Once per year, the BLS benchmarks its payroll estimates against state unemployment insurance filings, which last year saw a significant drop in the previously-reported payroll employment levels. 


In the benchmark revision for the year beginning March 2009 (printed in 2010), the net effect of the BLS revision was an upward adjustment to the number of jobs losses during the recession of 900,000 jobs.  When the BLS first announced the massive 2009 benchmark revision, in effect the statement indicated that the underlying assumptions to the Birth-Death Model were missing certain jobs losses and it is not a reliable indicator.  The BLS’s model assumes that jobs created by start-up companies have more than offset jobs lost by companies going out of business.  So for the BLS this becomes their equivalent of a fudge factor; the ability to make the employment situation appear better than it really is.  We will be following up with a more in depth analysis of this effect early next week.


So far this year, the model has created an average of 53,000 jobs per month, including 115,000 jobs this month.  In this economy, it is interesting that the bias has been positive and not negative!  While there is no shortage of misinformation being broadcast through the media, the government seems to be a fully engaged participant.


With the September payroll numbers, the BLS is scheduled to publish its initial estimate of the benchmark revision for March 2010; once again we are likely to learn that the BLS got it wrong again and hundreds of thousands of people lost their jobs that we did not know about. 


Knowing how flawed the Birth/Death model is flawed, backing out the 115,000 of addition jobs this month, the non-farm payroll number would be closer to -169,000; worse than consensus and acceleration from last month's loss of -131,000. 

We just bought the TLT exchange-traded fund.   If the hope that unemployment is meaningfully improving and housing is stabilizing, we’ll be a buyer of the long end of the bond market on associated weakness.


Housing is not improving and unemployment situation is not either.


Howard Penney

Managing Director


Wynn Encore Macau has been open over four months.  While still preliminary, we took a look at the incremental revenues and EBITDA from the new property.



How is Encore doing?  Based on the first four months of data – admittedly preliminary – we’d definitively say that Encore is doing, well, okay.  We look at the Encore contribution in two ways:  1) by calculating the incremental market share gain and deriving an estimate of EBITDA and 2) calculating the incremental EBITDA from Q1 (pre-Encore) to Q2 (post-Encore) and adjusting for the hold differential.


In Q2, Wynn generated $216m in EBITDA versus $181m in Q1.  After adjusting for the fact that Encore was only open for 72 days in the quarter and hold percentage was significantly higher in Q2 and Q1, we calculate the annualized incremental EBITDA from Encore was $83 million.  Encore cost $600 million to build so the ROI per this method was a respectable 14%.


The second methodology yields a lower ROI of 11%.  Given the market growth from Q1 to Q2, we decided to look at the Wynn Macau VIP market share following the opening of MPEL’s City of Dreams on June 1, 2009 but before the April 21st opening of Encore (June 2009 through March 2010 period) and compare it to the May-August period (post Encore).  We are focusing on VIP because Encore did not add any Mass tables.  In fact, according to the numbers, Encore added nothing to Wynn’s Mass share.  The 2.2% increase in market share would generate approximately $64 million in annualized incremental EBITDA per our math.  See the chart below.




So the jury is still out on Encore.  However, Wynn’s post Q2 market share has been substandard and trending lower.  I guess we’ll just have to wait and see.

Europe’s August Woes Continue…

Conclusion: European PMI Services fell or substantially slowed in August, which is line with our forecast for a negative inflection in the August data from Europe. We continue to expect a decline in consumption across Europe post the exuberance of the World Cup and in response to the enactment of austerity measures that should induce individual belt-tightening and hamper confidence. The British Pound is one European currency that’s taken a notable dive alongside headline data, down -3.4% over the last month. 


Of the countries reporting, here are the PMI Services numbers in August versus July:

  • UK51.3 versus 53.1
  • France:  60.4 versus 61.1
  • Russia: 47.0 versus 54.2
  • Spain:  49.2 versus 51.3
  • Ireland: 52.9 versus 55.7
  • Germany:  57.2 versus 56.5
  • Italy:  51.4 versus 49.6
  • Eurozone55.9 versus 55.8

The German, French, and British economies are anchoring points in our analysis. The negative move in August PMI (German PMI Manufacturing released on Wednesday was unchanged in August, while the UK fell to 54.3 from 56.9) bodes poorly for the region, especially due to the fact that Germany, France and the UK are often the largest trading partners with other EU member states. 


Matthew Hedrick



Europe’s August Woes Continue… - Services1


Europe’s August Woes Continue… - manuf2

Early Look

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Back in July, we decided to map out where the restaurant companies were in terms of their positions on the SIGMA chart.  Changes in top-line growth and margin expansion/contraction clearly illustrate key operational trends in each company.  Tracking these changes as the quarters roll over, and the different valuation multiples that are assigned companies as trends change, offers valuable insight.


All restaurant companies want to live in Nirvana, with same-store sales positive and margins growing on a year-over-year basis.  Not all of the restaurant companies in Nirvana are there for the same reasons; some companies may be lapping easy comparisons, driving comps entirely by pricing or thanks to a temporary but very favorable cost environment.  In these cases, such companies will not sustain their positions in the Nirvana quadrant. 


The following companies are currently enjoying positive same-store sales and margin growth as of the most recently reported quarter: CMG, MCD, YUM US, YUM China, BJRI, DPZ, PNRA, SBUX, TXRH, CAKE, RT and MRT.  All of these companies, with the exception of YUM US and BJRI, were operating in Nirvana territory before the most recent quarter was reported. 


As I did in July, I would like to bring to your attention a few names that I think may be “moonlighting in Nirvana”.  YUM China, TXRH, MRT, CAKE and RT are the five names I would highlight as being particularly vulnerable to a move from Nirvana in the second half of 2010 (or by fiscal 2Q11, in RT’s case). 


YUM continues to expect to face labor and commodity inflation in China during 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 higher food and labor costs materialize.


TXRH is guiding to same-store sales of +1% for the remainder of the year which implies a relatively stable two-year average trend.   Food deflation is set to provide a sequentially more favorably environment than in 2Q but not as much as the company enjoyed in 1Q.  That being said, YOY comparisons from both a cost of sales and restaurant-level margin perspective are set to become more difficult in the back half of the year.


My concern for MRT is primarily top-line related.  While there is a certain amount of risk in their beef costs only being 20% contracted for 2010, given the 14% increase in Live Cattle prices YTD, I believe that the steep increase in sequential comps from 1H to 2H09 will make it difficult for MRT to maintain positive comps, particularly in 4Q10.


CAKE could also face pressure going forward due to an average check problem; customers have been trading down to small plate and snack items.  In an effort to maintain comps going forward the company implemented a 1% effective menu price increase in August.  Same-store sales and margin comparisons become decidedly more difficult, for CAKE, in 2H10.


RT’s outlook for their next quarter (1QFY11) is quite positive; same-store sales could improve again on a one-year and two-year basis and restaurant-level margins should increase year-over-year.   However, as I wrote in my recent note “RT: IMPROVING BUT THINGS SHOULD SLOW”, momentum will likely slow from there for RT.  Same-store sales, by my reckoning, will come under pressure for the balance of FY11 with margins likely following suit due to higher food costs as a percentage of sales and more difficult comparisons come to bear on the bottom line.   RT could possibly be heading for the Deep hole in 2QFY11.


Other Nirvana standouts:


CMG: CMG is largely unlocked from a commodity perspective and this could impact margins adversely in the second half of 2010.  Further increased costs on the labor, other operating cost (higher marketing) and G&A lines could further impair CMG from maintaining positive margin growth in the back half of this year.  Investors may be less concerned about this increased margin pressure if the company is able to maintain its sales momentum from the second quarter.



The Deep hole quadrant is inhabited by companies experiencing negative same-store sales and declining restaurant level margins.  


The following companies are currently suffering: SONC, DIN, BKC, WEN, EAT, CPKI, KONA, JACK and RRGB.  The trouble about the Deep hole quadrant in this current environment is that there is no “magic bullet” that can solve the issues that have led the company there.  Sometimes there are plans that management initiates that are margin accretive and build sustainable top-line momentum, but these strategies require a patient management team (resisting the temptation to take short cuts to print good numbers) and several quarters to implement.  McDonald’s “Plan to Win” is one example of an effective strategy that has changed that company. 


For the QSR names in the list above, MCD is the main problem.  They continue to knock the cover off the ball – I estimate a +7% comp in August – and it is hurting BKC, WEN, SONC and JACK.  For these names, I would not expect much movement from the Deep hole over the next few quarters and I believe that will be reflected in their valuations.  Compounding the impact of MCD’s outperformance, JACK’s geographic issues augment the macro headwinds.  Their overexposure to California and young Hispanic males (high unemployment cohort), in particular, has been pressing their stock for some time.


Other Deep hole standouts:


EAT: We expect the top-line to be volatile in the near-term as the customer familiarizes itself with the new menu.  Following the most recent quarter’s earnings, I am marginally less confident in Brinker’s ability to meet earnings expectations over the next two quarters (1H11).  I do expect, however, the company to see a material YOY improvement in restaurant-level margin in FY11, despite near-term sales volatility.   Having extensively researched the operational initiatives and changes being undertaken by the firm to increase margins and customer satisfaction, I see the potential for a strong turnaround for Brinker.  I remain confident in the direction of the company but believe that the turn in fundamentals is further out than previously thought.



Trouble Brewing:  We believe that the trends associated with the Trouble brewing and Life-line quadrants are unsustainable.  Companies usually find themselves in either territory in a transitional phase.  Typically, if a company is posting positive same-store sales and declining year-over-year margins, the company is not leveraging the positive top-line and is spending too much on growth-related costs or increasing discounting.  Whatever the reason, it usually spells trouble.

PFCB is currently situated in this quadrant.  On a sales-weighted basis, its concepts are running same-store sales of +0.8%.  Having taken price in May, for the first time in two years, and improved operational performance during the first half of the year, the company could see top-line strength persist if traffic can hold up (as of the date of the most recent earnings call, 7/28, traffic had been positive for five months).  I expect a gradual improvement in restaurant-level margins in the second half of the year for PFCB.   


PFCB is facing easy comparisons in 3Q10 on many fronts.  At the same time, trends are getting better at the Bistro, which should make for a strong third quarter.  PFCB could move up and to the right into the Nirvana quadrant during the back half of the year after starting out the year in the deep hole.



The Life-line quadrant is usually populated by companies that have “pulled the goalie”.  When customers are not coming through the doors, sometimes companies cut costs in order to maintain bottom-line numbers in the absence of top-line strength.  This clearly is an unsustainable situation.  In other cases, such as 2Q for BWLD, a shift in commodity margins can boost margins and add to profitability even in a difficult top-line environment.


The following companies are in the Life-line territory currently seeing restaurant-level margins increasing year-over-year but same-store sales declining: BWLD and DRI.  BWLD is likely going to experience year-over-year restaurant level operating margin expansion over the next number of quarters.  This is largely due to the 31% decline in chicken wing prices since the YTD peak in January.  The company is in the process of closing underperforming, lower volume stores but it is likely going to take some time. 


RESTAURANT SIGMAS – MOVERS AND SHAKERS - sigma chart restaurants 92


Howard Penney

Managing Director

EARLY LOOK: Corner Banging

This note was originally published at 8am this morning, September 3, 2010. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.





“Twenty years from now you will be more disappointed by the things that you didn't do than by the ones you did do. So throw off the bowlines. Sail away from the safe harbor. Catch the trade winds in your sails. Explore. Dream. Discover.”
-Mark Twain


EARLY LOOK: Corner Banging - chart1



On Tuesday, Keith comes back from vacation.  I’ll be honest, setting aside the fact that Keith and I have been friends for upwards of 15 years and I like having him around, wearing his jersey in the mornings is not easy.  I’m all about hard work, but, seriously, you try preparing for a 20-minute conference and writing a strategy note all by 8:30 am every day.  I’m starting to understand why some of his morning notes make him sound a bit a grumpy, this isn’t easy!
If you didn’t know, corner banging is a sailing term.  It basically means to sail all the way to one side of a race course in search of a strategic advantage.  If you bang the corner, you either win big, or you lose big.  That’s it.  For those of you who have been reading our notes for the last couple years, it is likely quite clear that we are not corner bangers.  If we’ve said it once, we’ve said it many times: we are Risk Managers.  In fact, the term is so common around our office, we even added it to the name of our company, Hedgeye Risk Management.
Managing risk isn’t about being short or just having a high allocation of capital to cash, but rather preparing and contemplating events that could happen and impact our portfolios.  As we look forward over the next couple of months, one specific event that jump out in our minds is the midterm elections.  There is potential that the Republicans, who are expected to do well, which could have an impact on whether the Bush tax cuts are extended.  It is our belief that the idea of the Bush tax cuts being extended is not currently priced into the market.
The Bush tax cuts are meaningful. To highlight this point, in the bullet points below we compare what would happen to certain tax rates if the Bush tax cuts are not extended:

  • Short term capital gains would go from 35% to 39.6%;
  • Long term capital gains would go from 15% to 20%;
  • Qualified divided taxes would go from 15% to 39.6%;
  • Non-qualified dividend taxes would go from 25% to 39.6%; and
  • Wage taxes in the top bracket would go from 35% to 39.6%.


On a very basic level, an increase in divided taxes should decrease the value of those companies that pay dividends, all else being equal.
On September 7th at 230pm, Keith and I will be hosting a call with Karl Rove to discuss the midterms with the title, “Could The Midterm Election Be A Major Stock Market Catalyst?”  Karl, as many of you know, is known as “the Architect” for putting together the successful Gubernatorial and Presidential campaigns for George W. Bush.  Now let’s be clear, we get that Mr. Rove is a Republican and that many of you may be athwartship (a sailing term that means at right angles) politically with Karl, but this is not a political call.  This is about sitting down with one of the premier political analysts in the country and having a Big Boy Talk with him. The point is to try and determine whether the midterms will indeed be a catalyst.  If you are a current subscriber or would like to trial our service and participate in the call, please email us at
As former long time Speaker of the House famously said: “All politics is local.” Typically this is indeed true, so while we can presume to know what is going on from our perches in Manhattan, Boston, New Haven, or wherever we may be, bringing in a man who has studied elections in this country on a county by county level is sure to help make sure our sails are directed toward the wind.  Currently, the Republicans clearly have the wind behind their sails.
To begin with, President Obama’s approval ratings are quite low.  According to the Real Clear politics poll average, 46.4% of those polled approve of the job President Obama is doing and 47.8% of those polled disapprove.  So, in aggregate, less than half of the country approves President Obama and more disapprove than approve.  Interestingly, in the Rasmussen Daily Tracking poll (which we have highlighted below with a picture of Hedgeye’s own sailor, Zach “The Hammer” Brown), President Obama has improved over the last month or so.  His current approval index is -13 (which is the difference between Strongly Approve and Strongly Disapprove), which is an improvement off his all time low on May 26th, 2010 of -22.  Despite this improvement, the point is President Obama’s approval rating is low, which won’t bode well for the Democrats.




EARLY LOOK: Corner Banging - chart2


The other important point to consider is that there is substantial dissatisfaction with politicians these days.  In fact, congressional approval is as low as it’s ever been, so the concept of incumbency advantage is likely going to be less impactful than typical this election.  As I wrote back in May:
“As many studies note, incumbents typically win re-election 90% of the time.  These early data points are noteworthy and mark the beginning of perhaps a serious shift by voters away from incumbency. This idea is also supported in recent polls.  Specifically, a recent ABC News-Washington Post poll indicated that nearly six in 10 respondents they’re not likely to vote for their current representatives to Congress.”
A backlash against incumbents naturally hurts the Democrats because they hold more seats.
As we survey the Electoral Ocean in front of us this is what the polls looks like in terms of the shift of power according to the poll averages at Real Clear Politics:

  • Republicans to pick up 8 seats in the Senate but the Democrats will retain control at 51 to 49;
  • Republicans will win 206 seats in the House, the Democrats will win 194 seats and 35 seats are a tossup currently; and
  • The Republicans will pick up 8 governor seats to hold a 32 to 18 seat advantage.


The potential for major Republican victory in the fall is realistic, and we need every advantage we can get to ensure we fully understand the probabilities.  Keith and I hope you will join us on Tuesday.
As you head into the long weekend with your friends and family, I’ll leave you with one more quote from Mark Twain:
“Denial ain’t just a river in Egypt.”
Enjoy the weekend.
Yours in risk management,
Daryl G. Jones


TODAY’S S&P 500 SET-UP - September 3, 2010

As we look at today’s set up for the S&P 500, the range is 30 points or 2.7% (1,061) downside and 0.01% (1,091) upside. 

Equity futures are trading flat to higher as the market awaits key US non-farm payroll data later. Today's macro highlights include: Aug Nonfarm Payrolls, Aug Unemployment Rate, Aug Private Nonfarm Payrolls, and Aug ISM Non-Manufacturing Index.

  • Arcsight (ARST) didn’t mention sale in 1Q earnings after WSJ last week reported co. is on the auction block
  • Esterline Technologies (ESL) boosted 2010 EPS forecast to $3.85-$3.95 from $3.45-$3.65, vs est. $3.60
  • Finisar (FNSR) forecast 2Q rev. $215m-$230m vs est. $206.1m
  • H&R Block (HRB) reported 4Q loss per share of $0.36 vs estimate of a loss of $0.41
  • Krispy Kreme Doughnuts (KKD) forecast FY11 operating income ex charges $13m-$17m, up from prev. guidance $11m-$15m
  • Quicksilver (ZQK) reported 3Q rev. $441.5m vs estimate $443.7m
  • SeaChange International (SEAC) CUTS FY rev. forecast to $215m-$220m from $225m-$235m
  • Sunoco (SUN) said former GM CEO Frederick A. Henderson has joined the company as a senior VP
  • Take-Two Interactive Software (TTWO) boosts FY adj. EPS forecast to $0.60-$0.70, from loss $0.10-$0.30, vs estimate $0.20 loss
  • Ulta Salon Cosmetics & Fragrance (ULTA) forecast 3Q adj. EPS $0.20-$0.22c vs estimate $0.17
  • U.S. Airways Group (LCC) said August passenger rev. per available seat mile increased estimate 15%


  • One day: Dow +0.49%, S&P +0.91%, Nasdaq +1.06%, Russell 2000 +1.16%
  • Month-to-date: Dow +3.05%, S&P +3.89%, Nasdaq +4.07%, Russell +5.02%
  • Quarter-to-date: Dow +5.59%, S&P +5.76%, Nasdaq +4.30%, Russell +3.74%
  • Year-to-date: Dow (1.04%), S&P (2.24%), Nasdaq (3.05%), Russell +1.10%


  • ADVANCE/DECLINE LINE: 1228 (-1005)
  • VOLUME: NYSE - 960.71 (-19%) - volume drying up ahead of the jobs report
  • SECTOR PERFORMANCE: All sectors up XLU
  • MARKET LEADING/LAGGING STOCKS YESTERDAY: Nordstrom +8.05%, Goodyear Tire +6.30% and LTD Brands +6.10%/Abercrombie -3.88%, Tyson -3.32% and Total Systems -3.30%
  • VIX: 23.19 -2.93% - down 15.3% in past week - YTD PERFORMANCE - +7.0%         
  • SPX PUT/CALL RATIO: 1.32 from 1.21  


  • TED SPREAD: 16.91 +0.249 (1.495%)
  •  3-MONTH T-BILL YIELD .14% +.01%
  • YIELD CURVE: 2.13 from 2.08


  • CRB: 271.15 +0.98%
  • Oil: 75.02 +1.50% - a 2 day rally looks to end today
  • COPPER: 349.55 +0.52% - Dr C ragging ahead again
  • GOLD: 1,250 -0.36% - up 4 of the last 5 days


  • EURO: 1.2808 +0.09% - looking at a 4 day rally
  • DOLLAR: 82.463 -0.07% - looking to be down for the last 3 days



  • Nikkei +0.57%; Shanghai Composite (0.01%)
  • Most Asian markets ended higher or flat fuelled on the day. Technology stocks in the region outperformed tracking Nasdaq’s rise yesterday.



  • FTSE 100: +0.25%; DAX +0.31%; CAC 40: +0.40%
  • Major European indices are trading flat ahead of US non-farm payroll data later today. Technology stocks are higher in the region tracking gains by their peers in Asia earlier and on the Nasdaq yesterday. Food & Beverages and Autos are among the worst performing sectors this morning in Europe.
  • UK Aug Services PMI 51.3 vs consensus 52.9 and prior 53.1
  • EuroZone Aug Final Services PMI 55.9 vs preliminary 55.6
  • EuroZone Aug Final Composite PMI 56.2 vs preliminary 56.1
  • Germany Aug Final Services PMI 57.2 vs preliminary 58.5
  • France Aug Final Services PMI 60.4 vs preliminary 59.9
  • Eurozone July Retail Sales +1.1% y/y vs consensus +0.6% and prior revised +1.2% from +0.4% 
Howard Penney
Managing Director












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