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Like SBUX, CMG seems to be doing the right things…investing in labor (to increase throughput), food quality and sourcing (“food with integrity”) and marketing to drive a better customer experience and improved traffic.  Higher YOY labor and marketing costs, along with modest food cost inflation, will put increased pressure on restaurant level margin in 2H10, but this seems to be a high quality problem and also a function of tough comparisons.


Comp Trends:


As I said in the CMG – FIRST LOOK post, comp performance will likely matter more to investors and CMG stated that its sales momentum continued into July.  Management said it is cautious about the current economic environment and the recently reported softness in consumer confidence, but it has not yet seen an impact on trends.


Due to the still fragile consumer, CMG has no plans to increase pricing unless they face significant food cost inflation, which they are not currently expecting (guided to modest inflation in 2H10).


Real Estate Strategy – A-model sites:


CMG commented on the success of its A-model sites, which is the new development model it is using to enter tier two trade areas.  These sites require less investment costs.  I criticized this strategy when CMG first announced it as I thought it might cause the company to be less disciplined about its real estate site selection.  Specifically, management had said the A-model sites allowed the company to “bolster [its] real estate portfolio while the sluggish economy limits the availability of the new developments that [it] traditionally pursued.”  I questioned whether the company would be better served to slow growth rather than pursue tier two sites.


The company is still in the early stages of this development strategy but management said that these A-model sites continue to open at similar sales levels to traditional units with lower occupancy and development costs.  We will have to see what happens after the honeymoon sales period, but the early results sound promising.  Only 10 A-model sites are open at this point but they are expected to account for 25% of the company’s 120-130 unit openings in FY10.




Howard Penney

Managing Director




Another huge calendar 2Q10 comp surprise...


CMG’s 2Q10 earnings of $1.46 per share came in much better than the street’s $1.39 per share estimate.  Same-store sales grew 8.7%, better than both my 6.0% estimate and the street’s 5.4% estimate.  On a two-year average basis, trends improved nearly 200 bps from the prior quarter and the company’s press release stated that traffic drove most of the comp increase.  For reference, CMG was facing an easy comparison from 2Q09 when traffic was down 3.3%.  Traffic up close to an estimated 8.0% is impressive, nonetheless.  Management raised its full-year comp growth guidance to up mid-to-high single digit, from up mid single digit (prior to earnings, street’s FY10 estimate was +4.8%).


Restaurant level margin growth was up nearly 90 bps in the quarter to 26.9%, putting CMG in the “Nirvana” quadrant of our sigma chart for its sixth consecutive quarter.  The company’s rate of YOY margin growth slowed from the first quarter due primarily to the delevering of the labor and other operating expense lines, as expected as a result of increased wage rate inflation, lapping of labor efficiency initiatives and increased marketing expense.  Food costs were also not as favorable on a YOY basis in the second quarter.  We will have to see what management says on its earnings call, but maintaining positive margin growth in 2H10 will be more difficult as food costs put increased pressure on margins.  If the company is able to maintain its comp growth momentum, investors may not be too concerned.




Howard Penney

Managing Director

R3: From Underwear to Outerwear

A few noteworthy read-throughs on the consumer as we kick off earnings.



We’re getting an early look into the strength of consumer spending here today with results out of both Hanesbrands and VF Corp.. Perhaps the most noteworthy trend here are the results themselves with each company both beating expectations by a healthy margin and raising full-year guidance. While we’re not going to rehash all of the details of the calls here, there are several noteworthy read-throughs to consider as it relates to consumer spending:


-          Both companies exceeded top-line expectations suggesting that spending remained strong through June with broad-based results reflecting positive growth across product categories, distribution channels, and end markets. However, in speaking to trends since the quarter the view is decidedly more mixed with evidence of softness underway according to VFC this morning while HBI continues to see an overall increase in consumer spending. One of the areas of weakness highlighted by VF in particular was premium denim, which has deteriorated even further over the last 8-weeks.


-          While shelf-share gains accounted for 6% of HBI’s 9% top-line growth, the balance was driven by increased sell-throughs at retail. Among the reason’s management cited for raising guidance was both higher productivity of its new programs than expected as well as an continued increase in overall consumer spending. Yes, replacing one’s underwear is less discretionary than some might like to admit, but the reality is that this is not simply a basics business – quite the opposite actually.


-          All of HBI’s top brands (i.e. Champion, Just My Size, and Hanes) drove the outperformance in Outerwear segment (+16%) with particular strength in the new plus-size initiative Just My Size that’s sold through at Wal-Mart. Following better than expected sell into at the mass retailer over the last two years, this line continues to outperform. Granted the majority of growth here is coming from share gains, but Wal-Mart is obviously seeing healthy demand for the for product.


-          Cost inflation remains at the forefront of retailer concerns with the offset coming in the form of higher prices at retail. Interestingly, it appears that the channel with greatest price flexibility is at the mass channel. While pricing is going through across the board at HBI, VF noted that its sees the opportunity for continued pricing in its Lee and Ryder product, which is sold solely in the mass channel.


-          Lastly from a meteorological perspective, VF cited unseasonably warm weather over the last two months as a headwind for denim sales – no doubt. Challenging the obvious, The North Face best known for its winter jackets continues to post strong results.



Casey Flavin






- Add Brooks Brothers to the list of brands translating their adult fashions into kids. The company is testing two kids stores, one in Westport, CT and the other in Kansas City. The stores are called “Fleece”. With Crewcuts, Abercrombie, Ralph Lauren, AE ’77, and PS by Aeropostale all carrying an Americana aesthetic we wonder if this niche might be becoming overstored in a hurry.


- Rumors are swirling on Madison Avenue that Chanel is about embark on price increases for the company’s classic (iconic) handbags. The word on the Street is that prices are set to increase by 20% on August 1st. Now that’s serious inflation for a product that remains unchanged but cost about 40% less only two years ago.  


- Add a little fashion to what is otherwise a stable, but boring category, and you end up with Diaper Wars. After Kimberly Clark announced it sold 2 mm denim-printed diapers so far this summer, Procter and Gamble has responded with a fashionable item of its own. P&G and Target have joined up for an exclusive line of diapers with 11 styles designed by Cynthia Rowley. By the way, 60% of Mom’s purchase denim for their infant before the age of 6 months. As Fall approaches we wonder if a corduroy version of Huggies is on the horizon.





House Passes Miscellaneous Tariff Bill To Reinstate Expired Import Duty Breaks - Yarn spinners, fabric firms, footwear brands and retailers have been paying tens of thousands of dollars in duties on imported components since Jan. 1 because Congress let legislation expire that suspended tariffs on hundreds of imported products. Over the past seven months, companies have had to drop product lines, increase prices and find substitutes, all at a cost to the bottom line. On the plus side, the bill includes a retroactive provision that will provide full or partial refunds to companies on duties paid on all covered products since January. On the downside, the measure would increase duties on several hiking-boot and shoe imports because trade has grown significantly.  <wwd.com/business-news>

Hedgeye Retail’s Take: Geared mostly towards a sundry of goods like basketballs, ski boots, and fishing waders, the duties re-imposed by the bill were estimated in the tens of millions of USD per year so a nice benefit to outdoor players, but not a game-changer per se.


Study Shows Toning Shoe Is A Myth - The American Council on Exercise (ACE), the organization that certifies fitness professionals, released what it believes is the first independent study on toning shoes. Results showed no evidence to suggest that the shoes help wearers exercise more intensely, burn more calories or improve muscle strength and tone. The study enlisted a team of researchers from the Exercise and Health Program at the University of Wisconsin, La Crosse. In particular, it explored the effectiveness of popular toning shoes including Skechers Shape-Ups, MBT (Masai Barefoot Technology) and Reebok EasyTone.  ACE's Chief Science Officer Cedric X. Bryant, Ph.D  stated, "Unfortunately, these shoes do not deliver the fitness or muscle toning benefits they claim. Our findings demonstrate that toning shoes are not the magic solution consumers were hoping they would be, and simply do not offer any benefits that people cannot reap through walking, running or exercising in traditional athletic shoes." <sportsonesource.com>

Hedgeye Retail’s Take: While we’re surprised it’s taken this long for an independent study to come out on the merits of toning shoes, were not surprised in the result…and don’t expect consumers will be either.


Luxury Spending Is On The Rise, But Apparel Isn’t Feeling The Love - The country’s richest consumers will drive luxury spending up between 6% and 8% this year, according to a survey of affluent Americans conducted by American Express Publishing Corp. and Harrison Group, but apparel is unlikely to benefit. Apparel spending by these consumers has recovered somewhat, but continues to slide, falling 5% in the first quarter and 4% in the second quarter. By comparison, apparel spending by this group slid 8% during the fourth quarter of 2008 and 9% in the first quarter of last year.   <wwd.com/business-news>

Hedgeye Retail’s Take: Why buy something new when you can just pull the tag off something in your closet that has yet to be worn? We suspect a bit of over-supply in the wealthiest consumer’s closets is likely the culprit for share gains by more durable items (i.e. shoes, bags, and home furnishings).


SGMA Study: Nearly 80% of Americans Participate in a Sport, Fitness, or Outdoor Activity - While more than 50% of all Americans are considered 'frequent' sports participants,  12% are classified as 'regular' sports participants and 15% are active on a 'casual' basis. Unfortunately, 23% of all Americans are not active at all -- according to the Sporting Goods Manufacturers Association's Sports Participation in America report (2010 edition).   <sportsonesource.com>

Hedgeye Retail’s Take: Without this 20% sample the toning craze simply wouldn’t exist.


Wal-Mart May Open Hundreds of India Stores if Foreign Restrictions Lifted - Wal-Mart Stores Inc. may open hundreds of stores in India, the world’s second-most populous nation, should the government lift a ban on foreign direct investment in multi-brand retailers. <bloomberg.com/news>

Hedgeye Retail’s Take: As multi-nationals continue to beat on the door of this lucrative market and now Wal-Mart…we suspect the mounting pressure will force the government update its stance on foreign direct investment in the near-term.


The Buckle Hits Some Hard Times - Are the glory days of double-digit comparable-store gains a thing of the past for teen retailer The Buckle Inc.? Once the golden child of specialty retail, Buckle startled analysts earlier this month with a 7.3 percent drop in June comps, far worse than estimates ranging from a small gain to a low-single-digit drop.  The company blamed the disappointing results on the economy and difficult compares. But, it appears that Buckle’s long-standing aversion to price promotion may have also played a role.  <wwd.com/business-news>

Hedgeye Retail’s Take: While many in retail consider Abercrombie the last to adjust its pricing, which it did several quarters ago now, there’s still Buckle insisting on holding tight to price…and is falling fast in the process. It’s tough to help brands that can’t help themselves.


Ked's Exposure in Bloomingdale's - As part of Keds’ sponsorship of the Whitney Museum of American Art’s summer season, the brand installed a window at the Bloomingdale’s flagship store. Titled “Works on Canvas,” the installation — which closed last night — showcased shoes, a touch-screen mechanism for ordering customized kicks, and three art students in the windows making Americana-inspired art. Rubel said the initiative was a success by many measures. The window installation drew hundreds, while the blog for the event, at Theoriginalsneaker.com/whitney, attracted more than 10,000 unique page views. Keds also saw very high double-digit sell-throughs at Bloomingdale’s, as well as online at Keds.com, in the two-week period that the windows were up, according to Rubel.  <wwd.com/footwear-news>

Hedgeye Retail’s Take: Rubel and his team continue to find creative ways to promote this brand including the company’s recent collaboration with GAP – all indications here are that the brand is growing once again.


R3: From Underwear to Outerwear  - R3 7 22 10


JCP Showcases its New LIZ Line - With high expectations for market share and margin growth, J.C. Penney unveiled its exclusive Liz Claiborne collection on Wednesday. It’s an expanded version of its Liz & Co. line, which has been discontinued, but with comparable prices. Penney’s Claiborne collection launches next month in more than 1,100 stores and on jcpenney.com with 30 categories across men’s, women’s, accessories and home, which joins the assortment in January. The fall collection stays true to the Liz Claiborne image with a versatile sportswear array of novelty knits, nautical striped sweaters, classic denim in a variety of washes as well as outerwear ranging from a country buffalo plaid jacket to a chic fake fur urban version. Accessories run the gamut, including shiny handbags, while jewelry exudes plenty of sparkle and shine.  <wwd.com/retail-news>

Hedgeye Retail’s Take: This is huge for LIZ. As we highlighted in a note out yesterday, August is a big month for the retailer in more ways than one.


R3: From Underwear to Outerwear  - R3 2 7 22 10



Mexican Headwinds

Position: Short Mexican equities via the etf EWW.


Conclusion: The outlook for Mexico’s macroeconomic health is tepid at best and incremental data points suggest there is more downside to come.


Last Thursday, Daryl Jones, our Managing Director of Macro, wrote a note outlining our short thesis on Mexico. In summary, the conviction is three-pronged: overreliance on oil, slowing growth in the U.S., and a drug war that by official estimates shaves a full percentage point off of GDP each year. In addition to these headwinds, additional bearish points on housing and government funding spell incremental trouble for the Mexican economy.




The first prong of our bearish outlook on the Mexican economy is an unhealthy reliance on oil will continue to be a headwind for the Mexican government’s budget, as oil production in the country continues to decline – down 29% in the last six years. The State-run oil conglomerate PEMEX funds an estimated ~35% of the federal budget, so as these funds continue to erode, the Mexican government will have to look elsewhere for support. While a substantial rise in the price of crude would be positive for the Mexican economy, we do not see that as a likely outcome for now. Oil is broken from an intermediate term TREND perspective ($78.50). We have been vocal in the past couple of months suggesting REFLATION based on U.S. dollar debasement will be less of a supportive factor this time around, as waning demand from tightening in China and economic slowing in the U.S. (the two largest consumers) continue to weigh on the price of crude oil (down 2.6% in the last month). As a point of note, the Mexico Bolsa Index has a 0.81 r-squared to the price of crude oil on a TREND duration.


 Mexican Headwinds - Mexico Crude Oil Production


The second prong of our bearish outlook for the Mexican economy concerns its leveraged exposure to the U.S. from a trade and investment perspective. Last year, 80% ($177 billion or 15% of Mexico’s GDP) of Mexico’s exports went to the U.S. A slowdown in U.S. consumption, of which we have a great deal of conviction (see Hedgeye Macro’s Q3 Themes: American Austerity & Housing Headwinds), is very negative to Mexican growth and job creation. This setup suggests Mexican retail sales will roll over hard from the 23-month high of 5% Y/Y in May of 2010.


The third prong of our bearish outlook for Mexico’s economy is the most obvious from a news flow perspective – drug wars. Weakness in May retail sales along the U.S. border (the most prominent area of violence) only tells part of the ominous story which has plagued Mexico for quite some time. Mexico has had upwards of 25,000 organized crime deaths related to the drug war since 2006 with 28% (7,048) of them occurring this year alone! The impact of violence is the single greatest threat to the Mexican economy, according to 57% of Mexican executives – up from 49% in March and 22% in December 2009. Furthermore, tourism, which accounts for 13% of Mexican GDP in aggregate, will continue to suffer as a result of the uncontained drug-related violence.




Mexico’s reliance on the U.S. for investment and aid is having an incremental negative effect on the Mexican government’s drug war efforts. According to a recent report from the U.S. Government Accountability Office, the U.S. has delivered only about 9% of the $1.6 billion in drug-war aid promised to Mexico and Central America, citing a lack of staff and funding. If the effects of American Austerity continue to gain steam, reprieve in the form of a U.S. hand-out may be unlikely in the near term.


Speaking of hand-outs, Mexico is seeking a $1 billion loan from a Chinese development bank and another $500 million from the World Bank to finance home lending. Sociedad Hipotecaria Federal (SHF) needs further funding to inject liquidity into Mexico’s mortgage market, even after receiving a $1 billion loan from the World bank in 2008 and installments of a $2.5 billion credit line from the Inter-American Development Bank. Rising delinquencies (delinquency rate +350bps Y/Y) brought on by the sharp increase in unemployment last year has SHF looking for further funding to finance an estimated 1 million mortgage loans this year. While the Chinese loan may be signed as soon as September, the delay or denial of either facility would be very bearish for the Mexican housing market – particularly if you factor in the employment headwinds brought on by a slowdown in the U.S. economy.


Darius Dale



Mexican Headwinds - Mexico Unemployment

THE MACRO MIXER - When LEADING is LAGGING or just meaningless

Things could be worse than they appear but it’s not a leading anything.


Today the Conference Board's Leading Economic Index declined by 0.2 and has now declined for two of the last three months.  Upon further review, things could actually be worse that they appear.  The movements of the sub-components of the index were very mixed, with four of the components declining, five rising and one flat.


The rising components during June (in order of positive contribution):


(1)    The yield curve

(2)    Building permits

(3)    Index of consumer expectations

(4)    Manufacturers’ new orders (consumer goods and materials)


At this point in the economic cycle, the yield curve is somewhat meaningless.  The yield curve has been sending a strong growth signal continuously since 2008, but there is no expansion in credit and low mortgage rates are not stimulating home sales.  A favorable yield curve is not providing the kind of stimulus that has occurred historically at similar interest rate levels.


The rising consumer expectations number is in sharp contrast to the Conference Board’s June 29th report on consumer confidence, which showed a sharp drop in confidence.  How can the same organization show consumer confidence rising and falling the same month?

In addition, a good part of the index is subject to changes and given the recent softness in the MACRO data, we are not likely to see upward revisions.  The press release from the conference board states, “the resulting indexes are therefore constructed using real and estimated data, and will be revised as the unavailable data during the time of publication become available.”

Today’s surging S&P is on the back of strong earnings from a number of companies.  At the time of writing, 40 of the 52 companies due to report today have reported (the others are reporting post-market) and only 2 missed in the earnings line and 10 missed on the revenue line.   For now, the negative news on jobs, housing and the supposed leading indicator are taking a back seat.


Howard Penney

Managing Director


THE MACRO MIXER - When LEADING is LAGGING or just meaningless - 1


Fiscal 3Q10 was a great quarter and after listening to the earnings call, I was left thinking that everything seems to be working well.  Starbucks continues to have sales momentum, is investing in the right areas of the business and most importantly, has the financial flexibility to continue to do so.   However, as I said yesterday, expectations have caught up with the company. 


I have been confident in Starbucks’ ability to continue to yield better results in fiscal 2010, but I never expected the level of same-store sales growth achieved year-to-date in the U.S., particularly the 9% growth in 3Q10.  To that end, I have underestimated the company, but expectations will remain high as the company’s FY11 same-store sales guidance of low-to-mid single digit growth assumes a fairly steady improvement in two-year trends.  For reference, +1% same-store sales growth in the U.S. in FY11 would imply a 350 bp improvement in two-year average trends from FY10 (assuming 6.5% growth for FY10).


I think same-store sales and margin growth will continue to materialize in FY11 but the rate of growth will slow and the company’s ability to continue to surprise to the upside from both top-line and bottom-line perspectives will likely diminish.  That being said, I think the stock still makes sense on a long-term basis as the company stands to benefit from continued leverage of its existing store base, international growth, its increased investment in marketing and its pursuit of additional platforms of growth (largely VIA and Seattle’s Best Coffee). 


Given current expectations and the stock’s recent performance, getting the right entry point matters most.  Below I provided Keith McCullough’s long-term buy TAIL and sell TRADE levels.




Relative to our restaurant sigma charts that look at same-store sales and restaurant-level margin growth, Starbucks is likely to remain in the “Nirvana” quadrant in fiscal 4Q10 with both positive same-store sales and YOY restaurant-level margin growth.  Management guided to mid single-digit comp growth in both the fourth quarter and for the full year.  A +5% number implies a 50 bp sequential improvement in two-year average trends.  For FY11, I am modeling positive same-store sales and restaurant level margin growth; though the company may dip out of “Nirvana” from quarter-to-quarter as a function of difficult comparisons.




Starbucks Read-Through:


We know now that Starbucks had a strong quarter, particularly from a top-line perspective in the U.S.  I do not think these strong results, however, should be interpreted to mean that we will see similarly strong demand for the remainder of the restaurant companies left to report calendar 2Q10 results.  To recall, we already know that casual dining trends on average, as reported by Malcolm Knapp, slowed about 50 bps in 2Q10 on a two-year average basis from the prior quarter.



Howard Penney

Managing Director

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