March 2, 2015

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The Key to Understanding Financial Statements: Why We Like SBUX


Restaurants Sector Head Howard Penney recently gave a presentation entitled Demystifying Financial Statements at Rutgers Business School.


In this excerpt Howard walks you through what line items he cares most about when analyzing restaurant stocks. Using SBUX as an example he shows you the key drivers to our bull case.

The Week Ahead

The Economic Data calendar for the week of the 2nd of March through the 6th of March is full of critical releases and events.  Here is a snapshot of some of the headline numbers that we will be focused on.

Click to enlarge.

The Week Ahead - Week Ahead

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Investing Ideas Newsletter

Takeaway: Current Investing Ideas: TLT, EDV, MUB, HOLX, PENN, YUM and RH.

Below are Hedgeye analysts’ latest updates on our seven current high-conviction long investing ideas and CEO Keith McCullough’s updated levels for each.


*Please note we added Penn Gaming (PENN) this week and removed Utilities (XLU) and Medidata Solutions (MDSO)


We also feature two additional pieces of content at the bottom.

Investing Ideas Newsletter      - levs 

Trade :: Trend :: Tail Process - These are three durations over which we analyze investment ideas and themes. Hedgeye has created a process as a way of characterizing our investment ideas and their risk profiles, to fit the investing strategies and preferences of our subscribers.

  • "Trade" is a duration of 3 weeks or less
  • "Trend" is a duration of 3 months or more
  • "Tail" is a duration of 3 years or less


Investing Ideas Newsletter      - Yellen cartoon 02.27.2015




Yum! Brands has been on a tear, outperforming the SPX by 4.9% and 6.8% over the past week and month, respectively.  Our thesis is slowly becoming more mainstream, as activist talk has recently heated up. 


In fact, management seems to have gotten the memo as well and is now facing pressure from some of its largest shareholders.  In response, management implemented a shareholder friendly amendment to the company’s by-laws that will permit a shareholder, or group of shareholders, with 3% or more ownership of common stock (for three years or more), to nominate directors representing up to 20% of the board.


This is good news for several reasons: 1) an activist may be involved in the name 2) shareholders are speaking up 3) management is feeling the pressure and 4) management is open to adopting more shareholder friendly policies. 


Albeit seemingly minor, this is the best news we’ve received in a while regarding YUM.  We continue to believe there is significant upside here despite the stock’s strong recent outperformance.  This stock is one major announcement away from hitting $95.


Investing Ideas Newsletter      - fred


Penn National Gaming is the best way to play improving domestic regional gaming trends due to its superior operational management and unit growth opportunities.  Catalysts include positive estimate revisions, the opening of the first Massachusetts casino in June, and industry leading earnings growth in 2015 and 2016.


Click below to watch video we sent to subscribers this week.

Investing Ideas Newsletter      - RPP


Shares of Hologic have risen over 22% since Hedgeye Healthcare sector head Tom Tobin added it to Investing Ideas on 1/2/15. The S&P 500 is up approximately 2% in that time. Tobin will provide an update on his HOLX thesis next week.


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Investing Ideas Newsletter      - hopp



The U.S. economy is not booming, contrary to what you may have heard from various media "sources" after the Q3 2014 quarter-over-quarter annualized GDP print of +5.0%...Year-over-year (that's how you measure growth) U.S. GDP is closer to 2% than 4-5%. This is the most basic information in America despite the obfuscation by some.


Click image to enlarge.

Investing Ideas Newsletter      - whap


Long-term Treasury (EDV, TLT) and Municipal bond (MUB) exposure is where you want to be during this growth slowing, deflationary environment with a continued trend of U.S. dollar strength (fixed payments, in U.S. dollars are worth more).


Dollar up, rates down, = global deflation of asset prices (get out of commodities and volatile growth stocks)


After a big week of growth slowing data, we recommend you stay with the same positions that have worked over the intermediate-term:



  • Annualized GDP for Q4 revised down to +2.4% YoY in 4Q14 vs. the initial +2.5% print
  • Full-year 2014 GDP remains at +2.4% on a year-over-year annualized basis which differentiates the Hedgeye model
  • Friday’s revision remains far lower than the +3% growth expected by consensus or the “The economy is booming, +5.0% GDP!” allusion from unaccountable mainstream media sources


In short, MORE DEFLATION which crushed those sectors leveraged to price inflation (ENERGY, COMMODITIES, and INDUSTRIALS among others)…

  • Core CPI, which the federal reserve anchors on for gauging a “healthy level of inflation” remained constant at +1.6% on a year-over year basis (which is below its 2% target)
  • CPI miss = lower rates for longer, which = Deflation with more USD strength
  • In other news, meat prices and shelter/rent is up +12% and 3.4% respectively (Does that feel like inflation?)

Policy (Lower for Longer)

A slight pivot in Janet Yellen’s commentary this week when she took the stand on Capitol Hill continues to support our call. IN SHORT, LOWER FOR LONGER.

  • Yellen put an end to the consensus bond-bear (bond bear is bullish on rates) fear-mongering of removing the word “patient”
  • She emphasized her concern (dovish) about inflation not achieving her “target”

Included below is a snapshot on how our GROWTH, INFLATION, POLICY ("GIP") comes together to help us target the asset classes most likely to outperform.

It’s a busy chart but it says to stay LONG of TLT/EDV/MUB!


Click image to enlarge.

Investing Ideas Newsletter      - beno


Shares of Restoration Hardware have underperformed WSM and the XRT index since the company pre-announced on 2/5/15. For the record, we think this story is very much on track and remains our favorite name in the retail space. 

Investing Ideas Newsletter      - RH chart 2 27


The biggest concern we’ve heard from investors following the pre-announce had to do with the company’s 24% sales growth deleveraging to 22% EPS growth. We think a few factors contributed to that.


1) Store closures and Openings – For the quarter sq. ft. grew by 9%, with the two biggest pieces of that growth opening at the end of 3Q and start of 4Q. Because of the shipping window (10-12 weeks) you get the expenses associated with paying rent, but no top line to offset that cost until at the very earliest start of 1Q.  

2) Dead Rent – Based on the company’s new store opening calendar in 2015, new stores that will open in the back half of 2015 just started to hit the P&L. It usually takes RH about 6 months to build out the interior of a new property after it receives the keys from the landlord, and RH pay’s rent the whole time.

3) Distribution Center – RH opened a new distribution center in 4Q. It will help the company gain shipping efficiencies over time, but those costs will be a headwind until they anniversary the opening next January.


If we step back and look at the year holistically. RH grew sales at 20% and earnings close to 40%. We expect that type of growth and then some in 2015.


* * * * * * * * * * 


Ici fund flow survey: slightly less defensive

For the first time in 2015, all equity products outpaced all fixed income products in the most recent 5 day period.

Investing Ideas Newsletter      - z1

pandora: walking the plank

P gave itself some breathing room, but likely not enough. More importantly, the much bigger risks are approaching.

Investing Ideas Newsletter      - 9p

Commodities: Weekly Quant

Commodities: Weekly Quant - chart1 divergences

Commodities: Weekly Quant - chart2 deltas

Commodities: Weekly Quant - chart3 correlations

Commodities: Weekly Quant - chart4 volume

Commodities: Weekly Quant - chart5 open interest

Commodities: Weekly Quant - chart6 implied vol

Commodities: Weekly Quant - chart7 sentiment


Key Takeaway

4Q sales and earnings fell well short of estimates, but the stock has been resilient as the street has found solace in a solid guide.  This, however, doesn’t mean the guidance was right – in our view, 2015 and 2016 estimates remain far too aggressive.  We’d short DFRG on this pop and continue to see downside to the $10-14 range.



EPS down $0.12 since 2012.   Is management’s growth strategy working?  You know where we stand on this, but let’s take a step back for a second and recognize the divergent trajectory between unit growth and earnings growth over the past two years.  DFRG’s earnings per share have decreased 15% from $0.94 in 2012 to $0.82 in 2014, while units have increased 35% from 34 in 2012 to 46 in 2014.  We understand the costs associated with aggressive unit expansion, the time it takes to reach normalization, etc., but to show such a significant level of earnings deterioration over this time on the back of 30% sales growth must tell you something’s wrong – DFRG doesn’t have a legitimate growth algorithm.  For a company that touts itself as a “one of the growth leaders in [the] industry,” this is a serious issue.




Management commentary proved the Grille is not ready to grow.  With restaurant level margins at the Grille down 200 bps y/y, management is scrambling to right the ship.  In other words, they should be taking their foot off the proverbial growth pedal, but they’re not.  Instead, in conjunction with this growth comes an effort to improve its training program, recipes, cooking methods, kitchen prep times and technology (speed up service, reduce labor costs).  While this can be viewed as a positive, on the margin, it’s important to understand why management is in this predicament in the first place.  What’s more bothersome than this, however, is that they have not identified the concept’s optimal target market and, as a result, are currently conducting market research to do so.  This is the same issue that is plaguing the underperforming NDLS.  You shouldn’t be growing an asset base by 38% if you don’t even know its target market.  It’s inevitable that a certain percentage of their new units will be underperformers and, ultimately, need to be relocated or closed.  Management better hope they’ve found all the answers in a short period of time – if not, they could be looking at another year of negative earnings growth.


2015 is set up to be another disappointing year.  Guidance was solid, and perhaps that’s why the stock has held up, but that doesn’t mean it’s right.  Considering the lower full-year EPS base of $0.82, management’s 2015 guidance of 15-18% EPS growth implies a range of $0.94-0.97 – a far cry from the $1.02 the street expected heading into the print.  And, at this point, $1.26 in EPS in 2016 is completely out of the question.  We have no doubt comp and cost of sales guidance is on the money, because the revenue growth is there and they have the benefit, or as they call it “natural hedge,” of the Grille working in their favor on the food cost line.  Our concern lies within the operating, marketing/advertising, and G&A which we believe will call for incremental investment over the course of the year.  The street expects other restaurant expenses to delever ~59 bps y/y to 47.31% of sales.  Given the current initiatives going on around the labor line, we have a hard time getting there.  We’re looking for closer to 5-10% EPS growth this year, but it could be much worse than that.