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If Kentucky Grilled Chicken was helping to drive increased traffic and profitability for its franchise operators, I think they would be in full support of the product.


It was reported earlier this week that KFC franchisees have initiated court proceedings against YUM over a debate as to the current direction of the company’s marketing campaigns.  According to a Washington Post article published on January 9th, a coalition of franchisees is not happy with the company’s focus on the new grilled chicken platform and decision to devote the advertising budget to promoting Kentucky Grilled Chicken.


YUM rolled out its Kentucky Grilled Chicken product nationally in 2Q09, supported by advertisements that told consumers to “Unthink KFC.”  When YUM reported positive 2Q09 same-store sales growth for KFC, it seemed that the company had finally found a way to drive traffic back into KFC.  That positive growth, however, quickly turned negative during 3Q09 when KFC’s comparable sales declined 2% (And, KFC was lapping an easy comparison of -4% from 3Q08).  The initial success of Kentucky Grilled Chicken was actually even more short-lived than that with management citing an “unprecedented” 30-point swing in same-store sales growth at KFC during the first month of the launch versus pre-launch, followed by a flattening of sales immediately after the introductory launch.  YUM’s 4Q09 same-store sales in the U.S. continued to be weak with management guiding to -8% in early December.


I don’t know how many of the 4,000-plus U.S. franchised KFC units are included in the coalition that is taking legal action YUM, but this type of “noise” in the system is never good for business and does not convince me that the grilled chicken product is yet as successful as management has claimed.  On the 3Q09 earnings call, YUM management stated, “At KFC, Kentucky Grilled Chicken has been an unqualified success.”  If this statement was entirely true and the grilled product was helping to drive increased traffic and profitability for its franchise operators, I think they would be in full support of the product and the advertising spending being used to increase trial of the product. 


During the company’s 2Q09 earnings call (the first quarter of the new launch), management stated in regard to Kentucky Grilled Chicken, “another reason why it’s very popular, not only with our customers but with our franchisees is the margins are actually better on a grilled piece of chicken versus a fried piece of chicken.” As I stated before, during 2Q09, the grilled chicken launch helped to drive positive comparable sales growth so franchisees may have been happy with the product, but at this point, the franchise community does not seem to be in complete agreement with the company about the push behind grilled chicken. 


KFC’s sales have been weak for some time now so management had to do something to try to turn around the brand.  Broadening the menu seemed like a good idea to me, but I do think it is always somewhat risky for a concept to pursue a strategy that moves away from its core competencies and its core users.  Yes, chicken is KFC’s core product, but that chicken has always been fried in the past and when people think KFC, they still think fried chicken.  It will take a while to train consumers to think anything else, which explains why the company needs to spend behind the grilled chicken platform.  In the meantime, the company needs to be careful not to abandon its core users who continue to want fried chicken.  Even if the Kentucky Grilled Chicken launch has driven grilled chicken to become an impressive 30% of KFC’s sales mix, fried chicken still represents a bigger piece of sales.  And, the company’s campaign to “Unthink KFC” may not appeal to the concept’s current users who were perfectly happy with the brand.



We were bullish on China for all of 2009 (outside of our call in July for a slight correction); we are not short China right now but we are not long it either.   


One of our more important themes for 1Q10 and potentially for the whole year will be our call on China.  We think there are a number of factors that are going to cause the growth machine to slow in the first half of 2010, thereby causing the market to underperform in the intermediate term. 


Importantly, the long-term TAIL story for China is still very strong.   


One way to think about China in 2010 is in terms of QUALITY GROWTH versus SPECULATIVE GROWTH.  From the recent actions of certain Chinese officials it’s clear that they don’t like the US and blame us for the financial crisis.  How ironic is it that they borrowed a page from the playbook that brought on the financial crisis.  The Chinese have flooded the system with so much money in a short period of time that the pace of growth cannot be maintained.  I don’t want to call it a bubble, but structural bubbles (in money supply and housing) are a threat to China’s growth rate, on the margin. 


The financial crisis put pressure on the Chinese government to stimulate an economy that was humming along at a very strong pace.  The Chinese economy has long been viewed as export dependent.  While exports are important for the Chinese economy the industrials side of the economy is now far more important.  It’s amazing to think that the Chinese economy barely missed a beat as the economies of China’s largest export markets - U.S., Europe, and Japan - were falling off a cliff.


(1)    Money supply growth slowing.  Right now the central bank has not stated a 2010 target for growth in M2, but had a 17% goal last year.   The actual growth rate was more than 25% for 2009, peaking at 29.7% growth YOY in November.  We think that money supply growth could be cut by 1/3 of its current pace.


(2)    Loan growth slowing in 2010. Chinese banks extended 9.21 trillion Yuan of loans in the first 11 months of 2009, compared with 4.15 trillion Yuan in 2008. We think loan growth could drop by at least 1/3 of its current pace.


(3)    Bullish on the Chinese currency. The Chinese Yuan appreciated +18.7% between 2005 and 2008, but has been basically flat for the past 18 months. This will change, when the Chinese government decides to appreciate both lending and currency rates again in 2010. We think that currency appreciation will be at least +3-6% in the coming 6-12 months.


China is not alone as most of Asia is raising interest rates.  Australia’s central bank raised borrowing costs by 0.25% on Dec. 1 to 3.75% after increases in October and November.  The Bank of Korea recently kept its benchmark rate at 2%, but it is likely to be 3% by the end of 2010. 


Similar to our view that “HE WHO SEES NO BUBBLES” (Bernanke) needs to remove his current unsustainable and unreasonable monetary policy of “extended and exceptional”, the People’s Bank of China has altered its policy verbiage from “appropriate increases” in lending to “moderately loose” monetary policy. 


Also, on December 27th, Premier Wen Jiabao said last year’s doubling in new loans had caused property prices to rise “too quickly” and that he “pledges to cool” China Property Prices. On January 7th, 2010, the Chinese sold 3-month bills at a rate of 1.37%. That was the first explicit interest rate hike in the last 5 months.


 Yesterday, the People’s Bank of China raised the proportion of deposits that banks must set aside as reserves by 50 basis points starting Jan. 18.


Since the initial debut of our CHINESE OX IN A BOX theme, there was a widely publicized article on the NY Times that fames short seller, James Chanos, who is bearish on China.  While we agree with Mr. Chanos in many respects, China has been in a BULLISH FORMATION, much like the S&P 500, up until today when the TRADE line broke.  That being said the issues with China are real.  There is an overcapacity issue with excess retail square footage space and limited increased capacity for those industries already sourcing product from the Chinese.


Howard W. Penney

Managing Director




Do You J Crew or Rue?

Do You J Crew or Rue?


The entire team is attending the ICR Exchange in rainy Dana Point, CA over the next couple of days.  Along the way we’ll be keeping you abreast of any interesting presentations, anecdotes, and data points that we pick up.  Kicking of the conference was an informal presentation by J Crew’s Mickey Drexler.  The standing room only presentation wasn’t filled with too many new insights, but one of the most respected merchants in retail did provide some interesting insights:


  • JCG will remain in a “balanced” growth mode.  A mix of offense and defense.  Questions surrounding missed sales opportunities due to tight inventory management were quickly dismissed.  There is “no hurry to grow inventory”.  Inventories planned flat for 1H10, and will continue to be planned at levels below sales growth.
  • Drexler was bullish on opportunities beyond the core brand.  Madewell.com, Madewell store growth, incremental Crewcuts catalogs, additional Men’s Stores, and bridal shop-in-shops are all part of the near to intermediate growth plan.  When asked if overall growth could be ramped up, Mickey suggested it was unlikely although possible if the right locations came along.
  • Overall bullish on e-commerce and direct business.  Drexler’s off the cuff comments on the demise of video rental stores and potential disappearance of retail bookstores (thanks to the Kindle and others) supported his commentary that “online investments are very appealing compared to bricks and mortar”.  This supports one of our core themes that retailers embracing online as a key growth driver will continue to gain profitable share. 


Following, J Crew was a unique presentation by Rue 21.  The first five minutes were centered on the company’s recent IPO, strong share price performance, growth track record, and plan to dominate retailing like we’ve never seen before (I may be exaggerating, but not by much).  Key points from Rue (that I’m not making up):


  • When asked by the company’s pre-IPO investors if they were ready to go public, the CEO responded “Why not?”.  The entire IPO process was completed in 3 months!
  • On several occasions during the presentation, the CEO mentioned that Rue is the fastest growing retailer in the U.S.  With just over 500 stores, management now believes there is an opportunity for 1,500 stores! Prior expectations were for a 1,000. 
  • It’s all about speed.  Speed to market on merchandising through exclusive use of domestic resources and US based importers.  Speed to open stores, which only takes 6 weeks from signing a lease.  Speed to double the store base which should only take another 3.5 years. 
  • Contrary to J Crew, Rue does not operate an e-commerce site.  It appears that management is entirely focused on opening stores at this point.   Oddly, this seems a bit contradictory given the core demographic for the brand is a 12-17 year old.
  • Finally, the CEO ended with “I’m proud to say our stock price is up 60% since the IPO and we’ve added $300 million to our market cap”.  Hmm…I think we know what motivates these guys.

 Do You J Crew or Rue? - 1


Eric Levine



Casey Flavin

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While investors generally tend to be more optimistic at the start of a New Year, consumers don’t seem to share the same enthusiasm.  An ABC index of consumer confidence declined the most last week since February 4, 2008.  The confidence index fell to -47 in the week ending Jan. 10, down 6 points from a week earlier.  According to the ABC index, consumers don’t feel much better than they did one year ago when the index stood at -49.  


This week’s PERSONAL FINANCES measure dropped to -8 from +2 last week; the average over the past year is -9. 


Despite the market being up 67.9% from the March 9th low and all the billions the government has spent to support the economy, the measure of the consumer’s view of the STATE OF THE ECONOMY has gone from -88 a year ago to -82 last week; the average over the past year is -84.


That being said, the sharp rally in early 2010 is helping the bullish sentiment to improve.  According to Investors Intelligence the number of BULLS reached its highest level since Dec-07; the BEARS are at the lowest reading since Apr-87.


The Hedgeye Risk Management models have the S&P 500 in a Bullish Formation.  A Bullish Formation is when the immediate term TRADE (3 weeks or less) underpins the intermediate term TREND (3 months or more) and the long term TAIL (3 years or less).
Howard Penney

Managing Director




HOT should report a decent Q4 and provide more detailed guidance for 2010. We still think the Street has the margins wrong.



2010 Overview

In many respects, we are not far off the Street’s expectations for 2010.  Our revenue estimate of $2.68 billion is probably a touch higher than most estimates.  For management & franchise fees and other, we are projecting $660 million, in-line with the Street.  Where we differ is in the owned & leased hotel category but not with revenues – we are at $1.53 billion.  Rather, the Street’s margin projections appear too high and we’ll tell you why.


On October 22, 2009, HOT guided 2010 RevPAR for company owned hotels worldwide to fall 0% to 5% in local currency.  In US $s, guidance was 200bps higher given the exchange rate on that date.  The dollar has moved higher since then which will be a bit of a drag from the guidance number but not that germane to our discussion.  Given where the industry is in the cycle, room rates will undoubtedly be negative in 2010 if HOT’s RevPAR guidance proves accurate.  Since room rates are almost pure margin, it is inconceivable that margins will be flat, as predicted by the Street.  We wrote about the margin flow through of rate versus occupancy in our 10/15/09 post, “LODGING: HISTORY REPEATS”. 


For 2010, we are projecting $699MM of EBITDA and $0.41 of EPS compared to consensus of $730MM of EBITDA and $0.57 of EPS.  Below are some of our assumptions vs. management guidance.




  • Guidance of 0 to -5% for WW operated hotels and 200bps higher on a dollar basis if FX rates stayed at 10/22 levels
  • We have FY2010 RevPAR of -1% (FX impacted) assuming down ADR and positive Occupancy
  • Our Owned RevPAR is down 20 bps but margins are down roughly 300 bps given that FX will also impact costs, higher occupancy and flat constant currency cost per occupied room assumptions



Management, Franchise fees and Other Income

We estimate a 9.5% decline y-o-y, mostly due to the $80MM+ of “Other” Bliss revenues.  Below are our assumptions:

  • Base fees + 5%
  • Incentive fees down 2.5%
  • Franchise fees + 7.5%
  • Amortization of gains & termination fees down 3%
  • Bliss & Miscellaneous income -74%




  • Timeshare will be negatively impacted by new FASB rules (see our note on 10/26/2009 “LODGING: BETTER TIMESHARE ACCOUNTING”)
  • SG&A should decrease almost $80MM just as a result of the Bliss sale, so let’s see how much “net” cost inflation creeps back into pay and bonuses.  We’re only estimating 2% which gets us to $326MM 
  • Interest expense:  Realistically HOT will need to redo its bank facility early next year, despite the extension which gets them to Feb 2011 (otherwise they become current).  While HOT should be able to keep very little drawn on the new facility given the capex reductions and cash generation from liquidation of timeshare inventory, the new facility will likely come at a materially higher cost.  Ignoring this, and assuming the draw is de minimis, we estimate net interest expense of $220MM in 2010.

R3: NKE -- The Next Burst is Near


January 13, 2009


It’s time for investors to get NKE on the front burner. The next ‘burst’ is near.





We’ve made no secret over the past year that we really like what Nike is doing to reposition the organization for its next ‘burst’ of growth, but simply that the repositioning effort is a 12-18 month effort that was tough to get too far in front of.  There are two things that have changed since we made this call repeatedly last year: 1) Time, and 2) Our increased confidence that the new organization is beating to the same drum to crush the competition. The bottom line is that we finally think that it’s time for investors to get NKE on the front burner. The next ‘burst’ is near.


Check out the chart below. It shows the 4 distinct bursts in the stock over the past 25 years where the stock doubled or tripled. The end of those periods usually are marred with stories in major newspapers or magazines noting the end of Nike as we know it. They’ve been wrong every time. People usually don’t step back and take the big picture into context on this name.


R3: NKE -- The Next Burst is Near - NKE Stock Price


If you want to clip an occasional 20% return in either direction, you can usually trade Nike based on noise around futures, anecdotes from retailers about new product launches, or gaming the usual ‘beat and guide down – only to beat again’ nature of how management sets expectations. If you want to do that, then be my guest. But that’s not the real juice to this story.


The real question is what will drive the next wave of growth, can the org chart handle it, and is it in expectations or not? This is a name that I study pretty darn closely, and have the highest degree of confidence in out of any name out there as it relates to really understanding bigger picture.


The key to growth will unquestionably be layering the category focus over deeper geographic penetration to get Nike’s on feet of the next wave of the 5.6 billion people it currently does not touch – and synching up apparel to gain traction where its performance has been average at best in recent years.   Can the org chart handle it?  Having recently spent time with management, I must say that it’s been a while since I’ve seen such cohesion in the growth plan. The answer there is ‘Yes’.  Is it in expectations? If we’re going to measure ‘expectations’ by consensus estimates – then the answer is No. Next year (May ’11), I think the Street is low by 20%.


In the meantime, can you get cute and trade ebbs and flows in futures, and momentum building up through the Olympics (not a huge deal), World Cup (much bigger deal), and what we think will be a turn in the retail landscape for athletic footwear in 2010? Sure, of course you can. A bigger kick should be the product acceleration out of Nike as we cycle the layoff period experienced in Feb-May 2009 when there was extreme uncertainty inside the organization, and productivity took a hit. We’re living with the fruits of that today given the 6-9 month lead time on much of Nike’s product. Since May, productivity and morale picked up meaningfully, but we have yet to see it in the numbers yet. Dial the clock forward 6-9 months from then. You do the math…


We should be in full swing from a revenue momentum standpoint by mid-summer. That’s when the people that did not start doing the work today will have to answer the question as to why they ignored the story.


There’s many layers here – more than can fit on a simple summary like this. Let us know if you’d like to discuss.





Target zeros in on its team of e-commerce platform builders - It’s going to be a busy year for Target Corp. as the multichannel retailer lays the groundwork for launching its own e-commerce site by the start of the holiday shopping season in 2011. Target, No. 20 in the Internet Retailer Top 500 Guide (a PDF version of the company’s financial and operating profile can be ordered by clicking on its name), announced yesterday several of the vendors it has engaged to build Target’s own e-commerce platform. Target announced last year it would move off of Amazon.com Inc.’s e-commerce platform. Amazon, which has provided Target’s e-commerce platform for several years, will continue to support Target.com until the new Target site is launched. Target will utilize Sapient Corp. as its chief systems integrator and will build the new Internet infrastructure on a WebSphere e-commerce platform from IBM Corp. and database software from Oracle Corp. Endeca Technologies Inc. and Autonomy Corp. will provide applications for site search and content management, respectively, while Sterling Commerce Inc. will supply the site’s order management capability. Huge Inc. will provide web site design and related services.  <internetretailer.com>


Puma Names General Manager of International Footwear - PUMA announced that Mary Taylor has become the new General Manager of International Footwear effective Jan. 1, 2010. Based in Boston, she is responsible for the management of PUMA's footwear product design and development as well as product innovations in the sport performance and lifestyle ranges on a global level. Taylor reports directly to Melody Harris-Jensbach, Chief Product Officer of PUMA. Taylor has more than 20 years of experience in the footwear industry. Before PUMA, she was Chief Product and Marketing Officer at ONE7 LLC, a brand management company based in Boston, USA, where Taylor successfully re-launched global footwear product concepts and strategies. She also held senior positions with international brands such as Converse, Fila, Reebok and Keds/Stride Rite. <sportsonesource.com>


Bloomingdale's Outlets Said in the Works - Bloomingdale’s is pushing forward to launch outlets, according to sources, becoming a Johnny-come-lately into a potentially very lucrative channel of distribution for the department store chain. One real estate executive said Bloomingdale’s could be close to a deal with Simon Property Group Inc. to open several outlets around the country, taking a dramatic dive into the Simon-owned Mills properties, which typically comprise over 1 million square feet of gross leasable area and include traditional mall, outlet center and big box retailers and entertainment uses. In these sprawling centers, Simon has reclaimed some space from departing tenants, paving the way for Bloomingdale’s outlets, likely to be in the 30,000- to 40,000-square-foot range. Among the 16 Mills centers are Sawgrass Mills in Sunrise, Fla., Arizona Mills in Tempe, Ariz., and Potomac Mills in Woodbridge, Va. Bloomingdale’s declined to comment Tuesday on the strategy.  <wwd.com>


Sears Taps Wal-Mart Veteran James Haworth - Sears Holdings Corp. named James Haworth executive vice president and president of retail services, tapping an operations specialist who was widely reported to have been dismissed from Wal-Mart Stores Inc. in 2004 for violating unspecified “well-known company rules.” Haworth succeeds Kevin Holt, who is leaving the firm, and will oversee operations at Sears and Kmart and also serve on the internal holding company business unit board. He begins Jan. 31 and will report to the internal retail services board. Haworth spent two decades at Wal-Mart and was executive vice president and chief operating officer when he left under a cloud in December 2004. He founded a consulting firm the following year and most recently was chairman, president and chief executive officer of Chia Tai Enterprises International Ltd. & CP Lotus, an investment firm operating one-stop shopping centers in China.  <wwd.com>


Jones Apparel launches line for Kmart - Bristol Township’s Jones Apparel Group announced Tuesday its new GLO jeans line would be carried exclusively at Kmart stores starting this month. The GLO jeans collection targets teenage consumers and includes denim and non-denim bottoms, knit tops, woven tops and dresses. It will retail from $19.98 to $22.98 for basic denim, $26.99 to $29.99 for fashion denim and $19.99 to $21.99 for spring cropped pants. An national advertising campaign featuring ads in Seventeen magazine, People Style Watch magazine and various social networking and online initiatives will accompany the launch. <phillyburbs.com>


Ambani’s Retail Unit to Spend $87 Million on Footwear Stores - Reliance Retail Ltd., a unit of a company controlled by Asia’s richest man, plans to spend 4 billion rupees ($87 million) to add 100 outlets in India to sell branded footwear by Asics Corp., Stylo Plc and Adidas AG. Reliance Retail, today signed an agreement to sell Asics shoe brands including Gel-Kayano in its Reliance Footprint stores, the company said in a statement in Mumbai today. Mukesh Ambani’s retailing unit is tapping the $3.3 billion Indian footwear market forecast by the company to expand by a quarter as incomes rise in the world’s second-fastest growing economy. India’s growth may quicken to 10 percent in a “couple of years,” Kaushik Basu, chief economic adviser at the finance ministry, said on Jan. 4. <bloomberg.com>


2010 Must-Haves: What Consumers Want - Tech toys will be prominent on must-have lists at the dawn of the new decade. Hot new apps and mobile technologies were named by a handful of marketing experts — and close to 3,000 adults in a new Zogby Interactive poll — as things most desired to simplify lives, empower people and stay connected with others. These things “help people sift through a world when too much is available,” said John Zogby, chairman, president and chief executive officer of Zogby International. Asked to name one of 20 inventions or technological developments they could not live without, 2,841 adults polled Dec. 28 to 30 ranked high-speed Internet access as number one, followed by e-mail, Google, computer laptops/Netbooks and digital video recorders/TiVo. Spending more time online communicating via e-mail, social networks and video sites, Zogby said, is resulting in a “redefinition of peer groups — tribes of like-minded people who are becoming more important than any single demographic, like age and religion,” to marketers, among others. <wwd.com>


Challenge for 2010: Consumers Choosing Simplicity - This will be a year of living without. The U.S. is heading in that direction, marketing experts said. Brands face the challenge of consumers now accustomed to doing without things they once considered essential: attending a concert or sports event, dining out regularly, buying a new car when an old one was still running, and buying premium liquor or a status handbag.  In short, the country’s long-running, pre-recession spending spree isn’t likely to resume anytime soon. Consumers are expected to stay focused on buying fewer, more important things, in a time of the “anti-big” — a period in which they are redefining what they value, engaging in more local activities and spending more time at home with friends and family. A Zogby Interactive poll of 2,841 adults taken Dec. 28 to 30 found 40 percent of Americans anticipate having less disposable income at the end of this year than they did at year-end 2009, while one-third foresee having about the same amount in their coffers.  <wwd.com>

dering that the economy continues to lose jobs. <gallup.com>

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