Starts & Permits | Noise-Free Highs

Takeaway: September Housing Starts offer further evidence that Housing continues to trend in the right direction.

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.


Starts & Permits | Noise-Free Highs - Compendium 102015 



Today’s Focus:  September Housing Starts & Permits

With the residual distortion in the July/Aug Starts data following the NY tax exemption pull-forward in May/June now rearview, this morning’s data for September provides the first (largely) noise-free read on the underlying trend in new resi construction activity in 5-months. 


Total Starts rose +6.5% month-over-month and accelerated to +18% year-over-year with activity rebounding back to the 8-year highs recorded in June.  Multi-family activity led the advance, rising +18.3% month-over-month (not overly surprising given the post-pull forward hangover) and +28% year-over-year.  MF permits, which have been exceedingly volatile on a month-to-month basis, dropped -12.1% sequentially while retreating to +1% YoY.  


The gain in single-family starts was more muted with activity rising just +0.3% sequentially with year-over-year growth holding at +12%.   SF activity continues to hold near post-crisis highs, growing +11% YoY on average YTD and flirting with 700K in average starts annually for the first time since 2007.


The crawling but continued rise in new resi construction activity continues to accord with the ongoing advance in Builder Confidence which made another new 10-year high in yesterday’s HMI print for October (HERE).  With ~38% upside left to LT average levels of SF construction and 250% upside to the prior peak, the MT/LT mean reversion and cycle opportunity for the sector remains conspicuous.   



Starts & Permits | Noise-Free Highs - Total Starts LT


Starts & Permits | Noise-Free Highs - Total   SF Starts 2Y


Starts & Permits | Noise-Free Highs - MF Starts   Permits LT


Starts & Permits | Noise-Free Highs - MFF Starts   Permits TTM


Starts & Permits | Noise-Free Highs - SF Starts   Permits LT 


Starts & Permits | Noise-Free Highs - SF Starts   Permits TTM



About Housing Starts & Permits:

The US Census Bureau records the number of new housing units that have obtained permits for construction and those that have begun construction. This data includes new buildings intended primarily as residential units. The US Census Bureau defines a start as, “Start of construction occurs when excavation begins for the footings or foundation of a building.” 




Joshua Steiner, CFA


Christian B. Drake



We are taking Sonic (SONC) off the Hedgeye Restaurants Best Ideas list as a SHORT and moving it to the SHORT bench. 


Current trends are tracking better than expected.  Depending on how the trends play out, we will look to re-short it.  We still expect MCD to make life difficult for a number of players in the space.


Yesterday after the close SONC reported 4Q15 earnings. Same-store sales (SSS) results were no surprise given they already released this information back on September 14th (see our note HERE). These results show an initial decent from SONC’s recent strong performance, and comps are not getting easier. As they head into the 1H of 2016 they will face an 8.5% comp in 1Q16 and an 11.5% comp in 2Q16, not an easy mountain to climb in an increasingly competitive environment.




This quarter represents the calm before the storm in our opinion. SONC reported revenue of $175.3mm which was in line with consensus street expectations. They reported SSS of 4.9% marginally beating consensus estimates of 4.8%. The comp consisted of a 4.9% SSS increase at franchise drive-ins and an increase of 4.5% at company drive-ins. SONC beat bottom line expectations as well, reporting EPS ex-items of $0.43 versus consensus estimates of $0.42.



The biggest news today arguably was the acceleration of share repurchases due to favorable market conditions. Due in large part to this acceleration the company now expects EPS to grow 16% to 20% in FY2016 as compared to the previous outlook of 14% to 18%. The remainder of the guidance is as follows:

  • 2% to 4% same-store sales growth for the system
  • 50 to 60 new franchise drive-in openings
  • Drive-in-level margin improvement between 75 to 125 basis points
  • Capital expenditures of $35M to $40M
  • Free cash flow of $70M to $75M
  • The planned repurchase of $126M of stock across the fiscal year, with a higher concentration of share repurchases in 1H of the fiscal year


Please call or e-mail with any questions.


Howard Penney

Managing Director


Shayne Laidlaw





Earnings, Euro and Housing

Client Talking Points


Are we entering an earnings recession? After a Q2 where S&P 500 earnings declined -2.1% in aggregate, earnings growth thus far in Q3 is down -9% after 15% of companies have reported. Consumer Discretionary is the only sector that has registered positive earnings growth thus far. It’s early, but don’t get roped in from the bull-market storytelling. As we outline in our Q4 macro deck, earnings recessions have preceded  economic recessions in the last 3 cycles.   


The ECB meets this Thursday for an interest rate decision. The cross is down 11% year-over-year…look for it to dive lower if ECB President Mario Draghi issues incremental QE (easing), a real prospect as inflation at -0.1% is ways away from its 2.0% target. The immediate-term risk range for the EUR/USD is 1.11-1.14. 


This morning’s Housing Starts & Permits data for Sept. is likely to reflect continued crawling improvement as we hold near post-crisis highs in new, single-family residential construction activity.  Looking forward, the Implementation of TRID  (TILA-RESPA INTEGRATED DISCLOSURE) regulations on Oct. 3rd is likely to continue to drive excessive chop in the high frequency data (weekly Purchase Applications) over the next few weeks as lenders go live with implementation and purchase agents attempt to risk manage any early bottle-necks.  Moreover, the demand pull-forward we saw to close out September will likely serve to juice both the New and Pending Home Sales figures for September as the bolus of pre-TRID demand flows through the reported volume figures. We’ll get the New and Pending Homes Sales data on 10/26 and 10/29, respectively.  


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McDonald’s reports 3Q15 earnings Thursday, October 22nd before the market opens, with a conference call at 11:00am ET. We are expecting strong sequential improvement in performance globally. We look forward to giving you an update on the company’s performance next week, but this week we wanted to focus on the ‘Looming Crash in Beef.'


On Thursday, October 15th, we held a thought-leader call regarding the declining price of beef and how long it will continue. Prices have sky rocketed in recent years and are now standing at more than two standard deviations above the 30 year average. We believe a 50% decline down to historical averages is well within the realm of possibilities. Declining beef prices will be a major tailwind for McDonald’s as they navigate their turnaround.


Restoration Hardware opened its new Full Line Design Gallery at the Cherry Creek Shopping Center in Denver this week.  This is another anchor property -- using 53,000 feet of the 90,000 left vacant by Saks at Cherry Creek.


RH is taking up the size of its stores from an average of 8,000 square feet to about 40,000+ for its new stores – and productivity rates on these new assets are headed higher. In the old stores, RH could only show 10% of its assortment, while in the newer format stores, the company is showcasing better than 75%. Consumers can’t (and don’t) buy what they don’t see.


The #SlowerForLonger theme from Hedgeye Macro has been consistent and straightforward. Our pivot in advance of the most recent jobs report to get long of gold and stay out of the way short-side on commodities turned out to be a good position.


Growth expectations have been correctly revised, but there’s still a good amount of room between Hedgeye estimates and consensus. We are expecting GDP in a range of 0.1%-1.5% for Q3 and another 1-handle in Q4. If that proves accurate, flatter goes the Treasury curve (TLT, EDV), wider goes high yield spreads (bad for JNK), and down goes the USD (GLD).

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CHART OF THE DAY: A Middle Finger Salute North of the Border

Editor's Note: Below is a chart and brief excerpt from this morning's Early Look written by Hedgeye Director of Research Daryl Jones. Click here if you'd like more information on how you can subscribe.


CHART OF THE DAY: A Middle Finger Salute North of the Border - zzz COD 10.20.15 chart


"For those of you not familiar with Canadian political history, the "Trudeau salute" was a middle-fingered gesture former Canadian Prime Minister Pierre Trudeau gave to protestors in Western Canada in the early 1980s.  To Western Canadians at the time, it was symbolic of years of policy that undermined their commodity laden economies. is difficult to see in the short run how Trudeau will have a positive impact on the Canadian dollar or economy.   In part, of course, the Canadian dollar has front run this and is down about 11% over the last year, but with a deficit that is likely to expand, the floor has probably not been established for the Loonie.

The Trudeau Salute

“The essential ingredient of politics is timing.”

-Pierre Trudeau


For those of you not familiar with Canadian political history, the "Trudeau salute" was a middle-fingered gesture former Canadian Prime Minister Pierre Trudeau gave to protestors in Western Canada in the early 1980s.  To Western Canadians at the time, it was symbolic of years of policy that undermined their commodity laden economies. 


Yesterday, Canadians elected Justin Trudeau, the 43-year old former son of Prime Minister Pierre Trudeau, as their next Prime Minister.  This was as much an election that rejected Prime Minister Stephen Harper as one that voted in the relative neophyte, Trudeau. 


Trudeau’s victory marks the biggest political rebound in Canadian history. The Liberals become the first third-place party to win an election, and the party’s seat gain from the prior election of around 150 is the largest ever.  In fact, the Liberals, who had governed for about two-thirds of the 100 years before Harper came to power, won just 34 districts in the 2011 election, the worst result in their history.


After almost 10 years of Conservative rule, the Canadians wanted change.   And change they have elected, in an epic way.  Some would even argue with an emphatic middle finger to the departing Prime Minister.


Prime Minister-elect Trudeau has basically indicated that his economic policies will be built around two key points: raising taxes on those making over $200,000 and increasing government spending on infrastructure.  (Incidentally, he also intends to legalize marijuana quickly, which is clearly a priority for a nation in recession.)   By and large, Trudeau will be taking a page right out of the Keynesian playbooks of many European countries. 


The Trudeau Salute - zzz trudeau


Back to the Global Macro Grind...


From our purview, it is difficult to see in the short run how Trudeau will have a positive impact on the Canadian dollar or economy.   In part, of course, the Canadian dollar has front run this and is down about 11% over the last year, but with a deficit that is likely to expand, the floor has probably not been established for the Loonie.


There is a more significant issue facing Canada than a collapsing currency, which is the state of the Canadian banking system.  Our financials team introduced their call to short the Canadian Banks this summer and in an update note in late September wrote the following:


“You would think that with the Canadian economy in recession, energy prices tumbling, Oil & Gas loan impairments skyrocketing, and the whole Canadian housing market sitting atop an historic bubble, the Canadian banks would be at Defcon 4: building reserves, speaking cautiously, slowing loan growth. Instead, however, management(s) couldn't be more unconcerned, disinterested, and generally indignant at the mere suggestion that risk is rising.


Over the last two weeks the big six Canadian banks (BMO, RY, NA, CM, TD, BNS) and CWB reported their fiscal 3Q15 earnings. Generally speaking the results were not terrible. There were four beats, two misses and one in-line print.


Part of the reason the results weren't terrible is that the banks continue to avoid taking reserves against future losses. There's no better example than in the Oil & Gas patch. A major focus of Canadian bank earnings conference calls over the past two weeks was the effect (or supposed lack thereof) of low oil prices on the Canadian economy and on bank earnings. The consensus from management teams is that it’s no big deal, and their lack of concern concerns us. We can't help but be reminded of Aesop's The Ant and the Grasshopper fable. In a word, the Canadian banks are Grasshoppers, all.”


In light of yesterday’s election results, we’d recommend you email to review our work on the Canadian banking system and set up a call with our financials research team.  The short thesis is timely this morning.


Canada isn’t the only sovereign we have concerns about in the current environment of political change.  In fact, tomorrow we will be doing a call on Spain, which has been a perpetual weak economic link in the Eurozone.  Similar to Canada, Spain has an important election scheduled on December 20th.  On the call, Hedgeye contributor Daniel Lacalle, a former buy-side PM at PIMCO and Citadel, will talk through his scenario analysis on Spain.


In contrast to Canada, Spain has been under Conservative rule for the last four years.  In that time period, the Conservative Party (PP) unwound years of deficit spending from the previous administration. In fact, the PSOE had left a deficit of 9% of GDP after promising a maximum of 7%.  


As Lacalle has written, when the socialist government left office, Spain had more than 40 billion euro in unpaid invoices from the public administrations to the private sector, the public savings banks presented a capital requirement of 100 billion euro and the regions and municipalities faced a bailout of 125 billion euro. To many, this was seemingly an insurmountable situation.


However, after a large austerity plan that was split 50% in tax increases and 50% in spending cuts, and a very substantial set of reforms, including the financial sector, labor market, entrepreneurship programs and early payment schemes, Spain recovered.


Between 2014 and 2015 Spain started to grow well above the EU average. It led job creation in the Eurozone, with more than one million jobs, and brought unemployment rates back to September 2010 levels. It went from a massive trade deficit to a balance by 2015.


In summary, Spain undertook the largest adjustment seen in an OECD economy, 15 points of GDP, and managed to do so growing and creating jobs.  But as austerity is prone to do, it does make some folks unhappy.  As a result, much like in Canada, the December 20th election in Spain will be referendum on the Conservatives.   And with political change, comes investment opportunity.  After all, the great thing about being stock market operators is that we can go both ways.


Our immediate-term Global Macro Risk Ranges are now:


UST 10yr Yield 1.98-2.08%


VIX 14.94-20.69
Oil (WTI) 45.08-47.99

Gold 1144-1195


Keep your head up and stick on the ice,


Daryl G. Jones

Director of Research


The Trudeau Salute - zzz COD 10.20.15 chart


McDonald’s (MCD) is on our Hedgeye Restaurants Best Ideas list as a LONG.




Our long standing view has been that the inflection point for the MCD turnaround will be 3Q15.  We are now two days away from that event and the confidence in our call remains very strong.  McDonald’s is a resilient company and its new leadership team is making some significant changes to how the company is being run.


The company will also be hosting an analyst meeting in NYC on 11/10/15.  On the earnings call, I believe the company will defer questions about the long-term strategy to the analyst meeting.  Importantly, at the analyst meeting the company will outline the decision on what to do with the company’s real estate holdings.  I now believe that there is a greater than 50% chance the company will likely create a more efficient tax structure with its rental revenue stream.        






Optimize the menu to offer customers their favorite food & drinks more effectively

  • Shrink the menu, improve existing products, develop new products, adjust pricing, create more excitement about the food
  • All Day Breakfast
  • Improve the value message: At the analyst meeting the company will discuss a national value platform in the U.S.


Transformation of the customer service experience

  • Modernizing the interaction between MCD and the customer to create a memorable experience. Self-ordering kiosks are a great experience for the customer, and they allow the kitchen to operate more efficiently.


Refranchise and close stores

  • Eliminate underperforming stores to cut costs and improve profitability, leading to improved industry metrics.


Manage complexity of restaurant operations

  • With everything management has added to the restaurants, it was getting too complex, keep it simple.
  • New training programs for employees to improve accuracy and experience for the customer and employee.
  • The company has completed the installation of smaller drive-thru menu’s


Financial strings to pull

  • Refranchising and store closures must lead to sizeable SG&A savings at corporate
  • Financial engineering, potential to lever up and buy back more shares or increase the dividend
  • Reduce capital spending to improve ROIIC.  (We should begin to see the impact of this in 3Q15)



MCD EPS peaked at $5.55 in FY13, and will earn $4.75 in FY15, down 15% from the peak.  Street estimates have MCD earning $5.15 in FY16.  As it stands today, our estimates are for MCD to post a near record tying EPS in FY16 of $5.40-$5.60 with $6.00 being a real possibility. The potential for $6.00 is dependent on how aggressive the company gets with any additional G&A cost cutting to be announced at the upcoming analyst meeting.   




I expect the mood at the analyst day in NYC will be very upbeat (following the better than expected 3Q15 performance) and the momentum being experienced internally given the major changes that are taking place at MCD.  In addition, the tone of how CEO, Steve Easterbrook will manage the business going forward was set in his first 100 days as CEO of MCD:

  • “everything is in play”
  • "constructive agitator"
  • “internal activist”
  • “I’m honest and fair and don’t dispense forced kindness”
  • “We will try new things, move fast with what works and even faster from what doesn’t”
  • “We’re making the business more responsive to market conditions by using our scale advantage more effectively, we cannot afford to carry legacy attitudes and legacy thinking, and we won’t”


Some of the themes we expect to hear at the NYC Analyst day

AWARENESS – The new corporate structure is changing the way McDonald’s does business around the world for the better.  What to look for:

  • We are expecting MCD to make additional SG&A cuts.  There are significant opportunities to cut from the estimated FY15 $2.3 billion spent in this line item.
  • The new structure is accelerating the innovation pipeline. Leaders are more in touch with their regions than ever before, giving them greater ability to share best practices across like markets.


RATIONALIZATION/SIMPLIFICATION – There are parts of this that MCD has already talked about but there is so much more to focus on. 

  • Stores – store closings (already announced)
  • McCafé – Please no espresso drinks (should be addressed)
  • Cost Cutting – as per above there will be more G&A cuts
  • Changes to the Menu – In addition to McCafé, management will talk about regional simplification to its menu


SUSTAINABILITY – Will McDonald’s compete effectively in the consumer centric world of sustainable food?

  • We think so, McDonald’s is improving their food, from the source to how it is prepared. They have committed to using cage free eggs by 2025 and they pledged to move towards antibiotic free chicken within two years.


REAL ESTATE – Could this be the year!

The big news coming from this year’s analyst meeting will be what the company has decided to do with the company’s massive real estate holdings. 


If the current pattern of behavior holds true the company will be looking to alter its real estate holdings.  For over 50 years many people including myself said MCD can’t sell breakfast all day.  I have also said they will never do anything with their real estate.  I was wrong about and breakfast and chances are I will be wrong about the real estate too. 


I imagine there are others who are working overtime to help the company see the value that can be created by changing the structure of the real estate.  According to FactSet, there are two large shareholders of McDonald’s who are classified as “activism threat level is high.”  I assume both of them want MCD to think differently about the real estate.


I also found it out of character that a McDonald’s Board member would give a quote to the WSJ about the review process.  McDonald’s Board member Miles D. White said on Thursday, “McDonald’s board and management haven’t made a decision yet, but we have had a lot of review and a lot of debate.”   Mr. White is chief executive of Abbott Laboratories and head of the corporate-governance committee for the McDonald’s board.  Why was he speaking on behalf of the company one week before they report earnings?


Between 2008 and 2011 there has never been a need for the company to do anything with the real estate, because the business was strong. Since the business began to decelerate in 2012, the real estate rumors have become more pronounced. The CEO at the time, Don Thompson, did not have the internal mandate to make those types of changes.  Under CEO Steve “everything is in play” Easterbrook, the odds of the company changing the structure of the real estate have gone up significantly. 


The issue at hand is the company’s ability to re-arrange royalty rates with franchisees.  The company generates over $6.0 billion a year in rental income with operating margins running north of 75%.  This is all taxable at the effective tax rate of 32%.  If the company can structure an internal REIT to own the rental stream the company could save billions in taxes, creating substantial shareholder value.  As a general rule, for every $500 million the company can save in taxes (at 22x) it creates an $11 increase per share in shareholder value.


Objections to altering the real estate structure in the past have centered on giving up control of the real estate and preservation of its credit rating.  If the company can establish a REIT to shelter its rental income, while controlling the real estate and maintaining its credit profile everybody wins!


Please call or e-mail with any questions.


Howard Penney

Managing Director


Shayne Laidlaw




Early Look

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