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    MARKET EDGES

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The following is a monthly look at restaurant trends, valuations, and key macroeconomic factors.  For a complete look at my overview of the restaurant space for January, please click here for a pdf, or copy and paste the link into your browser: http://docs.hedgeye.com/Restaurant%20Perspectives.pdf

JANUARY THEMES:

  • Consumer stocks are underperforming in January and Restaurant stocks underperformed the S&P 500 by 180bps in January. 
  • Heading into what I believe will be a turbulent year for restaurant stocks from a commodity cost perspective, there is a divergence between companies that have simplified their focus and operations and those that are less focused and, therefore, more exposed.
  • EAT, SBUX, COSI, and – most recently- WEN, are a few of the management teams that I think are focusing their energy in the right areas and best positioning their companies to navigate 2011.
  • I still like where SBUX is going with is business model and that is good for PEET and bad for GMCR.
  • I continue to believe that MCD faces serious challenges in 2011, as detailed in my Black Book released mid-January.  The company has been less and less focused on its core business over the past couple of years.  While that worked in the short term, boosting comps through frappes and smoothies, in 2011 I believe MCD will face serious issues with slowing sales and soft margins.
  • DRI’s inflation outlook for FY 2012 is sobering and the company will likely experience margin compression in FY 2012.

QSR VALUATION THOUGHTS:

  • CMG continues to maintain its premium valuation, as it has been for some time.  While its food with integrity resonates with consumers, concerns are emerging about the company’s commodity exposure.  Longer term its new focus on an Asian-style chain will likely be a negative, not a positive, for the stock.
  • I expect GMCR’s multiple to contract as SBUX paves its own way through different channels of the coffee category.
  • WEN is cheap and set to improve returns with a more focused approach now that Arby’s is on the block.

FULL SERVICE VALUATION THOUGHTS:

  • EAT remains one of the cheaper names in this category from a valuation perspective and the potential upside remains significant.  I expect a continued improvement in the relative fundamentals of the company on the top line as well as marked progress towards the net 400 bps of margin expansion management is targeting.
  • Like it or not, weather is an issue for the group.

THE HEADWINDS FACING THE CONSUMER:

  1. Inflation – it’s not just in Egypt that people are fed up with high food costs.
  2. Unemployment – the jobs picture has been improving but at a crawl.
  3. Consumer sentiment – points 1 and 2 are keeping sentiment down.  There is a disconnect between sentiment surveys and the SPX.
  4. The Government continues to support consumer spending trends, but the impact will wane as we move through 2011.

Howard Penney

Managing Director