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The good news is that EAT is operating from a position of strength.  The company has a strong brand in Chili’s; strong margins and significant free cash flow.  The bad news is that industry sales have slowed; the competition has regrouped and now Chili’s needs to regain some traffic!  I suspect that the biggest change in industry dynamics over the last six months has been Olive Garden performing better.  While they might not be a direct competitor, Olive Garden can move the needle on industry sales when the chain generates positive sales and traffic.  That being said, depending on how Chili’s responds, it could be a negative for DRI and the improving Olive Garden.  DRI is currently on the Hedgeye Restaurants SHORT bench.


The casual dining space is under significant pressure right now.  The Restaurant MACRO environment is unfavorable as all of the following factors are slowing on the margin:

  • Payroll’s
  • Personal consumption expenditures
  • Consumer confidence
  • Industry sales trends  


A theme we are now hearing during the 3Q earnings season is an increase in the competitive (discounting) activity as the bigger brands are fighting for the incremental consumer.  All of this is starting to be reflected in lower multiples for the casual dining space overall.


Currently, EATs EV/NTM EBITDA is trading at a 10% discount to the current industry average of 8.4x.  Clearly some bad news is priced in to the stock, but it’s unclear what the financial outcome of managements shift in strategy will be.  Right now estimates for the balance of FY16 look aggressive, given current sales trends.


We have no position in EAT currently so we are waiting and watching!  





Globally, our business delivered comp sales of positive 4.8% during the quarter, driven by effective marketing platforms and regional marketing co-ops and aided by a favorable Ramadan shift. We opened six additional restaurants during the quarter, including a new market entry into Tunisia, which marks our 31st country for the Chili's brand and demonstrates the strength and relevance of Chili's across the globe.


SELF INFLICTED WOUNDS - Continuing from last quarter there was some sales softness through the transition to the My Chili's Rewards program. “The shift from our direct marketing program to loyalty hasn't performed as strongly as expected. And we're now adjusting the mix of loyalty and direct marketing to optimize the investment.”


“We were challenged with a couple of macro factors, both within our industry and in the broader economy.” 


MACRO FACTORS - Persistently low oil prices and the appreciation of the dollar, means greater challenges within oil markets and border towns.  “There have been pockets of softness within those regions for a while, but the top-line challenges expanded during the quarter across Texas, Oklahoma, Arkansas and Louisiana, home to about 30% of our restaurants.  And it's unusual for us to see that much regional variability.”


INDUSTRY FACTORS - The battle for market share continues to intensify. “We saw increasingly aggressive discounting and deal rates still at five-year highs. This intense level of promotional activity resulted in some competitors taking share during the quarter.”


EAT IS GOING TO FIGHT BACK - Over the last six months, we stayed consistently focused on our long-term strategies and have refrained from engaging in heavy promotional activity. We've built a solid foundation with our strategic work on food, service and atmosphere, as well as the digital guest experience. And the good news is we've achieved the margin strength to enable us now to take a much more aggressive approach to turn the tide on sales and traffic in the near-term while we maintain the health and sustainability of our brands over the long-term.



LUNCH - First, we're reigniting our lunch business with the same intensity we had five years ago when we reinvented that day part. We're introducing new products with more compelling price points and linking that new value proposition to technology like Ziosk, NoWait and our mobile app, so guests can now set their own pace that meets their needs at lunch.


DINNER – “At dinner, we're messaging both value and new news with the launch of our Prime Rib Fajitas and the introduction of bottomless chips and salsa with any fajita purchase. And we're testing big ideas that lean into value and further differentiate Chili's as a Fresh Tex, Fresh Mex brand.”


HAPPY HOUR – “We're also reinvigorating our happy hour business with the launch of a national program that offers more aggressive appetizer pricing and drink specials, like a $5 Presidente Margarita.”


MARKETING – “And finally, we're ramping up support with local and regional marketing efforts to strengthen our competitive position and drive traffic in our oil and border town regions.”


TECHNOLOGY – “This rewards program is part of our overall digital guest experience, a crucial strategy to help us learn from and communicate more effectively with our guests. We're also optimizing our technology investment to drive top-line in the near-term. As I mentioned, the My Chili's Rewards program isn't generating the incremental traffic that we need the program to deliver, but there is tremendous acceptance and engagement from our guests in the program, which are critical as we work to drive the incrementality. We've signed up over 3.7 million members so far. More than 16% of our checks include loyalty transactions, and we know from the data that our rewards program members rate the brand even higher in terms of experience and they're much more likely to return than the average Chili's guest.”


MAGGIANO’S - Maggiano's, experienced some unexpected softness in their banquet business, resulting in negative sales for the quarter, but as we approach the busy holiday season, we are confident Maggiano's sales will rebound.


SAME STORE SALES - Total company-owned comp restaurant sales decreased 1.6%, driven by a 2.1% decline in traffic and a negative 1.4% change in mix, partially offset by a 1.9% increase in price.


MARGINS - Now, turning to margins, our restaurant management teams continue to operate the business effectively, with overall restaurant operating margin improving 10 basis points to 14.6%. This performance reflects solid margin expansion in our base business, partially offset by the mix impact of the Pepper Dining restaurants. Excluding Pepper Dining, our restaurant operating margin improved 50 basis points, driven by a 40 basis point decrease in cost of sales and a 10 basis point decrease in restaurant expense. Restaurant labor expense was flat for the quarter.


COGS - First quarter cost of sales improved 40 basis points, reflecting 40 basis points of favorable menu pricing and 20 basis points of favorable commodity pricing, partially offset by 20 basis points of negative mix. Commodity pricing primarily benefited from lower avocado, cheese, and seafood costs, partially offset by higher steak, fajita beef, and poultry costs when compared to prior year. Restaurant expense improved 10 basis points, mainly driven by a shift in advertising to My Chili's Rewards support, partially offset by deleverage and the timing of repair and maintenance expenses and other costs.


LABOR - While the restaurant labor expense line was flat to prior year, it included the impact of increased wage rates of approximately 2%. Depreciation expense increased $3.6 million to $39 million in Q1. This reflects our investment in key capital initiatives such as the nearly completed re-image program and the acquired restaurants. In addition, general and administrative expenses were $33 million, a $0.5 million increase versus prior year, primarily due to the loss of transition services income previously received from franchise Pepper Dining. This level of spend is below our planned rate of expense and reflects cost management efforts to offset top-line challenges.


CAPITAL ALLOCATION - Capital expenditures for the quarter were $24 million. During the quarter, we repurchased 900,000 shares for $51 million and we ended the quarter with $66 million of cash on our balance sheet. Since the end of the first quarter, we purchased an additional 328,000 shares for $17 million, leaving an outstanding authorization of about $550 million. This includes the additional authorization of $250 million approved by our board in August. We also raised our quarterly dividend to $0.32 per share, representing a 14% increase over prior year.



  • We are reaffirming our full year earnings per diluted share guidance range of $3.55 to $3.65
  • We now expect revenue growth for the fiscal year to increase 10% to 12% compared to prior guidance range of 12% to 14%.
  • Comp sales guidance for company-owned restaurants is now expected to be in the range of down 0.5% to down 1.5% compared to the prior range of up 1.5% to 2%. We expect second quarter comp sales to be below first quarter levels, third quarter close to flat, and we expect positive growth in the fourth quarter.
  • Reported operating margin is unchanged from our original guidance of flat to down 25 basis points. Excluding the impact of Pepper Dining, our restaurant operating margin is also unchanged from our original guidance of up 25 to 50 basis points.
  • We now expect overall commodity inflation of less than 1% for the current fiscal year versus prior expectations of up approximately 2%. This reflects favorability from beef, partially offset by higher produce costs. Currently, 97% of our commodities are contracted through the end of calendar 2015, 86% through the end of fiscal Q3, and 71% are contracted through the end of fiscal 2016.
  • Depreciation expense is now forecast to increase $10 million to $12 million year-over-year, a reduction from our prior guidance of $12 million to $15 million increase.
  • Our anticipated increase in G&A expense in fiscal year 2016 is now expected to be $3 million to $6 million, down from prior guidance of $10 million to $12 million.
  • We expect weighted average share count to be between 59 million and 61 million, due to a lower average share price for buybacks compared to prior guidance of 60 million to 62 million.



“So if you were to look at the map and the black box data regionally, you would see that the whole industry is a little more challenged in Texas than in other parts of the country right now.”


“No, really you guys have been asking us the question for quite a few calls actually, if we've been seeing softness. And while there had been some pockets, it had been fairly isolated into really kind of those very specific smaller oil towns. And what we're seeing now is a broader kind of impact, if you will, to the larger geography. And it's moving. It's moved into some bigger locales.”


“So on the comp sensitivity, 100 basis points would be around $0.10 to $0.12”


“And so as we look at our situation right now, we've given up too much traffic. We need to get the traffic patterns changed. And that's what we're focused on and that's what those initiatives we've talked about are really all kind of geared for. We think there's opportunity to take some check where it's possible and to continue to grow it, but, for the most part, we're focused on turning the traffic pattern around.”


Please call or e-mail with any questions.


Howard Penney

Managing Director


Shayne Laidlaw





The CNBC Circus Act

The CNBC Circus Act - GOP debate cartoon 10.29.2015

We thought the focus of the (embarassing) GOP debate last night in Colorado was supposed to be on the candidates, not the (shameless) moderators. CNBC owes an apology.

DE, AGCO, CNHI | El Nino? No Bueno

Takeaway:  El Nino correlates to weather, and weather correlates to DE.  But the direction is not so obvious.  We would view fleet dynamics as more important.  Volatility in weather is more of a risk to our short thesis than a further support of it. 



Replay & Materials From Ag Equipment Black Book:


Short DE Best Ideas Addition (5/22/2015) 

Where To From Here? (9/21/2015)



This is just a quick response to a bearish El Nino narrative circling farm equipment this week, in particular DE and AGCO.  For us, what is likely to matter most to farm equipment sales are fleet demographics and farm income trends.  We think we are in a period were the former is most critical.  Ongoing commentary from dealers and the advance orders support our more negative view. 


However, inflections in El Nino do appear to correspond well to inflections in DE’s relative performance.  Over the past decade, a short sample period for industrial equipment, the DE-El Nino correlation has been negative.  However, a longer series shows that the relationship with El Nino is not particularly consistent or, most likely, useful.  Unfortunately for DE, volatile weather cannot undo years of above trend farm equipment investment, aggressive pricing actions by inventory sodded competitors, or decrease stocks of used equipment.


DE, AGCO, CNHI | El Nino? No Bueno - DE 10 29 15



Upshot: El Nino correlates to weather, and weather correlates to DE.  But the direction is not so obvious.  We would view fleet dynamics as more important.  Volatility in weather is more of a risk to our short thesis than a further support of it.  

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Cartoon of the Day: The Dark Cloud of U.S. Growth

Cartoon of the Day: The Dark Cloud of U.S. Growth - GDP cartoon 10.29.2015

Our macro call here at Hedgeye remains #LowerForLonger (Rates) due to #SlowerForLonger (Growth). Witness today's U.S. 1.5% GDP report. The answer to Hedgeye CEO Keith McCullough's question below? Seems pretty self-evident. 


"When GDP gets cut by more than 50% quarter-over-quarter, the Fed should "raise rates", right?"

MTW | Operational Focus

Takeaway: The split is on track for February, but now with better leadership and significant identified restructuring opportunities.  We think that MTW is one of the most undervalued and least understood names in the sector.





We think that the departure of Glenn Tellock is a positive for MTW and that Hubertus Muehlhaeuser seems a very promising segment leader.  The restructuring opportunities in the 3Q release suggest a substantial opportunity to improve operations, which is not that surprising given a lack of prior operational attention.  The 3Q preannouncement was somewhat misleading, in our view, since it provided little context on weaker Crane results that we now know were driven heavily by delayed VPC shipments.  The planned split was defended robustly on the call, including the point that an investment grade credit rating for either segment is not needed.  In all, we continue to think the split will unlock substantial value and that MTW is one of the most undervalued and misunderstood companies in the sector. 





Preannouncement Head Fake:  MTW’s preannounced a GAAP number, which we thought inappropriate given the separation costs.  Today, we learned that MTW had $10.4 million in costs associated with restructuring and separation, as well as a “ballpark” $15 million hit from delayed shipments of newly introduced VPC cranes (now corrected).  Backing out those items, MTW generated an estimated operating income of ~$68 million vs. $83 million in the year ago period.  While down, it is hardly as catastrophic as headlines suggested.  Those items should also have been disclosed in the preannouncement.


Split Defended Strongly:  Apparently, no one on the Board cares if Cranes is investment grade, or if it has a fairly small valuation and profitability.  We agree that the split is a great value-unlocking opportunity; as we see it, the Crane segment has a ‘negative’ valuation at present. We also think that the Cranes business is less broken than some believe (see below). 


Tellock Out Is A Positive:  It seems clear that Glenn Tellock was let go by the Board.  Hubertus Muehlhaeuser, the new head of the Foodservice business, sounded very strong on the earnings call this morning.  That is a significant upgrade from his introduction on the last call, when Tellock didn’t given him much of an introduction.  Hubertus’s presentation was detail oriented and he handled the Q&A effectively.  As we see it, Tellock did not appreciate activist meddling and never seemed on board with the split.


Restructuring Guidance Quite Large:  The restructuring announcements suggest a substantial opportunity to improve operations, which is not that surprising given a lackluster prior management team.  If you caught all of benefits from the restructuring items, it sounds as though Foodservice should spin with a substantial earnings growth opportunity baked in. Expect new management to market these, and we wouldn’t be surprised if more opportunities pop-up in Cranes as new leadership comes in.

  • Foodservice: The nearer-term consolidation of the Cleveland facility is expected to result in $30 million in cost savings next year, and $40 million by 2017.  Over the next 3 years, they indicated an extra 150 basis points to the margin in addition to that Cleveland restructuring.
  • Cranes: There should also be a benefit from the right-sizing and capacity reductions in the Crane segment of $35 - $45 million over the next three years, with a portion of that expected next year.  We should get more detail here as new leadership takes over.



Sentiment Very Negative, Inconsistent:  For a company with a solid value-unlock catalyst in just four months, the analyst community certainly hates MTW.  The questions from sell side analysts with higher ratings were even nasty in tone.  It isn’t clear to us how the price target from the Street could have been literally cut in half over the last year.  After all, it is the exact same group of businesses and the sales and margins in the Foodservice segment (the vast majority of the firm’s value) are higher today.


MTW | Operational Focus - MTW 1 10 29 15



Cranes Not Below Prior Trough If Appropriately Adjusted:  If the delay in VPC shipments is backed out, which is appropriate since it is associated with a hitch in a new product introduction, crane margins look much better – certainly above the prior cycle low.   Sales in the quarter would have been about $55 - $60 million higher at a “ballpark” 25% incremental margin.  Should this have been emphasized in the earnings release?  Obviously.  As for crane orders, the quarter was pretty weak.  That is a negative, but it is hard to say if the VPC issue also delayed orders or how much is related to weaker commodity prices – an impact that should roll off as construction is the key crane end market.


MTW | Operational Focus - MTW 2 10 29 15



Crane Orders Are Incredibly Noisy Quarter To Quarter:  The September quarter is typically the seasonally weakest.


MTW | Operational Focus - MTW 3 10 29 15



TTM Less Remarkable:  The trailing 12 month orders for the MTW crane segment shows a trend unlike the prior downcycle.


MTW | Operational Focus - MTW 4 10 29 15



Upshot:  The split is on track for February, but now with better leadership and significant identified restructuring opportunities.  We think that MTW is one of the most undervalued and least understood names in the sector.




Takeaway: The Fed has raised rates 9 times since April 2014 based on Wu-Xia math. This explains a) why growth is slowing and b) why it's late cycle.

Editor's Note: Below is a complimentary excerpt from a research note written today by our Financials team. If you'd like more information on how you can subscribe to our institutional research please send an email to sales@hedgeye.com


* * *


Claims are maintaining steady strength below 330k, rising by just 1k last week to 260k. However, even with claims now marking their 20th month below the 330k level, the Federal Reserve once again held the Fed Funds rate flat at zero yesterday. Last week, as we show in the chart below, we pointed out that this delay in a rate increase appears to be different versus previous cycles. Historically, by now the Fed would already be well underway raising rates. This is one of the arguments put forward by bulls for why the current cycle may not yet be long in the tooth.




The reality, however, is that the Fed has actually been tightening policy since December 2013 when it began tapering QE3. Interestingly, as Christian Drake of our Macro Team pointed out, the Fed actually quantifies the effect of the current cycle's non-traditional policy action and the tapering thereof in the chart below with a measure called the Wu-Xia Shadow Fed Funds Rate (HERE). The Shadow Rate is basically the rate the Fed has set by implementing non-traditional policies. The following chart shows that we have been in a rising rate environment since April, 2014 and the effective Fed Funds rate has risen ~225 bps to -0.75% from -3%. This is one of the main reasons why a) growth is now slowing and b) the cycyle is, in fact, very late stage.




On the energy front, claims in energy states continue to worsen versus the country as a whole as we approach the end of the year around which point many energy firms' hedges will roll over. The chart below shows that in the week ending October 17, the spread between the indexed series of energy state claims and country-wide claims widened to 22 from 20 in the prior week.




The Data

Initial jobless claims rose 1k to 260k from 259k WoW. The prior week's number was not revised. Meanwhile, the 4-week rolling average of seasonally-adjusted claims fell -4k WoW to 259.25k.


The 4-week rolling average of NSA claims, another way of evaluating the data, was -9.2% lower YoY, which is a sequential improvement versus the previous week's YoY change of -8.2%





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