DRI - There does not appear to be a Macro Process

My number one concern about DRI continues to stem from the company’s new unit growth targets, which I don’t think properly reflect the current environment. Management acknowledged the tough environment saying, “There's no question it has been a difficult quarter and given the difficult economic environment, it looks like it is going to be a challenging year. Our current sales and earnings outlook reflects that.” Despite these challenging times when operating profit growth declined at each of the company’s core concepts, Red Lobster comparable sales declined for the third consecutive quarter with traffic down about 5.5% in 1Q and LongHorn posted a 4.9% same-store sales decline with traffic down about 7%, DRI maintained its FY09 unit growth targets (75-80 new restaurants, or 4%-5% unit growth).
DRI management has been saying for some time now that the company’s plan to achieve sustainable growth at Red Lobster has three phases: first phase was to strengthen brand fundamentals. The second phase included refreshing the brand, broadening its appeal and building guest counts. The third phase included accelerating new unit growth. As early as 4Q07, DRI communicated that this plan included the expectation that phase 3, or new unit growth, would begin later in FY09. I would have thought phase 3 would have been contingent on phase 2 having been accomplished, but the company stated again today that it will resume meaningful unit growth in 2H09 and expects to open 10 net new restaurants. Management admitted that although operating fundamentals (phase 1) have greatly improved, that Red Lobster is still working to “broaden the appeal of their brand and recapture lapsed users,” which communicated to me that they understand that phase 2 has not been completed, but they are moving ahead with phase 3 regardless. Traffic continues to decline (again, part of phase 2), but management appears unwilling to back away from their initial forecast for growth in FY09.

Apparently, I am not the only one concerned about DRI’s growth outlook as management was questioned on its conference call this morning about its continued commitment to restaurant development at Red Lobster in 2H09 relative to the concept’s performing below expectations. CEO Clarence Otis replied by saying that from a traffic standpoint, Red Lobster has outperformed the industry in the last couple of years with a materially higher average check, which leads him to believe Red Lobster has performed strong competitively. I found this answer to be a little surprising because the industry has experienced negative traffic for the better part of the last three years so outperforming these negative metrics will not lead to enhanced returns.

Additionally, Mr. Otis said that the decision to add new Red Lobster units is more of a restaurant by restaurant and market by market type of analysis. “I don't know that we have a pace of expansion that we think makes sense versus we scour the country and look at the markets and decide market by market does this restaurant make sense from a return perspective. And so it is very much a bottom up driven expansion. Here's a market that's expanded, that is strong a trade area we think we can get X guests out of. It makes sense to open this restaurant. All that adds up to five one year, other years to ten. It is more about that, and to the extent that the guest count level that we start to make that restaurant by restaurant assumption from is lower and we scale out over 30 years, fewer trade areas will make sense. So that's a little bit of how we think about Red Lobster. I don't know that there's a master plan as opposed to a unit by unit investment decision.” I found this comment to be interesting because if the CEO does not know the master plan, who does? Given the trends in the quarter and the outlook for the balance of the year combined with the current level of unemployment, trends in macro factors would point to a different strategy.

MCD – Coffee could be the tipping point!

Yesterday, at the Bank of America investor conference, MCD’s Chief Operating Officer Ralph Alvarez said MCD is working to renovate it’s drive-thus in the U.S. to accommodate making the new drinks. He went on to say that all of McDonald's Corp.'s U.S. locations should be able to offer espresso drinks by the middle of next year, with a new line of smoothies and frappes on all menus by 2010.

How is this possible!

To reiterate what I posted last month, here are is what we know so far:

4Q07 – No comment from the company when asked on the conference call about the number of stores selling specialty coffee, but they did not expect to see critical mass until later in 2009.

1Q08 – “We are currently in about 1300 restaurants and expect the rollout to accelerate and pick up pace later in the year.”

2Q08 – “Specialty coffees is just one element of the combined beverage business and it’s currently in more than 1600 restaurants.”

3Q08E - ???

If we assume the company accelerates the conversion process in 2H08 and converts 1,200 stores, the total number of McDonald’s stores with the ability to sell specialty coffee in the US would be 2,800. This represents only 25% of the McDonald’s system! McDonald’s senior management has set expectations for a national launch for the specialty coffee program in mid-2009. If it has not started already, the 2009 budgeting process needs to incorporate the national launch of the specialty coffee program. If only 25% of the store base has the ability to sell specialty coffee, how can the company justify spending the marketing dollars in 2009? More importantly, will the franchise system embrace the move?

I believe they need to reset expectations.

A "One on One" some didnt get - the masses are meeting TED today!

This TED spread that we have been ranting about for the past 3 months is finally finding mainstream groupthink. Facts are hard to ignore, particularly when they are flashed to your boss or bank, after the fact!

Below we have updated the reality of the situation on both a 3 month and 3 year basis. US Treasury yields look more and more like Japanese ones as of late. European bond investors are running for the exits. LIBOR continues to track higher.

The Fed Funds rate in this country needs to be raised. Creating cheap money leverage cycles is not the answer to this structural problem.

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Focus Chart Of The Day: The US Dollar

After a massive +12% move in a compressed period of time (9 weeks), the US Dollar has indeed proven that cold hard American cash is king. But what next? Post the AIG deal, Bernanke and Paulson have the bailout balance sheet of the US Government taking on water again... this is US$ bearish, on the margin - and everything that matters in markets happens on the margin.
  • I had short term momentum support at $79.25. That broke today as the US$ Index weakens to $78.83. Next support is $78.21. If that levee doesn't hold, watch out below.
chart courtesy of

CKR is like Braveheart

Like William Wallace in the movie Braveheart, CKR is trying to break out of the oppressive U.S. restaurant environment. At 6.4x NTM EV/EBITDA, the stock is a relative bargain. Its core brands continue to post same-store sales in line with or better than other QSR operators. The river card for CKR will be the company’s ability to overcome significant food inflation when its reports EPS on Sept 18th. With short term commodity trends looking favorable, compared to a disastrous fiscal 2008, the earnings and forward-looking commentary should be positive.

The Truth

Look at the means which a man employs, consider his motives, observe his pleasures. A man simply cannot conceal himself!

Its global this time, indeed. It’s ‘Macro Time’ out there too, so let’s get at it and take some proactive measures of leadership this morning. AIG collapsing last night reminds us all that you are only as safe as the quality of your management. Leadership and cash remain kings.

Not all cash is king. Asian or Eastern European cash is actually frightening right here and now. Alongside a terrorist attack overnight on the US Embassy in Yemen, we have an attack on King Dollar too. The unthinkable has been revealed – the oldest money market fund in America, the “Reserve Primary Fund” was levered long Lehman Debt! Welcome to the new rules of ‘You Tubing’ the US Financial system. After revealing the truth, the “Reserve” fund saw 60% of its assets liquidated. Who is managing your cash? JP Morgan and my mattress have mine.

Transparency, Accountability, and Trust – simple concepts, yet so difficult for the greed mongers out there to uphold. The aforementioned Confucius quote is classic and it’s ringing in the ears of American living rooms all of a sudden. I have looked into the whites of the eyes of plenty of Wall Street’s said leaders. Some are the highest integrity people I have ever met, but then there are the others – give a person a lot of money, and their true character is revealed.

Back to the global economy, Japan and Russia are giving out dump truck loads of cash in trying to stabilize their markets right now. I’m ok with the Nikkei rallying +1.2% overnight, primarily because we covered our Japan (EWJ ) short yesterday, and now I can re-short it higher. The facts remain the same in Japan – they run a government sponsored bailout program at every hint of economic duress, and continue to suffer a generational malaise of economic stagnation as a result. The Bank of Japan kept rates at a free money rate last night of 0.50% - that’s no surprise. What is a surprise is the expediency by which they are injecting Yen into their economy. After plowing another 1 Trillion Yen into its domestic money market last night, my scorecard has it at 4 massive cash injections in the last 2 days!

Russia is doing the same, and to zero avail. They are in the midst of halting the Russian stock market’s trading right here and now as the Russian Trading System Index is down another -6.4% this morning at 1058. Since our “Fading Fast Money” call on 5/19, the former KGB leadership has lost -57% of their country's stock market value. Since the beginning of September alone the RTSI is down -36%!! Between China trading down another -2.9% last night, taking its cumulative losses close to -70% since October, and the implosion in Brazilian and Indian equity markets, you don’t need Larry Kudlow to define whether or not these are called “crashes”. Remember, the bullish narrative of the acronym “BRIC”? I do. This global economic crisis looks more like a brick to the forehead.

Lehman, AIG and Linen’s & Things going under is all about the same thing, a complex system of interconnect global market factors that are colliding with one another. While CNBC is focused on AIG this morning, the governing coalition in the Ukraine is collapsing. The Ukrainian stock market was down -14% yesterday! It’s down -71% since January, and no one is talking about it! We hockey players have never been accused of being an overly intelligent bunch, but I for one can read a map. The economic contagion associated with the Russian fallout in Georgia is real.

I know, I know. Wall Street billionaire’s are the “smart” money. Who am I to call these said “leaders” onto the mat? Well, the good news is that more people are behind my proactive plan with each passing day. Confucius was intelligent, so take it from him rather than me - the lack of foresight, judgment, and leadership in our financial system can no longer be “concealed”.

I bought and covered 8 positions in the ‘Hedgeye Portfolio’ yesterday at the level that I issued in yesterday’s note (1172-1196 in the S&P500). I moved to 82% cash, down from 84%. I have a proactive risk management plan that I am happy to share with 100% transparency, and I execute against it. That’s it.

Keep it simple stupid is what you can say to me, and I am cool with that. Don’t forget to keep a “Trade” a trade however, all the while. Name calling is cool too – this is a full contact sport, and I can take a punch. Two hours until US market open game time. Let’s get at it.


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