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YUM – DELIVERING, BUT THE BAR WAS SET HIGH

U.S. and China in Nirvana.

 

YUM reported 2Q10 numbers that were much better than I was modeling from a profit standpoint, with the biggest upside to my estimates coming in the U.S.  Relative to my estimates, U.S. same-store sales were basically in line, a little better at Pizza Hut and KFC but a little light at Taco Bell.  In the U.S., there was more leverage than I was expecting across most of the P&L (particularly on the labor line).   In total, restaurant level margin increased 140 bps YOY.  The improved margin performance at KFC stands out as an anomaly given the 7% decline in same-store sales, although KFC’s two-year average same-store sales trends improved 350 bps sequentially from 1Q10.  Also, management commentary about “lower insurance expense” in the U.S. speaks to managing the P&L around a difficult sales environment.   

 

YUM’s stronger-than-expected results in the U.S. enabled the company to move out of what we call the “Deep Hole” (negative same-store sales and YOY decline in restaurant operating profit margin) earlier than I had anticipated.  I had expected this segment to begin to recover in the second half of the year as the company lapped easier comparisons, but as of 2Q10, the company is now straddling the line between “Life-line” (negative same-store sales and positive restaurant operating profit margin growth) and “Nirvana” (positive same-store sales and positive restaurant operating profit margin growth).

 

Going into the quarter, I also said that I would not be surprised if YUM fell short of its 5% operating profit goal in the U.S. but this 2Q10 upside makes this guidance more achievable, particularly as the company laps 4Q09’s 23% decline in operating profit.

 

YUM – DELIVERING, BUT THE BAR WAS SET HIGH - YUM US

 

Same-store sales in China were in line with expectations, implying a 300 bp deceleration in two-year average trends, but again, the bottom line came in slightly better than expected.  Restaurant level margin improved 170 bps as food costs as a percentage of sales were down 240 bps YOY, more than I had anticipated.  That being said, the company continues to expect to face labor and commodity inflation in the second half of the year.  Overall, as expected, China continued to operate in “Nirvana” during the second quarter, but will likely move into the “Trouble Brewing” quadrant (positive same-store sales and YOY decline in restaurant operating profit margin), and potentially, into the “Deep Hole”, during the back half of the year as the higher food and labor costs materialize.

 

YUM – DELIVERING, BUT THE BAR WAS SET HIGH - YUM CHINA sigma

 

YUM increased its FY10 EPS guidance to $2.43, from $2.39, but this guidance still falls short of the street’s $2.47 estimate.  YUM has a record of beating expectations but management will likely get a lot of questions tomorrow on its earnings call about whether this new guidance is conservative.

 

Howard Penney

Managing Director

 

 


The Deficit Still Looks Ugly, Normalize For Tarp And It Looks Uglier

Conclusion: While June was an improvement for the deficit due to timing related to Memorial Day, the year-to-date numbers remain concerning.  On the other hand, the appointment of Jack Lew to OMB Director is a marginal positive.

 

The U.S. government reported a smaller monthly budget in June versus June 2009 with a deficit of $68.4 billion versus $94.3 billion last June.  In the year-to-date, the budget deficit is $1 trillion versus $1.1 trillion over the same period in 2009.  On a year-to-date basis, the budget deficit as a percent of GDP is 9.2% versus 10.2% in the same period in 2010.  While this high level summary suggests marginal improvement, the underlying facts still suggest dire fiscal issues in the United States on a number of fronts.

 

First, the June improvement in deficit can be attributed primarily to timing of revenues.  Due to the Memorial Day, a large amount of tax revenue was pushed into June.  In aggregate for the year-to-date, overall revenues are only up 0.5%, with corporate income tax contributing all of this increase growing 33% y-o-y.  Personal income tax, on the other hand, is down -4.4% in the year-to-date.  So despite the “economic recovery”, tax receipts from individuals are still lagging on a year-over-year basis (jobless recovery sound familiar?).

 

Second, while reported outlays were $73 billion, or 3%, lower for the first three quarters of the fiscal year, this decline included a reduction in nearly $350 billion from a combination of TARP, Treasury payments to Fannie Mae and Freddie Mac, and net outlays for FDIC insurance.  If normalized for TARP, so removing the $350 billion from last year’s numbers, then spending ex-Tarp is up 10.6% on a year-over-year basis!  Not a good trend.

 

While a large proportion of this was driven by unemployment insurance, every major line item showed a meaningful increase year-over-year.  Specifically,

  • Defense spending was up 5.8%;
  • Social security was up 6.0%;
  • Medicare was up 4.3%;
  • Medicaid was up 8.9%; and
  • And Other was up 9.1%.

Line item spending dramatically outpaced the economy vis-à-vis GDP growth and tax revenue growth.

 

In conjunction with this release, President Obama also named Jack Lew the new budget director.  While Orzag has a following amongst the paparazzis in Washington, Lew is actually an experienced hand in the budget area and has spent seven years in the OMB. He was lastly OMB director under President Clinton until 2001, and produced a budget, with the help of a healthy economy, that resulted in a surplus of $236 billion. 

 

Given his prior experience, prior success, and proven ability to work across bi-partisan lines, President Obama seems to have made a solid choice in Lew.  Even though he spent some time as Chief Operating Officer at Citi Alternative Investments, we will still give him a free pass on that job choice for now.  He certainly has the wherewithal to take a tough stance on the budget, but the next few months will actually show how serious the Obama administration is about narrowing the deficit.

 

Daryl G. Jones

Managing Director

 

The Deficit Still Looks Ugly, Normalize For Tarp And It Looks Uglier - US Federal Budget


Bear Market Macro: SP500 Levels, Refreshed...

We are in the 6th day here of a bear market bounce. At 1096 in the SP500 this easily makes me feel as uneasy as I have felt… well… in 6 days.

 

From an intermediate term TREND perspective, unless the SP500 closes above 1131, this will remain a bear market by Hedgeye’s definition. That doesn’t mean that the bulls can’t annoy me and/or test the validity of either of our American Austerity of Housing Headwind Q3 Macro Themes in the meantime.

 

Quantified, a close above 1096 puts the probability of a move to 1131 in play. That’s why I have been doing a lot of waiting and watching today. The long term TAIL line of resistance for the SP500 is 1096 and the long term TAIL line of support for the Volatility Index (VIX) is 23.69. As of 3PM EST, we are trading right at these lines.

 

What was TRADE line resistance is now immediate term TRADE support at 1074. While the 1004 level of downside support is still what we would consider probable on a 3-day probability model basis, its also what we would call less probable than what we called it yesterday.

 

As the markets change we will continue to, but we need these SP500 and VIX levels to confirm for at least 3 days on a closing basis to change our positioning.

KM

 

Keith R. McCullough
Chief Executive Officer

 

Bear Market Macro: SP500 Levels, Refreshed...  - S P


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PENN: ANY MARGIN GAS LEFT IN THE TANK?

With the exception of a couple of properties, top line trends have been less than inspiring. PENN needs to pull the cost cutting lever to make the quarter.

 

 

Same store sales (SSS) be damned.  2010 was supposed to be a year of recovery for US gaming markets following an awful 2009.  Easy comparisons have become not so easy.  PENN’s Q2 SSS fell 10% in 2008 and another 3% in 2009.  Still, we project Q2 SSS will decline 7% further in 2010. 

 

For Q2, we expect that EBITDA and EPS will fall slightly short of management’s guidance of $0.26 and $141.5 million, respectively.  For the year, our EPS and EBITDA projections of $1.12 and $575 million, respectively, are close to management’s guidance of $1.13 and $578 million.  At the time of management’s last update, we thought they were padding guidance.  However, casino revenues have remained sluggish and their previous guidance looks reasonable.

 

Lawrenceburg and the Hollywood Casino in PA are the only two properties showing year over year growth.  However, Lawrenceburg will have lapped the Q2 2009 expansion by the start of Q3 2010, thus impeding further growth.  PA should continue to grow with the advent of table games later this year. 

 

We remain positive on the long-term prospects for PENN.  Management is strong and the company does maintain a growth pipeline consisting of projects in NEW markets.  Thus, investment returns will be significantly higher and exceed PENN’s cost of capital.  The Ohio projects should contribute up to 25-30% CAGR in EPS from 2010 to 2013.  Our hang up remains domestic gaming trends and the macro environment.  Gaming revenues are tied to housing and GDP and the Hedgeye macro call is fairly negative on these important metrics.  Still, the valuation of 7x 2011 EV/EBITDA is reasonable for the growth and certainly attractive on a relative basis for patient investors.


American Austerity: Leading Indicator or Buy-And-Hope?

Conclusion: Short the US Dollar (UUP)

 

Our call 6 months ago was the same for the Euro as it is for the US Dollar now. The currencies of countries with burgeoning deficit and debt to GDP ratios are leading indicators for their domestic stock markets.

 

The US Dollar is getting smoked to lower-intermediate-term-lows today and the US equity market is cheering it on as “reflation” because that’s exactly what Dollar Down equated to during the 2009 phase of what we called Burning The Buck.

 

Unfortunately, inverse correlations and r-squares aren’t perpetual. There are always multi-factor and multi-durations to consider. As chaos theorists, it is our job to recognize these risks and intermediate term TRENDs as they emerge from immediate term TRADEs.

 

If the week were to end today, the US Dollar will be down for a 6th consecutive week. Not only is the immediate term TRADE line for the US Dollar broken, but the long term TAIL and intermediate term TREND lines are broken as well (see chart).

 

This time we don’t think the “reflation” TREND will recur because global equity and commodity prices don’t have the tailwind of accelerating global and domestic growth. Our outlook on US growth in particular for the next 3-6 months is actually for quite the opposite. The US stock market is sucking some people into the long side today, much like early 2010 rallies in European equities suckered people in as the Euro started to break down.

 

Keith R. McCullough
Chief Executive Officer

 

American Austerity: Leading Indicator or Buy-And-Hope? - DXY


RESTAURANT INDUSTRY – SHORT INTEREST, CPKI, AND MORE

The restaurant space is seeing a rise in short interest despite activism and buyout rumors.

 

With a group of investment bankers working overtime to sell the company, CPKI’s second preannounced results for 2Q10 were a little better than the first.  The recent release detailing 2Q10 results showed improved EPS in a range of $0.15 to $0.17 (vs. prior guidance of $0.10 to $0.15 given on 6/21/10 - down from the original guidance of $0.24 to $0.26 communicated on 5/6/10).

 

2Q10 same-store sales came in at -5.9% (vs. prior guidance of -6.0% to -7.0%) and 3Q10 same-store sales through July 11th improved to -0.6%, according to management.  This significant sequential improvement is partly attributable to the fact that the company’s 2Q10 results were negatively impacted from lapping the strong results from last year’s Thank You Card Program which ran during 2Q09 and benefited comps by about 1.4%.  CPKI will be launching the program again during the third quarter on July 28.

 

Notably, CPKI was one of the restaurant stocks with the biggest increases in short interest over the past month.  Other notable increases in short interest ahead of earnings season are BWLD, EAT and RRGB. 

 

RRGB is being pressured by an “activist” as the fundamentals continue to be severely challenged for the company.  Pressing the short here is not a good bet from a risk/reward perspective. 

 

JMBA has seen short interest accelerate to the upside ahead of news detailed in The Wall Street Journal today.  An article titled, “McDonald’s Smoothie Launch May Juice Up Entire Category” discusses the launch of McDonald’s smoothies nationwide and the impact on the smoothie category.  Jamba Juice Chairman and CEO James White said, “their advertising will expand interest in the category”.

 

We will be releasing our restaurant Industry “sigma” positioning by the end of the day, but BWLD is currently operating in the quadrant we call “Trouble Brewing.”  I continue to believe that there are several issues that will plague the company for some time.

 

Over the past month, EAT saw the third biggest increase in short interest at 31.9%.  As a percentage of the float the absolute short is still low at 7%, but it’s up 1.68% in the last month.  Over the weekend, Barron’s described the CEO of DIN as a canny operator, but she is doing nothing of consequence to alter the operation within the four walls of the Applebee’s concept.  The company’s ability to do anything other than sell off stores is limited by the leveraged balance sheet.  This offers an ongoing market share opportunity for EAT.

 

Brinker is on the other side of the table with enough liquidity to buy back 20% of the equity value of the company and is making big strides to improve restaurant level margins and the overall guest experience.  Apparently, the market likes leverage more than cash!  Over the past month EAT is down 5.8% and DIN is up 2.6%.

 

RESTAURANT INDUSTRY – SHORT INTEREST, CPKI, AND MORE - short interest

 

Howard Penney

Managing Director


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