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The Real Winners/Losers of World Cup

Let’s face it. Western Europe hasn’t exactly shown up thus far for World Cup. There are 6 negative standouts. 4 of 6 are Adidas teams. One is Umbro (NKE) and one is Puma. Of the 6 winners, they are evenly split between Nike and Puma.



We’ve seen our fair share of upsets thus far in the initial round of World Cup play. The biggest is probably the stone cold reality that Western Europe has – thus far – failed to show up for the event. Specifically, England, France, Germany, Italy, Spain (and of course…poor ‘ol Greece) need to overcome insurmountable odds in order to make a push into the next round.


Slovenia, Serbia, Portugal, Holland, Switzerland and Denmark are surprising on the upside.


Of those surprising on the downside, 4 of the 6 are Adidas teams. One is Umbro (Nike), one is Puma.

Of the 6 surprising on the upside in Europe, 3 are Puma and 3 are Nike. Sorry HErbert (Hainer -- Adidas CEO).


Ironically, the big winner in all of this is Brooks, which endorses only one team – Chile – which has performed far beyond expectations.


I bring this up not out of human interest, but because the magnitude of this event on a world stage can, and will, have regional economic consequences. The poorly managed brands will let the winners of a match dictate their product/brand fate. The well-managed brands will use either victory or loss to establish an emotional connection with a consumer to build the brand (remember what Nike did when Liu Xiang in China when he disappointed at the Beijing Olympics).


The Real Winners/Losers of World Cup - World Cup 2010

R3: TRU Snowjob Begins


June 23, 2010


Lot’s of stuff in here today folks. A) Toys-R-Us banking on Wall Street not having memory that recognizes how it failed in the 1990s, and how Yuan revaluation will hurt w 90% of toys made in China. B) Bangladesh labor unrest shutting 700 factories. C) WSM, AMZN, SHLD, M, etc…





As part of the pre-IPO process, Toys R Us indicated it is significantly increasing its remodel and side-by-side store relocation efforts. As a result, capex is expected to double this year to $400 million. At the same time inventory is on the rise as the company builds a pipeline for holiday pop-ups as well as takes advantage of excess inventory purchases at favorable prices. Management reiterated that one of the company’s competitive strengths its ability to store inventory rather than cross-dock it.


Ok, so let me get this straight…


Toys-R-Us is asking for capital so we can bet on their ability to invest capital in remodels and inventory? Sound vaguely familiar to 13 years ago?  We’re talking toys, not diamonds! Aside from a Monopoly board and diapers, this stuff depreciates rather quickly.  Oh and by the way, the only category in retail that has greater exposure to China from a sourcing standpoint is Toys (over 90%).  So with an appreciating Yuan v. $, either a) the brand eats the cost increase, or b) the retailer eats it, or c) the consumer pays more. Mark my words, consumers will not pay a penny more for a Barbie. Brands and retailers will start beating each other up again.





- As a reminder that Williams Sonoma is one of the forward thinking retailers when it comes to e-commerce, the company reiterated its commitment to spending 20% of its marketing budget (up from 6%) this year on digital. Additionally, the company noted that the bulk of future capex will be centered on technology and ecommerce infrastructure as the core brands are less likely to see major square footage growth from here.


- Yet another chapter in the American Apparel hiring policy saga is unfolding. This time the company has added disclaimers to new hire packets which are aimed at enforcing a confidentiality agreement. According to the language in the document, employees could be penalized $1 million if they breach the agreement by speaking with unauthorized parties. Again, we reiterate that focusing on same store sales and margins may be the best course of action for the company rather than spending so much time on building a retail police state.






China Returns to the Top of the Global Retail Development Index - China returned to the top spot for the first time in eight years while emerging markets in the Middle East and North Africa dominated consulting firm A.T. Kearney’s ninth annual Global Retail Development Index of markets seen as ripe for retail expansion. China, third in the 2009 study, leapfrogged over India, which fell to third from first, and Russia, down to 10th from second, in this year’s study, while Kuwait, not included in last year’s rankings, moved into the second spot. Following the study’s preparation, the floating of the yuan will mean the purchasing power of the Chinese consumer is really going to increase. If you’re sourcing there, prices are going to go up, but selling to the Chinese is going to become easier. The study measured global expansion opportunities in 30 markets based on 25 different criteria, including retail saturation levels, economic and political risk, retail market attractiveness and the spread between rising gross domestic product and retail growth. <wwd.com/business-news>

Hedgeye Retail’s Take:  Putting the list aside, China is pretty much the only market that domestic retailers are increasingly focused on.  Interestingly, recent discussions surrounding India’s loosening of its Foreign Direct Investment laws may soon boost that country’s attractiveness.  On the luxury side, expect Brazil to draw additional focus as many premium brands are looking to tap into the country’s growing pockets of wealth. 


R3: TRU Snowjob Begins - 1 


Labor Unrest Shuts 700 Apparel Factories in Bangladesh - About 700 garment factories in Bangladesh were shut Tuesday after days of violent protests by tens of thousands of workers demanding better wages. The news is likely to undermine confidence in the country's ability to replace China as a low-cost source for apparel and footwear production. On a separate note, Bangladesh is now targeting $400mm RMG exports to Latin American countries over the next 3 years. <sportsonesource.com>

Hedgeye Retail’s Take:  Believe it or not, Bangladesh is the 4th largest exporter of apparel to the US, with just over 7% of our goods cting from this country.  Despite any disruption to the supply chain that may result from a prolonged protest, it appears that this is yet another case where higher wages are likely to lead to higher prices. 


UK Retail Sales Remain Negative in June - UK retail sales remained in negative territory in June but retailers expected a return to sales growth in July, according to the Confederation of British Industry's May survey. Retailers saw a balance of -5 on the sales volume balance - up from -18 in the May survey and better than the expected balance of -15 seen last month. The expected sales volume of balance for July is +11. If sales growth does turn positive in July this would be the fourth positive outturn in 2010. The CBI results have been volatile recently. The CBI said retailers are more optimistic about prospects for sales in July in part becuase of the impact of the World Cup.  The CBI said High Street sales weakened slightly, particularly in footwear and leather goods, with grocers and durable household goods seeing solid growth. <automatedtrader.net>

Hedgeye Retail’s Take:  Will consumers really return to the stores if their team doesn’t make it into the elimination round? 


Travel and Tourism Spending Rose in Q1, But Still Below Pre-Recession Levels - Real spending on travel and tourism rebounded in the first quarter, but remains far below pre-recession peak at levels last seen in early 2005, the federal government reported. Retail spending by tourists rose 4.1% over the fourth quarter, while spending on recreation and entertainment rose 3.1%, According to the Department of Commerce’s Bureau of Economic Analysis. <sportsonesource.com>

Hedgeye Retail’s Take:  Good news for the retailers with a high concentration in tourist areas.  However, recent currency moves are more than likely to keep the spigot of tourists flowing freely. 


Macy's Reassigned Top Merchant Jeff Kantor as President of Online Merchandising - Macy’s Inc.’s Web sites — macys.com and bloomingdales.com — exceeded $1 billion in sales last year, but the corporation wants much more. Macy’s is developing a strategy to speed growth of its e-commerce businesses with Jeff Kantor to become president of merchandising at macys.com, effective Aug. 1. Mobile marketing is another big opportunity. Macy’s has an iPhone app that drives sales, and the retailer will this fall test ShopKick, a start-up retail mobile program, to reward customers who visit Macy’s stores. <wwd.com/business-news>

Hedgeye Retail’s Take:  With essentially no square footage growth opportunities, it’s not surprising that Macy’s continues to focus on e-commerce as a profitable growth engine.  With that said, the challenge of creating a seamless online/offline brand experience persists as the high level of promotional activity and high SKU count makes a department store site difficult to execute.


Men's Fashion Slowly Improving - In a season of anniversaries, Italian men’s wear designers continued to reference their archives while simultaneously moving fashion forward. “The best shows were the ones where designers started innovating again,” said Richard Johnson, men’s wear buying manager for Harvey Nichols. “Past seasons have focused so much on heritage, but this season, the best shows experimented with color, fabric and form.” Overall, the mood was upbeat. Buyers said they were working with budgets that had increased in the single digits, adding more chic sportswear to their offerings. <wwd.com/retail-news>

Hedgeye Retail’s Take:  Sounds like a bit of risk taking is coming back into men’s fashion.  All in, men are never going to move the fashion needle when it comes to sales but it is refreshing to see experimentation begin to accelerate.  Newness is key…


HOTT Goes International to Canada - California-based mall retailer Hot Topic is readying its first international brick-and-mortar push with two store openings in Toronto this August. The apparel and accessories retailer currently operates 681 stores in the U.S., as well as a website for overseas customers.  <licensemag.com>

Hedgeye Retail’s Take:  Yet another retailer heading to Canada in the past few weeks.  Zumiez, Target, and Kohls all make the list of Canadian bound retailers we’ve pointed out recently.


Amazon Looks for Upscale Fashion Push - Amazon is reportedly hiring new developers and graphic designers with high-end fashion backgrounds as part of a more upscale approach to selling apparel and footwear. <sportsonesource.com/news>

Hedgeye Retail’s Take:  We suspected this was the next logical move for AMZN after its purchase of Zappos.  There is no reason why better merchandising mixed with AMZN’s solid customer service and logistics can’t help boost the company’s sales in higher-margin apparel and footwear.


Borders Joins the E-reader Price War - After yesterday’s opening volleys by Barnes & Noble Inc. and Amazon.com Inc. in an e-reader price war, Borders joined the fray by offering a $20 gift card with its $149 Kobo e-reader. <internetretailer.com>

Hedgeye Retail’s Take:  Borders still struggling to keep up, this time waiting a day to throw a gift card into the mix.  This move is yet another in a long history of being a follower in the bookselling space.  Recall that BGP opened its superstores after BKS invented the concept and it launched e-commerce late relative to AMZN and BKS.


Sears To Offer Video Streaming - Sears.com and Kmart.com are joining the increasingly crowded video streaming space that includes Best Buy Co.. Apple Inc., Wal-Mart Stores Inc., Amazon.com Inc., Netflix Inc. and Blockbuster Inc. <internetretailer.com>

Hedgeye Retail’s Take:  We’re still waiting for the re-launch of Wal-Mart’s Vudu to see how a retailer may embrace a revenue opportunity derived from content streaming.  At least in the case of WMT, they own the technology platform designed to deliver the goods.  History suggests you need to not only deliver the content but develop an easy and elegant platform for which to deliver it.  This is something that retailers a) don’t want to spend the money on to develop, and b) really don’t have the expertise to achieve.


Brooks Sports Appoints Director or Apparel Merchandising - Brooks Sports, Inc. added Kurt Heimbach to its management team as director of apparel merchandising. Prior to joining Brooks, Heimbach served as the global apparel director for men's and women's running, tennis, and basketball at Reebok International Ltd. <sportsonesource.com/news>

Hedgeye Retail’s Take:  We suspect the recent boost in the technical running space is fueling a pick-up in apparel related efforts.  While Brooks is primarily known for its quality running shoes, the company’s apparel program is small relative to the overall business.  With some wind at their back, it’s clearly time to pick up their efforts in this high margin category.




The Macau Metro Monitor, June 23rd, 2010


ADELSON COMMENTS Asia One News, Reuters, Bloomberg, Channel News Asia, SCMP, macaubusiness.com


  • MBS could generate +$1 billion a year in EBITDA.
  • Expects between 125,000 to 150,000 daily visitors to MBS once the casino is fully open by 2011. On average, there are 25,000 MBS visitors daily.
  • MBS will primarily target customers from Singapore, Malaysia and Indonesia, with an eye on other Southeast Asian countries like Thailand and Vietnam.
  • Company officials said MBS received 500,000 visitors this month. (~550,000 people visited MBS in the first 25 days of May).

On Macau:

  • “Macau is serving Hong Kong, Taiwan and southeast China... They are two different markets and they appeal to two different constituencies.”
  • The Venetian Macao gets about 40,000 visitors to its shopping malls during the week and about 65,000 on weekends.

Other comments:

  • Gaming in Las Vegas should return to pre-crisis levels within two years.  "Gaming activity in Las Vegas will return to “+80%” of pre-crisis levels in 2011 and “probably about 100% in 2012.”
  • "I am really keen on setting up an integrated resort experience on the lines of the Las Vegas strip in India, anywhere Mumbai, Chennai, Bangalore or Delhi. But the government is sadly not keen.”
  • Expressed interest in building Las Vegas-style casino strips in Greece, Italy, and Spain.
  • “I believe we can put the equivalent of five plus Las Vegases, with 140,000 hotel rooms each in five different locations in Asia, and it still won’t saturate the demand"--referring to Asians' propensity to gamble.
  • Expects 90% of LVS's revenue to come from Asia by 2020. (Asia accounted for 73% in 2009).


 “Regarding the hotel [Four Seasons], the case will be carried out according to the law and the Government’s policies,” secretary for Transport and Public Works Lau Si Io yesterday told reporters.  Secretary Lau has stressed that the apartment-hotel is not a housing complex and is subject to regulations similar to those of hotels.


 Total visitor arrivals surged by 31.8% YoY to 2,098,267.  Visitors from Mainland China soared by 43.5% YoY to 1,135,430 (54.1% of total visitor arrivals), with 450,037 traveling to Macao under the Individual Visit Scheme (42.4% YoY). Visitors from Hong Kong (589,644); Taiwan, China (103,862) and Japan (36,778) rose by 20.5%, 6.0% and 39.5% respectively; visitors from India (25,631) and the Republic of Korea (25,341) also registered remarkable increases.



Singapore's consumer prices climbed 3.2% on-year to a 14-month high in May.  CPI rose 0.6% MoM.

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For the second day in a row the USA was one of the worst performing markets in the world.  The worst performing market was Luxembourg, which was down 2.8%, as compared to the Russell 2000 down 2.1% and the S&P 500 down 1.6%.  Volume on the NYSE was up 5% day-over-day, but remains at very low levels.  All of the major indexes closed around their worst levels for the session, with the S&P 500 back below its 200-day moving average.


All nine S&P 500 sectors declined yesterday and it was a nasty day for the Hedgeye S&P 500 Sector Risk Management model; four sectors broke their intermediate term TREND lines (XLY, XLP, XLI, and XLF) and there are currently no sectors positive on TREND. 


There are some key MACRO data points coming up in the next 10 days.  First, we have today’s FOMC meeting.  The FOMC is widely expected to leave the federal funds rate unchanged at 0-0.25% and reiterate its long-standing compromised policy that rates will remain exceptionally low for an extended period.  The FED’s policy statement will likely point to the recent weakness in inflation and the MACRO headwinds from Europe as the primary reason to keep rates low.  Second, there is a G-20 meeting this weekend and third, next Friday we have the release of June employment data.  Following that we kickoff Q2 earnings season.


In Washington the Obama administration is appearing more dysfunctional by the day and there continues to be lingering uncertainty surrounding some of the more onerous provisions in the financial reform legislation, which remain an overhang on sentiment.  Also hurting the Financials (XLF) and Consumer Discretionary (XLY) are the heightened concerns about a double-dip in housing following another round of weaker-than-expected May data.  Existing home sales fell 2.2% to a 5.66M unit annualized pace in May, well below the 6.2M consensus.


Of the four sectors that are broken on TRADE and TREND, two are consumer related - XLP and XLY.  Over the past week the XLY is down 4.9%, as compared to the S&P 500 down 1.8%.  Yesterday, for the fifth straight day, housing-related stocks finished lower, with the S&P Homebuilders index down 2.9%. In addition to the home builders, companies leverage to housing were notable decliners; USG (6.9%) and AWI (4.5%), LOW (3.3%) and HD (2.6%).  In addition, the S&P Retail Index (2%) finished lower for a fifth straight session, highlighting some concerns about a recent slowdown in discretionary spending.


Restaurant stocks were among the worst performers in the consumer discretionary sector today. Notable decliners included casual diners RT (5.4%), RRGB (5.1%), PFCB (4.4%), BWLD (3.6%) and TXRH (3.2%).  The underperformance was triggered on Monday after CPKI (2.4%), said that May-June comps fell considerable from the trends in Q1.  In the QSR space SONC declined (8.3%) also after posting some disappointing numbers. 


Treasuries rallied today with the weaker-than-expected housing data, an afternoon selloff in stocks and a strong two-year note auction.  The DXY rose by 0.2% yesterday and the Hedgeye Risk Management models have the following levels for the USD – Buy Trade (85.07) and Sell Trade (86.67).  The VIX moved higher for the second day in a row by 8.7%.  The Hedgeye Risk Management models have the following levels for the VIX – Buy Trade (23.56) and Sell Trade (31.92).


The Euro is starting to stabilize on the immediate term risk management model; 1.22 is an important support that needs to hold.  The Hedgeye Risk Management models have the following levels for the EURO – Buy Trade ($1.22) and Sell Trade ($1.24).


The best acting sector yesterday was Technology (XLK), down only 0.9%.  The outperformance was driven by AAPL +1.4%, as the company announced that it has shipped 3M iPad units in the 80 days since its early-April launch.


The Energy (XLE) sector was the worst performing sector yesterday, down 2.9%.  Both crude and natural gas declined yesterday; with natural gas down for a third straight day.  The E&P group was a notable decliner, with the EPX down 4.5% and the OSX declined 3.5%.  The group failed to garner any reprieve from news that a federal judge in New Orleans lifted the Obama administration's six-month moratorium on deepwater drilling.  The Hedgeye Risk Management models have the following levels for OIL – Buy Trade ($77.09) and Sell Trade ($79.54).


In early trading Copper is directionless, after yesterdays 1.7% move to the upside.  The Hedgeye Risk Management Quant models have the following levels for COPPER – Buy Trade (2.95) and Sell Trade (3.05).


The Hedgeye Risk Management models have the following levels for GOLD – Buy Trade (1,233) and Sell Trade (1,256).  


As we look at today’s set up for the S&P 500, the range is 42 points or 0.8% (1,087) downside and 3.1% (1,129) upside.  Equity futures are trading above fair value after an ugly day yesterday.  Today's highlight is the FOMC rate decision although no material change to the Fed's "extended period" language is expected.


Howard Penney













Rigorously Frugal

“I am for a government rigorously frugal and simple, applying all the possible savings of the public revenue to the discharge of the national debt; and not for a multiplication of officers and salaries merely to make partisans."

-Thomas Jefferson


In the spirit of searching for historical answers to the current problems in my head, I have started reading “Founding Brothers: The Revolutionary Generation” by Joseph J. Ellis. Suffice it to say, some of these common men rose up in the most American of ways – in a meritocracy.


American political history, like Washington and Wall Street storytelling, can be romantic. After all, for many, it’s all about twisting facts to fit a certain fiction that consensus can consume as believable. The reality of life seems to be that we never quite realize we are making history in the moment.


If Jefferson wasn’t partisan in his politics, John Adams wouldn’t have lost his marbles as many times as he did going off on Jefferson’s duplicity. Watch what people do, not what they say – we all have some form of partisanship in our lives. We are human. With that understood, it’s easier to consume the quotes of great leaders and storytellers at face value. The aforementioned Jefferson quote is brilliant when I consider it in the context of today’s conflicted professional politicians.


George Washington, John Adams, and Thomas Jefferson certainly had their political differences. Most men with a point of view do. One thing these “Founding Brothers” had in common, however, was their concept of frugality.


Per our friends at Wikipedia, frugality “is the practice of acquiring goods and services in a restrained manner, and resourcefully using already owned economic goods and services to achieve a longer term goal.”


You can tell stories about how frugal you may be but, within the context of our fore-fathers definition of the word, as an American society we have veered far from it. Being Rigorously Frugal is a solution that I’d like to put forth to this colossal American balance sheet mess. Everything starts with respecting the cost of capital and savings.


In the chart of the day, we’re showing the long term TAIL of the US Savings Rate going back to 1971 (when America was endowed with the world’s reserve currency). Today, US Savings are only 3.6% of GDP and, never mind “applying all the possible savings of the public to discharge the national debt”, our professional politicians get overly paid to perpetuate a levering up of our diminished savings!


As a reference point, Brazilian and Chinese savings as a percentage of GDP are approximately 4x and 10x America’s, respectively. Throughout the global economic downturn of 2008, neither of these countries fear-mongered their citizenry into believing that we were experiencing a “great depression.” Throughout the global economic upturn of 2009, both of these countries had the political spine to tighten monetary policy in the face of inflating prices.


Hopefully, you are already murmuring that China and Brazil are different than the US. From a growth perspective, they are – we get that. There is a huge difference between unlevered organic growth and levered deficit Spend-And-Hope growth.


Chinese savings (including corporate and household) have amassed to 49.5 TRILLION Yuan. Yes, that’s a lot of Yuan ($7.3 TRILLION US Dollars) – and guess what the wealth effect is for anyone bearing that Chinese Yuan is when China allows their currency to appreciate?


A large number of Americans living in the modern day Roman Empire of Fiat Fools don’t win here. If they aren’t Rigorously Frugal, that is. Gluttons of government sponsored over-consumption get taxed on anything we import from China or Brazil as the value of their respective economies and currencies appreciate. It doesn’t have to be this way, but until we change ourselves, the world will likely change us.


America is not alone in its addiction to cheap fiat moneys and over-consumption. The difference between America and the UK as of the past few months however is that the British are making the hard decisions that the “multiplication of officers and salaries” in the Officialdom of Washington aren’t willing to make.


Both Adams and Jefferson were more than half a decade dead by 1886 (they actually both died within 5 hours of one another), but that was the last time Britain had a Chancellor of The Exchequer as young as recently appointed George Osborne.


Osborne is my age and apparently agrees with my solution to this mess. This is what he had to say last night after he made cuts to healthcare spending, public salaries, housing subsidies, etc:


“I’m not going to hide hard choices from the British people… This is an emergency budget, so let me speak plainly about the emergency that we face.”


Maybe Osborne and newly elected PM, David Cameron, aren’t as Rigorously Frugal as implied by the 79% asset allocation to cash I moved us to on June 9th, 2010; certainly not as Rigorously Frugal as the 96% cash position I moved to on September 18th, 2008; but, directionally at least, frugality is as frugality does.


The beauty of having cash savings is that you can invest those hard earned moneys opportunistically. Since June 9th, the SP500 is +3.6% higher. I have been investing opportunistically. I have been picking my spots. This morning the cash allocation in the Hedgeye Asset Allocation Model is down to 61%.


I’ve always been conservative in my finances. I’ve never used leverage in running a fund. This doesn’t make me the Street’s favorite hedge fund manager, but it certainly keeps me alive. That’s all this Rigorously Frugal believer of what I think I will call a “Revolutionary Generation” 30 years from now has to say about that.


My immediate term support and resistance lines in the SP500 are now 1087 and 1129, respectively. Yesterday, on market weakness, we raised our asset allocation to International Equities from zero percent to 3% by buying a country that has a very respectful savings rate - Singapore (EWS).


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Rigorously Frugal - hilt


Darden is scheduled to report fiscal 4Q10 earnings after the close tomorrow.  Casual dining names, in general, have traded lower in response to CPKI’s revised calendar 2Q10 guidance issued yesterday.  CPKI provided the first real glimpse of May trends and it was not good.  CPKI announced that May same-store sales declined 7.9%, following a 2.7% decline in April.  For reference, CPKI was facing its easiest monthly comparison of the quarter in May so 2-year average trends decelerated rather significantly for the concept as well.   We have yet to hear how the industry as a whole fared in May as Malcolm Knapp will likely report industry data soon after Darden reports its quarterly numbers, but judging from CPKI’s May numbers, the Knapp May whisper-number of -1%, which implies flat 2-year average trends, seems aggressive. 


Darden widened its gap to Knapp performance during its fiscal 3Q10 and I would expect the company’s outperformance to continue in the fourth quarter.  Through April, the industry on average, as measured by Malcolm Knapp, improved about 100 bps sequentially on 2-year average basis from Darden’s fiscal 3Q10 timeframe.  May is obviously the big question mark for both Darden and the industry but my same-store sales estimates for Darden assume that 2-year average trends during 4Q10 held steady to improved slightly sequentially from 3Q10, excluding the estimated holiday and weather impacts, across all of the company’s concepts.  My -0.1% blended same-store sales estimate is slightly better than the street’s -0.4% estimate, reflecting my expectation for a stronger LongHorn performance (+2.0%) and slightly weaker Red Lobster number (-3.0%) relative to the street's estimates.  For reference, DRI guided to a -2.5% blended same-store sales number for the full year, implying -1% in the fourth quarter. 


Based largely on my slightly better than expected same-store sales estimate, I think the company’s earnings will come in at $0.90 per share, better than the street’s $0.88 per share estimate.  That being said, I expect both restaurant level and EBIT margins to decline about 40 bps YOY during the quarter as a result of sequentially more difficult comparisons; though EBIT margin should remain above 10% in the quarter.  It is important to remember that DRI reported a 10.8% EBIT margin in 3Q10 (excluding the $0.04 charge related to the company’s decision to adjust gift card redemption assumptions), a near peak margin, but management commented that it has “new targets for peaks at this point.”


Outside of May trends, investors will be most focused on what management has to say about FY11 guidance.  Darden provided its long-term EPS guidance of up 10% to 15% and said it was comfortable with this range on its last earnings call, but did not give a specific range for FY11.  It will be important to hear what the company says about its outlook for same-store sales growth and commodity costs.  The company’s long-term earnings guidance assumes +2% to +4% same-store sales growth which, depending on how the company fared in May and into June, could be a stretch as it assumes a continued improvement in 2-year average trends.


I am expecting there to be a lot of investor questions about the company’s food cost outlook in response to all of the media focus on the expected increase in seafood costs as a result of the oil spill in the Gulf of Mexico.  Just yesterday, it was reported that as a result of the oil spill, Red Lobster was removing oysters from its menu in a few weeks when the current supply runs out.  Although oysters only make up a small percentage of Red Lobster’s menu, potentially higher shrimp costs would have a greater impact on the concept’s margins.  This is not a concern for 4Q10 as the company is 100% locked in on all of its seafood costs for the quarter and guided to a mid-single digit decrease YOY.   As of February, however, the company was only locked in on 23% of its seafood costs through December 2010 or about halfway through fiscal 2011.  Seafood costs represent DRI’s largest ticket food item, accounting for 30% of total food costs. 


We will have to hear what Darden says on its earnings call on Thursday morning but, for now, I am comfortable with the company’s ability to grow EPS by at least 10% in FY11, within its long-term guided range of +10% to +15%.  The street is currently estimating 12% EPS growth.  I would not be surprised, however, if same-store sales fall slightly short of the 2% to 4% range. 


I continue to believe that DRI is one of the best positioned restaurant companies going forward and that return on incremental invested capital is moving higher in FY11.







Howard Penney

Managing Director


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