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    MARKET EDGES

    Identify global risks and opportunities with essential macro intel using Hedgeye’s Market Edges.

This post highlights some of the ideas we have been talking about on the “green” side.
  • DPZ - Looking at the overall industry, DPZ was not the only company to leverage its balance sheet at exactly the wrong time; they just took leverage to whole new level and the stock is down over 40% in the last 12 months as a result. The company’s business model generates cash, which should allow DPZ to pay down debt over time and start to reverse its current capital structure in the next 6-12 months. Additionally, overall pizza category trends have ticked up in 2Q08 so as the company’s top-line results improve going forward; investor concerns over leverage should dissipate.
  • SBUX - Starbucks is currently taking the right steps to reverse the issues that stemmed from its excessive capital spending over the last three years, most notably, declining U.S. operating margins and lower returns on incremental invested capital. Although the company’s decision to slow U.S. growth and close underperforming stores is not yielding immediate results (as did MCD’s plan to win strategy in 2003), the current consumer environment is working against the company. SBUX is changing the things it can control, which will reward shareholders in the coming quarters.
  • CKR - I have been voicing my concerns about the level of G&A spending at CKR for some time, highlighting the fact that although the company’s system-wide store count had declined by 8% since 2002, G&A per store had grown nearly 40%. Additionally, CKR’s aggressive capital spending over the past 2 years has not led to incremental returns for shareholders and said that management needed to change its long-term unit growth strategy in order to reverse declining returns.

    Management lowered its capital spending plans at its annual meeting and Ramius LLC’s recent letter to CEO Andrew Puzder appears to have motivated management to focus on bringing G&A expenses down. I am not completely convinced that management will lower both its growth capital spending G&A spending down enough, but they are headed in the right direction. And, looking out over the next few quarters, things should to improve for CKR as the company is lapping some easier revenue and margin comparisons in 2Q and in the back half of the year. From a margin standpoint, CKR should see some benefit in 2Q because it will be lapping the initial spike in food and packaging costs that it experience last year, particularly at Hardee’s.
  • HSY – Hershey recently announced its new long-term growth initiatives, signaling that the company is on the path to rightsizing its business model on its own. Prior to the announcement, I had highlighted that the company had been under investing in the business and lowering advertising spend in an effort to keep margins stable. This led to a period of extended market share declines and a severe decline in margins in 2007.
    The company’s new initiatives include increasing total advertising spending by at least 20% in both 2008 and 2009 with a focus on its core brands, which make up 60% of total U.S. sales. This increased spending will further pressure margins so they could get worse before they get better, but it should help drive sales momentum and is necessary to the long-term sustainability of the business model and more importantly, the Hershey brand. Additionally, management is expecting 2009 to be another tough year from a commodity cost standpoint but the company is now managing for the long term, rather than managing expectations.

  • EAT – Brinker is focused on the things it can control and has significantly reduced its planned domestic company-owned restaurant openings. The company only expects to open about 70 restaurants in FY08 and is reducing that number further in FY09 and FY10 to 15 or less. In its most recent quarter, the company’s capital expenditures as a % of sales came down significantly, which I use as one measure of capital efficiency. Additionally, EAT saw an uptick in same-store sales trends at its most important concept, Chili’s. The company is currently making the right capital allocation decisions and has situated itself to outperform its competitors who are still growing despite declining returns.
  • PNRA - We have done a proprietary grass roots survey on the state of the new Panera breakfast sandwiches. We surveyed over 30 stores in the following states - CT, ME, MA, NY, DE, SC, FL, GA, IA, IL, KY, TN, TX, CO and CA. The following conclusions can be made from the survey data: (1) the stores generally indicate the new breakfast sandwiches are well received. (2) In about half the calls, we were given a wide range on the number of sandwiches sold per week - 200 to 500 per week. (3) On the margin, it appears that the new sandwiches are bringing in new people, but there are clearly people switching over from the soufflé.
SBUX - Ugly looking chart
EAT – Finding a bottom!