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SBUX - COST CUTTING GONE TOO FAR?

Take it as a data point or it may just be speculation, but the Starbucks bloggers are talking about insufficient staffing levels.  I would not even highlight this if so much of the margin recovery story at SBUX was not built on cost cutting.  To that end, the company continues to surprise to the upside with its cost cutting initiatives. 

 

From a Starbucks blog; “apparently there is such a staffing crisis at the SM (Store Manager) level in the DC area that several SMs in the Mid-Atlantic are being recruited to travel down to DC, all expenses paid, for a period of two months to help run the stores until ASMs and RMTs are ready to assume those positions. One of the SMs I know is going.”

 

More important for the Restaurant industry as a whole is the trend in turnover rates if the economy and the job picture gains momentum.  In an economy that is creating jobs there is an increased willingness to quit and walk away from a lousy job, and the restaurant industry will pay the price. 

 

For now, however, we don’t have much to worry about.  As our Financials Analyst, Josh Steiner, wrote today “Consistent with the trend year to date, claims remain in their ~450k range, too high for unemployment to improve meaningfully. This morning the reported number fell 14k to 460k, down from last week's revised print of 474k, and higher than consensus of 458k.  Rolling claims climbed 2k to 457k week over week.  Remember, we need to see initial claims fall to a sustained level of 375-400k in order for unemployment to fall meaningfully and, by extension, lenders' net charge-offs to return to normalized levels.  We remain well above that level.”

 

Cutting costs too deeply is a whole different issue.  Based on SBUX’s improving same-store sales trends, I had not been under the impression that the company was cutting costs to the extent that it was detrimental to the customer’s experience.  In the most recently reported fiscal 2Q10, store operating expenses (including labor costs) as a percentage of retail sales decreased 350 bps YOY in the U.S.  Management attributed the YOY decline to “sales leverage, the closure of underperforming stores and the continued application of lean principles in our store labor deployment.  Lower benefits expenses related to health and welfare programs, which tend to vary from quarter to quarter also contributed to the improvement. As a result of the lean work to-date, productivity and customer satisfaction have both improved dramatically compared to last year. We continue to refine these important activities as many of them are customer facing. In addition we have other initiatives under way such as a new labor scheduling tool and a new point-of-sales system that we expect will further increase productivity once fully implemented.”

 

It will be important to monitor whether customer satisfaction scores continue to improve to ensure that the company’s cost cuts are sustainable and not a result of management “pulling the goalie” to improve margins.  I don’t think this is the case, however, as management seems focused on improving the customer experience and sequentially better same-store sales and traffic trends seem to reflect that renewed focus, but insufficient staffing levels would be concerning.

 

SBUX - COST CUTTING GONE TOO FAR? - SBUX US store op exp   of sales

 

Howard Penney

Managing Director


Berlusconi’s Rallying Cry

Position: Short France (EWQ)

 

As we spelled out in our Q2 Theme call, the Sovereign Debt Dichotomy will not be isolated to Greece. While the fiscal excesses of the Greek government were first to be exposed, we’ve called for Spain, France, and Italy to follow, with the spotlight reaching the USA in 6-9 months.

 

Following spending and austerity measures issued in recent days by Spain, Portugal, and the UK, Italian PM Silvio Berlusconi announced a $30 billion plan in spending cuts late yesterday and is vocal today calling the measures “absolutely necessary” to defend the Euro and Italy, saying “defending the euro today means saving Italy’s future.”

 

Like Greece, Berlusconi’s government has plenty of fat to trim in the form of bloated civil service pay over recent years and room to rein in tax evasion (Italy’s annual tax revenues lost are 2nd only to Greece). While the package is a start, we don’t think the package alone (nor Berlusconi’s confidence) will be enough to deflect the reality of Italy’s fiscal problems. While Italy’s budget deficit of 5.3% of GDP is nearly half of those ‘affectionately’ named the PIIGS or Club Med countries, Italy’s total debt as a percent of GDP is as large as Greece’s at 115%.

 

Clearly, Berlusconi has seen the repercussions of the media’s frenzy with Greece (the Athex Index is down 28% YTD), and doesn’t want Italy to be next. Don’t forget that Berlusconi also has his own interest in the performance of the country’s capital markets as one of Italy’s wealthiest businessmen. 

 

One initial signal we’re following for heightened fears is CDS price. The chart below shows a recent spike in Italy’s 5YR CDS. While far from a 940bps high in Greek CDS in early May, or the 300bps tipping point for Lehman Brothers and Bear Stearns, this rise could be an early indication of something much bigger: the reality that you cannot kick the can of debt down the road in perpetuity. 

 

Matthew Hedrick

Analyst

 

Berlusconi’s Rallying Cry - italy


CLAIMS IMPROVE BUT REMAIN IN SAME RANGE THEY'VE BEEN IN YTD

Consistent with the trend year to date, claims remain in their ~450k range, too high for unemployment to improve meaningfully. This morning the reported number fell 14k to 460k, down from last week's revised print of 474k, and higher than consensus of 458k.  Rolling claims climbed 2k to 457k week over week.  Remember, we need to see initial claims fall to a sustained level of 375-400k in order for unemployment to fall meaningfully and, by extension, lenders' net charge-offs to return to normalized levels.  We remain well above that level.  

 

As a reminder around the census, May is the expected peak employment month. Starting next week the census will become a headwind for job creation.

 

CLAIMS IMPROVE BUT REMAIN IN SAME RANGE THEY'VE BEEN IN YTD - raw

 

CLAIMS IMPROVE BUT REMAIN IN SAME RANGE THEY'VE BEEN IN YTD - rolling

 

The following chart shows the census hiring timeline.  If the past two cycles are an appropriate model for this year's census, we should start to see Census employment draw down as we move into June, creating a headwind for employment. 

 

CLAIMS IMPROVE BUT REMAIN IN SAME RANGE THEY'VE BEEN IN YTD - census chart

 

Joshua Steiner, CFA

 

Allison Kaptur


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CLAIMS IMPROVE BUT REMAIN IN SAME RANGE THEY'VE BEEN IN YTD

Consistent with the trend year to date, claims remain in their ~450k range, too high for unemployment to improve meaningfully. This morning the reported number fell 14k to 460k, down from last week's revised print of 474k, and higher than consensus of 458k.  Rolling claims climbed 2k to 457k week over week.  Remember, we need to see initial claims fall to a sustained level of 375-400k in order for unemployment to fall meaningfully and, by extension, lenders' net charge-offs to return to normalized levels.  We remain well above that level.  

 

As a reminder around the census, May is the expected peak employment month. Starting next week the census will become a headwind for job creation.  

 

CLAIMS IMPROVE BUT REMAIN IN SAME RANGE THEY'VE BEEN IN YTD - raw

 

CLAIMS IMPROVE BUT REMAIN IN SAME RANGE THEY'VE BEEN IN YTD - rolling

 

The following chart shows the census hiring timeline.  If the past two cycles are an appropriate model for this year's census, we should start to see Census employment draw down as we move into June, creating a headwind for employment. 

 

CLAIMS IMPROVE BUT REMAIN IN SAME RANGE THEY'VE BEEN IN YTD - census chart

 

Joshua Steiner, CFA

 

Allison Kaptur


THE M3: UNEMPLOYMENT RISES

The Macau Metro Monitor, May 27th, 2010

 

UNEMPLOYMENT RATE INCREASES macaubusiness.com

The unemployment rate for February-April 2010 was 3.0% and the underemployment rate was 2.0%, up by 0.1% and 0.2% respectively over the previous period (January-March 2010).  Unchanged from the previous period, total labor force stood at 323,300 and the participation rate remained at 71.1%.


US STRATEGY – CHINA SPEAK

It takes two to speak the truth. One to speak and another to listen.
    --Henry David Thoreau

 

Yesterday, the S&P 500 fell amid rumors that China may consider reducing its investment in European government bonds, creating a very bearish close for the S&P 500; lower-highs on the open; lower-YTD-closing-lows on the close.  We are waking up to a big rally in Europe and Asia, as China said it remains a long-term investor in Europe.   Commodities are rallying across the board with the exception of gold.  One of our favorite sayings last year was that President Obama needs to “shake hands with the client.”   The power of the Chinese continues to grow.  I hope we, as a nation, are listening.

 

Consistent with our 1Q10 theme “Chinese Ox in a Box,” the Chinese market rolled over in Q1, taking down the US market in 2Q10 - “April Flowers, May Showers.”  Concern of an overheating Chinese economy has had broad implications for commodities and the REFLATION trade.  The Chinese market officially “crashed” in early May, putting copper and crude in a bearish formation, which both have a very high correlation to Energy (XLE) and Materials (XLB).   

 

With the Chinese market up in four of the last five days, commodities prices are starting to rally (China was up 1.1% last night.)  Yesterday, the CRB closed at 253, up 1.4%.  Crude closed at 71.55, up 4% and is trading higher again today.   The Hedgeye Risk Management models have the following levels for OIL – Buy Trade (68.51) and Sell Trade (73.78).

 

Yesterday, Treasuries were weaker despite the pullback in stocks.  The Dollar index was up 0.39% to $87.12.  The DXY is looking slightly lower today.  The Hedgeye Risk Management models have the following levels for the USD – Buy Trade (84.08) and Sell Trade (87.18).  We are short the Dollar. 

 

Another sharp downturn in the EURO may have also weighed on sentiment yesterday, but the EURO held our level of $1.21 and is trading higher today.  The Hedgeye Risk Management models have the following levels for the EURO – Buy Trade (1.21) and Sell Trade (1.24).

 

The notable stand out in yesterday’s weakness was Technology (XLK).  The downward pressure was attributed to comments from MSFT (down 4.1% yesterday) CEO Steve Ballmer, who reportedly said that the fallout from the fiscal crisis will not be limited to Europe and the company may have to shift its focus elsewhere in Asia given the impact of China's enforcement laws.   There have also been a number of articles recently criticizing the CEO’s performance and suggesting he should maybe step down.  The S&P Software index fell 2.6% yesterday.   

 

On the MACRO front in the US, April housing data continued to come in ahead of expectations as new home sales surged 15% following an upwardly revised 30% gain in March.  Not surprisingly, housing-leveraged stocks were among the best performers yesterday; HOV +1.5%, SPF +0.9% and LEN +0.5% were among the big gainers.  TOL was up 0.8% despite a somewhat disappointing April quarter, but all is forgiven with outsized order volume growth.

 

The VIX remains in a bullish formation and was up 1.1% yesterday.  The Hedgeye Risk Management models have the following levels for the VIX – Buy Trade (27.23) and Sell Trade (44.95).

 

As the demand outlook improves, so goes copper.  China up, copper up!  The Hedgeye Risk Management Quant models have the following levels for COPPER – Buy Trade (3.01) and Sell Trade (3.18).    

 

For the time being, gold may have seen its day in the sun.  The Hedgeye Risk Management models have the following levels for GOLD – Buy Trade (1,204) and Sell Trade (1,240).

 

As we look at today’s set up for the S&P 500, the range is 55 points or 2.3% (1,043) downside and 2.8% (1,098) upside. Equity futures are trading above fair value following Wednesday's late day sell-off, which saw gains reversed with Technology stocks leading the decline.

 

On the economic front, to be reported today are:

  • Q1 GDP (2nd read)
  • Personal Consumption
  • Core PCE
  • Initial Jobless Claims
  • Natural Gas Inventories
  • Treasury Secretary Geithner and German Finance Minister Wolfgang Schaeuble hold press conf 

Howard Penney

 

US STRATEGY – CHINA SPEAK - S P

 

US STRATEGY – CHINA SPEAK - DOLLAR

 

US STRATEGY – CHINA SPEAK - VIX

 

US STRATEGY – CHINA SPEAK - OIL

 

US STRATEGY – CHINA SPEAK - GOLD

 

US STRATEGY – CHINA SPEAK - COPPER


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