Hedgeye Break-In: Greek CDS At All Time Highs . . . Ignore At Your Peril

If you are wondering why European stock markets are down today, look no further than the chart below.  Greek credit default swaps are at their highest level ever.  And ever, as they say, is a long time.


As always, credit markets are leading indicators for equity markets.  The implication of this level in credit default swaps is that Greek debt is probably not worth the value that the European Central Bank is currently buying it at, which is at par.  The broader issue related to a Greek debt restructuring is the balance sheets of European banks that hold its debt.  As we noted on our Sovereign Debt Call in March . . .European debt is interconnected.  In fact, France, Germany, and Britain own the vast majority of Greek debt.


Aside from watching European CDS, we have also been very focused on European liquidity with a primary concern relating to the piling up of cash in the ECB deposit facility, a sign that banks are not lending.  As it relates to specific liquidity catalysts, July 1st should be a day of focus in Europe as that is the date the European Central Bank’s 12-month Long Term Refinancing Operation winds down.  Over the course of that 12-months, more than 440 billion euros of liquidity was added to credit markets.  Shortly, this will be in the rearview mirror, and with it the lows in the cost of capital in Europe.


Credit and liquidity issues in Europe are just beginning.


Daryl G. Jones

Managing Director


Hedgeye Break-In: Greek CDS At All Time Highs . . . Ignore At Your Peril - PIIIGS CDS

Bear Market: SP00 Risk Management Levels, Refreshed

From an intermediate term TREND perspective, this remains a bear market (1144 = TREND resistance in the chart below).


That said, all bull and bear markets get overbought/oversold on an immediate term TRADE basis. Its our risk management task to plant and prune our positions with overbought/oversold levels in mind.


We just covered our short position in the Dow (DIA) because we see any price in the SP500 at or below the immediate term TRADE line of 1077 as a good spot to cover some shorts. In other words, 1077 is the immediate term oversold line.


There is nothing about US economic growth expectations that we consider appropriately built into the powers that be of American consensus yet. That said, consensus meets reality over time where it matters – on the tape.


Give this bear market time. It finally has the bulls squirming.



Keith R. McCullough
Chief Executive Officer


Bear Market: SP00 Risk Management Levels, Refreshed - S P


Street account just reported that WEN is “is trading higher in reaction to a rumor circulating that Nelson Peltz, with the board, is considering a cash bid of $8/share for WEN.” 


On May 19, we published our sum of the parts analysis on WEN and came up with an estimated value per share of $7.81.  Please refer to the table below to see how we got there.  For reference, this sum of the parts analysis assumes continued margin expansion at Wendy’s in FY10 (though not to the same magnitude as we saw in 2009) and continued margin erosion at Arby’s. 


WEN – RUMOR MILL - wen sotp



Howard Penney

Managing Director



Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.


Going into the quarter, we said investors would be most focused on the read-through to current industry trends and on DRI’s outlook for seafood costs.


Management’s industry comments:  Industry same-store sales dynamics continued to improve during the quarter with guest counts -3.2% and average check +1.8% (first time positive in fiscal 2010).  Guest counts improved 90 bps sequentially from the prior quarter and average check improved 190 bps.  “Stepping back even further, same restaurant guest counts and sales during the fourth quarter marked the best industry performance in roughly two and a half years since the first quarter of our fiscal 2008.”


The higher average check is evidence of the reduction in deep discounting.  The current cost environment will not afford companies the ability to discount to the same extent as in prior quarters; promoting effective price points is still important.  Industry trends should continue to improve; though not too dramatically.


Despite Darden’s somewhat favorable industry outlook, investors don’t seem convinced.  What we know for sure today is that Darden’s trends slowed during the quarter, and for the most part, two-year average trends decelerated further in May.

Seafood cost comments:  The company sources some of its seafood from the Gulf, but all seafood, with the exception of oysters, is sourced from areas not yet affected.  The large majority of the company’s seafood is sourced globally and they are not yet seeing and don’t expect to experience big changes in availability and costs. 


Management expects seafood costs (30% of total food and beverage costs) to move slightly higher in fiscal 2011 due to increasing global demand.  DRI is covered on its shrimp (its highest volume item) and crab usage needs through 4Q11 at prices that are in line with FY10.  The company is contracted on lobster through calendar 2010 at favorable prices, but expects these prices to move higher in calendar 2011.


Total food and beverage costs are expected to be favorable in the first half of the year, but should level out in 2H11.  Specifically, management stated, “Our supply chain related cost savings initiatives and relatively stable commodity prices should contribute to lower food and beverage expenses as a percentage of sales.  We have many of our products contracted to the end of calendar 2010, which I will discuss in detail shortly here.  So we have about six months of full visibility on our costs.  There is less visibility beyond calendar 2010 in part because really we believe some commodities will continue to experience cost erosion as supply exceeds demand and we want to be in a position to benefit from that decline.”


Additional FY11 Guidance:  Management stated that the 2%-3% same-store sales guidance is expected to be driven by a 2% price increase, with traffic and mix contributing positively for the year.  As I said earlier, this guidance seems aggressive, given the slowdown in 4Q10 trends, as it implies continued improvement in 2-year average trends.

Darden expects the industry to continue to improve gradually with same-store sales coming in -1% for the year.  To that end, management is expecting its relative outperformance to widen to closer to 3.5% from 2.5% in FY10.  Darden’s outperformance, however, narrowed during the fourth quarter to 0.5% from closer to 5% in the prior quarter.  Darden attributed its weaker than expected same-store sales growth during the fourth quarter to promotional weakness at both Olive Garden and Red Lobster during April; trends were better than expected at LongHorn. 


The company expects to buy back $300 to $350 million in shares in FY11 versus $85 million in FY10.


Notes from the earnings call:



  • 13 wk vs 13 wk, sales would have been up 1% year-over-year
  • Knapp ex-Darden same-store sales were down ~1.4% for the quarter
  • Recognized a $12.7m reduction to revenue in gift card breakage
    • Non cash charge
    • Recognized across all brands
    • Not reflected in sss results


  • Comparing margins on a 13 wk vs 14 wk basis
  • Food and beverage expenses were 81 bps lower than last year
    • Benefitted from declining commodity costs in 2H
    • The sales deleverage created by the gift card correction adversely affected food and beverage expenses by 20 bps
  • Restaurant and labor expenses were 47 bps higher than last year
    • Wage inflation
    • The sales deleverage created by the gift card correction adversely affected labor expenses by 22 bps
    • The sales deleverage create bid the gift card correction adversely affected restaurant expenses by 10 basis points.
    • The sales deleverage created by the extra fiscal week in the prior year adversely affected restaurant expenses by 35 bps.
  • D&A expenses in the quarter were 41 bps higher year-over-year
    • The sales deleverage created by the extra fiscal week in the prior year and the gift card correction adversely affected depreciation expense by 25 basis points.
  • SG&A expenses were 24 bps lower as a percentage of sales



The effective tax rate for the fourth quarter was 26.2% and the annual effective tax rate was 25.1%.

DRI repurchased $85 million of company shares for the year and $1.19 billion over the past five years.  8.3 million shares remaining in repurchase authorization.  Consistently generating strong cash flows.  Annual dividend is $1.28 per share, an annual increase of 28%.



  • OG same-store sales were down 0.8%, 60 bps above KNAPP track.
  • OG softness was promotion-related (lapping last year).  Once promotion started in mid-May, sales improved significantly


  • RL same-store sales declined 1.7%
  • 30 bps below KNAPP track.
  • Comping a difficult period
  • Lent started earlier this year than last year
    • Negatively impacted sales results compared with prior year
    • Impact to April was greater than had been assumed


  • 2.3% growth, exceeding KNAPP by nearly 4%
  • Industry outperformance accelerated in May


The three concepts, blended, still outperformed the industry in 4Q.

FY11 Priorities

  • Continuing to build strong brands
  • Brand support platform to further enhance margins and sales
  • Red Lobster accelerating Bar Harbor remodels from 50 units last year to 100 in the current year

Oil Spill

  • RL sources from the gulf, but none from areas that have been affected
  • Source seafood globally
  • Don’t expect a meaningful adverse impact


  • Sharper brand definition, advertising, promotions have led to success
  • Adding more cravable items to menu in 2011
  • Continuing remodels of ranch house units
  • Opening 20-25 new restaurants this year

Three core projects:

  • The automation of the supply chain
  • The centralization of our facilities maintenance support
  • The adoption of more sustainable in restaurant operating practices related to energy, water, and cleaning supplies
    • All on track to meet or exceed the cost reduction targets we have discussed with you in the past.  Combined, anticipating $10 to $15 million of incremental savings from these projects during fiscal

Capital Grille

  • Outperformed peers with 6.9% same store sales growth
  • New software will allow teams to recognize the most loyal and frequent customers
  • Opening 4 new units in FY11, including first two locations in Southern California

Bahama Breeze

  • Outperformed KNAPP by 230 bps with same-store sales of 0.9%
  • Bahama Breeze will open one unit in FY11 and four in FY12

Season’s 52

  • AUVs for 2010 was $5.9m
  • SSS were -0.2%


  • Outlook based on SSS in three main concepts of 2-3%
    • Traffic  and mix positive
    • 2% pricing
  • 70-75 restaurants
    • 4% unit growth
    • 3.5% operating weeks growth
  • Sales increase will be 5.5% to 6%
  • Capex will be 475m to 525m vs 432m in 2010
  • Operating profit margins will be 70 bps to 100 bps expansion
    • Benefit s from food and beverage in 1H, leveling out in 2H
  • Others (SG&A, D&A) will be relatively unchanged
  • 6 months of visibility in costs
    • Believe some commodities will continue to decline
  • Seafood slightly higher than 2010 in 2011
    • 30% of food and beverage costs
    • Coverage thru 4Q 2011 for shrimp and crab
    • Lobster covered through calendar 2010
  • Beef prices are lower and DRI have extended coverage to January 2011
  • Chicken, poultry prices are higher year-over-year
    • Contracted through December 2010
  • Energy costs expected to be lower year-over-year
  • Labor costs will decrease due to sales leveraging
  • Restaurant expenses will be flat due to cost saving initiatives and sales leverage
  • Tax rate for the year should be ~27%
  • Paying out 180m in dividends
  • Expect 300m to 350m of stock repurchase in FY11 vs 85m in FY10




Q:  On the outlook for the comps for fiscal 2011, what is giving you the confidence that you can reach that 2 to 3% goal? If you could put that in the context of what you have been seeing in recent months and how much improvement might be needed to get to that number? 

A:  Improving underlying industry trend is the first pillar there.    DRI started at -8% in 1QFY10, roughly -6% in 2QFY10 and 4% in 3QFY10.  DRI has seen an improving trend through the year.  Next year the discounting environment will not be maintained as much by low costs.


Q:  What was the underlying May comp adjusted for the fiscal calendar? June comps?

A:  We continue to look at the fiscal week basis, because that best explains our fiscal reported results, so that's why we use those. 


Q:  Could you elaborate a little bit on the charge that was taken in the period.  In Q3 was there a large breakage gain, and then that was adjusted? 

A: The charge relates to the breakage that we're seeing in the gift cards.  We have seen a dramatic increase in the redemption of those cards. ~60% of the adjustment we took in the fourth quarter relates to cards that are three to ten years old.  


Q:  On Red Lobster performance.  Any change in consumer behavior related to Gulf oil spill or are they just working through that?

A:  No meaningful change in consumer behavior other than us not selling oysters.


Q:  Red Lobster price point strategy?  Do you think that you found the right mix of price point/quality promotions? 

A:  The foundation of Red Lobster's promotional strategy as it relates to price points is to provide price certainty, is to provide a sense of affordability, and we did two this year in the second half, and they were in the 12 to $15 range.  


Q:  EPS growth outlook for fiscal '11, 1H vs 2H, you have pretty easy comparisons in the first half, and on a comps perspective the 2 or 3% comps target, is there a progression that we should assume throughout the year given the difference in comparisons on a quarter basis?

A:  For the coming year, there is a little progression from quarter to quarter, although not dramatic when you look at prior year comp.  More of a skew on the earnings to the back part of the year, particularly as you look at wrapping over the gift card charges that we mentioned earlier


Q:  On promotional weakness at Red Lobster and Olive Garden in the quarter, do you expect to be more aggressive around price point advertising next year?  Marketing expenditures overall next year?

A:  Don’t want to enter into too detailed a discussion.  In terms of investment in marketing, the biggest thing to note would be an increase in media support for LongHorn.


Q:  On the commodity outlook, at the analyst day you gave specific numbers in terms of the inflation targets for fiscal '11. Can you update us on that number and how it may look in the first half versus the second half?  And clarify your shrimp comments; you said you were locked on prices through the end of fiscal '11?

A:  Yes, we are locked on our prices on shrimp through basically the end of our fiscal 2011.  Not a whole lot has changed from those planning assumptions from the analyst day.  Overall inflation rate on cost basket of about 1.5% - the food portion of that being about a quarter of a percent to a half a percent, so a fairly modest cost environment there.  No dramatic first half to back half of the year differential.


Q:  Are you seeing food costs impacting the promotional environment, or is that something you expect to develop as inflation starts to flatten out later in the year?

A:  We’re seeing industry data showing a decrease in check reduction.  Price points being offered in promotions recently are not showing discounts as deep as before.


Q:  With your FY11 comps being the 2% to 3% versus group assumption of -1%, is there a bifurcation between the haves and have-nots especially in light of the CPK announcement?

A:  Some of the folks who have outperformed will continue to outperform because they have been disciplined.


Q:  Do you believe you have the appropriate rate of investment now for the remodels at Red Lobster?  What is the expected lift to same store sales from the remodel?

A:  Very confident about the remodel investment at Red Lobster and it is driving positive same restaurant sales I think in the 5% range. 


Q :  The state of the consumer with all of the events over recent weeks?

A:  I would say that the sales are very bumpy from week to week.  It reflects sentiment and there is a lack of confidence.


Q:  On advertising for LongHorn.  Is most of the ramp in that advertising going to be product specific, or will some of it be positioning the brand? 

A:  Needs to do both.  It needs to establish LongHorn as a great steakhouse.


Q:  What has changed with the high end brands like capital grille?  Are sales less bumpy?

A:  The biggest change has been the return of the business travel and entertainment spending.  We have seen our business improve Monday through Thursday greater than on the weekend. 


Q:  Guidance for the interest expense for this year?

A: Flat year-over-year


Q:  With the potential disruption in oyster supplies from the Gulf, what % of your menu would that affect or what percent of your mix would that affect?

A:  Less than two-tenths of a percent.


 Q:  On plans to pay off or refinance the $150 million note that matures in August.  Is some of the cash on the balance sheet earmarked for that?

A:  You're correct.  We ended the fiscal year with a strong cash balance and are planning to pay that off.


Q:  How do the brands do against their own segments, most importantly for LongHorn?  Is steak improving versus other segments in general, or is LongHorn even improving against steak? 

A:  The biggest competitor in steak is obviously outback, less visibility on same restaurant sales reresults at outlook, so difficult to answer that question.  It’s important to remember that it's a variety seeking category, and while steak is a category is competitive, people are moving between the brands throughout the year.


Q:  Service programs at Red Lobster and Capital Grille.  Can you talk about the adjustment at capital grill and also any adjustments to the Red Lobster service initiative given the Gulf situation?

A:  For Capital Grille, it’s about communication.  We're enabling technology to reach out to them and confirm the reservation.  Those are the types of things that we're working on.  At Olive Garden we’re trying to do a better job of quoting wait times and at Red Lobster it’s about tailoring service for guests.


Howard Penney

Managing Director



The Macau Metro Monitor, June 24th, 2010



CEO Lawrence Ho reiterated his focus on the Macau market, in particular CoD and investment opportunities in Macau.  Stressing management efficiency can increase profitability, even with fewer tables, Ho supports the government's decision to cap gaming tables. Melco currently has 100 tables less than it initially did. 



The rate of increase in housing prices in Singapore slowed down in 2Q 2010, according to property consultancy firm DTZ.  DTZ attributes this to high asking prices and poor stock market performance.  The only exception was in the mass market segment where prices of secondary condominiums and apartments went up further compared to the previous quarter.  DTZ said the comparatively higher prices of new developments and aggressive bids for government land sales (GLS) sites in the suburban areas had a cumulative effect on raising the prices of homes in the secondary market.

Ms Chua Chor Hoon, Head of DTZ South-east Asia Research, noted that developers are likely to tone down their land bids in view of the unprecedented high number of suburban sites to be sold in the GLS in the second half. She said this will keep a check on prices of mass market homes going forward.


Jobless Claims Better Week Over Week, But Remain at a Level Inconsistent with Material Improvement

Initial claims fell week over week by 19k after upwardly revising the prior week by 4k, suggesting the actual improvement was 15k. More important to us is that the level of jobless claims - 457k - remains right in line with its trend year-to-date in the 450k-460k range. As a reminder, this level is too high for unemployment to materially improve. The level would need to be in the 375k-400k range by our estimates for unemployment to make real headway in the right direction. On a rolling basis, claims fell by 1.5k to 463k from 464.5k last week. On the margin, this morning's data is slightly positive, but it's only a small step in the right direction so we'll reserve our enthusiasm for the time being.




Below we chart the raw claims data. 




In the table below, we show the correlations of initial claims to U.S. equities. Consumer Discretionary (XLY) and Consumer Staples (XLP) have the highest inverse correlation on a one-year basis (r-squared = 0.76 and 0.75, respectively). Surprisingly, the Financials have the second lowest inverse correlation to initial claims on a one-year basis (r-squared = 0.40).




As a reminder, May was the peak month of Census hiring, and it should now be a headwind to jobs from here as the Census winds down.




Joshua Steiner, CFA


Allison Kaptur

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