#EuropeSlowing: Still in Play

Client Talking Points


Euro Down, Stocks Down? Oh boy, that’s not what European Equities are used to – so ECB President Mario Draghi has his work cut out for him tomorrow testifying in front of Euro Parliament. With the DAX and IBEX signaling oversold (both in crash mode, down > 20% vs. April highs) tomorrow = big central-planning event day. Reminder: they can’t CTRL+Print Growth.


The USD was straight up on some kind of hope yesterday that the Fed is going go “raise rates in OCT”… C'mon man! They don’t have a press conference in OCT – and, again, the rate of change in all U.S. data continues to slow here so take these Dollar Up, Rates Up days as buying opportunities in things that have fundamentals, like Housing (ITB).


Shall we call this the head-fake “breakout” chart of the year? Or of the last 4 years? Right back down to 0.68% this morning and there’s plenty of downside left if the “data dependent” Fed calls Q3 GDP for what it is #SLOWING – staying with Long-term Bonds and stocks that look like bonds, because that’s what’s working – still short Financials (XLF).


**Tune into The Macro Show with Hedgeye CEO Keith McCullough at 9:00AM ET - CLICK HERE

Asset Allocation


Top Long Ideas

Company Ticker Sector Duration

McDonald’s remains one of our Restaurant teams Best Ideas on the LONG side.  We continue to believe that 3Q15 will be the inflection point for the company’s turnaround and that we are going to be looking at a much different company 1-3 years from now.


Urgency has been instilled from the top down by new CEO Steve Easterbrook. He wants more speed and is encouraging people to get things done faster. The food and experience provided to the customer will greatly improve over the coming months as “Experience the Future” is implemented across the system. It won’t be instantaneous though, as MCD has a lot of work to do around changing the perception to bring back customers it may have lost.


Penn National Gaming continues to be our favorite Regional Gaming stock.


Regional numbers for August have come in soft, but we predicted the August weakness. September revenues should rebound and serve as a catalyst for the stock going into Q3 earnings. On the research side we have not altered our views of PENN’s long term growth story. We continue to see more upside from current price levels. 


Slower (and Lower) For Longer remains our non-consensus call. It's nice to see that the Fed is finally starting to see what the #GrowthSlowing late-cycle data does.

  1. GROWTH: is #LateCycle and will be slower (again) in Q3 than it was in Q2
  2. INFLATION: misreported, yes – in the area code of the Fed’s 2% “target”, no

Our estimate for Y/Y% GDP for Q3 is a range of 0.1% to 1.5%. Even the Q/Q SAAR # that consensus hangs on will be comping against a 3.7% Q/Q SAAR GDP print (second revision). Good luck positioning for a rate hike. Prepare for the fade…. AGAIN.

Three for the Road


DAX Support Is ‘Gone. Shot. Dead.’… via @hedgeye



The greatest discovery of my generation is that human beings can alter their lives by altering their attitude of mind.

William James


Macy's plans to hire 85,000 employees for this Holiday Season, which is down from 86,000 last year. 12,000 of the employees will be for DTC fulfillment centers.

Cartoon of the Day: #DAX Crash

Cartoon of the Day: #DAX Crash - down DAX cartoon 09.21.2015


Excerpt from note written to subscribers by CEO Keith McCullough this morning:


The Fed’s Dollar Devaluation (EUR/USD +2.5% m/m) thing isn’t appreciated by either the DAX or Draghi (he testifies to European Parliament Wed); DAX down another -0.6% w/ keeping the crash (-20.4% since APR) in play, but signals immediate-term oversold here, for a trade.


This call is likely going to be six months early, but now is the time to go LONG DFRG.


The LONG DFRG thesis is centered on management doing the right thing.  Management needs to right size the company with significant changes to its growth/operating strategy that will significantly improve profitability.  This will take time but it’s a critical step to building a stronger company.


The plan that the DFRG management team needs to execute has been done many times before by some of the industry’s largest and most successful companies.  The following is our theory about the operational cycle that many companies in the restaurant industry tend to go through. Typically, when a concept gets in trouble, the management team’s decision-making process has followed a certain pattern.  A company’s stock becomes a buy when the cycle is complete.


THE SYMPTOM - OVERCONFIDENCE AND IRRATIONAL EXPECTATIONS— A concept loses its operational integrity when unit growth exceeds the company’s capacity to manage that growth.  Also, a concept can lose its value proposition when management raises prices too aggressively or lowers the quality of the food, leading to a decline in customer counts.


Most management teams are unwilling to acknowledge the issues and try to grow through the mistakes, which usually make the issues more difficult and costly to fix.  The grieving process looks something like this:


STAGE 1 – SETTING THE GROUND WORK — In an effort to meet aggressive unit growth targets, management makes bad real estate decisions.  Management knows from the beginning that any given sight is questionable, but opens it regardless.  From the store opening, it takes about 6-12 months (depending on the size of the company) for the street to see it in the numbers.  For more mature companies, that raise prices aggressively, it is a two years process before consumers catch on and begin to frequent the concept less often. Traffic begins to decline and management usually begins to blame the weather or another external event.


At this stage the best SHORT stories are created!


STAGE 2 – THE DENIAL — Depending on the situation, denial can take many forms.  Unfortunately, bad real estate site selection is hard to explain away, but it usually comes in the form of lack of brand awareness.  In an effort to avoid the inevitable and appease the street, management begins to accelerate growth through the form of new unit acceleration in core markets.  More mature companies will look to the acquisition of new brands as a way of maintaining a growth story.  Unfortunately, the core business continues to deteriorate alongside a decline in ROIIC (return on incremental invested capital).


STAGE 3 – THE PANIC — As the numbers become self-evident, the fast money crowd begins to circle, pushing management to disclose more details.  In the beginning, the sell-side takes it easy on management, allowing for any initial strategy to play out.  Depending on how bad things look, management talks about a number of changes to operations and may respond by slowing new unit growth, although often not by enough. The core business continues to decline, as senior management begins to replace the operating team. Simultaneously, management concludes that the advertising agency is not creative enough and the search for a new agency begins.


STAGE 4 – DEPRESSION — Now it really gets ugly.  At this point one of two things can happen.  First, management can reduce labor at underperforming units to improve profitability, or second, management sacrifices margins to increase customer counts by implementing a deep discounting strategy. It then becomes clear that major changes need to be made across the enterprise.


STAGE 5 – THE UPWARD TURN AND HOPE — Management decides to close stores, stop growth and or stops discounting to improve profitability.  The next move is to attack the middle of the P&L to improve profitability.


At this stage the stock becomes washed out and the sell-side has abandoned the company.  It also becomes very hard for the buy-side to pull the trigger and buy the stock.  At this stage I like to go LONG! 


Having acknowledged the need to close stores and slow the growth rate of The Grille, we view DFRG as emerging from depression.  To that end, DFRG has announced the first steps to improving the broken company:


  1. Closing unprofitable stores
  2. Slowing unit growth
  3. Increase focus on existing assets


What we are missing from the DFRG story are the details behind what level of profitability (the improvement in EBITDA) will be coming from the store closings.  Despite management acknowledging the issues, the stock has been beaten to a pulp, down ~30% over the last three months. We are starting to feel that at 6x EV / NTM EBITDA all the bad news has been priced into the name.


Unfortunately, the company’s strongest brand, The Double Eagle, is seeing slowing sales trends due to market volatility and the associated decline in banquet business. As for the changes within their control, this is exactly what we want them to be doing, and we believe that they will get the Grille concept running smoothly.


From a sum-of-the-parts analysis the stock is significantly undervalued (see table below) as it probably should be given the current fundamentals.  That being said, six months from now, hope will turn into optimism and the stock will be a lot higher!







Please call or e-mail with any questions.


Howard Penney

Managing Director


Shayne Laidlaw



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P: Fool's Gold (Web IV)

Takeaway: The Register partially ruled in favor P. All this means is that P hasn't drowned yet; it's just treading water in the middle of the ocean.


  1. Fool's Gold: The Register ruled in favor of P regarding whether the Merlin deal is admissible.  But this is not a preliminary victory for P.  All this means is that the P-Merlin deal isn't getting thrown out, not the Register is endorsing the agreement.  That decision now falls back to the CRB judges to rule on the probative value of the P-Merlin deal as a benchmark.  The other ruling that came from the Register is that the judges are allowed to consider the Pureplay Agreement as evidence to determine its impact on existing market agreements.  In summary, the Merlin agreement is in, but will be tested for statutory influence. 
  2. P May Have Already Lost: The fact that the CRB judges were compelled to ask the Register whether it should throw out P-Merlin to begin with suggests that the judges already have reservations about the probative value of the P-Merlin deal as a valid benchmark.  Note that P conceded multiple times in its Response to the judges questions that P-Merlin was influenced by the Pureplay agreement, which it is also called the "prevailing statutory rate” that it was able to achieve a "discount off" of.  All the judges in every Webcaster proceeding leading into this one were clear that the willing buyer/seller standard is to assume no statutory influence (including the Web III Remand, which are the same judges presiding over Web IV).   


We will be hosting a two-part event this Thursday to discuss both the bull and bear cases regarding Web IV.

  1. P: Webcaster IV = Powder Keg (12pm EDT) – Our bearish thesis discussing the implications of the Web IV outcome on P’s business model.
  2. Speaker Series: David Oxenford, Counsel to Webcasting Companies (2pm EDT) – Fire-Side Chat on the relevant Web IV statutes and the Services' arguments.


In the interim, let us know if you have any questions or would like to discuss further.


Hesham Shaaban, CFA


McCullough: DAX Support Is ‘Gone. Shot. Dead.’


The German stock market (DAX) crash was a hot topic on The Macro Show earlier this morning. Here’s a brief excerpt of Hedgeye CEO Keith McCullough weighing in with some of his latest thoughts.


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


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EHS | Predictable Surprises & Delicate Balances

Takeaway: EHS took an unsurprising step back in August, but supply remains tight and 1st time buyers are slowly returning to the market.

Our Hedgeye Housing Compendium table (below) aspires to present the state of the housing market in a visually-friendly format that takes about 30 seconds to consume. 


EHS | Predictable Surprises & Delicate Balances - Compendium 092115 


Today's Focus: August Existing Home Sales

EHS | AS EXPECTED:  EHS declined -4.8% sequentially in August, the first decline in four months and largest since January.  While the magnitude of decline was a bit steep (the month-to-month numbers are noisy) the decline was not unexpected.  Relative softness in PHS in both June and July along with flat-to-down trends in Purchase Applications have signaled a soft existing number for over a month.  Interestingly, unless we get a sizeable negative revision or notable decline in Pending Sales for August (data due out next Monday, 9/28), the setup for EHS reverses with the risk shifting to the upside for Sept/Oct (see 1st chart below). 


Inventory & Price:  Units of inventory rose +1.3% MoM in August to 2.29 mm and with sales declining, inventory on a month-supply basis rose to 5.18 months – representing the 1st month in three above 5-mo but holding below the traditional balanced market level of 6-mo for a 36th consecutive month.  Ongoing supply tightness in the 90% of the market that is EHS remains supportive of improving HPI trends and the acceleration in price growth observed across the CoreLogic and FHFA price series in recent months.  Again, improving 2nd derivative trends in HPI augurs positively for housing related equities given the strong contemporaneous relationship between the two. 


1st-time buyers:  First-time buyers rose to 32% of the market in August, up from 28% in July and equal to the 3-year highs recorded May.  The share gain in August was a function of a decline in both cash and investor sales, a modest retreat in non-1st time conventional buyers and accelerating demand within the cohort itself.  Sales to 1st-time buyers rose +8.8% MoM and accelerated to +17.2% YoY (vs +6.3% prior).  So long as the labor/income fundamentals continue to improve across the 20-35YOA demographic, rising headship rates and single-family purchase demand should manifest on a moderate lag.   Mean reversion back to 40% market share remains the primary catalyst for taking EHS back over the 6.0 mm mark. 


Supply Redux:  A Delicate Balance

Because closed sales activity is well-telegraphed by prior month PHS, the inventory data sit as the primary figures of import in the EHS release and the lone (official) real-time read on the supply side of the existing market. 


Supply, Demand, and Price remain in a delicate three way dance towards normalization and, from an inventory-centric perspective, there are a number of leading factors posited as underpinning the supply stagnation in housing. 


Each are valid to some greater or lesser extent and their collective influence will continue to anchor the inventory environment in the existing market over the medium-term.  We summarily review each, in turn, below.   


  • Low Rates:  Low rates locked in during the post-crisis period remain a disincentive to selling/moving and an inertial headwind to rising inventory.
  • Demographics:  Top heavy demographics with Boomers (which are a significant % of the homeownership base) entering the peri-retirement period will weigh on housing turnover broadly.  Aging in place remains an emergent trend and moving-out will not become an outsized driver of supply for another decade when the Boomer bulge starts moving beyond 80 YOA. 
  • Equity:  If Boomers are dragging on inventory and Millennial demand is just beginning to percolate,  what’s left?  Mostly Gen X’ers.  Those aged ~35-50 represent a significant source of potential supply in the form of trade-up buying.  A meaningful percentage in this group, however,  remain in negative or near-negative equity positions, serving as weight to both entry level supply and mid/upper market demand. 


Rising prices are likely to spur supply as negative and near-negative equity positions turn increasingly positive and capacity for trade-up purchases improves.  Rising prices, however, can constrain affordability for new buyers and for 1st time buyers specifically – with the latter representing the lower rung in housing’s ladder and the primary liquidity source for trade-up buyers.  


The dynamics underpinning the supply environment are many-fold with the path to market balance a delicate one to tread.  Realistically, the least disruptive path to balance on the supply side – without a cratering in demand – probably, and simply, remains time.  Measured HPI alongside ongoing recovery in household incomes would provide for further emergence of 1st-time buyer demand in conjunction with crawling improvement in housing equity positions for prime trade-up buyers. 



EHS | Predictable Surprises & Delicate Balances - EHS vs PHS


EHS | Predictable Surprises & Delicate Balances - EHS Mo Supply


EHS | Predictable Surprises & Delicate Balances - 1st time buyer sales


EHS | Predictable Surprises & Delicate Balances - EHS Units   YoY


EHS | Predictable Surprises & Delicate Balances - EHS HPI regional YoY


EHS | Predictable Surprises & Delicate Balances - EHS Inventory Units


EHS | Predictable Surprises & Delicate Balances - EHS regional YoY




About Existing Home Sales:

The National Association of Realtors’ Existing Home Sales index measures the number of closed resales of homes, townhomes, condominiums, and co-ops. Existing home sales do not take into account the sale of newly constructed homes. Existing home sales account for 85-95% of all home sales (new home sales account for the remainder). Therefore, increases in existing home sales tend to signify increasing consumer confidence in the market. Additionally, Existing Home Sales is a lagging series, as it measures the closing of homes that were pending home sales between 1 and 2 months earlier.



The NAR’s Existing Home Sales index is published between the 20th and the 22nd of each month. The index covers data from the prior month.




Joshua Steiner, CFA


Christian B. Drake

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