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US STRATEGY – Financials Charge

The S&P 500 finished slightly higher by 0.17% yesterday, on a 25% improvement in volume.  Notably, the advance-decline line deteriorated by 149 to 371.  In our sector study it was surprising to see that 5 of the 9 sectors we track declined on the day.


For the second day this week, there were no big MACRO data points to help drive any one theme.  The RISK AVERSION saw some signs of life with the dollar up by 0.2% and commodities flat to slightly higher.  This dynamic seemed to weigh the most on commodity equities, particularly Energy (XLE) and Materials (XLB).  The Hedgeye Risk Management models have levels for the Dollar Index (DXY) at:  buy Trade (80.21) and sell Trade (80.87). 


The VIX traded slightly higher over the past two day but continues be broken on all three durations - TRADE, TREND and TAIL.  The Hedgeye Risk Management models have levels for the volatility Index (VIX) at:  buy Trade (17.08) and sell Trade (18.72).  Yesterday we sold our position in the VXX. 


For the past three day the Financials (XLF) has been one of the best performing sectors and yesterday was no exception.  Within the XLF, banking led the way, with the BKX +0.6%; the regionals were mixed with some renewed focus on capital needs.  Credit-card and credit/risk-sensitive mortgage insurers were also stronger on the day.


Yesterday, we sold out position in Technology (XLK). The XLK has been leading the market higher this week, and now it’s finally immediate term overbought. Yesterday, both tech and telecom outperformed the broader market.  The semis finished down slightly with the SOX down 0.2%; TXN was a drag following its mid-quarter update. Software was a bright spot with the S&P Software Index +0.7%.


Surprisingly, consumer stocks lagged the broader market yesterday.  In the Consumer Discretionary (XLY) retail snapped a three-day winning streak with the S&P Retail Index 0.5%.  On the positive side restaurants largely extended their outperformance despite weaker-than-expected Jan/Feb same-store sales out of BKC. 


Yesterday the Materials (XLB) finished lower for a second straight day.  The strong dollar can take most of the blame.  CF, X and FCX were the three worst performing name in the sector. 


As we wake up today, equity futures are trading above fair value ahead of another light day for corporate and MACRO data points.  As we look at today’s set up the range for the S&P 500 is 27 points or 1.8% (1,122) downside and 0.4% (1,149) upside. 


Copper gained for a second day after China’s imports of the metal rose 10% in February, adding to confidence that the economic recovery is gaining momentum.  In early trading copper is trading lower after declining slightly yesterday.  The Hedgeye Risk Management Quant models have the following levels for COPPER – Buy Trade (3.36) and Sell Trade (3.50).


Gold is slightly higher in early trading, after trading flat yesterday.   The Hedgeye Risk Management models have the following levels for GOLD – Buy Trade (1,105) and Sell Trade (1,145).


In early trading, oil is trading little changed as analysts forecast rising crude supplies in the U.S.  The Hedgeye Risk Management models have the following levels for OIL – Buy Trade (80.24) and Sell Trade (82.69).


Howard Penney

Managing Director


US STRATEGY – Financials Charge - sp1


US STRATEGY – Financials Charge - usd2


US STRATEGY – Financials Charge - vix3


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US STRATEGY – Financials Charge - gold5


US STRATEGY – Financials Charge - copper6



PFCB notes on Mr. Vivian’s ad lib presentation:


Pei Wei is what people are looking at most closely

  • 12-18 months ago it was suggested that PFCB abandon the concept
  • Mistakes corrected
  • Last 6 quarters have shown improvement in operations
  • Comfortable putting capital down to work
  • 3-4 new Pei Wei units this year, 10-15 in 2011, and a number larger than that in 2012 (maybe 20-25)
  • More next year (existing markets except Chicago)


Pei Wei had positive traffic last year

  • The expectation is that comps will be positive this year
  • Pei Wei unit potential is around 500 units


Currently all units are company-owned.  The company is not against using partners to grow this concept but management wanted to first make certain that they could make money with Pei Wei.  PFCB would be more open now to having those conversations (not currently having any conversations with potential partners for Pei Wei).



  • Very good concept
  • Struggling over the last couple of years to grow traffic but that is beginning to change
  • Looks like we’re going to be moving into positive territory as we move out of this year
  • If we’re negative this year, negative first half, positive second half
  • Business is slowly improving, when you dial out weather


190 Bistros, PFCB thinks 250 is the right number

  • First priority with cash is to build restaurants
  • Likely they will build ten or so too many and then have to find the right number


Bistro universe is shrinking so opportunities are less apparent



How do you evaluate returns at the unit level, when does it not make sense?

  • ROIC
  • pfcb.com investor relations page has a return on invested capital section with the returns of each year (‘07, ‘08 and ‘09)
  • Capitalizing lease, 30% return is PFCB’s aim
  • Last year, Bistro was 36% and Pei Wei was 28%



Q: Ever considered international expansion?

A: Yes. Three agreements outside of USA – Mexico, Middle East, and The Philippines.  Partners will likely open other international locations also.  PFCB is not committing any capital to international expansion.

Actually get a call a week from Asia for to expand there…



Q: Dividend…

A: Progressive dividend…rather than initiate a fixed dividend, we thought it made more sense to fix payout ratio and let dividend float. Better results will aid shareholders.  Ratio fixed @ 45% of Net Income.  Investor responses to the dividend announcement: He has been told that PFCB is the #2 in restaurant group in terms of payout


He has also heard that people are saying that the initiation of the dividend signals that PFCB’s growth is coming to an end. Bert’s response to that comment is that PFCB is producing a lot of cash…bistro is self sufficient. Pei Wei is nearing self sufficiency. Both concepts will soon be able to fund their own growth. Both international growth and the frozen food venture are not requiring any capital.


The right amount of cash on the balance sheet is $40/50mm so anything above that we are going to figure out how to best return it to shareholders.



Q: Unit economics of Pei Wei?

A: Cost $750k – 800k cash (recently took $50K out of the cost). Including lease obligations, it is about $1.4M-$1.5m, all in. Excluding a small group of under achieving units, Pei Wei generates about $37K-$38K per wk in sales



Q: Maturity curve?

A: Bistro reaches maturity in about 18-24 months.  Pei Wei hits the curve quicker. It is an easier model from an operational standpoint so maturity should be approximately 12-18 months.


PFCB extended a $10m line of credit to Sam Fox for True Foods Kitchen restaurants to build 3-5 restaurants. The agreement includes some provisions to allow PFCB to convert its loan to equity, but that decision is still a couple years away.




Howard Penney

Managing Director



FL: Hedgeye Internal Q&A

KM's quick ping to Hedgeye Retail team when FL stock turned down "FL - anything coming out of the meetings thats neg?"  Levine's quickie answer is below. More details to come later.


From Levine

Probably a bit of hype going in.  a little short on specifics as it pertains to product improvements (i.e what programs are forthcoming?).  areas of risk, such as the dividend, were put to rest.  It’s not going anywhere. 


Now this is an execution story, with the plans laid out in front of the Street.  I walked away confident that we’re spot on with our thesis and that the opportunities are big.


The only complaint I heard was that some people were hoping to gain exposure in greater depth to the management team, beyond the top 4 guys.  This didn’t happen although I’m sure this is still evolving.


Hicks saw our powerpoint and told me I was spot on with where they’re going.  Keep in mind that the work we’ve done is in far greater depth than what they spoke about today.  This is where the true upside lies…


Eric Levine

Hedgeye Retail


Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.48%
  • SHORT SIGNALS 78.35%

Spanish Piggy

Position: Short Spain (EWP)


I have been getting a lot of questions/emails today about Spain (I wrote negatively about it in my Early Look note this morning). Hopefully the “speculator” fun-cops over in the left wings of Europe don’t come after me. I am but one man, with an innocent chart and mouths to feed.


When it comes to size and scope, at $1.6T in GDP Spain’s economy is approximately 4.7x larger than that of Greece ($338B in 2009). There are 46.7 million people in Spain versus 11.3 million in Greece. That’s a lot of people who are likely offended by being called a Spanish Piggy.


When it comes to balance sheet and deficit problems however, the financial data doesn’t lie; politicians trying to put lipstick on it do. At 11.4%, Spain’s deficit to GDP rivals that of the USA’s and over $654 billion in public debt is pushing up against a worrisome risk manager’s level of 44% of GDP.


Because I am focused on these mathematical realities doesn’t make them new. That said, I am also very respectful of the fact that the last time the obvious risks implied by Spanish leverage started to freak people out, stocks went a lot lower than where they are currently trading.


In the chart below, you can wrap your head around the risk/reward of being short Spain’s stock market. Since the most recent YTD low established on February 5th, 2010 on Spain’s IBEX 35 Index at 10,103, Spanish stocks ripped the shorts for an expedited +9.4% rally. We short sellers of piggies call that an entry point.


We are using our intermediate term TREND line of resistance at 11,385 (red line in the chart below) as our risk management line. You can also use that as your stop loss level if you think there is risk that this Spanish Piggy can fly higher. With a Global Bubble in Bailout Politics forming, anything can happen…




Spanish Piggy  - spain

PSS: Looking for Another Strong Quarter

There are many tools we use to prep for a quarterly earnings release. As it relates to PSS, we included several of them below. The bottom line is that we’re well ahead of the Street. The consensus is looking for a loss of $0.26. We’re at a loss of $0.10. Could we be aggressive? Perhaps.


We need to temper comp expectations given the pull forward into 3Q from the Oprah promotion as well as the fact that PSS is not benefitting as much as some other retailers due to its lack of meaningful exposure to the ‘toning’ category. But when all is said and done they’re still going up against a -11% slide in traffic last year. A positive low/mid single digit comp is perfectly reasonable.


On the margin side, we’re coming out at a +470bp boost in margins versus last year. Yes, that’s a sequential reacceleration. But PSS is looking at the most favorable sales/inventory spread it’s seen in years. If there were ever a time to come in strong on the gross margin, now is it. If there’s any area we’d point to on the cost side that might be aggressive, it is our assumption for a 1% boost to SG&A – as we could see a potential pick up in incentive comp spending given the rebound in operating performance this year.


So yes, we’re anything but conservative headed into this print. But even if we soften up our comp and SG&A expectations, we have a tough time modeling a loss that starts with a $0.2 handle.  Is this a trade into the print? We don’t think so…not after a 18% run in the stock over the past 4 weeks. But we don’t think they’ll give enough ammo relative to expectations to cause a mass exodus from this name.



PSS: Looking for Another Strong Quarter - PSS 1 Revenue Slide 3 10


PSS: Looking for Another Strong Quarter - PSS 2 EBIT Slide 3 10


PSS: Looking for Another Strong Quarter - PSS Comp Store Estimate w NPD 3 10


PSS: Looking for Another Strong Quarter - PSS CompTrends Ind 3 10


PSS: Looking for Another Strong Quarter - PSS SIGMA 2 10




The Hedgeye Risk Management research team continues to focus on important long-term issues not yet in the EYE of the MANIC MEDIA. 


The flowing note below was recently published by Christian Drake of the Hedgeye Healthcare team.  The genesis of the note is a follow on to a note we published on 2/24/2010 called “Domestic Pigs,” which focused on state pension liabilities.


Fiscal Conservatism, at least rhetorically, is garnering more headlines as politicians and state officials attempt to right size state budgets operating increasingly at a deficit.  Political and fiscal motivations look to be coalescing around a same objective as mid-term elections approach and politicians address a growing base of discontent from a populous who, over the past year, have been forced to face their own ghosts of leverage past and are now seeing the canonical kick-the-can approach to public debt management for the financial malfeasance that it is.


Current estimates peg state budget shortfalls for 2010 & 2011 as high as $350B and as state governments look to reorder their fiscal house, Medicaid allocations, at 21% of state revenues for FY2009, will continue to be a principal target for prospective offsets. 


Collectively, NASBO, the Kaiser Foundation, and the U.S. Census Bureau provide some interesting data as it relates to the condition of State budgets and the historical and prospective effects on Medicaid eligibility and reimbursement.  

Roughly 60M people receive Medicaid support in the U.S. with rolls continuing to swell as unemployment persists and payrolls continue to decline.  As stated above, Medicaid made a new high in FY2009 as the state entitlement program absorbed an average of 21% of all state revenues - coming in just behind education as the single largest budget allocation.  Total Medicaid Spending growth averaged 7.5% against a budgeted average of 3.6%, as enrollment grew by the largest amount since the program was first implemented back in the 60’s. 


In an attempt to keep individuals insured and support State’s Medicaid funding obligations, the American Recovery & Reinvestment Act (ARRA2009) allocated some $87B to increase the federal matching percentage.  Prior to 2009, federal support, by way of FMAP (Federal Medical Assistance Percentage), averaged a matching rate of ~57% nationally.  With the ARRA2009 subsidy, the matching range increased ~6% to a range of 61% to above 84% with support totaling $44.1B as of Jan. 31st. 


An important stipulation in the ARRA legislation was that states could not restrict Medicaid eligibility or enrollment if they wished to qualify for enhanced FMAP matching.  When the ARRA program ends, so does the incentive for maintaining broad eligibility.   The enhanced FMAP has 12/31/10 end date and represents a huge budgetary trapdoor for states who expect Medicaid enrollment to continue rising in the face of economic stabilization & improvement.  Indeed, enrollment increased 9.3% in 2002 following the 2001 recession. 


The Kaiser Commission’s February update on Medicaid & the Uninsured (Here) found that halfway through FY2010, forty-four states are again seeing Medicaid enrollment and spending growth in excess of their budgeted projection.  Almost every state implemented some new policy measure to control Medicaid spending in FY2009 with the balance of measures coming in the form of provider cuts and benefit limits.  Moreover, 29 states reported that additional mid-year cuts in FY2010 are likely and 15 others indicated further reductions are under consideration but that it remained too soon to tell.   


Analysis by The Center on Budget and Policy Priorities, who updated their analysis of the current & projected state fiscal positions last week, tells a similarly bleak story.  You can find the updated report Here but the relevant takeaways surround the projected budget shortfalls for the FY’s 2010, 2011, & 2012.  As it stands, newly identified mid-year 2010 budget shortfalls equal $38B while projected shortfalls for FY 2011 & 2012 total 130B and 120B, respectively. 


Aggregate state budgets, defined as the sum total of state’s general funds, totaled $686.5B for FY2008.  Using this 2008 total as a budget baseline, the projected FY 2011 & 2012 deficits equate to 19% and 17.5% budget shortfalls, respectively.  Moreover, without continued Federal support such as an extension of ARRA2009 stimulus monies (which is slated to end Dec. 31, 2010/mid FY 2011), the FY2011 shortfall could move more towards $180B, or 26.5% of budget. 


Nationally, payments to Medicaid average 16-17% of total outlays from state’s General Funds.   Applying this percentage to the projected budget shortfalls for fiscal year’s 2010-2012 yields the projected Medicaid shortfall for the respective years.  Calculated in this way, the shortfall in Medicaid dollars as a percentage of the state’s Medicaid budget is 5.5%, 15%, & 17.5% for the balance of FY2010, FY2011, & FY2012, respectively.




Consensus commentary from Medical Directors interviewed in the Kaiser survey foreshadows significant reimbursement and/or eligibility cuts as 2011 budgets are contemplated. 


“Many governors’ proposed budgets for state fiscal year 2011 include drastic cuts to Medicaid as well as other state programs and state employees… Medicaid directors see the prospect for widespread program cutbacks in 2011, including eligibility cuts that would affect millions of Medicaid beneficiaries as well as the hospitals, doctors and other providers who

depend on Medicaid to pay for health care they provide to Medicaid enrollees.”


In varying proportions, States General Funds source the bulk of their revenues from income & sales tax.  While employment will continue to recover, tax revenues should remain under pressure as consumer’s continue to delever and wage inflation remains muted alongside continued excess capacity. 


Below we’ve highlighted Florida & New York as examples of the similar but different means by which states generate funds.  The principal sources of revenue for each come from income and sales tax, followed to a lesser degree by tariffs on tobacco, alcohol, insurance & other corporate taxes.    As can be seen below, Personal Income tax (73%) + Sales tax (14%) represent  87% of revenue for NY.   Similarly, income & sales tax represent 81% of Florida state revenues.  However, in contrast, Florida, which has a corporate income tax but no personal income tax, generates 74% and 7% of revenues from Sales tax & Corporate Income tax, respectively – almost the mirror opposite of NY.






Rainy day funds have been highlighted as a means of offsetting declining tax revenues.  Rainy day funds, which essentially represent the cumulative budget surpluses allocated to savings during feasting years, can be used to subsidize budget gaps during short-term periods of economic weakness.  While balances grew through the first half of the decade, finishing FY206 at 11.9% of expenditures, states drew heavily from these budget stabilization funds during 2008-2009 dropping that balance to 4.8% of expenditures.  Furthermore, NASBO reports that if Texas & Alaska are excluded from the calculation, total rainy day funds would amount to only 2.7% of expenditures.  Balances have likely dropped further since the December survey and, at this point, probably offer little in the way of budgetary support.


Healthcare reform measures passed through Reconciliation and resulting in an increased Federal shouldering of insurance coverage costs has the potential to significantly reduce state budget pressures, specifically as it relates to Medicaid.  Passage of any major reform initiative, however, remains a big “IF’ and clarity on the range & magnitude of measures that actually emerge in the final iteration of the legislation is still somewhat of a tossup. 


Passage or no-passage, Understanding State’s fiscal positions helps contextualize the pressures likely to be faced by healthcare providers & others levered to State & Medicaid reimbursement.   Indeed, cost pressures faced by states could preview fiscal problems and actions taken at the national level – future cost containment actions, an eventuality we’ve dubbed Health Reform II, implemented at the Federal level as our nation’s P&L & Balance sheet begin to drown in healthcare liabilities under expanded government control.




From an equity perspective, the most obvious follow through is to names directly levered to Medicaid reimbursement and eligibility decisions, namely Medicaid HMO’s.   Medicaid insurer’s are cyclical in so much as they are levered to state tax revenues.  In turn, given that the state coffers are singularly levered to the consumer, the group’s strong longer term correlations to indicators such as consumer sentiment and chain store sales isn’t particularly surprising.


Given the set-up, the fate of Medicaid HMO’s remains tied to the health of state budgets over the longer term while reform legislation will continue to dominate the immediate term. While no candidate can explicitly campaign on an agenda of alienating the uninsured in favor of fiscal austerity, on the margin, a general shift over the intermediate term towards fiscal conservatism would be a negative for provider’s and insurer’s levered to Medicaid.


Looking beyond the HMO’s, our initial screen returned 160 companies with a market cap over $500M who reference Medicaid in their 10K’s.  Some companies in the screen have minimal leverage to pressure on Medicaid spending while others hold more definite risk.  We’ll be working to narrow the candidate list to target those names most directly impacted by Medicaid reimbursement and those most likely to be targeted as offsets to prospective legislation which aims to add an expected $450B in additional costs to the State entitlement program.    


Christian B. Drake