RECENT NEWS FLOW
Friday, September 25
MCD | McDonald’s launches organic burger in Germany (ARTICLE HERE)
Thursday, September 24
MCD | McDonald’s named two new executives, David Fairhurst named chief people officer and Chris Kempczinski named EVP of strategy. Fairhurst an internal promote, has moved up the ranks, while Kempczinski is an external hire who previously worked at Kraft Foods (ARTICLE HERE)
Tuesday, September 22
DRI | Darden reported 1Q16 numbers that impressed, leading it to outperform the XLY by 2.9% last week. All brands had comps that beat expectations. Olive Garden, the company's most important concept, had traffic up for the quarter, but was very lump, -1.4% in June, +3.9% in July and -1.2% in August, not exactly giving us confidence in the recovery of the brand (ARTICLE HERE)
Monday, September 21
JACK | Announced a new $200mm share repurchase program (ARTICLE HERE)
Casual Dining and Quick Service stocks that we follow, balanced out to match the XLY last week, with Quick Service coming in slightly above and Casual Dining slightly below. The XLY was down -1.0%, top performers on a relative basis from casual dining were DRI and TXRH posting an increase of +2.9% and +2.7%, respectively, while NDLS and ZOES led the quick service group this week up +12.3% and +9.8%, respectively.
XLY VERSUS THE MARKET
The XLY has fared better than most other sectors in the YTD time period and as of late especially. In the last five trading days, while the SPX was down -1.4% the XLY was down only -1.0%, outperformed by XLK (Technology), XLP (Consumer Staples), XLF (Financials), and lastly XLU (Utilities).
From a quantitative perspective, the XLY looks bearish from a TRADE and TREND perspective, TRADE support is 74.02.
CASUAL DINING RESTAURANTS
QUICK SERVICE RESTAURANTS
Keith’s Three Morning Bullets
IMF cutting global growth forecasts (again) as macro markets continue to crash:
SPX immediate-term risk range = 1; UST 10yr 2.07-2.21%
Please call or e-mail with any questions.
Takeaway: A quick overview of our incremental thinking on our top ideas, long and short. RH, KATE, PIR, NKE, RL, KORS, FL, HIBB, KSS, TIF, W, TGT
RH: TAIL = $11 EPS and $300 stock. TRADE looks strong with Chicago opening this week, then Modern, Teen, and 175k add sq ft by Jan. This model is primed.
KATE: We think the downward spiral in sentiment is over. People are looking to own KATE again. Business is outstanding. $1.10 in EPS next yr makes this name cheap now.
PIR: One of best value stocks we can find. Capex cut, working cap improving, now 500bp of margin to recapture, which then drives top line. $2-3 down/$10-13 up.
NKE: This qtr was its best in history. But there’s likely more to come. We’ll outline puts and takes in our Nike Black Book Monday, October 12th.
RL: RL moved up to our Long list. We don’t think it will ever go below $100 again. If/when management gets the org plan right, the stock is over $200. With the stock at $108, that’s a big deal.
KORS: Does not have the momentum that KATE does, and never will (again). But evolving into more of a RL model. That’s a long transition. But at 9x EPS, we’ll assume that risk.
WWW: Under review.
FL: The fact that people took NKE’s results as a positive for FL is mind boggling. It’s the exact opposite. NKE DTC grew by $358mm. FINL inventories up 11% on 3% sales growth. NKE up 20% at KSS. FL has no room for error. We’re been waiting for the time on FL. We think it’s now.
HIBB: After all its problems, numbers are STILL too high. Oversaturated in core market, marginalized (by DKS/Academy) in new markets. No dot.com arm. Peak margins. Nothing but downside.
KSS: Richards and I debated pulling the plug given that this short has worked. But if our ‘credit cannibalization’ thesis is right, then estimates and the stock are going much lower.
TIF: If you don’t like the US macro setup, which we don’t, then TIF is your poster child short. It blew up twice this year – there’ll be a third. ’16 estimates are still high by $0.25-$0.50.
W: While there’s the potential for this rapid grower to print a profit by way of lower SG&A – and send the bears running for cover…the fact is our research suggests a single channel model in this space is destined to fail.
TGT: WMT is down 30% TYD and is at 13x EPS. TGT outperformed by 40% and is at 16x earnings. We’re concerned about how WMT will ultimately drive profits this holiday to offset labor costs – which won’t make TGT’s life easy. TGT also anniversarying a solid 4Q ly. Not a juicy short here, but we’ll hang onto it.
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Takeaway: Cash equity and options activity grew while futures shrank last week. 3Q15 Q/Q and Y/Y growth remains positive for all categories.
Weekly Activity Wrap Up
This week, U.S. cash equity and U.S. options volumes rose week-over-week while futures activity fell. All three categories continue to show Q/Q and Y/Y growth. U.S. cash equity volume averaged 7.8 billion shares this week, bringing the third quarter to a 7.3 billion ADV, an expansion of +28% Y/Y and +15% Q/Q. U.S. equity options activity averaged 17.0 million contracts this week. Year-over-year growth in U.S. options is tracking at +15%. Futures activity came in at an average 17.4 million contracts per day. That brings the third quarter to an 18.7 million ADV, a +6% year-over-year and +6% quarter-over-quarter expansion.
Our Best Idea in the sector continues to be the CME Group (CME). Volatility tends to be seasonally high as we move into the "back to work" months of September and October and CME Group exchange volumes have already begun to benefit from this trend. See our recent note on the company which highlights the back-end-loaded nature of the stock's returns given historical Fall volatility and its year-end variable dividend.
U.S. Cash Equity Detail
U.S. cash equity trading finished the week at 7.8 billion shares traded which is blending to a 7.3 billion daily average thus far for the 3rd quarter of 2015. This is +28% year-over-year growth for U.S. stock activity. The market share battle for volume is mixed. The New York Stock Exchange/ICE's share of third-quarter volume remains at 24%. NASDAQ's share also remained unchanged week over week at 19%, 100 bps lower than last year, a -4% decline.
U.S. Options Detail
U.S. options activity came in at a 17.0 million ADV this week which is blending 3Q15 activity to 18.2 million contracts per day, up +20% quarter-over-quarter and +15% year-over-year. The market share battle amongst venues continues to be one of losses at both the NYSE/ICE and NASDAQ. NYSE has lost 400 basis points of share year-over-year settling at just 18% of options trading currently. NASDAQ has shed 300 basis points of share, good for a -14% loss from last year as ISE/Deutsche Boerse and BATS mop up volume and share.
U.S. Futures Detail
CME Group volume came in this week at 12.8 million contracts. That blends 3Q15 volume to a 14.4 million average level, a +7% year-over-year expansion. CME open interest, the most important beacon of forward activity, currently tallies 96.7 million CME contracts pending, good for +15% growth over the 84.1 million pending at the beginning of 2014, consistent with the prior week's +15%.
Activity levels on the futures side at ICE hit 4.6 million contracts this week, with 3Q15 blending to a 4.2 million daily average, a +5% year-over-year expansion. ICE open interest this week tallied 63.7 million contracts, a -8% contraction versus the 69.2 million contracts open at the beginning of 2014, an improvement from the prior week's -9%.
Monthly Historical View
Monthly activity levels give a broader perspective of exchange based trends. As volatility levels, measured by the VIX, MOVE, and FX Vol should rise to normal levels after the drastic compression this cycle, we expect all marketplaces to experience higher activity levels.
Sector Revenue Exposure
The exchange sector has broadly diversified its revenue exposure over 10 years as public entities with varying top line sensitivity to the enclosed trading volume data. The table below highlights how trading volumes will flow through the various operating models at NASDAQ, CME Group, ICE, and Virtu:
We recently presented our investment thesis on the Exchanges. To summarize,
We think CME has $5 per share in earnings power in the out year and the stock will revisit near $140. As outlined in our presentation deck and replay below, a CME long position can also be paired with a short ICE position, with favorable fundamental exposures on each side of the trade.
Separately, recent IPO Virtu (VIRT) is being valued incorrectly by the market. Our main qualm is that the company takes intraday prop risk, but has no tangible equity capital to cover any potential trading losses. Shares of VIRT are currently on our Best Ideas list as a short with a fair value in the mid-teens (30-40% downside).
Hedgeye Exchange Black Book Replay HERE
Hedgeye Exchanges Black Book Materials HERE
Please let us know of any questions,
Jonathan Casteleyn, CFA, CMT
Joshua Steiner, CFA
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