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August 6, 2015

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BULLISH TRENDS

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BEARISH TRENDS

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WEN | Performing Well for Now

Wendy’s (WEN) was added to our SHORT bench as a result of our LONG thesis on McDonald’s. We still believe that it might be adversely affected by the resurgence of McDonald’s, but it’s not time to go SHORT on WEN yet.

 

Yesterday, WEN reported 2Q15 results, for the most part outperforming consensus, but as management put it, has room to improve on their value offering. The company-owned comp was +2.4% versus consensus of +1.7%, a 150bps decline YoY. This quarter was their toughest comp of the year at +3.9%, comps get easier in the 2H of the year. Total company revenue of $489.5mm beat consensus of $486.3mm, representing a decrease of -6.5% due to refranchising efforts. Company-owned restaurant level margins increased 40bps to 18.2%, beating estimates of 18.1%. Adjusted EPS came in at $0.08 below consensus of $0.09, representing an -11% decline YoY.

 

WEN | Performing Well for Now - 2Q15 CHARTS

 

Reimaged stores are having a strong impact, seeing 10-15% sales increases post completion, with 40-50% of that flowing through. Newly remodeled stores drove 170bps of the system-wide same-restaurant sales growth of 2.2%, which was above estimates of 1.6%. Management stated they are continuing to see strong results from core menu items and LTO’s. Recently introduced a refurbished chicken sandwich featuring new marinade and antibiotic free chicken, in certain test markets and hoping they can bring it system-wide. The company is notably having difficulties with price and value on some items, and working to fix it with value bundles in the $4-$6 check range. 

 

The company continues to invest in technology to improve customer interaction. They view Mobile Order & Pay and Self-Order Kiosks as a great ways to offset wage inflation, as well as improve the quality of the food and experience for the customer. Just staying on the wage topic for a moment, management was adamant that they do not, and their franchisees do not intend to pass a majority of this increase onto customers in the form of pricing. They will work on reducing staff, reducing hours, in general getting smarter around labor management. Management went as far as to say, “these wage increase will in the end hurt the very people they are intended to help.”

 

The hot topic in restaurants, the REIT was broached in this call, but largely pushed to the side by management. By 2017 they anticipate receiving $170mm a year in rental revenue, which is a strong dependent revenue stream they don’t want to get rid of.

 

MANAGEMENT OUTLOOK

WEN increased their outlook for 2015 adjusted EBITDA to $385mm to $390mm from its prior guidance of $375mm to $390mm, representing an 8% to 9% increase compared to 2014. The company also increased their outlook for restaurant operating margins by 50bps to 17% to 17.5%. EPS estimates remained constant at $0.31 to $0.33. The planned sale of 540 domestic company-operated restaurants is on schedule, and expected to provide $400mm-$475mm in pre-tax proceeds. Additionally, the company entered into an accelerated share repurchases transaction for approximately $165mm as part of a previously approved share repurchase authorization.

 

HEDGEYE OUTLOOK

We continue to think that looking out 1-3 quarters WEN sales will start to take a hit from the resurgence of McDonald’s. Until that happens this company will perform in line with expectations, comping at the 2.0% to 2.5% range. When MCD starts taking share, WEN will not be immune, it seems like the first company to get value right will win this race, our bet is on MCD. 



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RL | Two-Bagger or Value Trap?

Takeaway: RL is setting up to be a two-bagger, or the Mother of all Value Traps. We’re inclined to think the former. It’s all ‘bout mgmt. Stay tuned.

We said earlier this summer that we liked RL as a TRADE into today’s print. Fundamentally, the call played out – though we’re about flat on the stock.

 

Let’s get one thing out of the way…this RL quarter was horrible. Yes, it beat muted EPS expectations by $0.10. But revenue was down 5.3%, gross profit -7.1%, SG&A UP +4.3%, and EBIT/EPS down ~40%. Think it can’t get any worse? Think again, the cash conversion cycle is sitting  at 171 days, which is 26 days worse than last year. Finally, capex is up 25% this year, which is the icing on a really bad tasting cake. Put ‘em all together – P&L down 40% and Balance Sheet +25%, and you get RNOA of 13%, down 1,000bp vs last year.

 

Then why are we incrementally warming up to RL?  When it comes to consumer brands and retailers, some of the best longs we’ve seen (ones that double, and then double again) start with

a) positive rate of change in the balance sheet, which frees up cash to…

b) improve margins while investing in the content/Brand, and ultimately…

c) accelerate the top line. The stock will usually seem expensive early on in this process, and that’s where RL is today, as it’s trading at 17x a declining earnings stream.

 

We’ll very rarely give any company the benefit of the doubt for being able to turn such a value-eroding algorithm around – but Ralph Lauren is perhaps one of them.  The reality is that it is a brand with an aggregate value at retail of $15bn, and as the company positions its resources around its core assets on a global scale, we should see growth return, and Brand footprint go through $20bn. Specifically, as it relates to the criteria above…

a) on the Balance Sheet we should see Capex coming down next year by 25%, or about $100mm as spending on SAP, which should subsequently take the Cash Cycle down by a minimum of 25 from here (that’s $200mm in cash)

b) on the Margin line, we should see a lift from the 11.5% where it’s targeted to come in for FY16. For the record, that’s the lowest margin level –by a third – since 2005 when it faced dilution from integrating licenses(most by Jones Apparel Group).

c) better productivity in company-operated stores and e-commerce alone could add $3bn to consolidated sales – nevermind better efficiency in wholesale doors.

 

When all is said and done, in 2-3 years we could be looking at $9.5bn in sales, 15% EBIT margin and $11-$12 in EPS. The CAGR that would require such growth (25-30%) would arguably support a 20-25x multiple on $11+ in earnings. That’s when RL becomes a two-bagger.

 

All that said, we have to get comfortable with one thing, and one thing alone – and that’s management. We outlined the risks to that part of the story in our recent vetting book [LINK: CLICK HERE]. Aside from the fact that RL has the seventh oldest CEO in the S&P – and one who is more active today than ever in the day to day operation of the company, there are six new divisional presidents who need to learn their own job as well as hire and subsequently motivate teams of expensive people to be productive. That’s not a 1-2 quarter phenomena.  

 

We’re going to take RL up another notch on our Idea List, and will further vet the management angle before adding it to our Best Ideas.


McCullough: Just Say No To Losing Money

On The Macro Show today, Hedge CEO Keith McCullough defended his track record on calling out late-cycle economic and market conditions amid a sea of perpetually bullish research on Wall St.

 

Subscribe to The Macro Show today for access to this and all other episodes. 

 

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Making Sense of DM Asia, Emerging Market Macro Data

***The roundup below is an example of our daily internal data-driven research process. Specifically, it helps our team contextualize the key economic releases and policy developments occurring across Developed Asia and Emerging Market economies on a daily basis. To the extent you'd like to be BCC'ed on such emails please shoot us a quick note and we'll add you to the list.***

 

  • Key Takeaways:
    • Lots of interesting data to grind through today, specifically the July Markit Services and Composite PMI data, which, on balance was better than I would have expected. Looking to the composite indices specifically, China, Hong Kong and South Africa ticked down, Japan was flat and India, Australia, Singapore and Russia all ticked up. Globally speaking, however, the trend of #GrowthSlowing generally remained intact in July with our #EuropeSlowing theme picking up steam (see: Hedgeye Macro G-20 Composite PMI Summary Table).
    • The big news out of China today was the IMF’s decision to delay changes to the SDR basket from 1-Jan 2016 until September 2016, which buys China additional time to for necessary capital account reforms that would help the yuan meet the IMF’s definition of a “freely usable” currency. This has interesting implications for the global economy. On one hand, it may give Chinese policymakers scope to devalue, which would be as deflationary for manufactured goods [globally] as it would be inflationary for raw materials. For more details, refer to the following: “China SDR Discussion” and “Is Consensus Right On China?”. All told, we do not, however, think a devaluation is imminent as Chinese policymakers remain [at least rhetorically] committed to achieving reserve currency status for the yuan sooner rather than later.
    • Don’t look now, but suddenly Indian equities are the best performing factor exposure within the EM Equities asset class (see: slide 19 of our refreshed TACRM presentation). Our GIP Model had been calling for #Quad3 [marginal] stagflation here in the third quarter, but that’s not being confirmed by the first batch of 3Q data or in real-time market prices across the commodity space (which Indian CPI is unduly hostage to). Specifically, India’s Services and Composite PMI readings ticked up big time in July and call attention to the stimulus being thrust upon the Indian economy as a result of falling food and energy prices. If the bounce is sustainable (i.e. the SENSEX and EPI register bullish on our TREND duration signals), then we can get behind this narrative. For now, we are not inclined to chase given the elevated risk of a FOMC policy mistake in September.
    • As expected, the Bank of Thailand kept its one-day bond repurchase rate at 1.5% – in line with consensus. They probably want to cut given that both the finance ministry and BoT have recently cut their growth forecasts, but the baht is weakening substantially (-3.9% MoM) on a commensurate acceleration in capital outflows amid consensus speculation that the Fed is gearing up to hike rates in September. With Thailand’s economic growth slowing precipitously (see: Composite PMI, Exports, Industrial Production, Retail Sales, Consumer Confidence, GIP Model), we expect such trends to continue and view the +2% WoW bounce in the SET Index as a short-selling opportunity in the THD.
  • China
    • JUL Caixin Services PMI: 53.8 from 51.8
    • JUL Caixin Composite PMI: 50.2 from 50.6
    • IMF delays making change to SDR basket until September 2016 (StreetAccount):
      • An IMF staff paper on the 2015 SDR basket recommended delaying changes to the basket from 1-Jan 2016 until September 2016 as it reviews the current composition of currencies.
      • The IMF said the review would help determine whether the yuan met the definition of a ‘freely usable’ currency. MNI cited a conference call involving a senior IMF official, who added a number of issues had to be resolved before adding the yuan to the basket.
    • China's policy banks to place CNY1T bond to fund infrastructure projects (StreetAccount):
      • Sources told the Economic Information Daily that China Development Bank and Agricultural Development Bank of China will privately place special bonds with the Postal Savings Bank of China.
      • The first CNY300B of a planned CNY1T will be used to establish an equity fund to invest in big infrastructure projects.
      • The sources said that the projects will be chosen from a list submitted by the NDRC.
      • Later, MNI cited analysts who said that the increased reliance of the government on banks reduce the chances for system-wide easing.
      • A separate FT article highlighted the policy banks' heavy exposure to domestic infrastructure and property markets.
    • Cai says GDP only needs to grow at 6.5% (StreetAccount):
      • The People's Daily cited Chinese Academy of Social Sciences deputy head Cai Fang who noted that the economy needed to average 6.5% annual growth during the 13th five year plan (2016-2020) to meet the goal set in 2010 of doubling GDP.
      • Cai said that this is achievable, and the paper noted that the government has started to draft its 13th five-year-plan.
  • Japan
    • JUL Services PMI: 51.2 from 51.8
    • JUL Composite PMI: flat at 51.5
    • Corporates outperform regional peers (StreetAccount):  
      • Bloomberg reported that 159 of Japanese companies included on the Topix have reported better-than-expected results, while 97 have missed.
      • The article noted that only 74 companies included on the MSCI Asia Pacific ex-Japan have beaten estimates, while 96 have reported results below expectations.
      • Although it noted that the strong corporate results have not yet translated into the domestic Japanese economy, analysts see continued profit growth over the next two years.
  • India
    • JUL Services PMI: 50.8 from 47.7
    • JUL Composite PMI: 52 from 49.2
  • Korea
    •  
  • Australia
    • JUL AIG Services Index: 54.1 from 51.2
  • Taiwan
    • JUL WPI: -10% YoY from -9.4%
    • JUL CPI: -0.7% YoY from -0.6%
  • Indonesia
    • 2Q Real GDP: flat at 4.7% YoY
      • QoQ: 3.8% from -0.2%
  • Thailand
    • Thai Baht Weakens Toward 2009 Low as Central Bank Holds Key Rate (Bloomberg)
      • Thailand’s baht fell toward a six-year low as global funds sold the nation’s assets and the central bank left borrowing costs unchanged ahead of a possible increase in U.S. interest rates.
      • The Bank of Thailand kept its one-day bond repurchase rate at 1.5 percent Wednesday, a decision predicted by 21 of 23 economists in a Bloomberg survey. Global funds have pulled a net $157 million from stocks and bonds this week as the finance ministry cut its 2015 economic growth forecast to 3 percent on July 28 from an earlier estimate of 3.7 percent. Exports have contracted for six straight months.
      • The economy’s recovery is expected to maintain a similar pace to the second quarter for the remainder of the year, the monetary authority said in a statement today. Headline inflation is likely to have bottomed out and will pick up in the second half, it said.
      • “The monetary policy stance now is accommodative and will continue to be accommodative to support the economy,” Assistant Governor Mathee Supapongse told a news briefing. The central bank “will stand ready to utilize an appropriate mix of available policy tools to support the economic recovery.”
      • The central bank has decided to lower its economic forecasts and will announce them next month, Mathee said.
      • The finance ministry last week cut its forecast for GDP growth this year to 3 percent, which would be among the slowest in developing Asia. Exports, which make up the equivalent of more than half the economy, may contract 4 percent, it said.
  • Other Asia
    • Singapore
      • JUL Composite PMI: 51.3 from 51.1
    • Hong Kong
      • JUL Composite PMI: 48.2 from 49.2
  • Brazil
    •  
  • Mexico
    •  
  • Other LatAm
    •  
  • Russia
    • JUL Services PMI: 51.6 from 49.5
    • JUL Composite PMI: 50.9 from 49.5
  • South Africa
    • JUL Composite PMI: 48.9 from 49.2
    • JUL Business Confidence: 87.9 from 84.6
  • Turkey
    •  
  • Other Emerging Markets
    •  
  • Miscellaneous Links

 

-Darius Dale, Director


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