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PNRA: RON SHAICH MUST BECOME AN ACTIVIST CEO

Prelude

Given Panera’s dual-class shareholder structure, the company might not be in the line of sight of an activist.  With that being said, we believe Chairman of the Board and Chief Executive Officer Ron Shaich should take a page or two from our playbook and go activist on his own company!

 

Two former restaurant CEOs turned activist that we admire are Doug Brooks of EAT and Linda Lang of JACK.  Both stocks are up approximately 201% and 461%, respectively, since these CEOs originally laid out (EAT in 2010; JACK in 2005) fundamental changes to their business models in order to enhance performance and drive shareholder returns.  While these CEOs had to make very difficult decisions at the time, the rewards have been vindicating.  Thanks to their strategic moves, Brinker and Jack in the Box are now two of the best run restaurant companies in the space today.

 

An Open Letter to the CEO of Panera Bread Company

Dear Mr. Shaich,

 

I believe that you have a significant opportunity to restructure your company and, in the process, make your shareholders a lot of money.  At the same time, you will solidify your place as being one of the greatest, and most respected, CEOs in the restaurant industry.

 

Change is inevitable.  In fact, since you first started Panera, consumer tastes, behavior, and technology have all changed drastically – rendering parts of the Panera model outdated.  It’s time to become an activist CEO and reinvent the company.  What I’m going to write probably won’t sit well with you, and you will be inclined to immediately dismiss it, but I ask that you think long and hard about the suggestions forthcoming.  Ultimately, I believe they will make Panera an even stronger company.

 

Panera is a fantastic company, but it has a distinct opportunity to become greater, bigger, and more profitable than ever before.  To be clear, the best way forward today is vastly different from the ways of the past.  Importantly, my thoughts are in line with your stated belief that Panera’s success is dependent on your ability to create “long-term concept differentiation.”  Consumer behavior and tastes are evolving, and the changes you are currently making to your food policy are just the beginning.

 

Along those same lines, the company must address the secular decline in per capita consumption of bread.  While Panera’s identity is rooted in handcrafted artisan bread, consumer attitudes about bread have changed since you first started the concept.  I don’t think it’s a stretch to say that you’re not getting credit from the consumer by owning all the assets associated with serving this artisan bread.  Does owning the bakery chain supply chain generate a strong return on assets?  I don’t know, but I doubt it.  This leads me to my first suggestion:

 

1. Sell off non-core assets

Panera currently produces and distributes fresh dough through a leased fleet of temperature controlled trucks owned and operated by the company.  According to the most recent filing, as of December, 30, 2014, you had 224 trucks leased.  In addition, as of the same date, you had 24 fresh dough facilities, 22 of which were company-owned, including one located in Ontario, Canada.  We suspect this asset may be particularly inefficient considering it only supports 15 bakery-cafes located within that market.

 

As you’ve previously stated, the “essence” of Panera begins with artisan bread: “Bread is our passion, soul, and expertise, and serves as the platform that makes our other entire food special.”  While this may be important, this line of thinking may not properly reflect pronounced changes in consumer behavior.  Specifically, consumers have been consuming less bread, as per capita consumption of this food has been declining since 2000.  More importantly, absolute sales of bread in your stores only make up five to seven percent of sales.

 

Panera is the last remaining, vertically integrated public restaurant company that we know of.  Companies have argued for years that vertical integration is a competitive advantage.  Of course, in some cases, this is merely corporate speak.  Every vertically integrated company needs to decide whether they are operating more, or less, efficiently than they could be.  Jack in the Box was the last restaurant company to do so, when it rightfully decided to sell off its non-core distribution business.  The stock is up approximately 265% since this time.

 

Frankly, I don’t think distributing tuna, cream cheese, and certain produce to substantially all of your company-owned and franchise-operated stores gives Panera any competitive advantage.

 

Moreover, it seems as though the ownership of your supply chain actually limits the company’s future growth opportunities and creates inefficiencies on the P&L.  You already use other independent distributors to distribute some of your “proprietary sweet goods” and other materials to bakery-cafes.  Why not sell off your non-core assets and use independent distributors to distribute all of your products?  You could than redeploy this excess capital back into the business or return it to shareholders.  This leads me to my second suggestion:

 

2. Slowdown the rollout of Panera 2.0 and begin molding a concept of the future

I sincerely appreciate the level of detail you provided in the 4Q14 earnings release regarding Panera 2.0.  However, I don’t believe you accomplished what you had intended to, because the inconsistency of the results led to a lot of confusion.  I also appreciate that Panera 2.0 is part of broader set of initiatives designed to make your restaurants more competitive, but there can be much more done to improve the efficiency of the box.  None of the initiatives laid out address improving pain points that exist in the back of house or eliminating menu items that are difficult to prepare and simply don’t have the customer sell through.  In addition, it may be time to rethink the part of the box that is dedicated to selling bread.  Should we be thinking about Panera 3.0?  The structural changes that are needed at the core concept lead me to my third suggestion:

 

3. Slow unit growth and cut capital spending

It’s not possible to focus the company and its resources on Panera 2.0, or Panera in general, when you are accelerating unit growth.  There are a significant amount of unnecessary “growth” resources in place at Panera at a time when the box is in need of a major transformation.  Is this sending shareholders the wrong message?  Given the size and scale of Panera 2.0, why aren’t all of the firm’s resources going into it?  It’s also difficult to maximize profitability when you are spending G&A on unnecessary resources, which leads to my fourth suggestion:

 

4. Cut excessive G&A spending

Looking at comparable companies, your G&A seems to be much higher than needed – but this should come as no surprise.  Today, Panera is a vertically integrated restaurant company that is growing units at an inefficient pace.  Both of these can be easily remediated by thinking differently about the business model.  Every major restaurant company that has faced similar issues in the past has decided to streamline its structure and improve the operations of its existing asset base.  Panera has not addressed these issues which, in part, play into my fifth suggestion:

 

5. Aggressively refranchise stores

Refranchising will immediately help eliminate some unnecessary G&A.  While the majority of players in the restaurant space have transitioned closer toward asset-light models, Panera has taken the opposite approach.  Over the last four years, the percentage of company-owned stores has increased from 42% to 49%.  I understand these acquisitions were accretive to earnings at the time, but you now have a bigger problem on your hands.  As you know, you are the one responsible for investing shareholder capital to fix them.  Currently, your franchisees only operate approximately 51% of Panera’s bakery-cafes.  Given that these franchisees are well-capitalized (35 franchise groups operating approximately 27 bakery-cafes each), selling stores probably won’t be a challenge.  Even if current franchisees are out of the question, Panera is a highly desirable concept which, given the amount of liquidity in the market place, makes it likely that there are a number of potential buyers available.

 

Lastly we will be publishing our detailed thoughts in the coming weeks.  We believe that changes to your current business model will significantly enhance the margins, returns and overall earnings power of the company.  We put the base line earnings power of the company between $8-10 per share and the implied stock price between $240-$300  

 

I hope that you will consider some of my suggestions.

 

Regards,

 

Howard Penney


FLASHBACK | The Bear Case on $BABA: What The Street Is Missing

Takeaway: China’s Elite drives BABA’s GMV. BABA's user growth moving forward will come from a much weaker consumer; a double-edged sword for its GMV.

Editor's note: Hedgeye Internet & Media analyst Hesham Shabaan has basically been the only bear on Alibaba and has been highlighting the major risks to the BABA story since 10/21/14. Since then, we've witnessed the validation of his bearish thesis within BABA’s quarterly earnings with the emergence of a new concerning trend that landed BABA on our Best Ideas list as a Short on February 11. We are hosting a special call outlining the bear case on BABA this Thursday March 5th at 1pm. Ping sales@hedgeye.com for full access. The note below was originally published on November 26, 2014.


INTRODUCTION

We hosted a call last week laying out our BEAR case on BABA, and the key metric we're tracking to time the short opportunity (contact us for the deck and replay).  We're going to publish a series of short notes detailing the salient points from the call.  This is the first, and maybe the most important.

  

KEY POINTS

  1. CHINA’S ELITE DRIVES BABA’S GMV: Both GMV/Active Buyer (average spend) and its cohort commentary suggest China’s upper class drives its GMV.  After comparing these metrics to China consumer demographic data, there is no other plausible explanation.
  2. GROWTH WILL COME AT A PRICENew BABA consumers will have considerably less funds to spend.  In turn, user growth will pressure BABA’s average GMV; turning what was a growth driver into a headwind, and leading to a sharp deceleration in GMV growth through F2017.  Note that ~85% of BABA’s revenues are linked to its GMV.

 

CHINA’S ELITE DRIVES BABA’S GMV

The average consumer on BABA’s China Retail sites spends roughly ¥6.5K annually (~USD $1.1K).  In the chart below, you can see the distribution of China’s internet users by income (red columns) and what BABA's average GMV would represent as percentage of their incomes (orange columns).  In short, BABA’s GMV would be a prohibitively large amount for most consumers in China; especially since BABA can’t sell’s everything.   

 

FLASHBACK | The Bear Case on $BABA: What The Street Is Missing - BABA   China s Elite

FLASHBACK | The Bear Case on $BABA: What The Street Is Missing - BABA   Can t Sell Everything

 

The other thing to consider is BABA’s cohort commentary on its F2Q15 earnings call, which we have pasted below. 

 

BABA F2Q15 Earnings Call (Maggie Wu): “Let me share with you some color on this average spending per buyer. As I said that the longer customers stay with us, the more they're going to spend annually on our platform. I'll give you an example”

    • “The customer who stayed with us for a year's time, their average annual spending level is somewhere around RMB 1,000
    • “And for the ones who stayed with us for five years' time, their spending level is somewhere around RMB 15,000
    • “And then for the ones who stayed around 10 years, their levels is going to above RMB 30,000

 

The amounts spent by those on the platform for more than 5 years are just jaw-dropping when you consider the income distribution of China’s internet users.  If we compare these metrics to the first chart above, only 5% to 14% of China's internet population at most could afford to spend ¥15K-¥30K annually; let alone BABA's ¥6.5K average GMV. 

 

GROWTH WILL COME AT A PRICE

The obvious takeaway is that BABA’s GMV is currently hostage to the whims of its upper class consumers.  What’s more concerning is that GMV growth moving forward will be driven primarily by new consumers with considerably less to spend.  In turn, new user growth will come with disproportionately lower GMV growth since average GMV is facing decline; turning what was a growth driver into a headwind.

 

We illustrate this dynamic in our China GMV Market Model, which is driven by user growth and e-commerce spending projections (both by income cohort); the former being the more important driver.  As new lower-income consumers join the BABA platform, they will grow in proportion to BABA’s total users; driving down both average income and average spending of its user base. 

 

FLASHBACK | The Bear Case on $BABA: What The Street Is Missing - BABA   GMV Model Penetration

FLASHBACK | The Bear Case on $BABA: What The Street Is Missing - BABA   GMV Model growth

 

Note that roughly 85% of BABA’s revenues are linked to its GMV, which our model suggests is heading for sharply decelerating growth through F2017. 

 

We will be publishing a follow-up note with more detail on the impact of our GMV projections on BABA's business model.  In the interim, see link below for broader summary of our bearish thesis, or let us know if you would like to see our BABA deck.

 

 

BABA: Leaning Short, But...

10/21/14 07:02 AM EDT

http://app.hedgeye.com/feed_items/38742

 

 

Hesham Shaaban, CFA

203-562-6500

hshaaban@hedgeye.com

@HedgeyeInternet

 


The Macro Show, Live with Keith McCullough

 

Here is the replay of today's edition of The Macro Show, featuring live and interactive commentary from Hedgeye CEO Keith McCullough. 

 

 


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KATE: A 2-Yr Double, Again

Takeaway: We think numbers are still too low, and that 2015 will be a break-out year for KATE. There’s a clear roadmap to a $75 stock. 2-yr double.

Though most key metrics were already reported, this was a stellar quarter for KATE – marked by a) 28% comps (a 600bp sequential acceleration on the 2-yr), b) 31% growth in global store growth, c) 50%+ growth in e-commerce (2x+ acceleration from 3Q), d) a 21.2% EBITDA margin, closing (negative return), e) six new licensing agreements, and f) swift execution on the closure of Jack Spade and Kate Saturday. And all of this was in its seasonally most important quarter. This model is primed and loaded to have a fantastic 2015.

 

We’re Above Consensus. That said, we think that management was being overly cautious with its targets for 2015. There are so many levers in this model, and our sense is that the company downplayed them. KATE guided to $185mm-$200mm in EBITDA for the year – assuming the top end of revenue guidance, that’s 15.7%, or about flat on a year/year basis. But we’re modeling $237mm, or about 110bp higher than last year. That’s about 65% EBITDA growth for the year, a number we expect to moderate only slightly to 50% the year after.

 

Quite frankly, we like the company’s conservatism, as it will keep expectations grounded, and mitigate the liklihood of an earnings day sell-off, which happens too often for KATE to call it a coincidence.

 

What’s It Worth? So that begs the question as to what we should pay for KATE. By the end of this year, we’ll be eyeing about $345mm in EBITDA and $1.30 in EPS.  When looking at the 50% and 100% growth rates in EBITDA and EPS, respectively, we could definitely argue a big multiple. On the flip side, this is a fashion business, and there will almost certainly be a time (like KORS is experiencing now) where it will see multiple compression as it matures.   But keep in mind that KORS has a brand footprint of $6.4bn and EBIT margins of 30%. KATE has a $1.4bn footprint (smaller that Tory Burch at $1.9bn) and margins of only 11%. It will be a long time before we have to ask the ‘is it over’ question. Until then, we think the multiple will continue to defy gravity in the eyes of anyone that’s not a growth investor.

 

For argument’s sake, let’s keep the forward multiples in place that KATE has today – 50x earnings and 19x EBITDA. We think that there’s upside this year as the company beats. But on 2016 numbers we’re looking at 50x $1.32 = $66, or 19x EBITDA in the mid 50s. Roll ‘em to ’17 and you get to over $2+ in earnings power, or around a $75 stock.

 

KATE: A 2-Yr Double, Again - kate1

 

Here’s A Few Things That Were New To Us on The Call Today

License Agreements

-          KATE announced 4 new home license agreements to the portfolio today. That gives them 6 on the year in mostly focused in the home/tableware department, but the one we think presents the biggest opportunity is on the watch front with FOSL.

-          The way the math works, it’s good for $0.02-$0.03 in year 1, a nickel in year 2, and $0.10 in year 3.

 

Store openings

-          The company guided to 50-55 new KSNY stores for the year. Net out the Saturday and Jack Spade closures for the year and it equates to 24 new openings for the year.

-          It’s important to remember that these stores are not create equally. We think it’s generous to assume that KSS and Jack operate at 50% of the unit productivity of the flagship banner. Sales per average unit for the year were $4.5mm, meaning the combination of Saturday and Jack were in the $3mm ballpark while KSNY was producing at $4.7mm per box.

-          Not only that, but if we assume that the average Jack/Saturday box was plugging along at $3mm per unit, that means it was a $91mm retail operation with an operating loss of 21mm for the year. That’s a -23% EBIT margin.

 

Gross Margins

-          There was a lot of convoluted talk on the call around gross margins that we have to admit we had to read 3 times just to understand what the heck George was talking about. Here is our summary in plain English.

-          Inventory liquidations in the Saturday/Jack brands equated to a $14.4mm hit in gross margin. That’s 126bps of the 210bps erosion during the year. Then you have to factor in the fact that the two sister brands were operating at a gross margin about 1000bps+ below KSNY. That tells us Kate Spade proper was humming along at a 62% gross margin clip – we don’t think that Fx (which is 80% hedged) or a few new outlet doors will offset that.

 

EBIT/EBITDA Margins

-          Consolidated EBITDA margins ended the year at 12.6%. Up 200bps YY. The combination of Jack Spade and Kate Spade Saturday ate away 310bps in EBITDA margin. $6.4 from the 2Q14 inventory liquidation and another $29mm in 4Q.

 

Brian McGough

Alec Richards


CRUISE PRICING SURVEY FEB 2015

Takeaway: Caribbean was better in February but European risks remain

CALL TO ACTION

With oil prices no longer an EPS tailwind - bunker fuel gained 15% in February MoM - yields have to deliver. Our latest pricing survey uncovered mixed results, both from a market and company perspective.  Following the slowdown in our January pricing survey, pricing pivoted favorably, in part to one of the coldest February’s on record in North America.  CCL in particular seems to have improved.  However, Europe pricing moved lower again.  RCL pricing in this market was disappointing and we remain most cautious on the name. 

 

Please see our detailed note:

http://docs.hedgeye.com/CRUISE_PRICING_FEB_3.3.15.pdf

 


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