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RT: STRONG QUARTER

RT’s results last night were significant for both the company and, being somewhat of a first glimpse for this earnings season, for the wider casual dining space.  In terms of the company itself, as we can see in the quadrant chart below, margin expansion was sustained despite a significant step up in the difficulty of the year-over-year comparison from 1QFY10 to 2QFY10.  Same-store sales stole the show, though, with company-owned same-store sales growth coming in at +4.2%.  This is the best result on that metric since 4QFY06.

 

RT: STRONG QUARTER - rt quadrant

 

The same-store sales result also implies a significant gain in market share for the company.  The gap between RT’s sales and the Knapp-Track casual dining benchmark widened further over the most recently reported quarter on a one-year and two-year basis.   RT’s Gap-to-Knapp increased to +3.1% in 2QFY11 from the prior quarter.  On a two-year average basis, the Gap-to-Knapp increased to +3.4% from 2.6% in the prior quarter.   

 

In terms of the income statement, there were no significant red flags.  SG&A expense was up 130 basis points year-over-year as a result of testing the company’s new coupon strategy in national magazines and various other digital advertising expenses.  This was offset by a decline in interest expense due to a lower average debt balance and a lower effective interest rate due to a lower spread to LIBOR as a result of improved leverage ratios.  The tax rate was 13.3%, which was significantly down from 47.4% last year, but even a tax rate of 25% would only have made a difference of approximately $0.01.

 

In terms of outlook, management did not change their FY11 guidance.  From a comparison perspective, 2HFY11 is more difficult for RT than the first half of the year.  In 4QFY11, the company will be facing its first positive year-over-year same-store sales comparison since 4QFY07.  Notwithstanding this, given that two-year average same-store sales accelerated year-over-year by 220 basis points, management’s FY11 guidance of flat to +2% now seems conservative.  During the Q&A session of the Earnings Call, management cited the still-fragile U.S. economy and lack of predictability of business conditions as reasons for the hesitancy to raise guidance on the back of the strong 2QFY11 performance. 

 

Despite their cautious stance, however, management also implied current guidance may be conservative and stated that it is not a reflection of weakening trends, but rather a decision to not update guidance as opposed to offering fresh guidance.  Specifically, CEO Sandy Beall stated, “We’re in the – needless to say we feel comfortable with the guidance range we’ve given. We hope we can beat it and if that looks bad, it looks bad. But hopefully we can beat it. We don’t want to go out there over promising, the world’s not easy. It’s not easy, yet. It’s not as predictable as it used to be in the old days.”

 

The company is also lapping 19.5% and 19.7% restaurant level margin from 3Q10 and 4Q10, respectively, versus 15.9% and 13.7% in 1Q10 and 2Q10, respectively.  Management commentary on costs for the remainder of the year didn’t raise any concerns; food costs are expected to remain relatively stable compared to the prior year and restaurant operating margins, overall, are expected to be flat for the year which implies a slowdown in margins in 2HFY11 (given that margins were up 200 bps in 1Q11 and 140 bps in 2Q11).  This margin guidance would imply that RT would fall out of the Nirvana quadrant of our restaurant sigma chart in 2HFY11 after operating in Nirvana for three consecutive quarters.  Again, if same-store sales outperform the guidance range, margins could also come in better than management is forecasting.

 

Besides the fragile overall macro environment that Founder, President and CEO Sandy Beall alluded to - which is obviously the prevailing factor in RT’s ability to generate strong results for shareholders – RT seems well-poised for the remainder of FY11. 

 

With regard to December trends, management stated that there was a slowdown in trends from the 4% levels of 2QFY11, but that the performance was “reasonably good” despite the weather which affected everybody, “at least in the Eastern United States”.  Management highlighted Florida and New England as high-performing geographies for RT in the quarter ended November 30th.  RT’s peers are performing well today; along with RT, RRGB, CAKE, EAT, DRI and PFCB are all trading up.  Yesterday saw a divergence in price action with EAT trading up on accelerating volume with DRI, CAKE, RRGB, and PFCB trading down on accelerating volume.

 

Howard Penney

Managing Director


Is Swine Flu a Tail Risk You Are Contemplating?

Our Healthcare Sector Head Tom Tobin called out a global macro risk to us the other day that we had not been considering, the reemergence of swine flu (H1N1).  In the United Kingdom, almost 36 people have died of the virus this flu season.  Interestingly, almost all were under 65 years of age and, according to reports, 40 percent of the fatalities did not have the usual risk factors (weak immune systems, primarily).

 

Ireland, in particular, is seeing an acceleration in swine flu activity.  According the Public Health Agency in Ireland, as of the week ending January 2nd, reported swine flu cases had grown from 30 to 91 week-over-week – a +190% increase in seven days! (albeit on small numbers)

 

As a refresher, the H1N1 form of the swine flu is descended from the strain that caused the 1918 flu pandemic, which was estimated to have killed 50 – 100MM people globally.   The symptoms to swine flu are similar to other flues – chills, fever, sore throat, muscle pain, and general discomfort.   Fatalities occur as these symptoms accelerate, and the most common reasons for death are respiratory failure, pneumonia, dehydration, and kidney failure.  Not surprisingly, fatalities are most common in the young and elderly, which is what makes the recent strain in the U.K. interesting to note, as 40% of the fatalities did not come from this target group.

 

We actually did a Google analytics analysis to understand whether swine flu is a risk the investors are currently considering.  As the chart below outlines, currently search volume for the term swine flu is well below levels in 2009 and, in fact, search activity is quite low overall. 

 

Is Swine Flu a Tail Risk You Are Contemplating? - 1

 

Interestingly, we also looked at the last 30 days of search activity and noticed that swine flu search activity is beginning to break out to the upside, which suggests that the idea of swine flu as macro risk is gaining momentum.

 

Is Swine Flu a Tail Risk You Are Contemplating? - 2

 

In 2009, the World Health Organization (WHO) declared swine flu a pandemic and President Obama declared a state of emergency after more than 1,000 people had died from it.  In August 2010, the WHO officially declared the pandemic over.  While we are not trying to be alarmists in suggesting that a new pandemic is coming, we did want to highlight that there is evidence of a pickup in infections, which is not currently priced into expectations based on the low relative amount of Google search activity.

 

While it is tough to measure the potential economic impact from a broader breakout, it is likely fair to suggest that even a mild pickup in activity would hurt confidence and have a more severe impact on the travel and hospitality industries.  In 2009, the Brookings Institute estimates that “a mild scenario would cost the global economy about $360 billion and an ultra scenario up to $4 trillion within the year of the outbreak.”  Even if we are early and wrong, those are numbers that make this a Tail Risk worth considering. 

 

Daryl G. Jones

Managing Director


Government Whispering: Ahead of Tommorrow's Jobs #

Ahead of tomorrow’s US jobs print, here are some of our team’s thoughts: 

  1. Whisper of 580,000 payroll adds has been going around since yesterday
  2. Every market rally (from yesterday’s pre-market futures lows) has been followed up with people reminding me of the whisper
  3. Government Whispering is turning into the casino that Big Government Intervention built into your markets – get used to it 

Where are we at on estimates versus expectations: 

  1. The payroll number could be at least 3x consensus (it started the wk at 125,000 which is a bit of a joke)
  2. The question now is can it be 2x that (or better than the whisper of 580,000)? 

In terms of what an improving jobs picture actually means for the interconnected macro markets tomorrow: 

  1. BONDS: definitely baking this in (collapsing UST’s have been for a month and yields are bullish TRADE, TREND, and TAIL in our model)
  2. FX: definitely, maybe overly, baking this in (USD had its best day in a month yesterday and up again today)
  3. STOCKS: are trying their best to bake this in, but I think they’re going to look late 

Too late, because January looks more like November did to us (when the SPX was down) in terms of US growth, employment, and confidence trends (ABC conf hit -45 this week, down for 2 weeks in a row, and jobless claims this morn were more in line with what we see in the intermediate term TREND = Jobless Stagflation. The hype about US growth recovery is certainly getting disconnected with some very big cap consumer stocks (BBY, MCD, TGT, GPS, M, etc)…

 

From Josh Steiner:

 

I cannot speak to the NFP mousetrap that Barclays has built (my old alma mater), but I will say that our preferred method for tracking the employment situation is jobless claims. Jobless claims had their big move in December and that fueled much of the market rally over that time, so it would seem like a further rally on NFP for December would be overkill, though that’s not to say it won’t happen given how short-sighted this market is. Bigger picture, taking a step back from this one datapoint, our work suggests that claims will actually worsen over the next 4-6 weeks as they did in both 2010 and 2009, which may make tomorrow’s number a last gasp of good news on the employment front for some time, so the question becomes do you want to use that as an entry or an exit point? You also have to wonder about the importance of a single NFP print that disconnected from the claims series.

 

Not that anyone seems to care about the unemployment rate anymore, but there is very little likelihood that it will come down anytime soon based on the degree of contraction in the labor force participation rate, which is actually understating unemployment by around two whole percentage points.

 

From Howard Penney:

 

A few more relevant data points related to deteriorating or stagnant labor market conditions.

  1. The ISM’s purchasing managers survey (manufacturing) showed the December employment diffusion index dropping to 55.7 versus 57.5 in November.  The December reading was the lowest since March 2010. 
  2. The ISM’s purchasing managers survey (services) also showed the December employment diffusion index declining, from 52.7 in November to 50.5 in December.  The December reading was the lowest since September 2010. 

In Conclusion:

 

Tomorrow’s jobs # isn’t about anything other than the whisper at this point. Missing the whisper is probably as bad as smoking it (intraday rallies this week have been based on this 580k whisper, while the rest of the world’s stock markets in Asia and Europe have sold off). The short term performance spread between the VIX and SPX hasn’t been this wide since, well, ever.

 

That’s a very risky inverse relationship to be rolling the bones on the long side in front of a macro catalyst. At a bare minimum, that’s not what we are going to tell you to do.

 

Yours in risk management,

KM


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INITIAL JOBLESS CLAIMS RISE 21K - EXPECT A PAUSE IN IMPROVEMENT GOING FORWARD

Initial Claims Rise 21k

The headline initial claims number rose 21k week over week to 409k (18k after a 3k upward revision to last week’s data).  Rolling claims fell 3.5k to 411.25k.  We continue to remind investors that based on our analysis of past cycles, the unemployment rate won't improve until we see claims move into the 375-400k range. That said, it is worth highlighting an important caveat. This recession has been different in that it has pushed the labor force participation rate down by ~200 bps, which has had a correspondingly positive improvement on the unemployment rate. In other words, the unemployment rate isn't really 9.8%, it's 11.8%. So when we say that claims of 375-400k will start to bring down the unemployment rate, we are actually referring to the 11.8% actual rate as opposed to the 9.8% reported rate.

 

One thing worth pointing out is that in the last two years the first several weeks of the new year have seen raw SA claims rise. We would expect to see this trend continue. If not, it would suggest a stronger underlying improvement in the jobs environment.

 

INITIAL JOBLESS CLAIMS RISE 21K - EXPECT A PAUSE IN IMPROVEMENT GOING FORWARD - 1

 

INITIAL JOBLESS CLAIMS RISE 21K - EXPECT A PAUSE IN IMPROVEMENT GOING FORWARD - 2

 

There is seasonality in initial claims, which the BLS makes an effort to remove via the seasonal adjustment factor.  Below we show the non-seasonally adjusted initial claims series for purposes of comparison.  

 

INITIAL JOBLESS CLAIMS RISE 21K - EXPECT A PAUSE IN IMPROVEMENT GOING FORWARD - 3

 

In the table below, we chart US equity correlations with Initial Claims, the Dollar Index, and US 10Y Treasury yields on a weekly basis going back 3 months, 1 year, and 3 years.

 

INITIAL JOBLESS CLAIMS RISE 21K - EXPECT A PAUSE IN IMPROVEMENT GOING FORWARD - 4

 

Joshua Steiner, CFA

 

Allison Kaptur


European Chart of the Day: UK Services PMI

Position: Long Germany (EWG); Short Italy (EWI), Euro (FXE)

 

UK Services PMI for December declined to 49.7 versus 53.0 in November, and importantly fell below the 50 level that divides expansion (above 50) and contraction (below 50).

 

As we’ve noted in previous work, including yesterday’s piece titled “Europe’s New Year’s Update”, we believe inflation in the UK will continue to be a negative headwind in 2011. In the most recent Bank of England Minutes the committee concluded that over the intermediate term CPI could reach as high as 4.0%. Even at its current level of 3.3% Y/Y we’re cautioning that consumption can be chocked off.

 

While UK Manufacturing PMI showed a gain to 58.3 in December (the highest in 16 years) versus 57.5 in November, given the prospects for slower growth this year, including the economies of its main trading partners in Europe, there’s reason for caution. The UK’s austerity program over the next 4 years is a tax on the consumer and should weigh on confidence to the downside. With Services a stronger driver of overall growth than manufacturing in the UK, we believe this inflection in the Services PMI is meaningful and stagflation may not be far afield.

 

Currently we’re playing Europe’s Sovereign Debt Dichotomy with a short position in Italy (we re-shorted the etf EWI on 1/4), and are short the Euro (FXE) with a TRADE range of $1.30-$1.32 versus the USD. We remain long Germany (EWG) in our Virtual Portfolio.

 

The BoE meets next on January 13th to announce its interest rate policy, with consensus expectations of no change to the current main rate of 0.50%.

 

Matthew Hedrick

Analyst

 

European Chart of the Day: UK Services PMI - UK Services


INITIAL JOBLESS CLAIMS RISE 21K - EXPECT A PAUSE IN IMPROVEMENT GOING FORWARD

Initial Claims Rise 21k

The headline initial claims number rose 21k week over week to 409k (18k after a 3k upward revision to last week’s data).  Rolling claims fell 3.5k to 411.25k.  We continue to remind investors that based on our analysis of past cycles, the unemployment rate won't improve until we see claims move into the 375-400k range. That said, it is worth highlighting an important caveat. This recession has been different in that it has pushed the labor force participation rate down by ~200 bps, which has had a correspondingly positive improvement on the unemployment rate. In other words, the unemployment rate isn't really 9.8%, it's 11.8%. So when we say that claims of 375-400k will start to bring down the unemployment rate, we are actually referring to the 11.8% actual rate as opposed to the 9.8% reported rate.

 

One thing worth pointing out is that in the last two years the first several weeks of the new year have seen raw SA claims rise. We would expect to see this trend continue. If not, it would suggest a stronger underlying improvement in the jobs environment.

 

INITIAL JOBLESS CLAIMS RISE 21K - EXPECT A PAUSE IN IMPROVEMENT GOING FORWARD - rolling claims

 

INITIAL JOBLESS CLAIMS RISE 21K - EXPECT A PAUSE IN IMPROVEMENT GOING FORWARD - raw claims

 

There is seasonality in initial claims, which the BLS makes an effort to remove via the seasonal adjustment factor.  Below we show the non-seasonally adjusted initial claims series for purposes of comparison.  

 

INITIAL JOBLESS CLAIMS RISE 21K - EXPECT A PAUSE IN IMPROVEMENT GOING FORWARD - claims NSA

 

Yield Curve Remains Wide

We chart the 2-10 spread as a proxy for the trend in industry NIM. Thus far the spread in 1Q is tracking 38 bps wider than 4Q.  The current level of 276 bps is up from 272 bps last week.

 

INITIAL JOBLESS CLAIMS RISE 21K - EXPECT A PAUSE IN IMPROVEMENT GOING FORWARD - spread

 

INITIAL JOBLESS CLAIMS RISE 21K - EXPECT A PAUSE IN IMPROVEMENT GOING FORWARD - spreads QoQ

 

Financial Subsector Performance

The table below shows the stock performance of each Financial subsector over four durations. 

 

INITIAL JOBLESS CLAIMS RISE 21K - EXPECT A PAUSE IN IMPROVEMENT GOING FORWARD - subsector perf

 

 

Joshua Steiner, CFA

 

Allison Kaptur


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