Painless Starts

“The marvelous thing is that it’s painless.”

-Ernest Hemingway


In one of my favorite Hemingway short stories on mortality (The Snows of Kilimanjaro), that’s how a dying man explained the beginning of the end to his wife.


“That’s how you know when it starts”, he said. “It’s painless.”


To be clear, I don’t mean to bug you out this morning. I just wanted to remind you that while it’s been painless to be long of Chinese, Japanese, European (and now, on the margin, American) “easing” (in bond/stock market terms), this won’t end well.

Painless Starts - bubble cartoon 09.09.2014


Back to the Global Macro Grind


‘How could you write such a thing? Et tu, brute? How can you be bullish for the last leg of this ramp and, at the same time, remind me how it all ends? I knew it Mucker… you are a perma bear! You bastard.’


Enough of my literary attempts to entertain you, eh. Let’s just stick with the data (and some hilarious headlines for this stage of what’s been nothing short of an epic inflation of global stock and bond market prices):


  1. Chinese “investors” open a record number of stock brokerage accounts week-over-week (
  2. Mystery Traders armed with algorithms rewrites Flash Crash story (
  3. Greek Contagion risks may be higher than you think (


Ok. Maybe it’s not hilarious. I was just looking for some alliteration. But it is extremely amusing (which is the definition of hilarious).


As you know, mainstream media (especially Financial media), chases its own tail in its perpetual quest to prove to its advertisers that yesterday’s news matters today. #RatingsAtAllTimeLows


The way that these headlines work is that they are pro-cyclical to price action (i.e. they chase stories/price):


  1. Chinese stocks (Shanghai Composite) ramped another +2.4% overnight to +36.1% YTD
  2. Storytellers have been trying to become famous writing about the Flash Crash for years
  3. Oh, and if you didn’t think Greek stock market risks were real, you’re losing money long that


Since I haven’t had one real Institutional Investor ping me on the latest trader to sport the orange jump-suit risk for flash crashing the party (for a day), I give you a few more fun facts about Chinese and Greek stocks, instead:


  1. CHINA: since growth and inflation really started slowing in OCT, the Chinese stock market is +92%
  2. GREECE: since mainstream media started trumpeting “Greece Fixed” in DEC, Greek stock market -32%


In Hedgeye-speak, that makes China a bullish intermediate-term TREND and Greece a bearish one. If intermediate-term (3 months or more = TREND duration) is too short-term for you, look at both of these country stock markets year-over-year:


  1. CHINA: Shanghai Composite Index = up +112%
  2. GREECE: Athens General Share Index = down -44%


“So”, what I’d really need to get bullish on Greek stocks is:


  1. The Greeks telling the world the half truth (like China did) about slowing growth and #Deflation
  2. The Germans confirming that they get the truth, but have no intention of letting Greece “exit”
  3. And the mother of all Greek bailouts right when CNBC/Bloomberg are as bearish as they were on China last year


The death of the lies is where the painless progression starts, no?


It worked in Ireland and Iceland (sort of). And while I completely disagree with the policy to bailout losers, my political view on that front would have rendered my research opinions useless for the last 5-6 years too.


Can you imagine being the “smartest” man on earth right now (per yourself) and short Chinese stocks from last year’s lows? There is nothing painless about hubris. And I’ll define that in market terms for you too – not respecting Mr. Macro Market’s message.


I’ve lived and learned through this entire central planning circus alongside you, writing and ranting about it, almost every day for 7 long years…


I’ve always thought this won’t end well. But “ends” are processes, not points. And I’ve tried to time the beginning of the end as painlessly as possible. Because realizing perpetual P&L pain is no way to live.


Our immediate-term Global Macro Risk Ranges (with intermediate-term TREND views in brackets) are now:


UST 10yr Yield 1.85-1.95% (bearish)
SPX 2082-2112 (bullish)
RUT 1 (bullish)
DAX 115 (bullish)

VIX 12.37-15.27 (bullish)
USD 97.04-98.76 (bullish)
EUR/USD 1.05-1.08 (bearish)
YEN 118.99-121.14 (bearish)

Oil (WTI) 49.35-57.69 (bearish)
Natural Gas 2.44-2.65 (bearish)
Gold 1182-1209 (neutral)


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Painless Starts - 04.22.15 chart

CMG: Rinse & Repeat


CMG is indicated down premarket despite delivering another rockstar quarter.


Suffice to say, we've seen this story before.  Near-term concerns are legitimate, particularly given its lofty multiple, but "comping" mid-single digits while lapping +17-20% same-store sales growth is not a big deal to us.  Considering the long-term story is fully intact, we’d view notable dips moving forward as buying opportunities. 


This concept and company have never been stronger.


Earnings Recap

Revenues and same-store sales fell slightly short of estimates, but EPS came in well-above consensus at $3.88 vs $3.65 led by lower than expected cost of sales (benefit from dairy and avocados) and G&A expenses.  Same-store sales growth of 10.4% comprised of 6.1% price, traffic, and a minimal bump from average check.  Importantly, with pricing rolling off midway through the year, management plans to increase the price of its steak and barbacoa by the end of 3Q.  During the quarter, management repurchased $23 million worth of its common stock and has $170 million remaining on its share buyback program.  In addition, CMG continues to have no debt on its balance sheet.


CMG: Rinse & Repeat - 1


There’s More To The Story

In our view, there’s more to the story here than a temporarily decelerating top line.  This isn’t new news, in our view, and should be fully digested by the market.  A cursory look at the two-year average of +11.9% tells us things are just fine, and comes despite an estimated 100-200 bps negative impact from a harsh winter and backlash from the carnitas shortage.  Even with the disappointing comp, CMG realized significant operating leverage as cost of sales declined 59 bps y/y, restaurant level margins expanded 157 bps y/y, and operating margin expanded 316 bps y/y.  CMG boasts a best-in-class operating model that continues to show notable upside while continuing to grow units at a double digit clip.


Fundamentals Are Best In Class

Chipotle currently operates at all-time high restaurant level margins and AUVs.


With throughput constantly improving (+21 transactions per day in the quarter), catering ramping, more aggressive marketing, and mobile payment in the works, the opportunity for further growth is readily apparent.  To be clear, we think there is upside to the low-to-mid single digit comp guide, although our bullish bias partially discounts this.


Given the high returns it continues to see from new units, the company will continue to grow Chipotle at a double digit rate for a very long time and is currently molding two futures growth vehicles -- ShopHouse and Pizzeria Locale.  Valuation may be tough for some to swallow, but the stock trades at a discount to its five-year average of 40.7x P/E at a time when the fundamentals have been stronger than ever before.  Decelerating top line trends will be short lived and, while it gives the bears something to talk about, there’s a lot more positives that we can think of.  Even at 1,800+ restaurants, it will be difficult for investors to find a stronger growth story in the restaurant space.


Cash Is King

While this often goes overlooked, it is notable nonetheless.  Given Chipotle’s bullet proof balance sheet and over $1 billion cash and cash equivalents on hand, management has a number of levers it can pull—if necessary—to support shares over the intermediate-term.


CMG: Rinse & Repeat - 2


Takeaway: Latest data on bet levels in March corroborate our assertion that Street is underestimating the degradation in Macau’s grind mass segment.

  • Observed premium and grind mass posted minimum bet levels were lowered on average again in March.  Our new dataset, observed average bet levels, also continued its trend lower in March. 
  • We believe both metrics are indicative of demand.  Minimum bet levels are a measure of pricing set by the casino.  Observed average bet amounts are not as reliable but in the aggregate should directionally track true average bet.  Average mass bet size multiplied by the number of bettors should equal mass volumes.
  • The premium mass trend shouldn’t be a surprise. However, we’re most concerned with the trends in minimum bets and average betting levels for grind mass given the higher margins associated with this segment and the perception among analysts that it is still growing.  The data suggests otherwise.
  • Street estimates need to come down to reflect lower grind mass revenue assumptions for 2015/2016 and the associated negative margin impact.
  • While Hedgeye remains below the Street in our 2015 EBITDA projection for all Macau operators, the largest disparity (10%) remains with LVS - the most exposed operator to the grind mass segment.



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EAT: Becoming A Victim Of Its Own Success

Key Takeaway

Brinker is a great company, but we fear it is becoming a victim of its own success.  As it stands, the 16% earnings growth on 4.4% sales growth that consensus expects in FY16 looks aggressive to us, particularly with industry sales and traffic rolling over.  We don’t see how they hit these numbers and expect estimates to be revised down as the year progresses.

Earnings Recap

Brinker kicked off restaurant earnings season this morning with a disappointing 3Q15 print, as same-store sales and traffic fell short of consensus estimates.  Despite the soft top line, EAT managed to deliver in-line EPS of $0.94 due in large part to lower than expected other operating and G&A expenses.  During the quarter, management repurchased 1.7 million shares of common stock for $104.2 million and paid a $0.28 dividend.  The stock is trading down on the day, with the majority of the casual dining group following suit.

 EAT: Becoming A Victim Of Its Own Success - 11


Soft Comps Are Concerning

After years of operating margin expansion driven by strategic investments within its restaurants (new kitchens, POS systems, fryers, tabletop tablets, remodels, etc.), the brand is entering a phase that will depend on top line trends for incremental leverage.  Despite the recent menu innovation around the Fresh Mex and Fresh Tex platforms, we haven’t quite seen the bump in sales or traffic that most were expecting.  Traffic declined -0.2% in the period, though it was +0.6% adjusting for the Christmas shift, and has now been negative in eight out of the past ten quarters.  While Chili's same-store sales continue to outpace the industry, according to Knapp, its gap is narrowing.  Management attributed this to the aggressive price increases competitors are taking and noted that consumers historically tend to push back once pricing reaches the 3% range the industry is currently running at.  EAT took +0.8% pricing in the quarter and plans to take an additional +1% price increase in mid-4Q in order to offset some of the commodity pressure (burger meat, fajita beef, salmon) they are seeing.


Food & Loyalty Are The Future

While soft comps are concerning, management is betting that initiatives taken to enhance the menu will ultimately prevail and drive future growth.  They expect the Fresh Tex menu to begin to resonate with consumers as they educate the market place on what exactly it is and plan to continue to leverage the Fresh Mex menu given its high profit margins.  Chili’s also eliminated a number of low selling items from the menu, in an effort to streamline operations (improve speed of service, food delivery temperature, etc.).  Management believes it has made, and will continue to make, the proper investments on the technology front (Ziosk, NoWait) in order to drive traffic in the future.  Loyalty, in particular, will be critical moving forward and EAT now has the technology in place that they can leverage to support this effort.


The Earnings Algorithm Is Changing

It’s clear to us that the fundamental earnings algorithm of the company is changing.  A model that once heavily relied on a seemingly endless stream of strategic operational improvements to increase margins is now transitioning to one dependent on sales and traffic growth.  This concerns us given recent trends and will continue to heading into FY16.  Loyalty could ultimately be the top line driver the company has been missing, but we suspect ramping up the program will take longer than most suspect.  Brinker is a great company, but we fear it is becoming a victim of its own success.  As it stands, the 16% earnings growth on 4.4% sales growth that consensus expects in FY16 looks aggressive to us, particularly with industry sales and traffic rolling over.  We don’t see how they hit these numbers and expect earnings estimates to be revised down as the year progresses.


EAT: Becoming A Victim Of Its Own Success - 2


EAT: Becoming A Victim Of Its Own Success - 3

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