Takeaway: We hosted a one hour call this morning introducing our bearish thesis on PRA Group (PRAA). Links to the deck and replay are below.

Slides: HERE

Call: HERE





  • Supply/Demand Headwinds: The market for buying defaulted receivables is especially unfavorable. Demand for paper has exceeded supply for a few years now, mirroring the environment last seen from 2005-2007 when shares of PRAA tumbled ~70%.
  • Growing Debt: Leverage at the company has risen quickly in the wake of the Activ deal.  
  • Insiders Dumping: Widespread insider selling suggests that insiders see similar intermediate/longer-term headwinds.
  • History's Guide: Our analysis of the interplay between labor markets, terminal IRRs and pre-tax margins will shed light on what to expect fundamentally from a timing standpoint.
  • Regulatory Pressure: The CFPB is expected to set new rules for debt collectors in 2016.
  • Current Value Unsustainable: The ERC less cost to collect and taxes is currently ~$400mn below the net debt of the company.


Joshua Steiner, CFA


Jonathan Casteleyn, CFA, CMT

BREAKING: Wall Street Consenseless Has No Clue About Fed Rate Hike

Takeaway: We don’t put much stock in Old Wall’s Fed predictions.

BREAKING: Wall Street Consenseless Has No Clue About Fed Rate Hike - consenseless  2


More data. More bad news for Fed-hike prognosticators.


Today, U.S. industrial production year-over-year slowed again to the lowest reading of 2015. Here’s analysis and a chart from Hedgeye CEO Keith McCullough:


“With Industrial Production only 0.3% y/y now (lowest reading of 2015 - see red circles) we’re entering the next leg down of the cycle = Industrial/Cyclical Recession. Don’t forget that growth is reported y/y and the toughest compares were in NOV/DEC of 2014 (see green circle). Things should slow faster in the coming months.”


click image to enlarge.

BREAKING: Wall Street Consenseless Has No Clue About Fed Rate Hike - industrial production


That’s just the latest underwhelming economic reading. Don't forget New York Fed president Bill Dudley's recent concern that inflation is running “well below our 2 percent objective.”


Below are a few more recent economic misses (for those of you keeping score):


BREAKING: Wall Street Consenseless Has No Clue About Fed Rate Hike - miss


So a December rate hike isn’t necessarily such a sure thing. The Fed is 'data dependent.' Remember?


BREAKING: Wall Street Consenseless Has No Clue About Fed Rate Hike - wsj econ survey


And yet, the latest headscratcher from Old Wall is the overwhelming expectation of a December rate hike. If you think their predictive track record matters, think again. Here’s a Wall Street Journal survey of economists:


“There is near-unanimous agreement among private forecasters surveyed that the Federal Reserve will begin raising short-term interest rates next month after holding them near zero for seven years.


About 92% of the business and academic economists polled by The Wall Street Journal in recent days said they expected the Fed to raise its benchmark federal-funds rate at its Dec. 15-16 policy meeting…


In the latest survey, the economists on average estimated the probability of a rate increase next month at 71%, up from 48% a month earlier.”




Now take a second to look at how “well” these same folks have done forecasting the next Fed rate hike. Below is a recap also from WSJ. (Notice the overwhelming consensus, in July and August, that the Fed would hike in September):


BREAKING: Wall Street Consenseless Has No Clue About Fed Rate Hike - econ consensus


No, we don’t put much stock in Old Wall’s predictions.


BREAKING: Wall Street Consenseless Has No Clue About Fed Rate Hike - ex economy

McCullough: Ignore Volume and Volatility At Your Peril


In this brief excerpt from The Macro Show this morning, Hedgeye CEO Keith McCullough explains why investors need to pay closer attention to volume and volatility.



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


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Builder Confidence | Headfake or Harbinger?

Takeaway: Builder confidence slipped in November from its recent post-crisis high of 65, but remains well below prior cycle highs of 71, 78 and 72.

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.


Builder Confidence | Headfake or Harbinger? - Compendium 111715


Today's Focus: November NAHB HMI (Builder Confidence Survey)

Builder Confidence slipped -3pts in November, dropping for the 1st time in 6-months and retreating off the cycle high of 65 (revised +1pt) recorded in September. Across the sub-indices, Current Sales and 6M Expectations declined -3pts and -5pts, respectively, while Current Traffic rose +1pt sequentially. Regionally: West = +1pt and making a new 120-month high, South = -5pts off 120-mo high recorded last month, Midwest = -1pt MoM, Northeast = flat at 52 and holding at decade highs.


Off The Highs: Given the soft PHS and NHS data for October, it’s not particularly surprising to see Builder Confidence in November retreat moderately off the 10-year high recorded last month.  One month does not a trend make but if October was indeed the peak, it would fall well below the prior cycle highs of 71, 78 and 72.


Builder vs Consumer Confidence:  The pullback in the HMI is in-line with the recent trend in broader measures of consumer confidence which peaked in 1Q15 and have softened since.  Up to now, what has been interesting was the continued momentum in both the headline and forward expectations readings in the HMI, particularly given the tendency for Builder Confidence to lead both Consumer Confidence and broader macro inflections over recent cycles. We discussed this divergence in greater detail in reviewing the October HMI data (HERE).


Headfake or Harbinger | Profiling the Last 2 Cycles:  The HMI progression followed somewhat variant paths during the Tech and Housing bubbles cycles.  We profile each below but there are a few broader takeaways. 


  1. The trend in HMI is a good lead indicator for housing fundamentals and the broader economy and a decent coincident indicator for housing related equities (chart 1 below). 
  2. There are multiple instances in which HMI weakened for 1 or 2 months only to bounce back.  However, successive months of weakness have generally signaled further, ongoing softening (chart 2/3).
  3. Rates:  Rates have been a mitigating-to-primary factor in the HMI-Housing connection.  Inflections in builder confidence and housing/builder performance have occurred alongside changes in the policy rate and flow through shifts in mortgage financing costs (charts 2/3).  


Tech Bubble Cycle (97-03):  HMI peaked at 77/78 in Nov/Dec 1998 and then corrected down to 71 for Feb/Mar/Apr 1999, only to bounce back to 75/77 in May/Jun/July 1999.  The drop in HMI in late 1998 is fairly coincident with both a tightening in policy and the decline in Housing stocks in early 1999 through mid-2000.  However, housing stocks rose steadily from mid-2000 on –  a period which coincided with an ease in rates and a stabilizing of HMI in the 55-63 range (post-9/11, notwithstanding). 


Housing Bubble Cycle (03-08):  In hindsight it was obvious that the June 2005 reading of 72 was the high and it was downhill from there. However, it probably wasn’t clear at that time that things were rolling over (based solely on HMI in isolation) until the 61 print in November 2005, or the 57 print in December 2005.  After tripling over the preceding 2.5yrs, builder stocks peaked in July 2005, well ahead of the broader equity or economic peak but coincident with the turn higher in rates. 


So what do you do with the November data? ….  The short answer is probably ‘not much’ as a single month of data falls in indicator purgatory vis-à-vis a read-through on the Trend.  We will be more concerned if we see a 2nd month of retreat in December and the Fed pulls the normalization trigger into slowing growth.   The rates dynamic and duration sensitivity in equity exposure is more challenging to navigate in the current instance also as we expect a shallow hiking cycle (if any at all) and think a flattening yield curve is more probable than not in the face of a sustained attempt at policy normalization.



Builder Confidence | Headfake or Harbinger? - HMI vs Consumer Confidence


Builder Confidence | Headfake or Harbinger? - HMI Tech Buble Cycle


Builder Confidence | Headfake or Harbinger? - HMI Housing Bubble Cycle


Builder Confidence | Headfake or Harbinger? - NAHB LT


Builder Confidence | Headfake or Harbinger? - NAHB Optimism Spread


Builder Confidence | Headfake or Harbinger? - NAHB Regional


Builder Confidence | Headfake or Harbinger? - NAHB Survey Indicators


Builder Confidence | Headfake or Harbinger? - HMI vs Univ Mich Housing Sentiment



About the NAHB HMI:

The Housing Market Index (HMI) is based on a monthly survey of NAHB members designed to take the pulse of the single-family housing market. The monthly survey has been conducted for 30 years. The survey asks respondents to rate market conditions for the sale of new homes at the present time and in the next 6 months as well as the traffic of prospective buyers of new homes. The HMI is a weighted average of separate diffusion indices for these three key single-family series. The HMI can range from 0 to 100, where a value over 50 implies conditions are, on average, improving, a value below 50 implies conditions are worsening, and an index value of 50 indicates that the housing market is neither improving nor worsening.




Joshua Steiner, CFA


Christian B. Drake


Hipster Retailer + Earnings Slowdown = Pizza?

Hipster Retailer + Earnings Slowdown = Pizza? - urban pizza shirt


In what we view to be one of the most ridiculous “strategic” moves by a retailer in over 20 years, Urban Outfitters (URBN) has announced the acquisition of the Vetri Family group, which owns a handful of Italian food restaurants. The deal was justifiably lampooned in the media as an odd departure for a retailer, known primarily for pandering to the young, hipster crowd.


After looking at Urban Outfitters’ horrible third quarter earnings, the rationale became a bit clearer. Management is at the end of its rope and looking for ways to improve its core (slowing) business. 


Hipster Retailer + Earnings Slowdown = Pizza? - urban wondering


Investors aren’t pleased.


Urban Outfitters’ stock is getting crushed this week, falling 20%. It’s clear to us, if Urban is looking for a panacea to unlock future growth, this clearly isn’t it.


Here’s why.


This is an extremely small deal. Vetri owns just nine Italian food restaurants located primarily in southern Philadelphia. That could help explain why Wall Street analysts didn’t even question the deal. Of the twenty-six questions asked during the third quarter earnings call, not one of the 11 participating analysts asked about the Vetri transaction.


That’s troubling, though, given the significant slowdown in Urban’s business. The company has now missed sales expectations for the third quarter in a row. So, with the Vetri acquisition, Urban is obviously stretching for growth opportunities.


Hipster Retailer + Earnings Slowdown = Pizza? - urban pizza rest


The slowdown in shopper traffic has hurt other retailers too. In the past week, Macy’s (M), Kohl’s (KSS) and Nordstrom (JMN) all saw their stocks slide between 4% and 24% on lackluster retail sales data. It’s perhaps the clearest indication yet of a #LateCycle slowdown in consumer spending.


That said, Urban Outfitters has fallen harder. And faster. The stock is down 55% from its March high. Make no mistake. Even with the drawdown, the stock still isn’t a bargain and we still have lots of questions.


Hipster Retailer + Earnings Slowdown = Pizza? - urban chart



What's the real addressable market for each concept? How has the competitive landscape changed? And how much capital is needed to capture that growth? All in, there's no reason to think that those high-teens EBIT margins of old are 'owed' to URBN.


This might be the new normal. At least, that's what we're going with until our research changes.


But let’s parse the new Vetri “opportunity” a bit. Yes, Urban Outfitters’ target demographic might be a 25-year old consumer. Yes, 25-year old consumers might like pizza. But that doesn’t mean that URBN has earned the right to get into the pizza business.


Consider the pure logistical aspect of pivoting from owning pure retail stores to some retail-restaurant hybrid. We’re talking about a completely different level of operating scrutiny in the restaurant business, with food preparation, employee training, and FDA oversight. For starters, Urban Outfitters currently doesn’t have to monitor whether or not its employees wash their hands after leaving the restroom. Simply put, this is a fundamentally different model than anything URBN operates today.


There’s also a problem with searching for growth in an industry that is clearly declining. On the third quarter conference call, we found this comment from Urban Outfitters CEO Richard Hayne particularly odd:


“Spending on casual dining is expanding rapidly, and thus, we believe there is tremendous opportunity to expand the Pizzeria Vetri concept.”


As our Restaurants analyst Howard Penney pointed out, following the Vetri acquisition news, casual dining traffic and sales are “in a secular decline and not growing.”


click the image below to enlarge. 

Hipster Retailer + Earnings Slowdown = Pizza? - urban howard chart


Are we making a mountain out of a molehill? We don’t think so. The mountain is already there, and it’s causing what has been a very well-managed company to look far outside its core.


We are moving Chipotle (CMG) from the BENCH to the Hedgeye Restaurants Best Ideas SHORT list.


Please join us Today, November 17th at 1:00PM ET for a LIVE Flash Call regarding our SHORT thesis on CMG.


Toll Free:


Confirmation Number: 13625259

Materials: CLICK HERE

Live Video: CLICK HERE


When we added CMG to the short list on 9/30/15 (NOTE HERE), one of our primary concerns was focused on potential issues surrounding the supply chain and increased growth pressures coming from more expensive real estate and associated costs.  In addition, following the introduction of the Friend or Faux game, the company detractors were getting more aggressive exposing the Hypocrisy of the company. 


The hypocrisy movement has been elevated to a level that could seriously expose the company’s business practices and hurt the brand image.  The issues coming to light right now at CMG, remind us of what happened to Whole Foods (WFM) with their overpricing scandal in June of 2015. This caused detrimental damage to the perception of the brand that they are still working on shedding. The central issues about the CMG SHORT thesis are centered on:

  1. The hypocrisy over CMGs advertising is gaining momentum.  If CMG loses a class action lawsuit it might have to stop advertising that it serves non-GMO food
  2. The challenge is even greater when we come to grips with the notion that the company will likely outgrow the supply chain over the next couple of years 
  3. Four separate issues of foodborne outbreaks in the last year suggest the company is having a difficult time managing its supply chain
  4. The company’s relentless attacks on other restaurant companies and more recently attacking the entire supply chain suggests there are many who will revel in the anguish of CMG
  5. Over the last five years, capital spending has grown 131%.  Returns on capital over the next five years will come at much lower returns   


Back in September we asked the question, “Has CMG gone too far (in attacking the supply chain), who is fighting back?”  There is clearly a group attacking the company with its Chubby Chipotle ads and the article, “Chipotle Hypocrisy: American Antibiotics Bad, British Antibiotics Good.”


The Hypocrisy movement is growing and gaining momentum!


The CMG detractors are clearly calling out CMGs business model and challenging some of the ways the company does business.  In August and September 2015, two false advertising class-action lawsuits were filed against Chipotle Mexican Grill alleging that the restaurant falsely advertises that its food does not contain genetically modified organisms (GMOs) when it actually does. As the publicity of these lawsuits go more mainstream, CMG will have a difficult time defending itself in the eyes of public opinion. 


The lawsuits also put a spotlight on the supply chain issues and some of the complications the company faces as it gets bigger.  Added to these questions, the company is facing new creditability issues as it deals with four separate foodborne illnesses in 2015.  Importantly, each successive outbreak was worse than the last and there was even one that went unreported. 



It’s clear that the company is having growing pains with its supply chain and this issue is being manifested in the lack of controls over its suppliers.  While they have not found the source of the E. coli outbreak, it’s usually found in produce.  Given that CMG sources most of it produce locally, to keep up with its growth, it has been increasing the number of local suppliers. The constant need for supply could have led CMG to speed through the testing and qualification process for suppliers, potentially leading to the infected produce.


We would also note that in the 2014 10-K the Company changed how it defines the type of produce it supplies to its restaurant.  CMG removed the word "sustainably and replaces it with “responsibly grown produce.”  Meaning produce grown by suppliers who we believe respect the environment and their employees.  To the degree this change altered how the company looks for suppliers could be the origination of why things are different with the CMG supply chain.


Taken a step further, it’s well within the realm of possibilities that this is a sign of bigger issues at the company.  What other growing pains will be bubbling to the surface in the coming months? 


All of the companies Chipotle’s size or larger, (MCD, SBUX, CAKE, EAT, DNKN etc.) have at one point pushed too hard on new unit openings, only to be forced to regroup and slow down.  Despite how great or different Chipotle’s food is from every other concept, the foodborne illness issues demonstrate that the company is just like every other restaurant concept.  When it comes to pushing the rate of growth to a level that will cause internal problems, like other companies before them, CMG will be no different.  We suspect we are closer to that date than we have ever been.


Since 2010, the company has increased its capital spending by 131% to an estimated $262 million for the full year 2015.  The company increased its 2016 unit growth target on the last earnings call, but that may have been a response to slowing same-store sales trends.  The stocks performance following the call suggests that the market is no longer rewarding the company for faster unit growth.  If the company is experiencing, internal growth related issues, the accelerated pace of development will only add to the existing problems. 



Adding to this issue is the confusing remarks the company made during the last conference call versus what they put in the 10-Q.

  • On the 3Q15 call management said ― “We've built a fantastic development program as our real estate, design, and construction teams are finding favorable new restaurant sites and negotiating some of our best lease terms.”
  • In the 10-Q the company said ― “occupancy costs as a percentage of revenue increased for the three months ended September 30, 2015 primarily due to increased costs for leases entered into during 2015.” 


In a slowing sales environment expensive leases can hurt the P&L.


CMG has been a significant beneficiary of the non-GMO movement and those days may be over.  In August and September 2015, two false advertising class-action lawsuits were filed against Chipotle Mexican Grill alleging that the restaurant falsely advertises that its food does not contain genetically modified organisms (GMOs) when it actually does.


Beginning in March 2013, Chipotle released a comprehensive list of all of its ingredients on its online website, which was reportedly a first among fast-food chains.  When Chipotle first listed its ingredients online, 12 of the 24 ingredients listed contained the presence of GMOs, including Chipotle’s tortillas, rice, salad dressing, potato chips, and its meat products.  Chipotle stated, however, that it was committed “to removing the GMOs from” it’s Food Products “to the fullest extent possible.”  For the next 10 quarters same-store sales averaged 10.5%.  Undoubtedly the company has benefited from the news and consumer acceptance that the food has no GMOs.


On April 27, 2015, Chipotle announced and began advertising that it would only prepare food with ingredients that are free of GMOs.  Steve Ells, Chipotle’s founder and co-chief executive said that, “Just because food is served fast doesn’t mean it has to be made with cheap raw ingredients, highly processed with preservatives and fillers and stabilizers and artificial colors and flavors.  Despite that, same-store sales have softened and the numbers of company detractors are growing. 


According to the lawsuit “The California Consumer Legal Remedies Act (“CLRA”), Civil Code section 1750, et seq., was designed and enacted to protect consumers from unfair and deceptive business practices. To this end, the CLRA sets forth a list of unfair and deceptive acts and practices in Civil Code section 1770.


Chipotle's practices in connection with the marketing and sale of its Food Products violate the CLRA in at least the following respects:

(a) In violation of section 1770(a)(5), Defendant knowingly misrepresented the character, ingredients, uses and benefits of the ingredients in its Food Products;

(b) In violation of section 1770(a)(7), Defendant represented that the ingredients in its Food Products are of a particular standard, quality or grade, which they are not; and

(c) In violation of section 1770(a)(9), Defendant knowingly advertised its Food Products with the intent not to sell the products as advertised.


The complaint says “Chipotle represents that all of its Food Products contain “non-GMO ingredients” and fails to disclose that its Food Products necessarily contain GMO ingredients in order to convey to consumers that they are obtaining a product that provides more benefit and are safer for consumers than other restaurants which offer similar or substantially similar food products. These representations are false and misleading in that many of the ingredients composing Chipotle’s Food Products do contain GMOs.”


For further proof of the merits of the lawsuit you only need to look at the company web site.  “In the United States at this time, most of the grain used as animal feed is genetically modified. This includes most of the grain used to feed the animals that provide our meat and dairy. While we are striving to eliminate GMOs from our supply chain, there is currently not a viable supply of responsibly raised meats and dairy from animals raised without GMO feed.”


If you buy a burrito from CMG it has GMOs in it!


The plaintiff claims they were injured by purchasing (or overpaying for) Chipotle’s Food Products.  Possibly so!  At the very least as the details of this suit become more widely known it will be very bad publicity for a company whose mantra is 'food with integrity'.


If CMG settles or loses and they are forced to change their entire marketing strategy it will be very bad news.

The GMO loophole

The company’s defense will be that they are in compliance with the laws.  In the past the company has cited the GMO labeling law the state of Vermont passed (the only GMO labeling bill to win voter approval thus far) which goes into effect next year (CMG only has two locations in VT).


“Under that law, meat or dairy from animals that are fed GMO feed are still considered non-GMO. You could also look at the Safe and Accurate Food Labeling Act of 2015 (HR 1599) which recently passed in the House. It would similarly allow food to be labeled non-GMO if it is derived from animals that are fed GMO feed”


The fate of this is now in the California court and the court of public opinion, both of which could be very damaging to the company. 


Management is very bullish about the future and that the company is about to start a new three year cycle on same-store sales.  On the most recent earnings call John Hartung, Chief Financial Officer, Chipotle Mexican Grill, Inc. said – “we just finished a three-year trend, and I've talked about this on some earlier calls. If you go back and look to 2013, we started a new trend where we started in low single-digit comps, and we kind of built our comps for the next several quarters. We had a price increase in 2014. But if you combine the last three years – and this is kind of the end of that trend – our three-year comps are up in the high 27%-28% range.  We now need to start a new trend because we started that momentum. And if you look quarter to quarter, you can see that the momentum builds for several quarters, then it levels off. It peaked last year at 19.8%, and then as you are comparing through multiple years, up double digit comps.”


We believe it to be unrealistic to anchor a bullish call on CMG based on three year cycles.  We don’t believe that phenomena truly exist. The only three year pattern we see in the company, is price increases every three years.  The increase in traffic is more cyclical or luck than it is reality.  At the end of 2012 and the beginning of the last "3-year cycle", CMG announced that it was going GMO-free.  Around this announcement, the company generated a significant amount of incremental new customers. 





Yet, contrary to the CEO statement, its advertising campaign and instore signage, Chipotle’s ingredient list on its website admits “there is currently not a viable supply of responsibly raised meats and dairy from animals raised without GMO feed”


Non-GMO meat is able to come from cows that have been fed GMO feed. In order for consumers to completely avoid animal products that have been fed GMO feed, you must look for certified organic products, since organic standards prohibit the intentional use of GMOs.



Bottom line is that CMGs food has GMOs and it’s loaded with excessive calories! In fact, the average burrito in a tortilla will have around 1,000 calories, 2,300 grams of sodium 62 grams of fat and 60 grams of protein. Although the protein count is impressive, the other three stats aren’t as appealing.


Analyst sentiment is entirely too bullish, 53% of analyst have it rated as a buy, 47% as a hold and zero as a sell.



Short interest is near historical lows, at a time when the company is under the most pressure it ever has been.



Earnings revisions have barely come down for the company, and they are facing more headwinds then ever.



We see CMG trading at valuation levels below that of McDonald’s. The below chart implies no upside for the company, but significant downside.





Please call or e-mail with any questions.


Howard Penney

Managing Director


Shayne Laidlaw










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