The S&P rolled over on Wednesday, with all of the major indexes finishing down more than 1% on the session.  Tuesday’s euphoria over the election in Massachusetts was quickly overcome by the potential for Congressional gridlock on a number of important issues.  Overall the volume was still light, but was up 1.9% day-to-day; breadth was the worst it’s been all year. 


The Hedgeye RISK Management sector models saw a breakdown yesterday in two sectors – XLY and XLU – both broke TRADE. All nine sectors declined yesterday and all nine are positive on TREND. 


On the MACRO front, the “CHINESE OX IN A BOX” and liquidity concerns were on the front burner as the focus was on Beijing's efforts to curb new bank lending.  Not surprisingly, this dynamic weighed on the RECOVERY trade as the Dollar Index continues to trade higher.  Of the three worst performing sectors two are leveraged to the RECOVERY TRADE - Materials (XLB) and Energy (XLE).  


The XLE and XLB were also hit by the strength in our “BUCK BREAKOUT” theme, which underpinned the safe haven status (i.e. better fiscal outlook now that Democrats have lost in Massachusetts and heightened risk aversion with the VIX up +6.1% on the day yesterday.  Precious metals and industrial stocks were among the biggest decliners in the XLB, while higher-beta coal and oil services stocks were underperformers in the XLE sector.  On Wednesday, crude closed down 1.9% to $77.74 a barrel.


Also on the MACRO front the MBA mortgage applications slowed to 9.1% from 14.3% and housing starts declined 4% from 8.9% last month.  On the positive side building permits were 653,000 vs. 584,000 last month. 


Also taking center stage on the downside was Technology (XLK).  The XLK underperformed yesterday despite the Q4 earnings beat from IBM. There was weakness in the software group today, with the S&P Software Index declining 1.4%, while the Semis held up better than the broader XLK. 


The best performing sector yesterday was the Financials (XLF), down only 0.3% on the day.  Within the XLF the banking group bucked the broader market selloff today with the BKX up 1.4% with the Trust names (STT, NTRS and BK) trading higher following their Q4 earnings results. Regional banking stocks are also performing wells after their Q4 earnings reports.


As we look at today’s set up the range for the S&P 500 is at 20 points or 0.43% (1,133) downside and 1.05% (1,150) upside.  At the time of writing the major market futures are trading down on the day.  


Copper imports by China, climbed for a second month in December on rising demand.  Despite this news Copper traded down 2.67% yesterday and is flattish in early trading today.  The Hedgeye Risk Management Quant models have the following levels for COPPER – buy Trade (3.32) and Sell Trade (3.46).


In early trading today Gold is declining for a second day, after falling 2.4% yesterday; the biggest decline since December 17, 2009.  The Hedgeye Risk Management models have the following levels for GOLD – buy Trade (1,101) and Sell Trade (1,134).


Yesterday crude traded down by 1.9%, and is trading slightly lower in early trading today.  The strength in the Dollar and increased inventories are putting pressure on oil.  The Hedgeye Risk Management models have the following levels for OIL – buy Trade (76.94) and Sell Trade (80.49).


Howard Penney

Managing Director















SBUX’s fiscal 1Q10 earnings came in at $0.33 per share, better than my $0.29 per share estimate and the street at $0.28 per share.


The company raised its full-year EPS guidance to 1.05-$1.08 (above the street at $1.02), or +31%-35% growth, up from its prior +15%-20% range.  Despite the better than expected same-store sales growth of +4% in the U.S. and +4% internationally, SBUX maintained its prior guidance for modestly positive comparable store sales growth.  The company did reiterate the higher end of its prior revenue guidance of mid-single digit growth.  The biggest delta to the prior guidance comes from the company’s new outlook for 400 bps of margin growth in the U.S., up from its initial expectation of 200-250 bps of growth.  SBUX maintained its expectation for 200-250 bps of margin improvement in the international segment, but reaffirmed the low end of its prior margin guidance for the CPG segment of 35%.


SBUX is now targeting $1 billion in free cash flow for the full year versus its prior outlook of $900 million.  Part of this increase may stem from the company’s lowering its capital spending expectation to $500 million (from $500M-$550M); impressive, nonetheless.

Post-Holiday State of the Industry: Sports Apparel

This week's sport’s apparel sales confirm two trends that we are currently observing across the athletic apparel industry: 1) inventories are tight, and 2) the consumer "trade down effect" has largely bypassed the industry.  These conclusions are supported by the divergence in performance between traditional Sporting Goods retailers (i.e. branded/performance), the Family channel, and the Discount/Mass channel.  Since the November lows that resulted from the sales "pull-forward" during October (yes, it was weather), sales of athletic apparel in the Sporting Goods channel have been particularly strong. Sales of similar, value-priced athletic apparel have lagged however in the Discount/Mass channel.


 Post-Holiday State of the Industry: Sports Apparel - Dollar Sales Channel


Sales in the Sporting Goods channel have been up an average of 9% y/y each week since the beginning of December, with sales in the Family channel flat-to-slightly up over the same period. In contrast, weekly results in the Discount/Mass channel have been down an average of 14% y/y since the start of December.  Furthermore, average price points in Discount/Mass have declined an average of 9% over that same period.  Contrast that with improving ASP’s in both the Sporting Goods (up an average of 2% y/y) and Family channel (up an average of 6% y/y) since the beginning of December.  It is clear that branded, performance product is key to the diverging results. 


 Post-Holiday State of the Industry: Sports Apparel - ASP Channel


The chart below illustrates how sales in the Discount/Mass channel have largely been under pressure for some time now.  Interestingly, the recent weakness comes at time when comparisons are easing and will remain so throughout much of 2010.  Further sales declines suggest market share loss to the other, higher priced channels and/or the consumers’ lukewarm appetite for value-priced athletic apparel.  Oddly, this all comes at time when we’ve seen other value-driven apparel retailers like Old Navy, Uniqlo, and Aeropostale outperform dramatically.  After some initial worry a couple of years ago with launch of Wal-Mart’s Starter and Target’s C9 brands, it appears that these opening price point offerings have yet to make a measurable impact on the branded players .  Clearly, the innovation, branding, and authenticity in the performance apparel space is helping to drive demand and differentiate the channels. Tight inventories are also a key driver behind the ASP increases.


 Post-Holiday State of the Industry: Sports Apparel - Discount Mass


We know that one week's worth of data hardly creates a trend, but there are always a few notable callouts:

  • UA was the only company in the sample to see a sequential pickup in dollar sales, improving by 100bps vs. last week to +9% y/y
  • At -3% y/y, this week marks the 11th out of the previous 12 weeks COLM sports apparel sales have declined on a y/y basis
  • Despite falling by 301bps sequentially, NKE market share still came in at +217bps y/y; Adidas was a not-too-distant second at +145bps y/y; NKE has been gaining 3-5 points of market share each week since mid-November, while Adidas has been gaining 1-4 points of market share during the same period

Post-Holiday State of the Industry: Sports Apparel - Sports Apparel Trends


Post-Holiday State of the Industry: Sports Apparel - Sports Apparel Industry by Company


Post-Holiday State of the Industry: Sports Apparel - Sports Apparel Industry by Category


Brinker’s 2Q10 earnings of $0.29 per share (includes about a $0.04 per share benefit) came in much better than the street’s and my $0.22 per share estimate.  Same-store sales growth also beat expectations with Chili’s -3.2% and blended comps -3.1% versus my estimate of -4% for both and the street’s expectations of -4.2% and -4.3%, respectively.  Based on the definite change in management’s tone on today’s earnings call relative to last quarter, results may have exceeded management’s expectations as well.


Last quarter, Brinker did not provide any updates to the guidance it provided in its 4Q09 earnings release.  Today, EAT’s press release stated, “Brinker provides annual guidance as it relates to comparable restaurant sales, earnings per diluted share, and other key line items in the income statement and will only provide updates if there is a material change versus the original guidance.”  So although management maintained the same official guidance policy this quarter, the company did make comments about the specific guidance ranges it had provided at the start of the full year whereas last quarter management seemed unwilling to even repeat the prior ranges.


Last quarter, there seemed to be a question about whether the company’s unwillingness to reiterate guidance was due to management’s not feeling comfortable with the prior guidance.  Although management said that it just did not want to get into the habit of providing quarterly guidance, it was a little unclear in its answers to investors because it seemed unwilling to repeat any prior ranges. 


From the fiscal 1Q10 earnings call:

So that means it is suspended or the $1.15 to $1.30 is still a good guidance number or we do not have any guidance except for the line by line information?


Chuck Sonsteby
I would say that the second piece would be accurate.


Today, management said it was comfortable with the higher end of guidance.  Management also said that comps during the quarter were -3%, “comfortably within the initial -2% to -4% range.”


Other management comments that signal a real shift in management tone:


“We are gaining share…we are excited about that.”


“Up is up.”


“We are seeing small bright lights in the economy.”


Echoing PFCB’s CEO Bert Vivian’s comments from last week, Brinker also stated that it is seeing improved business spending.  Specifically, management said that the banquet business at Maggiano’s was better in December, which it attributed to more expense account spending.


Although Chili’s traffic improved sequentially in the quarter and same-store sales came in 80 bps better on a 2-year average basis, it may be a little premature for the company to remove its 3 Courses for $20 promotion.  Management said that the promotion has gotten “a little stale,” but I think it could be increasingly difficult to drive traffic without it.  Management is aware that consumers are still looking for value so it will be important to watch whether the promotions currently being offered at lunch, along with the company’s upcoming value initiative, which is expected to highlight the company’s new and improved menu, will prove as successful as 3 for $20. 


The company has made a significant step in downsizing its menu (to 8 pages from 12), deemphasizing items less critical to guest loyalty.  This alone should lead to more efficient execution at Chili’s.  As I have said before, Chili’s needed to simplify its back of the house operations by reducing menu items to include only the core items that represent the bulk of the chain’s sales.  These menu changes will allow the company to increase the quality of the items left on the menu (75% of menu items now include a new recipe, new ingredient or have been replaced).  A menu that is simpler to execute will translate into better food delivered to the guest with fewer complaints, thereby allowing the concept to build increased customer loyalty.  Importantly, it will provide a better work environment for restaurant employees. 


Gaming stocks have performed well in 2010, potentially signaling escalating expectations for the Q4 earnings season.



The following chart shows year-to-date performance for the largest gaming stocks as a gauge for investor expectations as we head into the Q4CY2009 earnings season.




PNK is the only gaming stock down year-to-date and after seeing those Louisiana numbers yesterday, it’s not hard to know why.  Even so, the stock is only down 2% on the year.  The regionals as a whole have been the laggard, up only 3%, relative to the major market operators and slot companies which have appreciated 23% and 10%, respectively.


Leading the way are the three US based Macau operators, MGM, LVS and WYNN, up 34%, 25% and 22%, respectively.  As we’ve written about, both LVS and WYNN will likely beat current consensus projections pretty handily.  We’re more concerned with “whisper” expectations which seem to have gotten pretty high.  Analysts may be setting the stage for disappointment.  The appreciation in MGM, on the other hand, may be more due to the incredibly high short interest in the stock at the end of 2009 combined with a growing belief that the Q4 may have represented the trough in Las Vegas.  We covered the potential for this outcome in our 12/15/09 post, “MGM: THE CONSENSUS SHORT”.


For the gaming equipment suppliers, calendar Q4 2009 looks like it may come in a little better than expected for the sector.  We’re not sure that will matter since Street estimates for the March and June quarters look a bit aggressive to us.  Likewise though, lower near term estimates may not matter much if the focus continues to be on new markets.  The long-term outlook for this group is very bright, mostly due to new markets.  It may take a slippage in the timing of new markets to drive the stocks in this sector down.  History suggests this is a real possibility.


Back to the regional operators.  We haven’t liked this group for a few months now due mainly to fundamentals.  Despite easy comps, revenue growth remains negative and could have been worse, if not for very low gas prices y-o-y.  The gas tailwind has now reversed, potentially squashing any hopes for positive growth in 1H2010.  As forecasted in the stocks, Q4 earnings and guidance are not likely to be catalysts for share appreciation.


Starbucks is scheduled to report fiscal 1Q10 after the close today and it should be another good quarter.  I think SBUX’s earnings could come in a penny better than the street’s $0.28 per share estimate.  Same-store sales trends and operating margins should continue to improve sequentially from the fourth quarter.  I am modeling +1.5% same-store sales growth in the U.S. (assumes a 20 bp improvement in 2-year average trends from 4Q09), which would mark the first quarter of positive growth since fiscal 4Q07.  My +3% comparable store sales estimate for the international segment implies flat 2-year average trends from the fourth quarter.  The company is facing its easiest same-store sales and margins comparisons in the first quarter.  From a cost savings standpoint, the company will get the biggest YOY benefit in the first quarter as it had only implemented $75 million of the total $580 million in FY09 cost during 1Q09. 


SBUX has worked and should continue to work as the company continues to grow margins throughout the year.  Same-store sales are likely to continue to get better as the economy improves and the company’s guidance of “modestly positive comparable store sales” growth is easily achievable, as is the company’s EPS guidance of +15%-20%.  This is already baked into expectations, however, as the street’s full-year 2010 EPS estimate of $1.02 implies nearly 28% growth.  Relative to expectations, there is a lot less upside potential for SBUX.  A little over six months ago when I published my SBUX Black Book, I called SBUX “underloved” by the sell-side community.  Since then the stock has moved nearly 60% higher, and analysts are now more bullish on the name (as shown below).


Back in June 2009, Keith McCullough also highlighted in the SBUX Black Book that from a sentiment perspective that SBUX was a buy.  Specifically, he said, “Short interest as a % of the float is lower than what it was but still relatively high for a stock with this kind of market cap (6% of the float). Insider activity has been benign for 2009 to date. However, share­holder concentration factors here are also scream­ing buy. Away from Fidelity, no institutional investor owns this stock for real. Capital Research is ap­proaching 4% of the shares out, but away from that position you easily make it into the top 10 holders of this stock with 2-2.5% of the shares outstanding.” 


Today, short interest has fallen to 2.6%.  Fidelity still holds the number one position with 11% ownership and you can still make into the top 10 holders with 2-2.5% of the shares outstanding.  The difference now is that Capital Research’s ownership is above 5%, T. Rowe is above 4% and two other holders are approaching 4% (Barclays and Vanguard).  So, more ownership is now required to make it into the top 5 positions.


Sentiment has turned for SBUX, and with expectations so high, it is getting increasingly harder to pound the table on this name.  Again, the first quarter will be strong, but with the stock now trading over 10x on a NTM EV/EBITDA basis, there is less to be excited about.  That being said, I am excited about the prospects of VIA and look forward to hearing how the product fared during the first quarter.  To recall, Starbucks put out a press release on October 12 stating that after only 2 weeks of national availability of Starbucks VIA, early indicators showed that the product was exceeding expectations.  Management did say that it intends to spend significantly higher marketing dollars than any typical quarter to support the launch in Q1 and that VIA should be profit neutral during fiscal 2010 so the level of spending behind the brand during the quarter and the year remains a big question.


June 8, 2009:







Early Look

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