"The epic ramp in China continues with the Shanghai Composite up another +3% overnight to +40% year-to-date," Hedgeye CEO Keith McCullough wrote this morning. "It's now up +96% since OCT 2014 as speculation runs rampant about precisely what at this point, we do not know!"
In this excerpt from today’s edition of RTA Live, Hedgeye CEO Keith McCullough discusses an area in the market we’ve been (and remain) bullish on. He also discusses one of our Retail team’s biggest calls, Restoration Hardware (RH).
Editor's Note: This is an excerpt from a note sent out earlier this morning by our Retail team. Click here for more information on our array of services and how you can subscribe.
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Good article today in WWD - Free Shipping: Retail's New Battleground
Takeaway: Free shipping = an offensive weapon for retailers to gain market share.
We have seen it used sporadically from players in the department store/mass channel. Most notably, Target (TGT), who over the holiday season eliminated the free shipping threshold all together, and then in February cut its free shipping threshold from $50 to $25.
Over the next 18-24 months, it's likely we see free shipping across the board. That will manifest itself during this holiday season when retailers make a free shipping offensive play.
We've seen retailers, most notably Kohl's (KSS), talk about how a $25 shipping threshold isn't sustainable from a profitability perspective. We agree with the company on that.
For Nordstrom (JWN), it makes sense to offer free shipping and returns given the basket size, but for the mid-tier space...it's 600-1000 bps dilutive. The problem is that a)
- Consumers want it (in chart below its nearly twice as important as any other online shopping feature)
- If one domino falls, all others will have to move accordingly
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Takeaway: PNRA remains on our Investment Ideas list as a long.
No Edge On The Quarter
This was likely a tough winter for Panera, considering its exposure to the Northeast, but same-store sales estimates of +2.2% seem to reflect this as they lag Black Box industry same-store sales of +3.0%. While we believe initiatives are driving a sales and traffic lift, incremental costs associated with these initiatives are increasing and we, along with the rest of the street, don’t have the greatest clarity around the potential impact of this.
Buy It On Down Days
While limited visibility kept us away from the long side for most of 2015, the announcement of several initiatives a week and a half ago tell us that Mr. Shaich is serious about righting the ship. While visibility is still somewhat limited, we see an asymmetric setup to the upside here. Estimates have come down 6% and 12% over the past three and six months, respectively, and the stock has underperformed the XLY to a large extent over the past three years. Importantly, management has a feasible opportunity to reverse this trend. This is a stock you need to buy on down days.
Management Commentary Is Paramount
While the recently announced initiatives are certainly a good starting point, they’re far from the endgame here. Levering up, refranchising, and buying back shares should support the stock over the intermediate-term as management works to operationally fix the business, but we see opportunity to go significantly above and beyond this. This is the first time management will address the investment community in a public forum since this announcement and additional commentary will be paramount. We laid out the activist playbook on a Flash Call immediately following this news, but don’t know to what degree management will be receptive of our suggestions. We believe there’s a significant opportunity to enhance Panera 2.0 (or create Panera 3.0), slow unit growth, aggressively refranchise stores, reduce capital spending, cut excess G&A, and sell off non-core assets such as the distribution business. We hope to hear about recent developments on any of these fronts on the call tomorrow.
Breaking Down 1Q15 Estimates
Same-Store Sales: The street is looking for 1Q15 EPS of $1.43 (-7.5% YoY) on sales of $659.1 million (+8.9% YoY). The system-wide comp outlook (+2.2%) represents a 90 bps sequential slowdown in the two-year average.
Cost of Sales, Labor Costs, Other Restaurant Expenses, and Restaurant Level Margins: The street expects cost of sales as a percentage of revenues to increase 26 bps YoY. We suspect PNRA could deliver a slight “beat” on this line considering the rather benign food inflation the industry is seeing to-date. At this time last year, Panera had 80% of commodity needs locked. Labor costs and other restaurant expenses as a percentage of revenues are expected to increase 132 bps and 5 bps YoY, respectively. We are in-line with these estimates. This would imply restaurant level margins of 16.87%, down 164 bps YoY. We could see a little bit of upside to this line depending on how cost of sales shake out. We note that this line has been a source of upside for multiple companies (CAKE, CMG) that have already announced 1Q15 results.
G&A Expenses and Operating Margins:
G&A as a percentage of revenues is expected to increase 13 bps YoY to 5.91%. We have little clarity on this line given the timing of certain initiatives, but wouldn’t be surprised if it proved to be conservative. Operating margins are expected to decrease 192 bps to 9.15%.
Sentiment and Valuation
With a $177 average target price and only 37% buy ratings, the sell-side community remains rather cautious on the name. Short interest comprises 10.9% of the float. At only 12.1x EV/EBITDA (NTM), Panera trades at a significant discount to the majority of its quick-service peers. An accelerated transition to an asset light model should result in immediate multiple expansion.
04/20/15 Monday Mashup
04/22/15 CMG: Rinse & Repeat
04/22/15 YUM: It’s A Win-Win
Events This Week
Monday, April 27
- ARCO annual general meeting 8:00am EST
- QSR earnings call 8:30am EST
Tuesday, April 28
- FRGI annual general meeting
- DFRG earnings call 8:30am EST
- PNRA earnings call 8:30am EST
- BWLD earnings call 5:00pm EST
Wednesday, April 29
- BLMN annual general meeting
- PZZA annual general meeting 11:00am EST
Thursday, April 30
- KONA annual general meeting
- DIN earnings call 11:00am EST
- FRGI earnings call 4:30pm EST
- HABT earnings call 5:00pm EST
Friday, May 1
- RUTH earnings call 8:30am EST
- YUM annual general meeting 9:00am EST
Recent News Flow
Monday, April 20
- BWLD launched the B-Dubs Fast Break Lunch program, available weekdays between 11:00am – 2:00pm at U.S. locations and 11:00am – 3:00pm at Canadian locations. The program offers food choices tailored for guests looking to eat a quick lunch. Under the program, guests can select from one of seven entrees alongside one of seven sides. BWLD will advertise for the program through a national radio campaign in addition to its social and digital channels.
- JMBA Chairman, President and CEO, James D. White, presented at the Franchise Times Franchise Finance and Growth conference.
- RRGB introduced the new Spring Chicken Burger and The Oh, My Darlin’ adult cocktail for the spring season.
- PLAY announced that Patricia H “Trish” Mueller has been appointed to the board as an independent director. Ms. Mueller has served as Senior VP and CMO of The Home Depot since February 2011 and has held prior roles at The Sports Authority, American Signature, Value Vision, and ShopNBC.
- RUTH announced that Mark Osterberg, Principal Accounting Officer, has notified the company of his pending departure, effectively immediately. Current CFO, Arne Haak, will assume the responsibilities of Principal Accounting Officer. In addition, Michael Hynes, Controller and Director of Accounting, has been promoted to VP of Accounting. Mr. Osterberg will continue to serve as an advisor to the company.
Tuesday, April 21
- PLKI announced the pending retirement of R. William Ide, III, who has reached the mandatory retirement age for board members. Mr. Ide has served on the company’s board of directors since 2001 and will not stand for re-election at the annual shareholder meeting this year.
Thursday, April 23
- JMBA celebrated “25 Years of Healthy Living” with a free juice and smoothie giveaway from 9:00am – 11:00am to guests across the nation.
- DNKN announced that John Costello, President, Global Marketing and Innovation, will retire in mid-2016. Mr. Costello will continue to serve in his current position until he retires, but will transition to a more strategic role focused on the evolution of the company’s brands with a particular focus on the international businesses.
- DNKN announced that its board of directors declared a quarterly cash dividend of $0.265, payable on June 17, 2015 to shareholders of record on June 9, 2015.
Friday, April 24
- PZZA announced its latest limited-time offer, all-new Garlic Knots, that will allow guests to pair a large two topping pizza with new Garlic Knots. Guests that order online will receive a $1 discount. The LTO will run through May 24.
The XLY (+3.2%) outperformed the SPX (+1.8%). Quick service stocks, in aggregate, outperformed the XLY, as casual dining stocks underperformed.
From a quantitative perspective, the XLY remains bullish on an intermediate-term TREND duration.
Casual Dining Restaurants
Quick Service Restaurants
Risk measures are currently neutral (intermediate term) to positive (short-term). The obvious flash point is Greece, which continues to play chicken with the EU. That said, while the probability of Greece's exit from the Eurozone continues to rise, the expected fallout from Grexit appears to continue to fall.
European Financial CDS - Swaps mostly tightened in Europe last week. However, with the continued absence of a deal for Greece's bailout, bank swaps in that country widened between 298 bps and 639 bps.
Sovereign CDS – Sovereign swaps mostly tightened over last week. Spanish and French sovereign swaps tightened the most, by -5 bps to 100 and -3 bps to 38, respectively.
Euribor-OIS Spread – The Euribor-OIS spread (the difference between the euro interbank lending rate and overnight indexed swaps) measures bank counterparty risk in the Eurozone. The OIS is analogous to the effective Fed Funds rate in the United States. Banks lending at the OIS do not swap principal, so counterparty risk in the OIS is minimal. By contrast, the Euribor rate is the rate offered for unsecured interbank lending. Thus, the spread between the two isolates counterparty risk. The Euribor-OIS spread tightened by 2 bps to 10 bps.
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