Over 80% of adjusted EBITDA in US $
  • Expect $35-45m FX impact on 2015 EBITDA guidance
  • Remaining Waldorf money (~$100m): will purchase 1 or more US assets in next 6 months

 

Q & A

  • 2015 Europe:  continue to see strength in Western Europe/ some Southern Europe tempered by weakness in France and Eastern Europe
  • FX impact:  no impact on inbound business to US 
  • Will consider other options on returning capital to shareholders (i.e. stock buyback) but dividend likely first
  • Lodging cycle: Demand is growing with historical low level of supply. US getting better, will drive strong transient results. Group is coming back. 
  • REIT spin-off:  constantly looking at real estate to maximize value.  Don't see 'meaningful arbitrage opportunity' at this moment.
  • Timeshare:  80% is capital light.  Have active loyal customers. Like their timeshare business. 
  • Most of development in US is in limited service and franchising
  • China 2015 REVPAR: in Q4 2014, REVPAR was 3% due to hotel specific issues. For 2014, it was 6%. Expect similar growth in 2015.  Starting to see F&B ease up a little bit (govt austerity). Seeing ancillary spend recover a little bit. Signed more deals in 2014 than 2013 (much more limited service).
  • 2015 incentive fees (ex 1x items):  high teens growth rate
  • US incentive contribution rate:  High 50s (moved from low 50s). Expect in 2015 to move to low 60s
  • 2014:  Lower-end outperformed upper-end by 100bps due to transient growth
    • 2015:  roughly equal growth rates in lower-end and upper-end (UUP and higher)
  • New York EBITDA exposure:  going from 8% to a little less than 5% after Waldorf sale
  • Waldorf transaction/exchange:  REVPAR growth rates will be high single digits higher, EBITDA will be double digits higher
  • Finished at historic high in occupancy in 2014.  Do not think it will be another high in occupancy in 2015.
  • 6-7% HLT supply growth is even split between full service and limited service
  • Probably no more arbitrage opportunities in the portfolio similar to Waldorf, unfortunately
  • Would never say never on buying a brand but economics suggest organic growth the better option.
  • 60% of Fx hit is to the fee business
  • Corporate negotiations are becoming more of seller's market. Free WiFi not really related to that

How Nike Is About to Revolutionize the Shoe Industry (Again) | $NKE

How Nike Is About to Revolutionize the Shoe Industry (Again) | $NKE - nk

 

Takeaway: This seems a little bit odd, but after we re-read this article a few times, it made perfect sense. Nike is about to revolutionize the way we design, manufacture and buy sneakers. FlyKnit technology is a big part of that. In other words, a shopper could go into a store, design a shoe, grab a burrito at Chipotle, and come back an hour later and leave with the brand new custom shoe that was assembled in the back room.

 

How Nike Is About to Revolutionize the Shoe Industry (Again) | $NKE - 222

 

This is one of the only industries where we haven't seen any major disruption to the typical wholesale model in at least 40 years. Nike is starting to push the envelope on that front.

 

We identified how important customization was to the 18-24 year old demographic, with 100% of customers who shop for athletic footwear online saying that the ability customize was the reason why. One of the problems with consumers designing shoes is that they can't see the end product. Now, with this patented technology, consumers can put on a pair of goofy glasses and design 3D shoes in store.

 

*  *  *  *  *  *  *

Editor's note: This is a brief excerpt from Hedgeye research courtesy of our retail sector team led by Brian McGough and Alec Richards. Click here to learn more about how you can become a subscriber to America's fastest-growing independent financial research firm.


Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.

Keith's Macro Notebook 2/18: USD | UST 10YR | Sentiment

 

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


Retail Callouts (2/18): Chain Store Sales, NKE, KATE, LULU, FOSL, URBN

Takeaway: NKE patent makes customized product design easier. LULU's first store in Dubai. KATE/FOSL watch agreement.

EVENTS TO WATCH

Retail Callouts (2/18): Chain Store Sales, NKE, KATE, LULU, FOSL, URBN - 2 17 chart2

 

 

ICSC RETAIL SALES (80 General Merchandise Stores)

 

Takeaway: Comps decelerated this week on a 1, 2, and 3 year basis. Through the first 7 weeks of the year the trend has been down and to the right against the easiest compares of the year. Compares get tougher as we enter April.

Retail Callouts (2/18): Chain Store Sales, NKE, KATE, LULU, FOSL, URBN - 2 18 chart1B

Retail Callouts (2/18): Chain Store Sales, NKE, KATE, LULU, FOSL, URBN - 2 18 chart3

 

 

COMPANY HIGHLIGHTS

 

FOSL, KATE - FOSSIL GROUP AND KATE SPADE & COMPANY ANNOUNCE

GLOBAL LICENSING AGREEMENT

 

Takeaway: To see our full note on the KATE/FOSL agreement CLICK HERE 

 

NKE - Nike Developing Technology to Make Customization Easier

(http://www.cnet.com/uk/news/nike-eyes-holographic-technology-for-sneaker-design/)

Retail Callouts (2/18): Chain Store Sales, NKE, KATE, LULU, FOSL, URBN - 2 18 chart4

Takeaway: This seems a little bit odd, but after we re-read the article a few times it made perfect sense. Nike is about to revolutionize the way we design, manufacture and buy sneakers. FlyKnit technology is a big part of that. That is, a shopper could go into a store design a shoe, grab a burrito at Chipotle, and come back an hour later and leave with the new custom shoe that was assembled in the back room. This is one of the only industries where we haven't seen any major disruption to the typical wholesale model in at least 40 years. Nike is starting to push the envelope on that front.

We identified how important customization was to the 18-24 year old demographic, with 100% of customers who shop for athletic footwear online saying that the ability customize was the reason why. One of the problems with consumers designing shoes is that they can't see the end product. Now with this patented technology, consumers can put on a pair of goofy glasses and design 3D shoes in store.

Retail Callouts (2/18): Chain Store Sales, NKE, KATE, LULU, FOSL, URBN - 2 18 chart6

 

 

LULU - First Lululemon store in Dubai to open this year

(http://gulfbusiness.com/2015/02/dubais-maf-open-canadian-brand-lululemon-stores/#.VOSCePnF83i)

 

Takeaway: This a new development for LULU and should give the brand additional touch points outside of the 40 new doors it will add in Europe and Asia by 2017 with very little risk. LULU has used licenses in the past to build it's geographic reach with mixed success. The Japanese joint venture shuttered in 2008. But, the Australian joint venture was taken in house in 2012. AUS/NZ now has 30 doors. One of the arguments we hear on LULU all of the time is centered on the company's slow paced expansion. The company has always taken a measured approach when it comes to new markets. First using a showroom to  measure demand and then a store 12-18 months later. That made sense for the company when the finance organization was extremely weak, but we think that new CFO Stuart Haselden has the ability to build the financial/logistical infrastructure in a way that supports a more rapid expansion effort.

 

OTHER NEWS

 

FOSL - 4Q14 Earnings

Retail Callouts (2/18): Chain Store Sales, NKE, KATE, LULU, FOSL, URBN - 2 18 chart5

 

Gilt - A $50M investment may make Gilt relevant again

(http://www.crainsnewyork.com/article/20150217/TECHNOLOGY/150219878/a-50m-investment-may-make-gilt-relevant-again)

 

Tory Burch to Open 4th Canadian Location at Sherway Gardens

(http://www.retail-insider.com/retail-insider/2015/2/tory-burch)

 

AAPL - Report: Apple redesigning its retail stores

(http://www.retailingtoday.com/article/report-apple-redesigning-its-retail-stores)

 

URBN - Urban Outfitters e-commerce fulfillment center moving to Pennsylvania

(http://www.chainstoreage.com/article/urban-outfitters-e-commerce-fulfillment-center-moving-pennsylvania)

 

TSCDY - Report: Tesco may lay off 10,000 workers

(http://www.chainstoreage.com/article/report-tesco-may-lay-10000-workers)

 

Ace Hardware pilots same-day delivery

(http://www.chainstoreage.com/article/ace-hardware-pilots-same-day-delivery)

 

ASNA - Ascena to Close Brothers Brand

(http://www.wwd.com/retail-news/specialty-stores/ascena-to-close-brothers-brand-8197286?module=Retail-latest)

 

AMZN - Regulations may ground Amazon.com's drones

(http://www.retailingtoday.com/article/regulations-may-ground-amazoncoms-drones)


Guest Speaker Call TODAY | Outlook For Natural Gas Prices and Basis

TODAY at 11:00am EST Hedgeye’s Macro and Energy teams will host a guest speaker call on US natural gas fundamentals with Keith Barnett, Head of Fundamental Analysis at Asset Risk Management (ARM), which is an independent producer services company that provides solutions for more than ninety clients through financial hedging advisory, physical marketing, and midstream solutions.

 

 

DIAL-IN INFORMATION AND MATERIALS

  • Wednesday, February 18th, 11:00am EST
  • Toll Free:
  • Toll:
  • Conference #: 39017544
  • Slides: CLICK HERE

Send questions for Keith to

 

 

TOPICS FOR DISCUSSION

  • Rapid growth in US production driven primarily by emergence of Marcellus / Utica shale play has created basis price dislocations as infrastructure and demand re-calibrate to new supply / demand regional balances…
  • Demand growth along the US Gulf Coast [industrial, LNG exports, and pipe exports to Mexico] create a “battle zone” for basis differentials to re-balance in 2016-2020, with the Haynesville waiting in the wings…
  • British Columbia / Northern Alberta shale plays will look for a home, especially if BC LNG exports continue to be delayed and lower crude prices dampen oil sands (gas demand) development…
  • Lower crude prices will affect the supply side through reduced liquid-oriented gas, and the demand side by impacting petchem plant development, global LNG price arb, and Mexico project development…
  • And more…

 

RELEVANT TICKERS......BWP, LNG, ETE, KMI, WMB, OKE, TRP, SE, MWE, DPM, DVN, CHK, ECA, SWN, RRC, COG, AR, EQT, XCO, UPL, WLK, LYB, DOW, MEOH, and many more... 

 

 

ABOUT KEITH BARNETT

Keith Barnett is Senior Vice President and Head of Fundamental Analysis at Asset Risk Management.  He has over 30 years of experience in the energy industry with leading companies like Chevron, Columbia Gas Transmission, American Electric Power, and Merrill Lynch Commodities. Keith held engineering, managerial and executive positions with those companies in the areas of production, drilling, offshore platform design, natural gas marketing, fuel procurement, trading and structuring analytics, corporate strategy and fundamental analysis of energy markets. He had significant participation in two National Petroleum Council studies; including leading the power demand team in the 2003 natural gas study and serving on the steering and report-writing committees. Keith was also the Natural Gas Task Force lead for the Edison Electric Institute for several years. He has testified before the Federal Energy Regulatory Commission and the Senate Sub-committee on Energy on natural gas and power matters. He is a frequent speaker on natural gas, power, and global energy markets. 

 

Prior to joining Asset Risk Management, Keith served as Director of Strategic Analysis for Merrill Lynch Commodities where he led the effort to create an integrated global point of view for energy commodities that could serve short term trading and longer-term investment horizons. He also worked most recently with Spring Rock Production, which is producing a state of the art natural gas and oil production forecast for the USA and Canada.  Keith has an engineering degree from Texas A&M University.

 

 

ABOUT ASSET RISK MANAGEMENT 

Headquartered in Houston (with offices in Chicago, Denver and Pittsburgh), Asset Risk Management (ARM) has been helping oil and gas producers make better hedging decisions since 2004. ARM represents more than 85 public and private companies and interacts with all major energy commodity counterparties. ARM’s value is realized not only in the development and implementation of dynamic strategies, but in the ongoing optimization of those strategies as warranted by market volatility, execution efficiencies, reporting and continual monitoring of technical and fundamental factors in the market with the client's best interests and specific objectives in mind.  Learn more: http://asset-risk.com/.


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