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DRI reported fiscal 4Q10 EPS of $0.86, or $0.87 when you exclude the $2 million pre-tax asset impairment charge, below both the street’s $0.88 per share estimate and my $0.90 per share estimate.  Relative to my estimates, the shortfall was largely due to lower same-store sales growth and higher SG&A and interest expenses. 


On a same-store sales basis, I was expecting sequential two-year average trends to hold steady to get slightly better in the fourth quarter, but instead, trends at the three major brands slowed when you adjust for all of the reported holiday and weather impacts in 3Q10.  Although Red Lobster’s trends looked the worst on a one-year basis (-4.6%), Olive Garden’s -1.5% result implies the biggest sequential falloff in two-year numbers.  On a positive note, comparable sales growth at both Capital Grill and Bahama Breeze came in better than I was expecting with 2-year average trends getting significantly better since the prior quarter.


Looking at monthly trends during the quarter for Red Lobster, Olive Garden and LongHorn, April appeared to be the roughest month on a one-year basis, but two-year trends slowed the most in May for both Red Lobster and Olive Garden (as shown in the charts below).


Even with the 2.3% decline in blended same-store sales growth, which fell short of management’s implied -1% guidance, EBIT margin continues to be strong at 10.5% (flat with last year), before the $12.7 million pre-tax reduction in sales related to gift card redemptions and the $2 million pre-tax asset impairment charge.  Margins have benefited from lower YOY food and beverage costs as a percentage of sales for the last six quarters, and with seafood costs potentially moving higher, this line item may prove to be a headwind in FY11.  As of February, 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.


Despite the slowdown in trends, Darden guided to 2% to 3% blended same-store growth in FY11.  Going into the quarter, I said this level of growth could be a stretch because it implies continued improvement in two-year trends.  Seeing that the company’s two-year average same-store sales growth already slowed during the fiscal fourth quarter with trends, for the most part, decelerating more in May , this full-year guidance seems aggressive. 


Although Darden’s same-store sales outperformance narrowed during the fourth quarter relative to the Knapp-Track benchmark to 0.5% from nearly 5% in the prior quarter, I continue to believe that Darden is one of the best positioned companies to navigate through this difficult economic period.  To that end, the company proved its financial strength by raising its annual dividend by 28% and buying back nearly $70 million in shares during the fourth quarter.


DRI – FIRST LOOK - RL May 2010


DRI – FIRST LOOK - OG May 2010


DRI – FIRST LOOK - LH May 2010


Howard Penney

Managing Director


Squirming Bulls

“When you’re finished changing, you’re finished.”

-Benjamin Franklin


My citing a Thomas Jefferson quote yesterday certainly stirred the pot. I haven’t had that many responses to an Early Look note since I took the other side of Barton Biggs (on May 27, 2010 after Biggs suggested that the Thunder Bay Bear was going to “squirm”). I appreciate all the feedback.


After getting plugged chasing a made for Manic TV CNBC “China” rally on Monday morning, and then seeing the SP500 close down for 3 consecutive days, the bulls are the ones doing the squirming now. The US stock market hasn’t had 3 consecutive up days since April.


Jefferson, like most politicians, was a professional storyteller, prone to hypocrisy, and subject to squirming. We know that markets don’t lie; politicians do. What we don’t know is why the Modern Day Roman Empire that is America’s financial system continues to believe that the rest of the world isn’t watching?


From a financial forecasting perspective, the Fiat Fools in Washington have proven that they are finished changing. So, in this brave new political era where the President of the United States is telling stories about “holding people accountable”, we’re going to tag along Benjamin Franklin’s aforementioned quote and assume the current US monetary policy experiment is “finished.”


Sadly, in what has become a proactively predictable statement of politically conflicted US Federal Reserve policy, in yesterday’s FOMC statement Ben Bernanke opted to pander to the political wind that has amplified both the volatility of markets and the cyclicality of growth since he took his lead from Alan Greenspan.


Our advice yesterday (for the US government to become Rigorously Frugal) was born out of the respect we have for both the cost and access to capital. Promising a “risk free” rate of return of ZERO percent to both domestic and foreign investors will not inspire investment. We live in an interconnected world where capital seeks yield. Ask the Brazilians and Chinese what they think about that…


Whatever you do, don’t ask Ben Bernanke and his Troubadour of the Willfully Blind at the Federal Reserve for an economic forecast. If he didn’t see economic growth and inflation in the last 12 months he’s definitely not going to see it now. Like a broken clock, he’ll eventually get it right – the double dip we are forecasting for both the US economy and US housing will be here come Q4. By then, Bernanke will be formally cutting his economic forecasts.


As a reminder, Bernanke’s forecasts on US economic growth are about as far out in the stratosphere of nod as we have seen in some time. That said, given his outlook, he should have the Fed Funds Rate at least 100 basis points higher than where it stands today (he is looking for upwards of 4% GDP growth in the US in 2011). So it’s time he either raises rates in line with his forecast or just takes a chainsaw to his forecasts.


Let’s think about those two options for a second:


1. Raising Rates – since he couldn’t raise them when he should have, now he won’t be able to cut them when he needs to. The yield on 2-year US Treasuries is hitting all time lows this morning of 0.64%. If one of the brave economists in Washington wants to tell me a story about how the US Treasury market is forecasting anything other than a double dip, please send me an email.


2. Cutting Forecasts – since Bernanke’s forecasts are turning into THE lagging global economic indicator, it is very probable that he cuts his economic forecasts in the coming quarters. By the time he does that, most of the Squirming Bulls are going to be looking back in the rear-view mirror at a US “growth and earnings” story that slowed (most recent sales updates from BBY, TOL, FDX, BBBY, etc are on the tape – they weren’t good).


If you are finished learning, you’re definitely finished thinking. How does Heli-Ben think about the interconnectedness of global markets? Where does the most relevant mathematical consideration since relativity (chaos/complexity theory) fit within his forecasting model? Do real-time market moves register on his radar or is he still busy marking-his-estimates-to-the-broken-Greenspan-model?


Don’t ask Timmy Geithner for a bone on these answers either – he’ll be the first to tell you that he is “not an economist.” He’s simply a professional politician advising the President of the United States on global economic matters.


Since the Chinese signaled that they’ll continue to wear the pants in this Global Creditor/Debtor relationship earlier this week, we have seen the three pillars of US economic growth hopes crumble: Industrials, Financials, and Consumer Discretionary (XLI, XLF, and XLY are the ETFs).


After holding their breath barely below this bear market’s water for the last 3 weeks, these 3 critical sectors (XLI, XLF, and XLY) in our S&P Sector Risk Management Model have broken on both an immediate term TRADE and intermediate term TREND perspective. These are called leading indicators, Mr. Bernanke. If you want some help, please send us an email at .


Other than collapsing US bond yields and US stock prices, what other global macro leading indicators have us forecasting double dips in both US housing and US economic growth?

  1. Chinese equities are down -21.7% YTD and have closed down the last 2 days
  2. Dr. Copper (a proxy for Chinese demand and US Industrial growth) remains broken from a long term TAIL perspective
  3. European equities continue to sell off this morning after rallying to lower-long-term highs in the last 2 weeks

Now if you don’t believe in the interconnectivity of global markets, complexity theory, or that the US growth engine isn’t tied to both, you won’t believe any of my storytelling this morning. If you’re finished reading, you’re not finished figuring this out yet.


My immediate term support and resistance levels for the SP500 are now 1081 and 1105 respectively. I sold 1/2 of our position in TIPs in the Hedgeye Asset Allocation Model yesterday, taking our allocation to Bonds back down to 6% from 9%, because a negative growth outlook is deflationary, in theory. Our allocation to cash bumped back up to 64% from 61% day-over-day.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Squirming Bulls - Pic of the Day


The S&P 500 finished lower by 0.3% on a largely uneventful Wednesday.  Day-over-day not much has changed globally and the markets are settling into the current pattern of events.  In the US the FED remains conflicted and compromised, European sovereign debt issues are not going away (but part of the consensus thinking), and China is strong but slowing.  What is the next catalyst up or down?  We will be hosting our 3Q THEME call next Thursday, July 1st at 11am.


The market rallied slightly on the fact that the FED’s continued free money policy was a sign of strength, and the slightly more downbeat assessment of the US economic economy was nothing to worry about. The FOMC noted that the "economic recovery is proceeding," while its prior statement argued that "economic activity has continued to strengthen." In addition, it pointed out that "financial conditions have become less supportive of economic growth," after noting in late-April that "financial markets remain supportive of economic growth."


Europe is trading lower today, as a more pronounced shift towards fiscal tightening is gaining momentum ahead of the G-20 meeting, particularly with countries such as Germany, which announced a new austerity package in early June.  Germany is also coming under some pressure for not doing more to underpin domestic demand.


In the US the string of disappointing May housing data continued, as new home sales plunged 33% month-to-month to a 300,000 unit annualized pace, the lowest on record. In addition, new home sales for March and April both saw double-digit downward revisions; months' supply jumped to 8.5 in May from 5.8 in April.  After five days of underperforming, housing-related stocks bounced with the XHB +1.2%. 


The RISK trade failed to garner any meaningful momentum, as treasuries rallied again today.  The dollar index was down 0.42% and the Hedgeye Risk Management models have the following levels for the USD – Buy Trade (85.06) and Sell Trade (86.66).  The VIX traded flat on the day; the Hedgeye Risk Management models have the following levels for the VIX – Buy Trade (23.65) and Sell Trade (31.76).


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).


Leading the market lower yesterday was the Utilities (XLU -0.9%), Energy (XLE -0.8%) and Financials (XLF -0.4%), while the only two sectors up on the day were Materials (XLB +0.2%) and Consumer Staples (XLP +0.6%).  The XLP is now positive on TRADE, putting a total of six sectors positive on TRADE.


The energy sector was one of the worst performers again today, as energy commodities were weaker on the day.  Outside of natural gas, Copper and oil declined over 1% on the day.  August crude declined 1.9%, suffering its biggest one-day pullback in almost two weeks.  Crude stockpiles rose by just over 2M barrels to 365.1M last week, the highest level for the period since 1990. In addition, regulatory headwinds remained in focus with Interior Secretary Ken Salazar expected to reissue a deepwater drilling moratorium that was recently blocked by a federal judge in Louisiana. The Hedgeye Risk Management models have the following levels for OIL – Buy Trade (73.96) and Sell Trade (79.63).  


So far in 2010, copper is down 11%, but the recent weakness in the dollar is helping to provide some support.  The Hedgeye Risk Management Quant models have the following levels for COPPER – Buy Trade (2.87) and Sell Trade (3.05).


The Hedgeye Risk Management models have the following levels for GOLD – Buy Trade (1,216) and Sell Trade (1,256).  


As we look at today’s set up for the S&P 500, the range is 24 points or 1.0% (1,081) downside and 1.2% (1,105) upside.  Equity futures are trading below fair value following the weakness in Europe and Asia.  Today’s focus will be on a handful of company earnings reports and initial jobless claims and durable good numbers. 


Howard Penney













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NKE: A Lot To Chew On

Initially, this onion smells punk. But when you peel back a layer or two, you see that growth is coming from the right places, and the US is inflecting. Oh, and by the way, guidance is ridiculous.



About 16 hours ago, I was sitting in our conference room in New Haven telling Keith and the rest of our investment team that I’m well ahead of the consensus for Nike. Given that there’s enough levers here such that Nike can print almost anything it really wants, I said that the one number I would be genuinely disappointed to see is a single-digit revenue growth rate. I was at 11.4% vs. the Street at 8.9%. We saw 7.7% -- not good.


Yeah, futures looked good, both in absolute terms and the trajectory. Also, inventories were down 13% on top of 8% revenue and 7% futures growth (+10% futures in constant $). The balance sheet was like an impenetrable wall of iron.

Some people might like the penny beat. But let's face it... Nike ALWAYS beats and guidance was cloudy at best. I’m staying true to my earlier comment/concern on revenue. The good news is that many parts of guidance make absolutely no sense to this (self-proclaimed) rational thinker. Also, when diving into the top line, I’m seeing the composition look better than it might indicate at first blush.


Here are some key puts and takes (in no particular order)…

1)      On revenue growth: There are actually encouraging signs from key parts of the business.

  1. US: North America revenue operating margins and futures all accelerated. In fact, when we look at the math behind the 8% futures growth number, we know that apparel (25%) of total was up mid-teens, which suggests that footwear is up around 6%. Either Nike’s share gain in the US is accelerating materially, or the market (in product other than toning!) is beginning to accelerate. We’ll take either.
  2. The biggest disaster of the quarter was Western Europe. 2% revenue growth, and a 17% decline in EBIT. Perhaps I’m being harsh given that constant dollar futures accelerated from 0% to 7% to 11% over the past 3 quarters. But they gave it all back in FX (from 12% to 11% to -2%). Maybe the metaphor of Western Europe failing to show up at the World Cup is still fresh in my mind and I’m clouding the two. But with EBIT margins down in the qtr by 470bp, you can’t blame me.
  3. Central and Eastern Europe: Here’s some irony for you…but the same countries whose teams are surprising on the upside at the Cup are also doing the same on Nike’s P&L and order book. A coincidence with close to zero investment significance, I know. But humor me...
  4. China is crushing it. Teens revenue growth, with margins up 266bps ON TOP OF 923bps improvement last year. As we’ve noted, China is approaching a $2bn revenue organization for Nike. With a 15-20% growth rate, and less than 30% of its $10bn in COGS sourced in China, we’re approaching a point where a floating Yuan is a wash for Nike – which gives it a competitive leg up.
  5. Japan: The Japanese economy has done a whole lot of nothing for what -- 20 years? Nike’s business is doing much of the same. Seriously, I’m beginning to wonder why they even do business there.
  6. Emerging Markets: 46% EBIT growth and 30% futures??? They’re crushing it here.

The bottom line is that we’re seeing solid growth in the most important regions – such as China, Emerging Markets, Central/Eastern Europe, as well as an inflection point in the US. Results are being dinged by Western Europe and Japan. The former is particularly important, as we can’t flat out ignore it. But the US is 1.7x the size of Western Europe. If the US turn continues, which we think it will, then it could offset much of a Western Europe decline.


2)      Gross margin guidance. I was pretty surprised to hear the company note that full year gross margins should be off by 100bp this year. Actually, my surprise very quickly turned to doubt. Much of the rationale was chalked to FX. But let’s face two facts…

  1. As much as the $/Euro has been all over the map in recent weeks, the weighted average impact across all of Nike’s trade partners is quite benign over the next 4-quarters using prevailing FX rates. Check out the chart below. Prior quarters of major (-100bp+) GM erosion was the result of a -5%-7% FX hit. We’re not anywhere in that ballpark today.
  2. Another point is that the facts show that the company’s least reliable guidance metric has been gross margins – by a long shot. Check out the accountability grid below. It shows what they said vs. what they did. Not exactly predictable. Our strong view is that conservatism won over this time around due to global risk factors, and the fact that they’re just heading into their 1Q11 and want a hurdle that they can clear with their eyes closed.

NKE: A Lot To Chew On - nkefc


NIKE: YouTubing Gross Margin Guidance 

NKE: A Lot To Chew On - Nike Gross Margin Guidance Table


3)      Acquisitions. For the first time ever, I am baking acquisitions into my Nike model – which normally goes against what I stand for. But there are four reasons why…

  1. NKE’s cash and short term investments are topping $5bn, or $10.50ps.
  2. We continue to see decoupling between ROIC and ROE, and both management and the Board knows it, and does not like it.
  3. Bernanke pandered yet again yesterday – in effect keeping the return on Nike’s hard-earned cash close to zero. While I don’t think they’ll relax standards, even an ROIC dilutive acquisition would be better than 0%.
  4. The acquisition strategy will be focused on buying licenses of brands it already owns and controls – as hinted at the analyst meeting.  Converse outside of US/Canada is the best candidate. I’m assuming $500mm in acquisition capital spend by end of calendar year with a 10% yield. Then I’m assuming assuming $1.5 in repo and 25% growth rate in dividend.


4)      Non-op income: Here’s another change to the model. With lower revenue and gross profit from FX (even though I am haircutting vs. the co’s guidance) we need to take up non-operating income due to higher marked-to-market on FX hedges.


NKE: A Lot To Chew On - FX and Non Operating Income


5)     Check this out... There has been only one quarter in the history of Nike where the cash cycle (Days Recievable + Days Inventory less Days Payable) has been less than 90 days. This quarter it came in below 75. No joke...


When all is said and done, I’m at $4.55 for this year, and $5.45 for next. That’s a dime below my estimate heading into the quarter. Though I suspect that by the time the Street is finished hitting plug-n-play on their models, I’ll end up 10-15% ahead. 


As noted earlier today, one of my main concerns is any sort of ownership rotation this name goes through as there is a transfer of earnings from the gross profit line, to SG&A leverage and non-operating income as it relates to how the company manages risk in its business to keep plowing forward.


Yes, I’m disappointed by the revenue. The Street’s numbers will be all over the place based on the guidance. But quite frankly, I don’t know which one of those two I trust less. But there’s much to the components of the quarter that give me the confidence that Nike is executing on the core plan I think is necessary to create value for shareholders.


NKE: A Lot To Chew On - NKE SIGMA


MGM Macau is likely to see continued improvement under Grant Bowie but net IPO proceeds to MGM are still unlikely to reach the suggested $500m.





While MGM Macau is unlikely to ever produce the type of numbers we see at WYNN, we do believe that they can continue to fix the sins of the past and materially improve results at the property.  So what went wrong?


When MGM entered Macau, there was no shortage of hubris.  They embraced the build it and they will come approach.  With MGM’s gaming expertise and brand name, and Pansy’s knowledge of the market, it was a slam dunk, right?  Well, Pansy is not a casino operator and has no experience as a property manager, and MGM did not have a track record of operating successfully outside the US.  MGM brand recognition was indeed high, in the mid 90% range.  Unfortunately, it was the movie studio that was well recognized.  Not many people in Asia knew MGM as a great casino brand.  Oops.


Here are/were some of the problems:

  • Bad layout that appealed to a US player but not an Asian player
    • Fixed
  • No marketing or sales function at the property
    • Now they have a marketing team in place
  • Surrounded by construction
    • Ceased, now that Encore and One Central are open
  • Confusing logo
    • Recently rebranded to MGM Macau instead of MGM GRAND MACAU
  • Had no business plan and strategy
    • We’ll see whether improved performance is a result of market strength and/or Grant Bowie’s strategy
  • Too many FTE’s
    • Cut 1,000 FTE’s from August 2009-March 2010
  • Too much bureaucracy with the 50/50 structure
    • Still an issue
    • Investors will penalize the IPO multiple
  • Too conservative with whom they dealt and lent money
    • Becoming more aggressive in the way they manage their business but only extend credit to players with assets outside of China
    • Increasingly extending credit to junkets

There is no question MGM is benefiting from the incredible strength of the market.  Unfortunately, market share continues to languish after a push forward late last year.  However, margins are expanding and the increasing use of junket and direct play credit should boost share going forward. 




MGM Macau generated only $150 million in EBITDA in 2009.  However, with Grant Bowie’s changes and the strength of the market, we are projecting $240 million for 2010 and $279 million for 2011.  We think it is fair to base the IPO valuation on a range of $250-300 million.  Based on that level of EBITDA, we calculate the net cash proceeds to MGM of only $178-380 million after factoring in expected joint venture debt and the repayment of MGM’s intercompany receivable (~$100MM), which will get repaid before divvying up the IPO proceeds.   We assume 20-30% of joint venture is sold through the IPO. 




Some may argue for a higher multiple range but we think investors will severely punish the IPO valuation for the joint venture structure and a lack of control.  The valuation may be enhanced somewhat by a credible and well-articulated Cotai strategy but investors are unlikely to ascribe significant value to that part of the story given the huge amount of Cotai supply coming online and MGM’s dismal development track record. 


Based on our research and analysis we believe it is unlikely MGM generates the $500 million in net cash proceeds it is expecting.

Austerity's Rift: Europe vs USA

Position: Short France (EWQ)


Heading into the G20 this weekend there’s a noticeable rift between Europe and the USA vis-à-vis the issuance of austerity measures to address government budget deficits: many European countries are wearing the proverbial “accountability pants” to address fiscal imbalances while the Obama administration has yet to critically address the government’s excess spending and future obligations. Maybe that’s why Peter Orszag (Obama’s budget director) is leaving.


Yesterday, in an emergency budget speech, UK Chancellor of the Exchequer George Osborne outlined initial go-forward spending cuts and tax-generating measures (in a formula of roughly 80/20) to shave down the country’s budget deficit. Here are the main tenants of the budget:

  • 25% cut in the budgets of government departments starting April 2011 through 2015 (a spending review is expected for released in October)
  • Tax on banks with liabilities greater than £20 Billion (the tax is expected to generate approx. £2 Billion annually)
  • Increase to the Value Added Tax (VAT) from 17.5% to 20% starting January 2011
  • Increase in capital gains tax for higher tax bracket earners, to 28%. No change (18%) for low to middle income earner
  • A 2 year wage freeze for all but the lowest paid among Britain’s 6 million public servants and a 3 year freeze on benefits paid to parents for rearing children
  • Cuts to the housing benefit and disability allowance
  • Decrease in corporate taxes, staggered over 4 years from 28% to 24%

In his speech Osborne stressed that he is “not going to hide the hard choices from the British people”. Obviously managing growth while cutting spending will be a great challenge for the newly elected Cameron government. UK growth is currently estimated by the Treasury for +1.2% this year and +2.3% next year. Interestingly, the emphasis to lower corporate taxes is in direct response to the government’s fear that an unfavorable tax environment would drive corporations out of the UK.  


Noteworthy, following the budget announcement, Germany and France expressed their support for a bank tax. While we don’t expect any concrete policy to come from the G20 this weekend in Toronto, we do expect the talks to surround the UK’s fiscal tightening and the growing rift between Europe’s “action” and Washington’s “inaction” in shoring up budget imbalances. 


As Keith has affectionately stated: a country can kick the can of debt down the road for only so long.  Maybe America will take a hint from the Europeans.


Matthew Hedrick

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