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The pattern of consolidation continues.  Down in the morning and up in the afternoon has been the pattern and it’s been most constructive with the Russell 2000 hitting a new high yesterday.  European sovereign concerns, some high-profile earnings disappointments in Technology (XLK) and Healthcare (XLV), along with lingering uncertainty surrounding a looming financial regulatory overhaul were the major headwinds. 


On the MACRO front, Greek funding concerns seemed to offer a more meaningful headwind for the risk trade early on.  Now Greece has formally called for the activation of a financial lifeline of as much as $60 billion in an unprecedented test of the euro’s stability and European political will.  Yesterday, an EU report showed that Greece's 2009 public deficit widened to 13.6% from the previous estimate of 12.7%, and could be revised even higher. In addition, Moody's downgraded Greece's sovereign debt to A3, and put it on review for a further possible downgrade.


Also on the MACRO front, housing-leveraged names outperformed again with the XHB up 3.8% yesterday and 7.9% over the past four days.  The economic calendar was the big driver of the move as existing home sales rose 6.8% month-over-month in March to a 5.35M annualized rate. The improvement in March helped reverse the declines seen in the prior two months. While the inventory of homes for sale rose 1.5% to 3.58M, supply still fell to 8 months from 8.5 months in February.


Lastly on the MACRO front, jobless claims for the most recent week, released yesterday, dropped 24,000 to 456,000 from 480.000 (revised down 4,000) in the prior week. This caused the rolling 4-week average to actually increase by 3k to 459.5k from 456.8k.


As our Financials analyst, Josh Steiner, commented yesterday “We hate to be the ones to take away the punchbowl, but consider this. As the charts below show, at 456,000, claims are at the same level they were at on 11/28/09 (457,000). In other words, claims have gone nowhere in almost five months. Compare this with the colossal improvement in claims from April 2009 through November 2009. In stark contrast to recent claims trends, the XLF has barreled higher some 17% over the last 4.5 months, with high-beta Financials rising by multiples of this.”


The broadest measure of support for the RESILIENCE trade can be seen in the consumer related sectors.  Yesterday the Consumer Discretionary (XLY) was the best performing sector closing up 1.8% on the day.  Over the past month, the XLY is also the best performing sector - up 8.9% versus the S&P 500 up 3.7%.   Some of the more upbeat results recently came out of the consumer discretionary space (NFLX +15.3%, CMG +14.2%, SBUX +7.3%, MAR +6.2%), while housing-leveraged names extended their rally on the back of a rebound in March existing home sales.  We took advantage of the consumer melt up and made a few sales.


SHORTING CMG - Now this is a world class short squeeze! Howard Penney thinks that headwinds start to develop in the quarterly earnings in the next 3-6 months. We'll short it for the immediate term TRADE up here. KM


SHORTING XLY - Today is another capitulation day for the short the consumer crowd. We are long names like SBUX, NKE, and FL, so we understand the pain some of the shorts are feeling. We'll hedge their fears up here, for a TRADE. KM


BUYING CIT - Josh Steiner and I have been waiting for the stock to correct and now it has. Josh has come full circle on this name as any analyst with an objective process should. KM


SELLING PSS - While McGough still likes the long term TAIL for PSS, it’s simply overbought here. We'll sell high and look to buy it back on a down day. KM


SELLING WFMI - We'd like to thank JPM for making a call on this the day after we got long. Levine likes their call, and I'll sell into it here. KM


The Financials (XLF) outperformed yesterday, with credit takeaways from the regional banks helping to underpin a positive sentiment.  In addition, overall takeaways from 1Q earnings seemed fairly consistent with the trends seen thus far during earnings season, including declining provisions and NCOs, slowing NPA formation and more upbeat management commentary.


The Chinese market continues to weaken of late, down 0.53% last night, and is now down 8.96% year-to-date.  The weakness in China and a stronger dollar has slowed the REFLATION trade.  The Hedgeye Risk Management models have levels for the Dollar Index (DXY) at:  buy Trade (80.96) and sell Trade (81.70).  We have no position in the VIX currently and it remains broken on all three Hedgeye durations.  The Hedgeye Risk Management models have levels for the VIX is: buy Trade (14.65) and sell Trade (16.85). 


Yesterday, Healthcare (XLV) was the worst performing sector for a second day in a row.  The sector has been dragged down over the last two days on concerns that the impact of healthcare reform has been bigger than expected for the companies that have reported thus far. Yesterday, BAX declined 13.3% as it became the latest company to lower guidance on healthcare reform, though the company also cited continued plasma market pressures.


Oil is trading above $84 after reports that Greece will request financial aid.  The Hedgeye Risk Management models have levels for the OIL is: buy Trade (83.74) and sell Trade (87.14). 


In early trading Gold may extend losses tracking a firm dollar overseas?  The Hedgeye Risk Management models have the following levels for GOLD – Buy Trade (1,130) and Sell Trade (1,163).


In early trading, copper is trading slightly higher on the bullish news from Germany.  The Hedgeye Risk Management Quant models have the following levels for COPPER – Buy Trade (3.51) and Sell Trade (3.63).


In early trading, equity futures are trading mixed to fair value having pared earlier losses as Greece formally asks for financial help from the EU as it tries to solve its acute funding needs.  As we look at today’s set up, the range for the S&P 500 is 37 points or 0.4% (1,203) downside and 0.5% (1,214) upside. 


Today’s MACRO calendar:

  • Mar Durable Goods
  • Mar New Home Sales
  • G20 meets in Washington to discuss global economy

Howard Penney

Managing Director















IGT was probably good enough. We'll have more on the quarter soon. For now, here are our "notes" from the release and transcript.


"Our second quarter results demonstrate real sequential progress at IGT.  An improvement in replacement units shipped, an increase in gaming operations yields and a decline in SG&A all reflect IGT's continued efforts to navigate our business through an operating environment which remains challenging."

- CEO Patti Hart



  • Gaming operations "revenues decreased primarily due to a lower installed base and the continued shift toward lower-yielding machines. Approximately $5.0 million of the decrease in revenues in the current quarter was attributed to property closures and the reduction of electronic charitable bingo terminals being operated in Alabama."
  • Reduced expenses, primarily depreciation and royalties, positively impacted [gaming operations] gross margins, which improved to 62% from 59% in the same quarter last year
  • Product revenues: North America revenues declines were largely driven by fewer new openings. International revenues increased 65% for the quarter, primarily due to the opening of Resorts World Sentosa in Singapore, improved sales in Europe, and favorable foreign currency exchange. Consolidated gross margin on product sales for the quarter was 46% compared to 48% in the prior year quarter, primarily due to higher obsolescence, including write-downs related to the closure of our Japan operations.
    • Excluding the write-down, international margins would have been 45% vs. 43%
  • As of March 31, 2010, IGT had approximately $85.5 million in development financing notes, $9.2 million in fixed assets, and $7.2 million in accounts receivables associated with their customers in Alabama.


  • Gaming operations was $51.70 average yield
  • Product sales:
    • Domestic shipments: replacements were 4,100. They are encouraged by the uptick in replacement demand
    • Increase in MLD: 51% of NA shipments in the quarter and led to higher prices, expect MLD's to continue to increase as a % of total mix
    • International benefited from increases in systems revenue for non-box sales
    • Going forward they expect 48-50% product sale margins
  • Operating expenses:
    • Excluding one time charges, their operating margins would have been 24% vs. 17% last year
    • SG&A declined 12% excluding bad debt, due to lower legal and compliance fees
      • no more BYI lawsuits
      • Still guiding to $95-100MM
    • Total D&A was $58MM - including game operations. The decrease was due to lower D&A on their WAP and Mexico games.  It should increase as they refresh their install base
    • $30MM of non-cash interest or $0.06 for FY2010 and $0.08 for FY2011
    • Tax rate was impacted by one time items - would have been 38%.  Going forward expect 37-39% tax rate
  • Balance sheet
    • Made a lot of progress with their WC cash flow
    • Saw their lowest inventory balance in 30 quarters (although i bet part of that is just due to low volumes)
  • Capex was $63MM this quarter.  Guidance of $65-75MM of Capex, although they continue to trend at the lower end of that range
  • Alabama bill to vote on electronic bingo games was not passed in the House
  • Gaming operations yields increased sequentially (as it should seasonally).  Mega Jackpots yields increased 11% sequentially.  Deployed 149 Amazing Race games and 93 Top Dollar games
  • New Products:
    • Wheel of Fortune - new center stage game, and Wheel of Fortune multi-play and WoF secret spins is coming out later this year
    • SB window solution for legacy games for 8960 footprint
    • Released 21conversion games for their legacy spinning reels
    • Sold 4017units under the Buy 1 AVP get 2 conversion kits program ("Dynamix" aka buy an AVP game and get 2 free conversion kits for other games)
  • Have 3,200 games in their backlog (participation), 2153 of which are for their top 3 games (Sex in the City, Amazing Race and Top Dollar)
  • Are encouraged by the performance of SB at Aria
    • Have had a number of successful trials internationals
    • Are in negotiations on 2 NA opportunities and several other Tier one opportunities
      • Cosmo?
    • Have closed 3 new advantage customers and are in talks with 5 more
  • Remain extremely focused on FCF generation
  • Central system provider for IL will be announced shortly. Expect to start shipping in the first quarter of FY2011
    • Expect a market of 35,000-40,000 units ( we expect a smaller market)
  • Remain cautiously optimistic to increased operator budgets allocated to slots
  • Adjusted their guidance to reflect risk of losing Alabama - new guidance is $0.77-$0.85 cents from $0.75-$0.85


  • Market share? 35-40% on replacements based on their internal estimates
  • Excluding Alabama, what would yields have been?
    • Saw a seasonal uptick but attribute part of that to their new products - Sex in the City and Amazing Race and also saw that in the WAP product
    • I personally think that looking at yields sequentially is not useful due to seasonality
    • And yes Alabama positively impacted yields since those games do about $24/day
  • Some of their backlog is due to jurisdictional approval of the games and some of that is due to waiting for a customer delivery date
  • Domestic ASP of $14.3k - due to Dynamix package (ie discounting)
    • Special pricing is ongoing - was initially through end of Feb and was extended by 3 months
    • Competitors are not responding with comparable deals
  • SG&A? They are budgeting for more but it's been coming in lower because of the variable compensation component
  • Customers want to replace units but it's a capital budget issue. They are focusing on how to help customers refresh their older games within their limited capital budgets. They are also focused on placing their new Jackpot games given the budget constraints
    • It's a strategic move to keep floor share
  • Italy- timing seems to have moved out given the multiple systems providers. Think that there may be shipments by the end of the calendar year.
  • "Other expense": Interest expense was $39MM, $1MM of other income, $15.7MM of interest income
  • They got 24-25% of Marina Bay Sands shipments
  • What will conversion kits sales do if replacements come back next year?
    • Unclear...maybe on legacy units.
  • Don't know when the entire floor of Aria will be SB - no hard stop date, expect by the end of IGT's FY year (Sept 2010)


CAKE reported stronger than expected earnings of $0.31 per share versus the street’s $0.25 per share estimate and management’s guidance of $0.23-$0.25 per share.  Same-store sales turned positive in the quarter at both Cheesecake Factory and the Grand Lux Café with blended same-store sales coming in +2.8% (better than management’s guidance of flat to +1%, including a 1% expected benefit from increased gift card redemptions).  This better comparable sales result implies a 370 bp acceleration in sequential 2-year average trends from the prior quarter, which the company attributed to continued improvements in traffic trends.  Operating margin improved about 250 bps YOY during the quarter.


Management does not provide guidance until the conference call, but based on these better than expected results, it would seem that the current full-year outlook for $1.16-$1.24 per share in earnings and -1% to flat same-store sales growth is going higher.  Based on the 1Q10 earnings beat, we would expect FY10 EPS guidance to move to at least $1.22-$1.30 (the street is already at $1.27).


The stock is initially indicating lower….Remember when less bad was good.  Based on 1Q10 earnings to date, the new question is how good is good?



Howard Penney

Managing Director

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Keith just shorted CMG in the portfolio.  Read on for his quantitative levels and a note outlining my thoughts on the name.


The chart below shows Keith's quantitative view on CMG at its closing price. 




Chipotle joined the party after the close yesterday.  The outlook for the company is strong and price action is reflecting that.  Longer term, there are many factors to consider.


Yesterday’s earnings were, as is the standard this quarter, above expectations for Chipotle.  The comparable sales increase for 1Q of +4.3% was mainly driven by traffic; there has been no price taken in the past twelve months.  Looking at the top-line, the outlook is strong.  On a year-over-year basis, the next few quarters should not be difficult for sales and management said as much on the earnings call, raising their guidance for comparable store sales for the year, “based on improved traffic trends, we’re raising our comp guidance from flat to an expected comp increase of mid single-digits for the full year.”




What will really be interesting will be how margins play out going forward.  Specifically, regarding commodity inflation, management stated that inflation outlook for the year is relatively benign and the company only has a few small items contracted for the remainder of the year such as rice, soy oil, corn, and tortillas.  Historically the cheese has been locked in but, in line with the company’s high standards for ingredients, it is now moving supply to more pasture-raised dairy.   The spot market in cheese was also, to management, “more attractive”.  Judging by data from the Bureau of Labor Statistics, the outlook for PPI index for cheese is less-than-benign.  At current levels, year-over-year inflation in PPI for “Natural, processed, and imitation cheese” would be 7.4% year-over-year, on average, over the next six months.  The move by CMG to buy on the spot market increases the potential for quarter-to-quarter volatility. 


In terms of the interaction between grain prices and margins, the chart below shows Restaurant Operating Margins, the CRB Grains Futures Sub-Index, and the CRB Livestock Futures Sub Index.  It is clear that the deflationary period of late 2008 and 2009 has helped Chipotle to achieve a higher level of operating margin.  In the past quarter, the uptick in sales clearly aided leverage over fixed costs.  Whether the company can prudently manage costs in the inflationary periods that we believe are ahead, will be a highly pertinent factor in the intermediate term.




In terms of Return on Incremental Invested Capital, Chipotle is at elevated levels.  As they continue into new markets, geographies, and different types of stores, it will also be important to monitor this metric.








Proud that during the toughest times, company has maintained standards and service.  As the economy improves, more people visiting Chipotle

  • First European restaurant is opening in London
  • Found good local ingredients
  • Taking a fresh look at many aspects of the brand

New advertising

  • Pointing out where CMG’s food comes from
  • High quality, building awareness will build loyalty

One area of focus is the team

  • High performing people culture
    • Difficult to articulate but clear that the culture is a factor in driving sales, margins, earnings
    • Hiring elite managers and providing incentives for managers to perform and reach “restauranteur” level
    • Helping managers understand their role in the overall vision in changing the way people think about fast food
    • Special people culture and people are helping the company achieve the goal



New units

  • 700k average development cost for 5 new untis this quarter
  • They are performing well initially
  • On par with traditional new restaurants despite lower opening and investment costs
  • New “A” model units have appeal for CMG
    • Same experience
    • Lower costs

“A” model

  • Providing the best customer experience possible
  • Growing CMG responsibly
  • Increasing shareholder value

1Q results

  • Tough consumer environment is improving somewhat
  • Efforts have paid off, new and existing customers coming back more frequently
  • Unemployment still high, cautious for 2010
  • We won’t stray from strategy
    • People
    • Quality
    • Growing
    • Did all this while strengthening business model


Highlights for quarter

  • Revenue increased 15.6% to $409.7m
  • Diluted EPS of $1.19 (vs $0.96 est)
  • Comp store sales increased 4.3%
  • Restaurant level operating margin was 26.1%
    • Increase of 260 bps
    • Labor efficiencies and comps drove margin expansion
    • Food costs dropped 80 bps
      • Rice, avocados, cheese
      • Net income was $37.8 million, increase of 49.1%
      • Diluted earnings per share was $1.19, increase of 52.6%
      • Other operating costs decreased
        • Lower promotional and insurance expenses
        • G&A declined due in part to increase in stock based comp
        • Opening 20 new restaurants in quarter



  • Raising guidance for comps from flat to up mid-single digit
  • 2H food inflation
    • Increased commodity costs and consumer demand
    • Little or no labor leverage going further
    • Marketing at 1.8% for the full year
    • No G&A leverage for the rest of 2010
      • Holding conference…22m for 2010
      • Opening 120-130 new units in 2010. 25% of those will be “A” models
      • Better positioned than ever to add to shareholder value




Q: Store productivity …thoughput in busier markets…can you update us on throughput?


A: We took our eye off this ball over the past couple of years.  Throughput fell off coming into the recession.  TCs were lower. Especially at peak hours, less business customers at lunch.  They fell more than they should have, though.  Over the past couple of years we’ve scheduled better, labor-wise. 



Q: Can you talk about comps through quarter and this present quarter so far?


A: In February we were starting to see momentum building in traffic but weather hit that trend in traffic turning.  We’re cautious with guidance because this is a new found trend, unemployment is still high, and consumer confidence has improved but not that much.  What we saw in March has continued into April.

Once weather is bad we get a couple of over performance for a couple of days when it clears up so we don’t think weather was overly material.



Q: Will commodity inflation in 2H make you consider taking pricing?


A: Seems manageable based on what we know today.  Not anticipating taking any price. Seeing food inflation in low single digit range.  For the year, wouldn’t expect menu price increases.  If things change, we can, but won’t rush.



Q: Growth outlook?


A: in terms of development outlook, two years ago, 70% of restaurants were new developments.  Last year it fell off and now it’s around a third.  No pick up in new developments yet. There is a substantial lead time.  The “A” model strategy tends to go into tier 2 locations and existing real estate.  We’re feeling positive about the “A” model strategy.  Looking to find as many good locations as we can in 2011 and beyond.  This year after the 3Q release we’ll have more concrete details on 2011 unit growth.



Q: Anything in human resources that would make you hesitate in the growth? Or is it real estate?


A: HR is not a problem.  We have a good ratio of leaders to stores. Restauranteur growth has been steady. 



Q: What kind of competition are you seeing in premium convenient segment and where are you taking market from?


A: It seems like all the news has been positive recently. Seems like consumer is out spending again.  We did the best we could while consumers were more timid, and made sure they had the best experience possible. 



Q: London team set up?


A: It will be consistent with how it was done in Toronto.  Restaurant employees are the only people working there…in London there will be a restauranteur opening the restaurant.  There will be two other restauranteurs at the same level that will help with sourcing, hiring, training.  That’s unusual but given the success of Toronto, we feel that it is the way forward in London.  Germany and France are on longer term radar screen.  Sending more talent to London initially.  We think it will be easier to find natural food in Europe – there is no RBGH diary in Europe, whereas in the US we have to look for food with integrity. 


Sourcing…everything will be cooked from scratch in that restaurant.  Going to be able to buy from small suppliers if needed. 


The design in London was approached as a chance to do something new – quite like the new ones in NYC. 



Q: Clarify marking spend and let us know how broad it will be. How many markets will use radio?


A: Rolling out in 30 major markets.  About half of those will have a strong campaign.  Marking came in at 1.1% for quarter because new marketing campaign is being rolled out now.  Should see marketing budget at 1.75% for year.  Marketing now is radio, billboards…radio just started so don’t know what the effect is as yet.  Marketing is designed to highlight food with integrity but making message clearer to raise awareness of food with awareness and taste.



Q: Kids’ menu?


A: rolled out in some markets…plan on rolling out the rest of the country throughout the year. June 1st will see another tranche.  The teams need to be trained adequately.  2% to 3% of transactions are for kids in the markets so far, without any marketing so far, it has ticked up.  Kids menu is priced slightly higher.



Q: Is some of that business incremental?


A: That’s tricky to see right now.



Q: What is your read on restaurant margin differential between “A” model and traditional?


A: It’s really early, we don’t know what the difference would be.  If you’re talking about comparable volume, they have opened at typical volume.  IF that continues, “A” models will be higher for sure.  Too early to tell at this point.  Sometime next year we’ll being to open “A” models in new and developing markets.  We don’t like new market margins for traditional units.  We anticipate “A” models performing better in this respect in new and developing markets.



Q: How do we stand on development of the new units? Backend weighted? Can you tell us where the 25% of “A” models in existing markets will be going in?


A: 120 to 130 this year. Heavily weighted towards 2H.  “A” models will be opening throughout that time. 4 next quarter and 12 in the next, 8 in the next, perhaps.   They’re going into proven markets…where we’ve been for a long time.  Most markets are proven markets.  Denver, DC, Dallas, Houston, Chicago, Phoenix…reduced risk of not having success.



Q: Marketing expense…1.8% of sales is for full year…is that evenly going to be expense now for quarters or did 2Q have a few weeks where it wasn’t jacked up?


A: Can’t commit to it being even for the remainder. Remaining flexible.  If it were even it would be around 2%. 



Q: Average Check?


A: Check was stable.  It was perhaps slightly up.  Nothing material.  Driven by the group size being a little bigger. More group sales, more fax orders, more online. Generally higher check. 



Q: Marketing…a year ago the new menu test…is any of the new advertising spend aimed towards educating the guest or is that for the restauranteurs and employees to do now?


A: There are aspects we like, the kids meal is a success in markets so far.  Trying to organize the markets in different ways. 



Q: Commodity – what was deflation in 1Q? What items are you seeing moving up? What do you have contracted for the year?


A: 80 bps deflation, net. Rice contracted through three quarters, soy, corn, tortillas for full year. That’s it. Not able to lock in much of ingredients. Cheese has been historically locked but we’re changing that, moving towards pasture raised dairy. Spot market was more attractive for cheese also.



Q: Are the stores you opening in the downturn ramping? Comment geographically?


A: comp is broadbased. Only spot that was lagging a bit was Texas, who entered the recession late.  Also returning to the comp trends that we saw before recession – new restaurants are comping well and older markets are positive. Comp guidance assumes no menu price increase.



Howard Penney

Managing Director


Starbucks continues to surprise to the upside.  The rate of improvement will slow, but margin growth should continue to materialize from here.


Yesterday, MCD reported stronger-than-expected 1Q10 earnings and the best quarterly U.S. restaurant level margin in nearly 16 years.  Following those results, I posted MCD’s stock chart, which showed it trading at an all-time high and highlighted that there seems to be some investor concern about where the stock and margins go from here.  After the close yesterday, SBUX followed up with another quarter of crazy good numbers.  With SBUX’s share price more than doubling in the last year alone and the company reporting record 2Q operating margins in both the U.S. and internationally, my first inclination was to ask the same question about SBUX:  where to from here?  Call me gullible, but I seem to believe management when it says the “best days are ahead” and that the U.S. business “has not seen its peak.”  Apparently, I am not alone as the stock is up 6% today, in contrast to MCD’s muted response yesterday.  To be clear, SBUX’s rate of improvement will have to slow (full disclosure: I feared this two quarters ago), but I am now convinced margin growth will continue to materialize.


SBUX is not MCD…

To start, SBUX is not trading at an all-time high; though it has had an impressive 275% move higher since its recent November 2008 low.  MCD is consistent.  I was concerned with the company’s decision to add the McCafe beverage platform because I feared the company would lose sight of its core business.  With March same-store sales up 4.2% in the U.S., the company seems to be charging forward with few issues.  The company will continue to refine its business, allowing it to better execute, but I question what the next layer of growth will be for MCD, particularly in the U.S.  I do not have the same concerns for SBUX. 








SBUX seems to have a lot of momentum right now when it comes to potential sales layers.  Additionally, these new avenues of growth will leverage the company’s existing retail store base but also extend beyond it. 


Within the retail store base:

  • Company transformation – the back-to-basics strategy has enabled the company to improve its customer satisfaction metrics, which has been directly correlated to the company’s improved traffic – Sharing best practices globally
  • My Starbuck Rewards – the recently launched rewards program is driving increased frequency with card reloads up 45% YOY in the second quarter
  • U.S. VIA – management would not break out VIA’s contribution to the 7% same-store sales growth in the U.S., but did say that VIA was an important driver of the 5% increase in average check – VIA is now expected to be slightly positive to profit in FY10 (had said profit neutral)
  • International VIA – the product has been rolled out in Canada, the U.K. and most recently, Japan and has exceed management expectations in each segment.  VIA will be launched in additional markets throughout the year
  • Remodels – over the next 12-18 months, SBUX will begin an “aggressive phase of existing store remodels and refurbishments in the U.S”


Within the CPG channel:

  • Management continues to believe that both VIA and SBC have the potential to become billion dollar brands for SBUX
  • VIA – the brand’s distribution will be greatly increased to more than 30,000 points of distribution by the end of 3Q10 supported by a nationwide U.S. advertising and marketing campaign, both print and broadcast
  • Regarding VIA, management looks “forward to offering new form factors and other innovations in the very near term for all things VIA.”  Management was fairly cryptic about what those other form factors could be but it was clear that it is heavily focused on the at-home market.  Specifically, management stated, “We’re certainly well aware as the leading specialty coffee brand of what’s going on around single serve and specifically at-home and have had a watchful eye on what Green Mountain and Keurig have been able to do and they’ve done a fantastic job. We’re looking at this in two ways. One, we think that VIA has an interesting opportunity to position itself in a way against what Keurig is doing at home because there’s no waste, there’s no cost of equipment and you can take VIA anywhere. And the quality of the coffee is significantly better and we’re going to have multiple SKUs and form factors that will create a portfolio of product. However, I think the market needs to stay tuned that we have every intention of understanding what single serve can be. And we’re not going to sit back and just watch Green Mountain and Keurig march their way into 20 to 30% household penetration without Starbucks not doing anything. So just stay tuned.”
  • Increasing CPG capabilities globally – recently entered the RTD coffee category in Europe and launched Starbucks Double Shot in the U.K. grocery and convenience channels
  • SBC – by the end of the year, the company will have expanded SBC points of distribution to 30,000 from 3,000


SBUX’s ability to identify new sales layers has been impressive, but like anything else, execution will be important.  Focusing on the core business has been a significant driver of the company’s recent success in the U.S. and it will be necessary to monitor whether SBUX can maintain this focus while executing these new growth initiatives.


Near-term issues:  As I stated earlier, SBUX’s rate of improvement will slow in the back half of the year as the company will begin to lap more difficult same-store sales and margin comparison from last year.  Based on the company’s full-year margin guidance, margins will continue to improve in the back half of the year but at a moderating pace from 1H10.  Keep in mind that margins in the third quarter will be further pressured by the increased investment behind the VIA launch , which will add an incremental $0.05 per share of marketing expense in 2H10 versus 2H09, which will fall primarily in the third quarter.  Management stated that 4Q margin should be higher than the 3Q level. 


As management indicated on its call yesterday, same-store sales in the U.S. improved through 2Q10 sequentially on a 1-year basis for five quarters and on a 2-year basis for four quarters.  Although I am expecting two-year average trends to continue to get better, it will be a lot more difficult for the company to maintain its trend of posting sequentially better numbers on a 1-year basis in the next two quarters.  I was surprised that the company was able to post a sequentially better number on a 1-year basis during the second quarter, but investors cannot count on too many more of these surprises.  To that end, management’s full-year mid-single-digit comparable store sales growth does not assume that same-store sales come in better than 7% in the back half of the year.


We included Keith McCullough’s risk management TRADE (immediate) and TREND (intermediate) levels in the chart below:




Howard Penney

Managing Director


PNK should beat the consensus Q1 estimate and 2010 probably needs to go higher. The stock has had a great run but management seems to be making all the right moves.



Q1 should look much better than Q4’s kitchen sink.  We have our own theories on why Q4 was so ugly but that’s yesterday’s news.  Top line in Q1 will not look strong but margins should be much improved.  This is not exactly ground breaking commentary, however.  The stock is up 66% since we highlighted the potentially strong quarter and positive catalysts in our 3/1/10 note, “PNK: Is the Worst Over?”  However, 2010 consensus EBITDA of $179 million looks low, so there still might be some gas in the tank.


For Q1, we are projecting $45.8 million of EBITDA, about $5 million ahead of the Street.  We think the main risk to our number will be if the company wants to be conservative with a new CEO at the helm.  For the year, we are at $188 million versus the Street at $179 million.  On the conference call, look for some important commentary on the cost side.  Here is our analysis:


How much can PNK really save?

  • In 2009, PNK spent $12.1MM maintaining the AC land
    • “In late 2008, we decided to suspend substantially all development activities in Atlantic City indefinitely.  The continuing pre-opening and development costs include property taxes and other costs associated with ownership of the land.” 
  • Getting rid of the airplane and consolidating the 3 offices will save them another $2.5MM/year 
  • They renegotiated their insurance policy – saving another $1MM 
  • Marketing expenses may be the largest saving for PNK, particularly in Louisiana – another benefit from jettisoning Dan Lee 

If we are right on the cost savings (without factoring in marketing cost reductions), PNK would have up to $15 million in potential cost savings this year plus marketing reductions.  We are not sure if the AC costs will be shown in discontinued operations until they sell the property.  If you add $22 millilon in net River City contribution (net of Lumiere Place cannibalization) plus the cost savings to the $173 million in EBITDA from last year, it's easy to see why we think the Street's 2010 estimate of $179 million looks conservative to us, even with degredation at the other properties.



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