U.S. market saw weak volume on yesterday’s rally. 




As we look at today’s set up for the S&P 500, the range is 20 points or 1.0% (1,083) downside and 0.9% (1,103) upside.  Equity futures are trading mixed ahead of the European banking stress tests results due at noon.  Analysts expect between 5-10 banks to have failed and will need to raise additional capital.




Moody's Investors Service said it placed Hungary's credit rating on review for a possible downgrade after the government was unable to reach agreement with international donors on fiscal targets.


The U.K. economy grew almost twice as much as economists forecasted in 2Q10.  Gross domestic product rose 1.1% after increasing 0.3% last quarter.  Economists forecasted 0.6% growth, according to Bloomberg. 


German business confidence unexpectedly surged to a three-year high in July after exports boomed and economic growth accelerated. The IFO institute said its business climate index, based on a survey of 7,000 executives, jumped to 106.2, the highest since July 2007, from 101.8 in June.




Overnight the MSCI Asia Pacific Index end the week higher for the third straight week.  China closed up another 0.4% last night, bringing the weeklong rally to 6.1%; China was the best performing market in the world last week.  The improving sentiment in China is due in part to speculation about some relaxation of property tightening measures.  China is still broken on TREND.


Copper was up 2.3% yesterday to close at 3.18, 0.01 below the TRADE line of resistance.  Oil is trading near its intermediate TRADE line of resistance of 79.12.  Yesterday, we shorted copper (JJC).  


Treasuries were weaker yesterday with the strength in global equities.


Europe was another bright spot on the back of the upside surprises in the flash Euro zone manufacturing, services and composite PMIs for July.


Yesterday, the S&P rallied on decelerating volume, while the down days are on accelerating volume; a bearish sign.




The Industrials (XLI) sector provided a nice chunk of upside leadership in the S&P 500.  Strength was fairly broad-based, though Transports +3.9% were the standout after UPS +5.2% beat consensus EPS expectations for Q2 on margin upside, while the company also raised 2010 guidance above the Street.

The rail companies were another bright spot following a meaningful EPS beat from UNP +4.8% on a lower-than-expected operating ratio.


Housing-leveraged stocks were among the best performers today with the XHB +3.7%. Recall that the group rallied nearly 4% on Tuesday despite the weaker-than-expected June housing starts data.


The third best performing sector yesterday was the Financials (XLF).  Along with the asset managers, which rallied on the back of an unexpected improvement in Q2 flows at JNS +11.8%, the financials were underpinned by the strength in the banking group, with the BKX +3.9%. Regional’s provided the upside leadership. 


Howard Penney

Managing Director


US STRATEGY – UP MARKET, DOWN VOLUME - levels and trends 723














The Macau Metro Monitor, July 23rd, 2010



According to a company statement, Sands CEO Steve Jacobs has left LVS. COO Mike Leven will run Sands, helped by Director Irwin Siegel, until a successor is found.  Steven Weaver, who was previously Sands China's president of Asian development, will serve as an adviser.  Although no reason was given for his departure, there was speculation it was due to rifts between him and Adelson, particularly on Jacob's comments regarding casino development plans in Japan.



Total visitor arrivals surged by 30.6% YoY to 1,904,395 though comparisons were easy given the swine flu pandemic last year.  Visitors from Mainland China increased by 44.7% YoY to 985,127 (51.7% of total visitor arrivals), with 377,491 travelling to Macao under the Individual Visit Scheme, up notably by 62.6% from June 2009 (232,161).



According to IAG, Ng Fok, a Macau businessman with ties to Stanley Ho, is one of the people behind Macao Dragon.  Mr. Fok is currently chairman of Hotel Presidente Macau, a four-star SJM-licensed casino hotel opposite Wynn Macau on Avenida da Amizade.


From SJM's perspective, motivation to strike a marketing deal with Macao Dragon to drive traffic to SJM-licensed Taipa casinos isn't very strong, given that SJM doesn't own the full economic benefit of the casinos.  However, IAG believes if they do team up, they could target mass market players who want privacy and more affordable hotel rooms on Cotai.  Taipa's SJM casinos could also be marketed to mid-level high rollers as distinctively Chinese-owned and managed properties. 


The Monetary Authority of Macau (AMCM) said,  “The growing pace of gaming receipts would slow in the second half, while the gradual increase in investment spending would add force to economic growth. As a result, the real GDP growth is expected to exceed 15.0 percent for the whole of 2010.” AMCM also forecasts a below 3.0% jobless rate, 3-4% CPI, and relatively stable local interest rates for 2010.


According to Mr Tam, the appreciation of the RMB and the supply of daily necessities from the Chinese mainland to Macau are the two major factors that will push up inflation in 2H 2010.  Once the inflation rate reaches 3% (based on average figures for a 12-month period), the government will adopt specific measures in a "timely" manner to ease the inflation pressure, added Tam.  For the 12 months ended June 2010, the average Composite CPI rose by 0.97% YoY.



Private home sales prices in Singapore slowed down to 5.3% growth in 2Q, compared with 5.6% growth in 1Q.  This was a tad higher than the 5.2% initial forecast reported earlier this month.


S'PORE CPI UP 2.7% IN JUNE Channel News Asia

The 2.7% CPI growth is less than the market forecast of 3.5% growth.



CBRC announced yesterday that the average NPL ratio for chinese banks was 1.30% at the end of June, 0.28% lower than at the end of 2009, indicating that the sector remains healthy despite concerns that a slowdown in the economy may damp loan quality in the longer term.


Jay Santiago, Pagcor's new spokesman, said  "We have four proponents which have made commitments to start off construction on the Entertainment City, which is connected to the Bagong Nayong Pilipino.  We are in the process of reviewing the contracts they've entered into, the business models that have been proposed, and we're looking at the lay-out of the project. Chairman Naguiat wants it to be more of a tourist attraction rather than a gambling destination."  The Entertainment City deal was brokered by former Pagcor chairman Efraim Genuino to ensure Aruze didn't pull out of the scheme for an Okada Resort, including casino.


Also, the Resorts World Manila casino and hotel project opposite the Manila International Airport  is under gaming policy review, ordered by President Aquino.


Important consumer commentary from management.


CAKE posted in interesting quarter.  Same store sales up 1.6%, traffic up 1.4% and price up 1.4%. The implication is that pricing was down1.2% for the quarter.  As management state the consumer is doing a little “check management” when they come to the Cheesecake factory.  This is a problem - especially with commodity prices increasing. 


The company has touted the success of the new section on the menu “Small Plates and Appetizers.”  Unlike some restaurant companies that count entrées to measure traffic trends, CAKE actually measure traffic in terms of actual guest counts, which the server inputs when inputting an order for the table.  While you can not directly draw this conclusion, it seems likely that the success of the small plates and lower price points are the driver of incremental traffic.


Despite this, the company wants to raise prices 1% with roll out of the summer menu.  The company is trying to balance an increase commodity pressures and other expenses, while at the same time trying to get back to peak margins.  With the incremental traffic being driven by lower price points, the risk to the business model increases.  In a cautious consumer environment, slowing traffic trends is real possibility.


As you can see from out CAKE sigma chart, the company is currently operating in “nirvana”, the quadrant where same-store sales and restaurant-level operating margins are increasing year-over-year.  Given the current trends the company will move down in the “trouble brewing” quadrant, where same-store sales are still positive but margins are contracting year-over-year.  And that is how I would describe the position the company is in.  There is trouble brewing when the incremental consumer is coming in for lower price points and you need to raise prices to maintain margins.  









  • Weary of macro environment
    • Fed revision
    • Consumer confidence
  • Still produced traffic +1.4%
  • Sales were solid
  • Comps and savings helped drive 22% of EPS growth
    • Anticipating more in savings this year than in 2009
  • Opening new model (final for year) next month
  • Seeing more availability of quality restaurant sites



  • 1.3% increase in operating weeks due to opening new restaurants
  • Sequential sales comparisons impacted by gift card redemptions and holidays
  • Traffic up 1.4%, pricing up 0.6%
  • Check management by customers – particularly with beverages
  • G&A were down 80 bps vs 2Q09
    • Lapping accrual related to CEO retirement plan
  • D&A was down 30 bps yoy
    • Lower depr reslting from impairment charge being recorded
    • Positive sales leverage
  • Operating margins in the second quarter of 2010 improved 180 bps to 8.9%
    • On track to surpass operating margins of 07 – 7.3%
  • No more interest rate collars in place on remaining debt outstanding
  • 670,090 shares bought back at 17.4m dollars
  • Cash balance of 86m despite using sme cash to pay debt and unwind interest rate collar
  • Generated about $58m million in free cash flow


3Q Guidance

  • EPS between $0.31 and $0.33
  • Assumes comps between flat and +1%
  • Expecting dairy pressure, preopening expenses yoy (no new restaurant in 3Q09), and additional marketing expense to impact EPS by $0.04 (combined)


Full year 2010

  • EPS between $1.32 and $1.38
  • Assumes comps between 1% and 1.5%
  • In 4Q CAKE hits hardest compares yoy
  • 60% commodities contracted for 2010 but food inflation of flat to +1%
  • Lower contracted proteins but higher dairy and fish




  • The worst market we have is down 1% - California




Q: Changed back half of year earnings guidance?


A: Earnings outlook changed by 4 cents and 3 cents was upside of 2H. we changed it by a penny



Q: How are trends looking now, consumer habits?


A: Not talking about month by month.  We continue in the quarter to track closely to forecast.  When we expected soft comps because of difficult yoy compares we got them. 



Q: Still going to grow at low single digit range?


A: We’re looking at many sites, more than we did for 2010.  We won’t have color on 2011 until lease negotiations are further along.



Q: Price? Average check – still incremental boost from small plates?

A: Comps are up 1.6%, 1.4% is traffic, price is 1.4%, negative mix shift negated price.  Guests managed checks by buying fewer beverages.


Definitely some trading down. 


Expecting cost of sales for year to be about flat.



Q: On negative menu mix, do you think you’ll start to lap trade down that consumers have been doing? Do you think summer menu price may stick more?

A: They might…(not too confident!)



Q: Looks like volumes are lower, is there any reason to believe that there is not a capacity to grow comps based on historical range?


A: There definitely is capacity to gain our comps back if we take guest counts back.  We lost traffic, not pricing.  We can get it if we can get customers not managing check as much.



Q: How confident are you that you can control check management more?


A: It’s an art not a science, have to find a balance. We’ve seen TC’s increase over the last two quarters. (not convincing here)…



Q: What are some of the plans for this quarter?  Do you see trends move when you ramp up spending on marketing?


A: We are spending more in 2Q than we did in 1Q? it’s timing.  2010 marketing as % of sales will be about flat on last year.  We see redemptions in weekly sales, certainly.  Marketing is focused on remaining on brand and not doing deep discounting.  Engaging customer.  And creating positivity. 



Q: You introduced small plates and snacks as economy slid…considering the economy is not doing what we might of though, what is your take now? Guest satisfaction?


A: Last year we increased satisfaction every quarter.  Our expectation for this year is to maintain or slightly raise the level.  We are maintaining the high level of guest satisfaction. 

Menu innovation is one of our advantages. We have a new menu in just a few weeks.  Recently we brought our new cheesecakes that are the best selling we’ve ever had.



Q: Grand Lux has a small base but obviously slowed slightly…commentary?


A: Negative holiday shift in 2Q impacted Vegas and Florida strongly and they are a big part of the pie.



Q: 10-12 openings maybe in 2011, are any of those small formats?


A: Right now the Annapolis size is now our favorite – 8,500 sq ft.  The answer is yes and we’re looking at 7,000 when we think we can do 7m.  Might earmark one 2011 site for 7,200.  8,500 is the favorite at the moment. 



Q: Impact from the gulf?


A: No exposure there…Miami was strong though.



Q: Labor turnover vs where it was at the peak?


A: Incremental savings coming primarily on the labor line.  Turnover remains strong, slightly higher than peak retention but far above peer average. 



Q: Guidance, bakery revenues? Outside accounts?


A: Primary role of the bakery is to provide high quality desserts for restaurant.  They also sell externally; there is not a large amount of outside customers.  Bakery revenues are difficult to predict.  One customer can move the needle. 


Q: G&A guidance?


A: In 2009 we held back on a lot of things (raises, infrastructure) that we are spending on in 2010.  Going forward I would expect that our growth in G&A will be less than revenue growth so some kind of G&A leverage as soon as 2011.


Howard Penney

Managing Director

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Big Boy Talks

“Expectations are the root of all heartache.” 

- Shakespeare


At Hedgeye, we use an expression called Big Boy Talks. These are discussions that occur when it is time to have a reality check and sometimes deliver a candid view about performance or expectations.  Or, in fact, to deliver news that might otherwise make a person uncomfortable.  The presumption is that Big Boys can deal with reality, which can sometimes be unpleasant in the short term.


Later today, the European Banks will be releasing the results of their stress tests.  The results will be released at 6 p.m. Brussels time, which is, of course, high noon for the equity markets in New York.  The timing, according to European officials, is appropriate to allow any major European banks to address capital issues through the weekend and not have to worry about the market’s immediate reaction.


As always though, there is a market open somewhere that will immediately vote.  In this instance, it will be the U.S. equity markets, which arguably have the largest single vote of any equity market globally.  The reaction of the markets is the equivalent of an Investor Big Boy Talk.  Markets react to facts, or perceived facts, and sometimes that reaction is not all that pleasant.


For weeks, European government officials have been talking up the results of these tests. In fact, as recently as last Friday, George Provopoulos, governor of the Bank of Greece, said in an interview published in the newspaper Imerisia:


“My feeling is that things will go smoothly for the six Greek banks included in the sample."


Typically, releasing results early to the market is called inside information.  In the instance of governmental data, it is more like business as usual.  Regardless, expectations have been largely set that there will be no major issues with the European bank tests.


In fact, the 54- member Bloomberg Europe Banks and Financial Services Index has risen 9.3 percent this month, boosted by optimism that these lenders will pass. If you didn’t know what expectations were for these tests, now you know.


Further, according to Dutch Finance Minister Jan Kees de Jager, the sovereign tests will not include a write down or the scenario of defaults on sovereign debts.  While we have not yet seen the results of the tests, we would of course have to seriously debate the validity of any European bank stress test that does not assume some form of sovereign debt write down.


In fact, as of yesterday’s close, Greek 5-year sovereign debt credit default swaps are trading at close to 800 basis points.  Credit default swaps are used, obviously, to insure against potential default.   When the cost of insurance against default is trading at such elevated levels, it simply implies that the likelihood of a potential default is not zero.  In fact, it is well above zero.


While obviously this is not entirely apples to apples, we have posted below a chart that compares Greek CDS to Lehman and Bear Stearns.  If history is a guide, the level of 300 basis points is a bit of warning line for potential default.  At least, that was the line at which Lehman and Bear passed the point of no return.


Currently, Greece (which is discussed above), Portugal, Romania, Latvia, and Hungary are trading at or above the 300 basis point CDS level.  This certainly doesn’t assure default, but it certainly does assume that there is some potential for default, which should be incorporated into the results of any legitimate stress tests.


As Confucius wrote about expectations:


“The expectations of life depend on diligence; the mechanic that would perfect his work must sharpen his tools first.”


Later today we will get to see how sharp the tools were that the Financial Mechanics of Europe used to analyze their 91 banks.  My expectations are not high that these tests will prove to be valid or thorough, and, in fact, may further highlight the real risks and real sovereign exposures of many European banks.


Some key questions to consider ahead of the test results later today are:

  1. How many banks of the 91 have failed?
  2. How many have written down sovereign debt? And what is the general exposure?
  3. What is the general validity of the tests?

Regardless of the answer to these questions, you can be sure of one thing: government invented stress tests are designed for banks to generally pass, and the results will simply reflect that fact.


Whether I’m correct in my assessment of these tests or not is somewhat irrelevant, as Mr. Market will be there to analyze the results and have a post test Big Boy Talk with us all.


Yours in risk management,


Daryl G. Jones

Managing Director


Big Boy Talks - cds1


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

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