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Slowing: Growth and Inflation

Client Talking Points

#STRONGDOLLAR

Has a chicken scratch down-day yesterday and is back up vs $1.09 EUR this morning – this is very deflationary, but anyone positioned for that from JUL (last year) to JAN (this year) knows that; bearish for multi-national revenue/eps growth too. 

EARNINGS

Apple was not Google, and Industrials revenues are down 4% (earnings -8%) for Q2 reporting to-date. Most materials and energy (read: #Deflation risk) companies haven’t printed and guided to reality yet – stay tuned (and short Industrials = XLI).

RATES

Locally and globally, rates continue to make a series of lower-highs as sovereign bond market volatility calms (and dovish Fed rhetoric ramps) – long-term investors stayed with the Long Bond because they get growth/inflation slowing – people chasing charts, sold them (German 10yr = 0.76%, Swiss 10yr back to negative yield -0.01%, 10yr JGB down to 0.40%).

 

**The Macro Show - CLICK HERE to watch today's edition at 8:30AM ET.

Asset Allocation

CASH 56% US EQUITIES 2%
INTL EQUITIES 4% COMMODITIES 0%
FIXED INCOME 27% INTL CURRENCIES 11%

Top Long Ideas

Company Ticker Sector Duration
GIS

The General continues to make tough calls as they work to further streamline their manufacturing footprint as part of Project Century. Last week, announcing the closure of two plants, one in West Chicago, IL and the other in Joplin, MO, eliminating approximately 620 positions in the process. West Chicago produced cereal and dry dinner products for the U.S. Retail organization, while the Joplin facility was acquired as part of the Annie’s acquisition and produced snacks. Because of union negotiations management is expecting these actions to be fully executed by fiscal 2019. We view this as a big positive for the company as they go to a more nimble asset light model, which will save on capex and allow it to be allocated to higher growth product platforms.

PENN

According to Gaming, Lodging and Leisure Sector Head Todd Jordan, additional state gaming agencies have reported revenues for the month of June. The good news here is that Penn National Gaming remains on track to beat second quarter estimates this Tuesday July 23rd. In addition, PENN will be hosting an investor day on July 24th. We will be there and communicate any noteworthy color and developments. Bottom line? The company remains one of our favorite names on the long side and boasts the best new unit growth story in domestic gaming.

TLT

After an awful retail sales print on Tuesday, the confluence of growth slowing data reared its ugly head Friday with a +0.1% year-over-year headline CPI print for June and a UofMich consumer sentiment reading that declined to 93.3 from 96.1 in May. Note that a +0.1% inflation rate is a heck of a long way from the Fed’s 2% target. These two prints were successful in taking the 10-Year Treasury yield down 10 basis points from Monday’s highs to finish the week at 2.35%. We remain one of the lonely bulls on Treasury bonds (bearish on yields) via TLT, EDV, VNQ.

Three for the Road

TWEET OF THE DAY

VIDEO (2mins): Gold vs. Central Bankers? https://app.hedgeye.com/insights/45332-mccullough-gold-vs-central-bankers … $GLD@KeithMcCullough

QUOTE OF THE DAY

The significant problems we face cannot be solved at the same level of thinking we were at when we created them.

Albert Einstein

STAT OF THE DAY

In more than 135 years of global temperature data, four of the five hottest months on record all happened in 2015: February, March, May, and now June.

 


The Macro Show Replay | July 22, 2015

 


July 22, 2015

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BULLISH TRENDS

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BEARISH TRENDS

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Early Look

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CMG | Is a Friend to Investors not a Faux

Chipotle is on the Hedgeye Restaurants Best Ideas list as a LONG.

 

Chipotle (CMG) delivered an impressive 2Q15 when you digest the numbers and get past the same-store sales comp miss. Reported revenue was $1.20B missing slightly versus consensus estimates of $1.22B.  Same-store sales (SSS) were +4.3% missing consensus estimates of +5.8% by 150 basis points. The build-up of the comp consisted of +4% price, traffic was slightly negative at -0.3% but offset by +0.6% mix driven by catering and kids meals. Diligent management of cost of sales enabled management to deliver a bottom line beat with reported EPS of $4.45 versus consensus estimates of $4.43.

 

CMG maintained its full-year 2015 guidance for:

  1. Comps of low-to-mid-single digits
  2. Unit development of 190 to 205

 

Given current trends and the outlook for the balance of 2015 the current consensus estimate for EPS of $17.34 appears to be conservative. 

 

A few things that impacted the quarter:

  • Poor management of the labor schedule as teams work to integrate the new software caused a $0.16 impact to EPS in Q2. This is expected to be resolved through Q3 and by Q4 management expects to make up some of this headwind.
  • Regulatory calls for higher wages, CMG already pays above minimum wage, but to continue to maintain the high quality workforce, they need to stay above it.
  • Absence of carnitas is obviously still an issue but with a new supplier online CMG expects to have all restaurants loaded with pork by early Q4. No bounce back from carnitas has been included in company guidance, providing possibility of further upside.
  • Commodity inflation, Avocados sourced from California and Beef system-wide will add pressure to the cost of sales line item, but management is adamant to try to pass some of the cost onto the customers.

 

Although traffic was negative for the quarter management stated that it has turned positive in the low-single digit range in July. We continue to be encouraged by Chipotle’s continued robust growth driven by strong employees and one of the most loyal fan bases. The opportunistic share buyback program will continue to support this stock, as management steers it towards growth for many years to come.

 

Below is a look at CMG’s performance versus a year ago and consensus estimates for this quarter. Please note that green is positive performance, while red is negative performance.

 

CMG | Is a Friend to Investors not a Faux   - CHART1

 

 


LVS: A NUANCED QUARTER

Takeaway: Q2 is a wildcard for the stock but 2H 2015 and 2016 headwinds are stiff and valuation is high

CALL TO ACTION

For the first time in many quarters, for any Macau operator, we’re actually in line with Street EBITDA estimates for a quarter.  That’s the good news.  Lucky play on the Macau VIP tables could be a $30m contributor to EBITDA (3%) and is probably the reason we’re in line.  Not exactly bullish but it may be good enough.  We’re actually not sure how the stock will react to Wednesday’s Q2 earnings release.  However, we believe estimates are ultimately headed materially lower owing to declining [high margin] base mass, falling market share (already happening in July), too optimistic non-gaming expectations and a full valuation.

Q2 EARNINGS

As you can see from the following chart, Hedgeye is very much in line with the Street for Q2 revenues and EBITDA.  It’s unclear whether high VIP hold in Macau is reflected in the Street estimates but it is in the Hedgeye projection.  Our projections are not much different than those laid out in our monthly Macau conference call on July 7th.

 

LVS: A NUANCED QUARTER - 1

 

We don’t have a specific call on the stock action immediately following the Q2 release but do believe the stock is ultimately headed lower. Here are the push and pulls for Wednesday night:

  • Dividend – The odds are pretty high and seem to be priced in that there will be no change in the dividend policy.  Any softening of management’s tone regarding protection of the dividend would be a huge negative for the stock.
  • High hold % – We know LVS held high at Sands Macau, Four Seasons, and Sands Cotai Central.  It’s unclear whether high hold is reflected in consensus.  In our model, we’re projecting a $30m positive contribution from good luck (3% of overall EBITDA).  Gaming stocks will sometimes trade up on a meet or beat even if it is related to luck, but that is usually short-lived.
  • Base Mass – Another significantly down quarter in this segment should force down 2015 and 2016 estimates given the high margins in this area.
  • Non-gaming - The Street pays little attention to non-gaming revenues as Macau is seen as a gaming market. However, RevPAR and other non-gaming revenues are headed materially lower, much of which will drop to the bottom line. At some point, the analysts' models will have to reflect that.
  • MBS – We’re slightly higher than the Street on EBITDA from the Singapore property but this property is always a difficult one to model.
  • Forward commentary  – While management may positively spin some of the government signals of late, the data suggest July is not a good month for the market, nor is it good for LVS.  How much of LVS’s 2%+ share loss vs trend is due to new competition from Galaxy Phase 2 and how much is hold related?  Phase 2 does seem to be ramping, at the expense of the market, and it is targeted at LVS’s core segments.

2015/2016 OUTLOOK

While our Q2 estimates are consistent with the Street, we remain well below for 2015 and 2016 as shown in the chart below.  Our primary concern remains the trend in Base Mass – the highest margin segment - that appears to be eroding faster than the Street expects.  Our analysis of average minimum table bet levels (see our most recent analysis, “MORE MACAU PRICE CUTTING” on July 10th) shows more elevated minimum bet cuts for Base Mass than even Premium Mass.

 

LVS: A NUANCED QUARTER - 2

 

The following chart shows the breakdown of Mass between Premium and Base for the last several quarters for Sands China.  Following a flattish Q4, Base Mass revenues began to fall YoY in Q1, 2 quarters behind the first Premium Mass decline.  We believe Base Mass will continue to decline, possibly throughout 2016 which will have significant margin and EBITDA ramifications.

 

LVS: A NUANCED QUARTER - 3

 

Moreover, we think LVS market share is at risk.  Following a few hold-aided months, market share appears to be headed south.  At 22.0%, LVS’s market share is tracking 220bps below recent trend during July month to date.  Galaxy Phase 2 has not grown the market and appears poised to continue to steal share, much of it from LVS.  Supply growth over the next 2 years will be aimed squarely at LVS’s Base Mass segment.  The hotel segment and other non-gaming should also be a drag on YoY profitability with room supply peaking at ~25% next year in an already declining rate environment.  LVS is the most exposed operator to rooms.

CONCLUSION

Stock action on Thursday could go either way but the intermediate trend in the stock price should be lower. There are just too many headwinds for the Macau market in general and LVS in particular to justify a 13-14x EV/EBITDA multiple, at the high end of the historical range.


FUNDAMENTAL WALK THROUGH | SBUX

FUNDAMENTAL WALK THROUGH | SBUX - CHART1

 

SBUX reports Q3 2015 earnings after the close on Thursday, July 23, followed by a conference call at 5pm ET.  The consensus is looking for revenues of $4.86 billion, up 17% and EPS of $0.41, up 21%.  We see little upside to current consensus estimates.  

 

We are adding SBUX to the SHORT bench of our Hedgeye Restaurants Best Ideas list.

 

SBUX obviously has significant growth potential, and has had industry leading innovation as of late. But we are growing increasingly concerned by the valuation of the stock, which trades at nearly 2 standard deviations above the five year average EV/NTM EBITDA of 12.9x.  The current valuation more than adequately reflects the company’s long-term growth potential.  That being said, we do have some reservations about the current growth strategy. 

 

Some of the issues on our radar screen are:

  1. We are closely watching the amount of items they are adding to their menu, as they may be overcomplicating it, which if history proves right again, would decrease performance of the stores.
  2. Is the latest round of mobile order and pay improving throughput?
  3. CAP region sales and margin trends.

 

PRICE PERFORMANCE

SBUX shares are up 35.75% year-to-date versus up 3.29% for the S&P 500. One turn on the EV/NTM EBITDA multiple suggest 5.9% upside/downside in the name. 

 

FUNDAMENTAL WALK THROUGH | SBUX - CHART2

 

FINANCIALS

 

SAME-STORE SALES

Looking out to 3Q15, SBUX should achieve its 22nd consecutive quarter of same-store sales growth of 5% or greater, which is an impressive feat given their large store base.  Imbedded in the 3Q15 performance we are looking for management commentary about the Mobile Order & Pay as well as performance of food items across all day-parts.  Same-stores sales will slow sequentially in 3Q15, but traffic trends are estimated to accelerate globally. 

 

FUNDAMENTAL WALK THROUGH | SBUX - CHART3

FUNDAMENTAL WALK THROUGH | SBUX - CHART4

FUNDAMENTAL WALK THROUGH | SBUX - CHART5

FUNDAMENTAL WALK THROUGH | SBUX - CHART6

 

AVERAGE CHECK

SBUX’s margins have benefited from a significantly higher average check.  The check has been rising at a steady 3%-5% for the past five quarters; consensus is expecting these increases to tail off to the 2.5%-3.5% range over the next four quarters.

 

FUNDAMENTAL WALK THROUGH | SBUX - CHART7

 

TRAFFIC

Traffic growth has been historically low over the last five quarters coinciding with the historically high price increases. Management is banking on innovation and Mobile Order & Pay to get traffic back up. The acceleration in traffic is critical at this valuation, especially in the Americas.  Watch out below if traffic decelerates sequentially in 3Q15. 

 

FUNDAMENTAL WALK THROUGH | SBUX - CHART8

 

MARGIN TRENDS

 

RESTAURANT LEVEL MARGINS

Globally, SBUX is expected to see Restaurant Level Margins accelerating, but at a slower rate than in 3Q14. Margins expected to increase 84 basis points YoY to 28.41%, compared to a 205 basis point increase in 3Q14.

 

FUNDAMENTAL WALK THROUGH | SBUX - CHART9

FUNDAMENTAL WALK THROUGH | SBUX - CHART10

FUNDAMENTAL WALK THROUGH | SBUX - CHART11

FUNDAMENTAL WALK THROUGH | SBUX - CHART12

 

OPERATING MARGIN

Globally, SBUX should see operating margin expansion in every region except CAP.  On a consolidated basis, operating margins are expected to be 19.18% in 2Q15, up 68 bps year-over year.  The company should benefit from favorable coffee prices, and supply chain initiatives taking costs out of the system. 

 

FUNDAMENTAL WALK THROUGH | SBUX - CHART13

FUNDAMENTAL WALK THROUGH | SBUX - CHART14

FUNDAMENTAL WALK THROUGH | SBUX - CHART15

FUNDAMENTAL WALK THROUGH | SBUX - CHART16

 

SENTIMENT AND VALUATION

 

FUNDAMENTAL WALK THROUGH | SBUX - CHART17 

 

EV / NTM EBITDA

Trading at 16.9x EV/NTM EBITDA the stock is not cheap, and is due for a correction. Long-term we are bullish on SBUX, but we are growing skeptical of the current valuation and product line extensions. For example, if the stock were to drop down to 15x EV/NTM EBITDA, 1 standard deviation above the five year average, it would imply a ~12% decrease to todays price. This is a scenario we believe to be likely, but with the upcoming quarter and current excitement around Mobile Order & Pay we wouldn’t want to get in ahead of the print.

 

POTENTIAL DOWNSIDE

Realistically we see about ~20% downside in this name if our thought process plays out. Before being fully convicted on this idea we need to hear management’s commentary during the Q3 call. Post the call we will give you our higher conviction take on the outlook for the company.

 

FUNDAMENTAL WALK THROUGH | SBUX - CHART18

 

SHORT INTEREST

SBUX’s short interest is low, hovering right around 1% of the float.  There is not a big bet against this company.      

 

SELL-SIDE SENTIMENT

With 79% of the analysts having a buy rating on the stock and zero sell ratings, there is a very strong positive bias to the name.  Given the financial performance of the company for the past two years, the bullish bias appears to be justified. But the future looks murky, as the over complication of the menu has the potential to spell serious trouble.

 

FUNDAMENTAL WALK THROUGH | SBUX - CHART19

 

 

 

HEDGEYE RESTAURANTS IDEA LIST

 

FUNDAMENTAL WALK THROUGH | SBUX - CHART20

 

 


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