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NKE: The Big Decoupling?

Nike's superb outperformance relative to nearly all other consumer stocks over the past year has been bound, in part, by the fact that the sell-side, long-only, and hedge fund worlds have been on the same page. 4Q's quality of earnings is likely to change that.

Let's face it. Nike's 4Q was definitely not what a $66 stock expected. I know this thing like the back of my hand and even I was surprised by the numbers. Yes, NKE beat by a penny, but in my mind, anything less than 5% upside is not a legitimate beat with Nike. Sales and GM% were both very solid, but to increase gross profit by 22% and post flat operating profit growth is a sharp reversal from the characteristics that have made this stock such a solid near-term hiding place. SG&A was obviously the big culprit due to Olympic and European Championship spending, but it will be impossible for anyone to miss that this was the biggest quarterly boost in spending since 1998. Nike got plenty of help on the tax rate, which accounted for about a dime relative to my number. The good news is that this is ongoing, but it does little to offset the 'quality of earnings' issue. The balance sheet looked good with the cash cycle improving by about 4 days vs. last year, but at a decelerating rate from what we've seen in prior quarters.

Net/net: My model still gets me to north of $4 in EPS for FY09 - which is likely 5-7% ahead of where the Street is likely to shake out. Even if the stock opens unchanged (which it won't) we're looking at 16x earnings and 9.3x EBITDA. Not ridiculously expensive, but not cheap either. This is when I turn to my Partner Keith McCullough for his take on where the stock is headed from a quantitative standpoint. His response sounded something like 'this stock is a buck away from breaking down - watch it like a hawk in the next few days.' I'll be doing just that.

No changes to my view on the long-term model - and even the near-term operating model for that matter. But with US futures flat, US EBIT down, Europe slowing on the margin, trepidation about 'what's next' in Asia after the Olympics, and pressure on the margin front for the industry, it's going to be tough to argue that we're not in one of those uncomfortable periods where volatility in this 'safety stock' picks up in a very meaningful way as views of the major constituents on Wall Street decouple.

I'm firm in my view that Nike will beat next year (based on many factors). We get sales growth and GM growth in 1H, and in 2H we get extremely easy SG&A compares to the extent that the top line weakens. If the stock does, in fact, break down, then later this summer it's a solid story to revisit vis/vis EPS beat and longer-term global growth.

CMG - Chipotle giving away Food??

Here's a free burrito to ease your gas pain [The Columbus Dispatch, Ohio]

Wednesday, June 25, 2008 4:41 PM

Jun. 25--Can a car run on beans and rice? Chipotle Mexican Grill thinks so -- sort of.

In an effort to offset the high cost of gasoline, the Mexican restaurant chain is offering customers free burritos, tacos or bowls from 5 to 8 p.m. today at Columbus-area stores -- one per person, no fax orders accepted. The company said it wants customers to be able to spend the money they'd usually spend on dinner on gasoline instead.

Discounting is never a good sign!


I like cash flow, especially if it's free. Buying the regional gaming operators at a forward free cash flow yield over 15% has historically generated outsized returns. I understand that FCF yield is a function of price so the two often move in opposite directions. However, even buying in at the beginning of the valuation cycle rarely has lead to significant losses. By my calculations, the regional gaming operators (ASCA, BYD, ISLE, PNK) are trading at an average forward free cash flow yield of 18%, very attractive indeed, especially in light of the historical precedent. The last time yields crossed the 15% threshold was the 9 month period from December 2002 to August 2003. This turned out to be a very opportune time to invest in the regional stocks. Buying the index at the average price during this period would've yielded a 125% return over the next 9 months. Even if one bought at the peak, the return would've still been 100%. Looking back even further to the elongated period of high free cash flow yields 8/98-7/2001, buying in at almost any point would've generate positive returns over the subsequent 12-18 month period. Can money be made in the current FCF cycle? Only time will tell but history and valuation support the long view. We've got our eye on PNK.

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VFC: Short

On days like today, when my macro view puts me in sell mode, I'm looking for names to short that are up. VFC gets today's nod.

Of course, it's always accommodative to have the dynamic duo of Barron's and Cramer recommending you buy it within the last week. Cramer is really having some performance problems by the way.

With only 2.3% of the shares held short, this company has been one of Wall Street's favorites in Consumer land. The problem there is implied, and creates opportunity to the downside, particularly when the Street's Q3 estimates are as far away from reality as they are from ours. There are 10 sell siders with estimates on VFC - no one has a sell on it, and an all time high of 67% of ratings are either BUY or Overweight (according to Factset).

Capital Research filed on it, and their 5.6% ownership in the company looks ripe to be sold down if we are right on the Q3 miss.

*Full Disclosure: I am now short VFC in my fund.

(chart courtesy of stockcharts.com)

Wyndham (WYN): Shorted On Strength Today

While it's not going to be as profitable a short as it was when I shorted it into JP Morgan's analyst positive recommendation last year, this is still an overvalued hotel stock, levered to the time share business, who's going to miss the Street's expected numbers by a wide margin if my Partner, Todd Jordan, is right on the sector call.

WYN still has relatively low short interest, at 4.4% of the float, and overly bullish sell side coverage. I'd short it with a $21.05 stop loss. This stock should continue to make lower highs, and lower lows.

*Full Disclosure: I re-shorted WYN today in my fund.

(Chart courtesy of stockcharts.com

SONC - More Clarity, More Concerns

In its earnings release, SONC stated that it expects 4Q system-wide same-store sales growth of 2%-4%, with partner drive-ins performing somewhat below this range. On the conference call, we learned the magnitude of this underperformance, with the partner-drive-ins expected to remain 3%-4% below the system average, which is in line with the reported 3Q results (system same-store sales -0.4% relative to the -3.9% partner drive-in number).
  • Partner drive-in traffic was negative in each month of the quarter (almost flat in May), but even with trends improving sequentially (becoming less bad), management indicated that traffic is only growing in the afternoon, which is when the company is discounting the most around its Happy Hour promotion. So the only daypart that is experiencing any traffic momentum is coming at the expense of margins (restaurant margins were down 140 bps YOY in the quarter). The company began in May to adjust its value message by promoting more combo meals and premium sandwiches to drive traffic during the more profitable lunch and dinner dayparts, but I am not sure how quickly this will translate into improved results because the company has built up such a reputation through its national cable advertising as being the place to stop in the afternoon. It will be particularly difficult in the summer months to steer its guests away from $0.99 shakes.
  • More margin pressures. SONC will be facing increased labor costs on two fronts. As I mentioned yesterday, SONC pulled the goalie to make numbers by cutting back on labor to maintain margins. The company attributes part of the fall off in partner drive-in same-store sales to the resulting decline in service, so going forward, management will have a renewed focus on customer service, which will cost money (company expects its overhead costs to increase 8%-10% in 4Q). Additionally, margins will be hit with the second round of minimum wage increases in July. And this time around, these labor cost increases will be felt more proportionately because last year the company raised its prices by 4% to help offset the rising costs. Management also blames this overly aggressive price increase for the slowdown in partner drive-in same-store sales because franchise drive-ins did not raise prices as aggressively at that time. That being said, I was surprised to hear the company is going to increase prices an additional 1%-2% this year. Although the company said it will be more strategic in its implementation of this price increase by doing so on a market by market basis, judging from recent results, the consumer does not seem ready to digest any increase.
  • And if that is not already enough, company margins will be hurt even more by commodity costs. The company did not give too much visibility around FY09 expectations (said it will provide FY09 outlook in early September), but it did highlight the more difficult environment as it relates to locking in certain commodity costs. Management stated that it is currently buying its beef requirements on a month to month basis at double-digit YOY increases, and that although it has historically used longer-term contracts to lock in these prices, that the premium charged to do so today does not make it an economical option (Please see related post Eliminating Some Certainty to the Earnings Model of the Restaurant Industry regarding commodity costs and long-term food contracts).

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