The Habit Restaurants (HABT) is on our Hedgeye Restaurants LONG bench.
HABT defied gravity this quarter, reporting +2.9% same-store sales growth, against a difficult +16.2% YoY comparison (their hardest one this year), walloping consensus estimates of -0.1%. Unfortunately, we did not officially move it to our core LONG ideas due to concerns about the tough compare and how the market would react if there was a miss. The company continues to grow traffic, up +0.8% in the quarter, handedly outpacing the industry. HABT currently trades at 11.38x EV / NTM EBITDA, which we think is a good value. Given the spike after market close, we are going to keep it on the bench for now and wait for a better entry point.
As we wait for that moment we are thinking about a few different things:
HABT turned in a stellar quarter beating estimates across the board. Revenue totaled $58.6mm in the quarter, narrowly beating consensus estimates of $58.3mm, representing a +25% increase YoY. Company operated same-store sales (SSS), as stated above, increased +2.9% in the quarter versus consensus estimates of -0.1%. The comp was composed of +2.6% price, +0.8% transactions and -0.5% mix. Most impressive was the traffic growth, evidence that they have converted trial consumers they gained as result of winning Best Burger in America about a year ago. Notably, Labor as a percent of sales increased 190bps YoY to 31.3%, driven by higher costs associated with the affordable care act, paid sick leave in California and the extended hours implemented in the quarter. HABT reported net income of $1.7mm or $0.06 per share, representing a $0.01 beat versus the consensus estimate of $0.05.
MANAGEMENT OUTLOOK FOR 2015
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Earlier today Keith and I were on the road visiting clients in FL and debating some noteworthy victory laps by several of our [bullish] competitors.
Unlike said competitors, our process doesn’t leave a ton of room for cherry-picking data. As you may know, we run a predictive tracking algorithm on every relevant data point from every relevant economy in the world. The goal of that algorithm is three-fold:
To contextualize sequential deltas as accelerating or decelerating;
To contextualize the trend in any given data set as accelerating or decelerating; as
To determine if the absolute value of the latest data point(s) is at/near a probable mean reversion level.
With respect to “global PMIs”, the table below compiles GDP-weighted Composite PMI data in the context of the aforementioned process:
With respect to said process:
Global PMIs did indeed broadly accelerate on a sequential basis in OCT. That is positive for the global growth outlook. Good.
Global PMIs are still broadly decelerating on a trending basis as of OCT. That is negative for the global growth outlook and implies that the aforementioned uptick is not sustainable – at least not yet. Bad.
Global PMIs are still far from “bottoming” given the average and median percentile readings in the far right column. In fact, economies like the Eurozone, Japan and U.S. are far from “bottoming” given where the latest data points fall within their respective cycles. Not good.
With respect to #2:
According to the JPM Global Composite PMI series, global economic growth is still decelerating on a trending and quarterly average basis (1st chart below). Bad.
According to the JPM Developed Market Composite PMI series, DM economic growth is still decelerating on a trending and quarterly average basis (2nd chart below). Bad.
According to the JPM Emerging Market Composite PMI series, EM economic growth is still decelerating on a trending and quarterly average basis (3rd chart below). Bad.
According to the ISM Composite PMI series, domestic economic growth is still decelerating on a trending basis. Bad.
In fact, when analyzing each individual country’s benchmark Composite PMI series, economic growth across the balance of G20 economies continues to decelerate on a trending and quarterly average basis (5th chart below). One month of good data does not a trend make. Bad.
In short, when considering the preponderance of the data, any “bottoming” call with respect to global growth:
Blatantly disrespects the TREND in domestic and global growth data.
Blatantly disrespects the absolute level of the data – especially considering that most investors who are now calling for a “bottom” failed to identify what was an obvious top back in early 2015.
Blatantly disrespects the risk of incremental #StrongDollar debt deflation – almost in cavalier fashion, especially given that the unwind of a #WeakDollar global leverage buildup is what got us in this mess in the first place.
After having done about 30+ meetings all over the country since we introduced our Q4 Macro Themes in early October, Keith and I remain of the view that #3 is arguably the most misunderstood and mispriced risk across asset markets today.
We are the authors of this view and suspect that most equity and credit investors still fail to grasp what macro investors view as a simple concept: a rising U.S. dollar tightens financial conditions globally.
Ten-plus years of financial repression in the U.S. created 10+ years of commensurate financial repression across the global economy (to prevent “Dutch Disease”) – especially in emerging markets (namely China). Such easy financial conditions perpetuated the world’s largest stock of USD and local currency denominated debt and, as a result, unprecedented levels of global demand. Now that cycle is in the process of coming undone, just as every cycle before it.
Required reading on this subject:
Two Schools of Thought Part II (6/8/12): We continue to view a sustained breakout in the USD as the most asymmetric and contrarian outcome facing global financial markets over the long-term TAIL.
Emerging Market Crises: Identifying, Contextualizing and Navigating Key Risks in the Next Cycle (4/23/13): We currently see a pervasive level of risk across the emerging market space at the country level and have quantified which countries are most vulnerable. As such, we find it prudent for investors to reduce their allocations to emerging market equity and currency risk in favor of US equity and US dollar exposure. #StrongDollar and commodity price deflation have been and should continue to be key catalysts for EM underperformance.
Are You Prepared for #Quad4? (8/5/14): Developing quant signals and fundamental data are supportive of investors adopting a defensive allocation w/ respect to the intermediate term.
1Q15 Macro Theme: #GlobalDeflation (1/8/15): Amidst a backdrop of secular stagnation across developed economies, we continue to think cyclical forces (namely #StrongDollar driven commodity price deflation) will drag down reported inflation readings globally over the intermediate term. That is likely to weigh heavily upon long-term interest rates in the developed world, underpinning our bullish outlook for U.S. Treasury bonds (TLT, EDV, ZROZ, etc.).·
Are You Prepared for a Deepening of the Global Earnings and Industrial Recessions? (10/22/15): Don’t be fooled by today’s price action in the DOW (which KM shorted into the close today). To the extent the ECB and BoJ incrementally ease monetary policy as our models suggests they will at some point over the next 2-3 months, the ongoing monetary policy divergence across G3 economies is likely continue perpetuating a severe tightening of credit conditions globally via a stronger U.S. dollar. Moreover, that is likely to perpetuate a deepening of the ongoing global earnings and industrial recessions.
4Q15 Macro Theme: #GameOfSlowing (10/8/15): With the Street, IMF, World Bank and OECD all still forecasting global growth of around 3% for 2015, we find it appropriate to reiterate our call for global growth to come in at or below half that rate. Moreover, while China's August CNY devaluation effectively made our #EmergingOutflows theme a consensus bearish cog in the global economic outlook, we do not think investors are appropriately positioned for a likely trend of negative revisions to the respective growth outlooks in the U.S., Eurozone and Japan throughout the balance of the year.
Moving along, the more we are right on our #EuropeSlowing view, our view that Abenomics will fail to achieve “5% Monetary Math”, or our view that the BoE is poised to shift dovish in conjunction with a rising probability of a U.K. recession, the more we will continue to be right on our structurally bullish bias on the U.S. dollar. Despite our bearish view on the U.S. economy, we believe the Yellen Fed is too far out in la-la-land with respect to its “dot plot” and GDP forecasts to implement QE4 quickly enough.
Moreover, the more we continue to be right on our structurally bullish bias on the U.S. dollar, the more we will continue to be right on our structurally bearish bias on inflation expectations and the respective growth rates of global capital expenditures, global leverage and EM consumer demand associated with said inflation expectations globally.
In short, the global economy might’ve recorded a few “green shoots” in OCT, but the TREND in global growth is decidedly lower with respect to the intermediate term.
We are hopeful that this late-night rundown of the "data" helps clarify any confusion our competitors may have caused. Yes, this is the same "data" some of them told you to "ignore" and failed to identify as slowing 6-9 months ago.
Keeping it real,
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Takeaway: While we suggested covering some in late September, the recent disclosures leave us more bearish and suggest our thesis is on track. Cat Financial apparently goosed 3Q15 results by changing model assumptions, adding an estimated 6 percentage points to the segment margin with an accounting maneuver. Caterpillar Financial cut the Allowance for loan losses amid unfavorable changes in credit quality, which seems odd. We can’t wait to hear CAT’s presentation on the Finance segment on November 17th, although we do not expect it to provide the data and granularity that investors want. The various investigations appear to have expanded, and the company’s postretirement benefit underfunding should increase next year. Overall, CAT’s 10-Q, proposed meeting on Cat Financial, and GS conference presentation continue to suggest further downside to us.
Key Earlier Publications
Feeling Used? CAT Black Book (latest of many)
Barron’s article response (8/8/15)
It Gets Worse From Here (7/23/15)
Writing On The Wall
“During the third quarter of 2015, as a result of management’s review, the loss emergence period and loss given default assumptions were updated and resulted in a decrease to the allowance for credit losses of $45 million. The decrease in the provision for credit losses was also due to the absence of a $14 million out-of-period adjustment in the third quarter of 2014 (included in the discussion above). These changes were partially offset by an unfavorable impact from changes in the credit quality of Cat Financial’s portfolio.”
Our Translation: Credit quality deteriorated, but we changed some model assumptions so that deterioration didn’t impact earnings.
Not Healthy: If you come home, and a three year old says “I didn’t draw on the wall” do you bother to check, or do you just grab Mr. Clean Magic Eraser? An unprompted denial usually doesn’t indicate anything good. For CAT, the assertion that “our captive finance company is healthy and strong” was a similar red flag in the 3Q15 earnings release, and would have been tough to defend had margins dropped over 6 percentage points. Write-offs were higher only in 2 quarters over the last dozen years, with both of those during the Financial Crisis. Healthy?
One Quarter Fix, Future Earnings At Risk: Amazingly, that disclosure on the $45 million benefit from an accounting assumption change did not make the press release or earnings call, at least that we saw. But the drop in allowance was highlighted. To quote Josh Steiner of our Financials team “taking reserves, not just reserve coverage, down amid (sharply) rising NPLs is reckless and aggressive. Any traditional lender would face villagers/pitchforks for this.”
Do You Know Who They Lent To? Here is part of the list of Caterpillar Financial mining Major Accounts from our June 2015 deck. As we understand it, these are not necessarily included in the Mining category of the portfolio in disclosures, but may be in regional buckets.
Problems Outside of Caterpillar Financial
Backlog Longer Than 12 Months: It is worth noting that CAT’s order backlog is getting somewhat longer dated, which is not positive for 2016 since the total order backlog is lower. It could also indicate that some delivery dates have been pushed out.
CAT has so many legal issues, that it can be hard to keep track of them. The key investigations seem to be heading in the wrong direction for investors as of 3Q15. The Federal grand jury investigation into CAT’s taxes apparently expanded, with additional subpoenas for, among other things, information on “dividend distributions of certain non-U.S. Caterpillar subsidiaries, and Caterpillar SARL and related structures.” The pressure on this does not seem to be easing, and it could be an expensive settlement for CAT, as we understand it. The investigation by the SEC into the accounting for the Bucyrus acquisition also generated additional subpoenas, and we think management should just restate, impair, pay a fine, or whatever is needed to get it over with, in our view.
Pension Losses May Impact 2016 Earnings
CAT disclosed in the 10-Q that “Based on market conditions as of September 30, 2015, we would be required to recognize an increase in our underfunded status of approximately $800 million at December 31, 2015.” The driver of the pension challenges was “due to year-to-date negative plan asset returns”. All else equal, this could increase pension expense in 2016 – a year that likely won’t need additional profit challenges.
November 17th Cat Financial Meeting For Investors
The last one of these meetings, which was on the Across the Table dealer initiative, was not especially helpful. We would be very surprised if this upcoming meeting on November 17th had the data and granularity that investors actually want. We hope that CAT decides to provide more transparency on the composition and exposures in the portfolio, but our expectation is that it will be a narrative driven presentation.
Upshot: While we suggested covering some in late September, the recent disclosures leave us more bearish and suggest our thesis is on track. Cat Financial apparently goosed 3Q15 results by changing model assumptions, adding an estimated 6 percentage points to the segment margin with an accounting maneuver. Caterpillar Financial cut the Allowance for loan losses amid unfavorable changes in credit quality, which seems odd. We can’t wait to hear CAT’s presentation on the Finance segment on November 17th, although we do not expect it to provide the data and granularity that investors want. The various investigations appear to have expanded, and the company’s postretirement benefit underfunding should increase next year. Overall, CAT’s 10-Q, proposed meeting on Cat Financial, and GS conference presentation continue to suggest further downside to us.
The surprise that Wall Street consensus isn't predicting? A gloomy jobs report on Friday. That would reduce the odds of a December rate hike. Here's more from Hedgeye CEO Keith McCullough on what that would mean for Treasuries:
"For the umpteenth time this year, the UST 2YR Yield is in this 0.75-0.80 zone and signals overbought on “they’re gonna raise rates” – you’re one more bad jobs report away from 0.59% 2YR and 1.98% 10YR. FYI – we are staying with that call."
We will host a conference call on Friday, November 6 at 11:00AM ET to present our view on the Macau stocks, a deeper analysis of the October numbers, our updated estimates for FY 2015/2016, and a comparitive analysis of the concessionaires' performance. As always, we will entertain questions at the end of the presentation.
RELEVANT TICKERS INCLUDE:
LVS, WYNN, MGM, MPEL, 0027.HK, 1128.HK, 1928.HK, 2282.HK, 6883.HK, and 0880.HK
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