DRI is scheduled to report fiscal 3Q10 earnings after the close next Tuesday.   I am not expecting too many surprises out of the quarter as the company preannounced better than expected sales and earnings prior to its February analyst day.  According to management’s revised guidance, it is going to be a good quarter with same-store sales improving on a 2-year average basis across each concept (with the biggest sequential improvement coming at LongHorn) and EBIT margins moving about 80 bps higher YOY.  I am modeling $0.93 earnings per share for the quarter at the high end of the company’s revised guidance and $0.01 above the street’s estimate.


Investors are already anticipating a strong quarter, however, as the stock moved nearly 4% higher on the day the company preannounced fiscal 3Q10 numbers and raised its full-year EPS guidance to +5% to +8% (from its prior flat to +4% range).  Specifically, management stated, “The signs of sales and traffic improvement we began to see late in the second quarter and discussed during our December conference call with investors continued into January and February.”  DRI has moved about 12% higher since the day prior to that announcement. 


What will matter more next week is what DRI has to say about current trends in early fiscal 4Q10.  Even if the industry continues to experience sequentially better trends, DRI’s 4Q same-store sales trends will likely not look as good as 3Q because the company benefited by about  80 bps in the third quarter from a holiday shift.  This benefit will go away in the fourth quarter and the company is lapping more difficult comparisons, particularly at Red Lobster (due to the earlier Lent this year, which helped 3Q10 and will hurt 4Q10).  EBIT margin comparisons get more difficult in the fourth quarter as well and into 1Q11. 


That being said, DRI looks to be in a good position for fiscal 2011.  If top-line trends continue to improve sequentially (this is obviously a big ‘if” but I am only assuming a moderate improvement), FY11 EBIT margin should move close to 50 bps higher, even considering a somewhat tougher commodity environment.  DRI guided to flat to +0.8% food and beverage inflation in fiscal 2011. 


Capital spending is expected to increase about 10% in FY11 as the company accelerates both its unit growth to about 4% from 3% in FY10 and its remodel initiatives at LongHorn and Red Lobster.  Through a combination of new units and remodels, 100% of the company’s LongHorn units will reflect the Ranch House look by the end of fiscal 2012 and 100% of its Red Lobster units will be in the Bar Harbor image by the end of fiscal 2014.  In FY11, nearly 20% of DRI’s capital spending is expected to be allocated to remodels, up from about 10% in FY10.  Additionally, the level of spending on remodels will remain elevated through FY14 as the company plans to accelerate its more expensive Red Lobster remodels as it winds down on the LongHorn reimages. 






Even with capital spending moving higher, DRI’s return on incremental invested capital looks to be moving higher in FY11.  DRI’s ROIIC has been coming down since fiscal 2007 but moved significantly lower in 2009 and 2010.  We won’t see an immediate return to the mid-to-high teen ranges of fiscal 2005 and 2006, but a double-digit number seems likely in fiscal 2011.  As I have said numerous times before, a stock’s performance will often follow the trajectory of returns.  And, I don’t think my numbers fully reflect the higher return associated with the bigger portion of capital spending going to remodels, which typically yield higher immediate returns.  Management guided to a 3% to 4% traffic lift from remodels at LongHorn and a 4% to 5% boost at Red Lobster.






DRI’s strong free cash flow will remain intact with capital spending moving higher as well.  DRI guided to $50 to $60 million in share repurchases in the back half of fiscal 2010, despite the fact the company has about $150 million in debt coming due.  Share repurchases are likely to move higher in FY11 as the company maintains its dividend and pays down another $75 million in debt (due in April 2011).


Howard Penney

Managing Director



DRI EBIT margins:




 The 50-65 yrs cohort is important for DRI:






Macro Mixer: VIX, Sovereign Debt, and The SP500

Volatility continues to be bombed out.  Yesterday, the VIX declined 4.4% and is down another 2% today.  Our refreshed immediate term oversold line for the VIX is 16.89, with it currently trading at 16.67.  This put the down move in the VIX in the 2.5 standard deviation zone, which our models show as typically a good entry point almost 90% of the time. 


Or, said another way, we are over bought on the S&P 500. 


We are currently long the VXX, which we understand is not a perfect way to play being long the VIX.  A more effective way to play long the VIX would be through options if you can do it - 18.64 is resistance on the VIX. 


The VIX is screaming complacency and right now the S&P is down slightly as the US MACRO data points today are mixed to say the least:


(1)    The CPI reading is inflationary


(2)    Modestly higher-than-expected jobless claims.  First-time jobless applications dropped by 5,000 to 457,000 in the week ended March 13.  The number of people receiving unemployment insurance increased, and those getting extended benefits also rose


(3)    A slight improvement in Philly Fed survey exceeded expectations


(4)    There is continued uncertainty regarding the resolution, or lack thereof, or Greece’s sovereign debt problem


We are currently short the SPY after seeing 11 straight days of have 9 of 9 sectors positive on TRADE, as measured by the Hedgeye Risk Management models.  It’s only the second day in a row where the models have 9 of 9 sectors positive TREND.  The models are showing perfect, but perfect is not perpetual.  We are managing risk accordingly.   


Greece is trading down over 3% today, bringing the year-to-date decline to -8%.  The issue of sovereign debt is not resolved and is unlikely to be resolved any time soon. 


We will be addressing the sovereign debt issue on a conference call with clients tomorrow at 11am.  The flowing chart is from Reinhart and Rogoff’s book This Time is Different, a Hedgeye-recommended account of 8 centuries of financial imprudence.  The chart clearly shows that sovereign debt defaults are more normal than investors realize.


Howard Penney

Managing Director


Macro Mixer: VIX, Sovereign Debt, and The SP500 - hp111



This morning's claims data was better. Claims dropped 5k week over week to 457k from 462k (no revision), while the 4-week rolling average declined by 4k to 471k from 475k. The following chart shows the rolling average trend line. Below that we show the raw data.




It is worth noting that next week, barring a significant uptick in the printed number, the rolling average number should fall materially. If next week's claims number is flat week over week the rolling average will fall by 10k - a large enough number to get people's attention, though still not enough to get claims back inside our 3 standard deviation trajectory. As we've said over the last few weeks, we continue to expect to see a claims tailwind throughout the Spring months as census hiring picks up and weather-related effects dissipate.




Joshua Steiner, CFA

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R3: No Go for Affordable Footwear Act


March 18, 2010


Potential call option for low-cost footwear retailers has officially lost support in Washington – no longer viable. This benefit was not in our models, and likely anyone’s expectations. But for those who were hoping…forget it.





It’s official, the Affordable Footwear Act will not be supported by the Obama Administration. The bill designed to eliminate import taxes on footwear has been put on ice again according to a U.S. Trade Representative last week removing a potential tailwind for the footwear supply chain and low-cost footwear retailers.


In a post last spring we provided an update on the bill, which resurfaced after efforts for its passage were thwarted in 2007. Originally designed to protect the domestic footwear manufacturing sector in the 1930s, the tax is now obsolete with imports accounting for 99% of all shoes sold in the U.S. In 2008, the government collected over $1.7B in duties on imported shoes. This bill would have eliminated nearly $800mm in duties by removing the tariffs on all children's footwear as well as lower cost shoes with fabric uppers. As we highlighted, this would have been an added kicker to top beneficiary Payless (in the chart below) and completely incremental – that call option no longer exists.


Resistance from the Administration lay in the fact that China, while not explicitly highlighted, would be the greatest benefactor of the legislation pocketing more than 75% of the tariff reductions. While that is indeed the case, let’s not forget that less than 1% of footwear is produced domestically and it’s not of the low-cost kind. The spirit of the bill was not intended to effect employment, which it wouldn’t, but rather support price deflation for those who would benefit most – America’s working-class. This is a classic example of an example of where addition by subtraction just does not apply.


R3: No Go for Affordable Footwear Act - AFA 3 10


Casey Flavin




  • In a rare commentary about a specific customer, Nike management endorsed the changes underway at Foot Locker. Nike is excited about Foot Locker’s efforts to differentiate and segment its stores as well as the opportunity to grow their running business. There were also positive comments about the re-emergence of growth in House of Hoops. Judging by the commentary on the running category as it pertains to Foot Locker, it sounds to me like the folks from Beaverton may have already paid a visit to the new running shop in Union Square, NYC. 
  • At a conference, Kroger management noted that if they could redo 2009 they would have been less promotional and aggressive in reducing prices in the first quarter of last year. Instead, they would ratably layered in pricing changes over the course of the year. By taking prices down at the beginning of the year, they believe they ultimately limited their flexibility in being able to react to the competitive pricing environment without it damaging the bottom line. 
  • According to the 11th Annual Online Fraud Report, ecommerce losses related to fraud posted their first drop since 2003. The reduction of 17.5% vs. 2008 equates to about $3.3 billion lost due to fraud last year. Online retailers further predict their loss rate will about 1.2% in 2010, vs. 1.4% over the past 3 years. The improvement is largely the result of improved technology and use of fraud detection processes that are now in use across the industry. 




Independent-minded Plans to Make "Big Push" into Apparel - It’s been five months since the world’s biggest online retailer officially acquired the largest online shoe store and so far the marriage between Inc. and Inc. is working well, Zappos CEO Tony Hsieh says in a new blog posting. With a bigger parent and deeper resources, Zappos was able to increase its gross merchandise sales by 18.8% to $1.20 billion in 2009 from $1.01 billion in 2008, says Hsieh. “Amazon has continued to allow us to run Zappos independently with our own unique culture, brand and way of doing business,” Hsieh says. “From our point of view, it's been as if we swapped out our previous board of directors with a new one, but we now have access to a lot more resources so we can continue to build the Zappos business even faster. Over the past few months we've actually seen our growth rate accelerate compared to the prior year.” With Amazon’s backing, Zappos will continue to expand further into apparel and other product categories, says Hsieh. “We're making a big push into apparel, which is four times the size of the footwear market, as well as other product categories including bags, accessories, and housewares,” says Hsieh. “We think we’re just at the tip of the iceberg of what's possible as we continue to build the Zappos brand.” began diversifying into other merchandising categories in 2008 when it acquired footwear and accessories site from for an undisclosed price. <>


Wal-Mart Considers Selling Yuan Bonds in Hong Kong - Wal-Mart Stores Inc., the world’s largest retailer, is considering selling yuan bonds in Hong Kong as China opens its markets, according to Asia Chief Executive Officer Scott Price. The company is “considering options” that may include yuan-denominated debt, Price said in an interview at Wal-Mart’s Asia offices in Hong Kong yesterday. Such a move would underscore the company’s commitment to support local communities and China’s financial system, he said. “Wal-Mart is in Asia and in China for the long term,” Price said. The company wants “the Chinese people to know that we see a responsibility to help build their economy,” he said. China is expanding its financial system, and will use Hong Kong as a testing ground for yuan products, according to the city’s former central bank chiefJoseph Yam. Foreign companies in February became eligible to issue yuan bonds as part of efforts to bolster the ex-British colony’s financial status and expand its role in promoting the yuan for commerce. The company has $38 billion of outstanding debt and more than $5 billion of bonds maturing by the end of 2011, according to data compiled by Bloomberg. The Bentonville, Arkansas-based retailer could be the first foreign non-financial company to issue yuan debt in Hong Kong. <>


Steve Murray Leaving Vans for Urban Outfitters - Urban Outfitters, Inc. announced that Tedford Marlow, president, Urban Outfitters Brand, will retire and be succeeded by Steve Murray on April 12, 2010. Murray has been president, VF Action Sports Coalition since February 2009 overseeing the Vans and Reef brands. Murray, 49, will join the company on April 12, 2010 from VF Corporation.  Prior to assuming the role of President, VF Action Sports Coalition, Murray was president of VF's Vans brand from 2004 to 2009. Murray had been the Chief Marketing Officer for Vans, Inc. from 2002 to 2004 and Senior Vice President, International from 1998 to 2002. Prior to joining Vans, Inc., Mr. Murray held various leadership roles in the US and abroad for Reebok International, LTD from 1991 to 1998. Murray holds a BA in Business Studies from Middlesex University.  <>


Della Valle Boosts Stake in Saks Again - Diego Della Valle is voting with his wallet that there’s more upside potential in Saks Inc. By spending an additional $30.2 million since March 10, Della Valle has boosted his stake in the luxury retailer to 9.4 percent from 7.1 percent. While the investment is significant, Saks has proven to be a lucrative deal for Della Valle: He has already made a profit of more than $44.5 million on the shares he has snapped up since last year. The chairman and chief executive officer of Italy’s Tod’s SpA, through his personal investment vehicle Diego Della Valle & C. S.A.P.A., has purchased an additional 3.62 million shares of Saks’ stock. The latest purchases, made between March 11 and 16, were for an average of $8.33 a share and boosted his holdings to 15 million shares, according to a Schedule 13D filed with the Securities and Exchange Commission Wednesday. Shares of Saks closed up 1 cent, or 0.1 percent, at $8.49 Wednesday, valuing Della Valle’s stake at just less than $127.4 million. The closing price translates into a profit of $4.92 a share on those shares Della Valle bought in 2009, or a total of about $41.7 million. It also adds up to nearly $2.9 million in profits for the additional stock he acquired this month. <>


Inditex Profits Rise 17.8 Percent - Inditex SA, Europe’s largest clothing retailer and owner of the Zara brand, is bullish about its prospects after reporting a 17.8 percent spike in fourth-quarter 2009 profits. Unveiling the results Wednesday, which beat analysts’ estimates, the company also said its store sales are off to a good start this year. Net profits in the three months ended Jan. 31 were 483 million euros, or $704.9 million, on sales of 3.32 billion euros, or $4.84 billion, which advanced 8.9 percent. Dollar figures are calculated at current exchange rates for the period. For the full fiscal year, Artiexo, Spain-based Inditex’s net profits gained 5 percent to 1.31 billion euros, or $1.84 billion, on sales that rose 7 percent to 11.08 billion euros, or $15.55 billion. Pablo Isla, Inditex deputy chairman and chief executive officer, said during a press conference in Madrid Wednesday that “satisfactory” results demonstrated the “global reach of our business model,” which has led to “a widely diversified sales platform.” Isla said “2009 has been a year of increased efficiency and tight operating control [and] as a result, we have generated a strong cash flow, which we have dedicated mainly to the expansion of the business.”  <>


Congress Passes Jobs Bill - The Senate sent a $17.6 billion jobs bill to President Obama on Wednesday that gives tax breaks to businesses that hire workers and invest in new equipment. Apparel industry and retail groups view the bill, which passed 68-29, as a good first step in helping companies. They also are seeking more help from the Obama administration to jump-start the economy and create jobs. The centerpiece of the bill is a $13 billion provision that offers an exemption from Social Security taxes this year to companies that hire new workers who have been unemployed for at least 60 days. Companies would also receive a $1,000 tax credit on their 2011 income tax returns for each new worker that is retained for a full year. Another provision allows small businesses to immediately write off equipment purchases made this year up to $250,000 as business expenses, instead of depreciating those costs over time. President Obama, speaking in the Oval Office, said the legislation was “the first of what I hope will be a series of job packages that help to put people back to work all across America.” The legislation “will provide tax cuts to small businesses that are willing to begin hiring right now, putting people back to work,” Obama said. “It’s also going to provide significant tax breaks to businesses for investing in their business, and so, hopefully, at a time when we’re starting to see an upswing in economic growth, that will help sustain it.” <>


U.S., India Agree to Stronger Trade Relationship -The U.S. and India took steps to strengthen trade ties on Wednesday.  U.S. Trade Representative Ron Kirk and Indian Minister of Commerce & Industry Anand Sharma signed an agreement to establish closer bilateral trade and investment between the countries. The accord is “a manifestation of our shared objectives to enhance the bilateral trade relationship, but it is just the beginning of that process,” Kirk said. “Both governments have agreed that the time has come to elevate the partnership between India and the United States of America to a higher level,” Sharma said. The trade framework will focus on goals such as enhanced intellectual property rights awareness and enforcement, increased cooperation on health care, education, information technology and environmental services, and more partnerships in the private sector. Kirk and Sharma also announced an initiative to better integrate small and medium-size businesses into the two countries’ markets.  <>


U.S.-Made Apparel Prices Fall in Feb. - Wholesale prices for U.S.-made apparel declined 0.1 percent in February compared with January and fell 0.2 percent compared with a year earlier, the Labor Department said Wednesday in its Producer Price Index. Women’s apparel prices rose 0.1 percent in February compared with a month earlier, but declined 0.4 percent year-over-year. Men’s apparel prices fell 0.8 percent in February and were down 0.2 percent in 12-month comparisons. Prices for all U.S. goods and services declined a seasonally adjusted 0.6 percent in February, driven primarily by falling energy prices. “Top-level producer prices are being bumped up and down month-to-month by fluctuations in imported crude oil prices,” said Brian Bethune, chief U.S. financial economist at IHS Global Insight. Prices for core finished goods were flat in February and there are no signs of inflationary pressures, he said. The PPI for apparel is not a true indicator of industry price fluctuations because the vast majority of clothing sold in the U.S. is imported. The Consumer Price Index, due out today, is a more accurate measure because it includes all goods sold at retail.  <>


National Retail Federation names new president/CEO -  National Retail Federation, a key trade association representing U.S. retailers, named Matt Shay as its next president and chief executive following the retirement of Tracy Mullin, who was CEO for 17 years. Shay joins NRF from the International Franchise Association, where he served as president and CEO. Shay will be elected formally at the June 22 NRF board meeting, NRF Chairman and Macy's Inc Chief Executive Terry Lundgren said in a statement on Wednesday. "Retail is the lifeblood of our economy and with the challenges we face on Capitol Hill, the stakes have never been higher. There is a lot of work to be done...," Shay said in a statement. (Reporting by Dhanya Skariachan; editing by John Wallace) <>  


This morning's claims data was better. Claims dropped 5k week over week to 457k from 462k (no revision), while the 4-week rolling average declined by 4k to 471k from 475k. The following chart shows the rolling average trend line. Below that we show the raw data.




It is worth noting that next week, barring a significant uptick in the printed number, the rolling average number should fall materially. If next week's claims number is flat week over week the rolling average will fall by 10k - a large enough number to get people's attention, though still not enough to get claims back inside our 3 standard deviation trajectory. As we've said over the last few weeks, we continue to expect to see a claims tailwind throughout the Spring months as census hiring picks up and weather-related effects dissipate.






Joshua Steiner, CFA


According to the WSJ, MCD is pushing to sell all soft drinks, no matter the size, for $1. 



My initial reaction to the news:


(1)    MCD’s maniacal focus on TC’s is reaching a new low

(2)    It’s not good for the other industry players profitability

(3)    Most likely another sign that trends are not getting better for QSR

(4)    Whatever happened to the idea that the $1.00 menu made sense because of the add-on profits of drinks and fries?

(5)    It will make it very difficult for MCD to sell $4 blended drinks this summer


We are currently short YUM in the Hedgeye Risk management virtual portfolio.  This news puts one foot in the door to adding MCD to that list.


Howard Penney

Managing Director

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