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MORE ON THE ALL IMPORTANT RELATIONSHIP: PRICE VS. TRAFFIC

O’Charley’s said at an investor conference yesterday that based on the casual dining industry numbers it is seeing, August was the worst sales period in 30 years. This statement reaffirms our view that the industry has not yet entered a period of stabilization, but instead continues to deteriorate at an accelerated pace. Management went on to say it would expect to see casual dining operators raise prices more aggressively than normal (up 3%-4% or more) in an effort to protect margins. The company said this is in line with Darden’s comments that it expects to increase FY09 prices at the higher end of its historical 2%-3% range versus its more typical 2.5% increase.

The primary driver of recent same-store sales weakness for casual dining restaurants has been negative traffic. In August, traffic declined 6.0% after falling 6.2% in July so although I am encouraged to hear O’Charley’s is focused on its margins and not just offering promotions across the board, I do not know if aggressive pricing is the answer to deteriorating traffic trends.

Short Selling Ban, Part III: Implications for Implied Volatility

Compromised markets create compromised data.

The impact of the short ban on the equity options market has been profound. There is debate surrounding the S&P level for Friday’s open that was used to calculate settlements given the fact that the final status of outlier prints on financial stocks from that morning is still up in the air. Meanwhile, bid ask spreads in some put series are wide enough to drive a truck through and the normally staid volatility levels for blue chips like GE are in the 40’s or higher.

When we say “volatility” we are talking about one of two things –either realized historical volatility or the volatility implied by option premiums. The VIX Index, the most commonly used barometer of market volatility, is a measure of the implied volatility of options on the S&P 500.

Implied volatility is calculated through a process of reverse engineering. Using a pricing formula such as Black Scholes, the premium for an option is used to derive the implied volatility level by backing out the known aspects (the maturity and strike price) as well as assumptions (the financing rate and hedge). These pricing formulas are all based on the assumption that a trader will be able to freely hedge the option exposure in the underlying market. The shorting ban leaves implied volatility calculations for those stocks heavily compromised by asymmetrical liquidity.

This may sound very abstract and irrelevant at first, but consider what a significant portion of equity trading volume is generated by quantitative managers who rely on implied volatility as an input for their modeling process. By changing the rules mid-game the SEC may be forcing these players to head for the sidelines.

Andrew Barber
Director

Hail Hagupit

Typhoon Hagupit is causing significant disruption in South East Asia, resulting in flight cancellations and ferry service suspensions. Hagupit is currently classified as a Gale Signal 8 (out of 10) which is the equivalent of a category three hurricane. The worst effects of the typhoon may be felt in Macau late afternoon today, Eastern Standard Time (early tomorrow morning Macau time), according to our source in Macau.

While we expect the existing casinos to withstand Hagupit with only limited damages, there is risk to the gaming projects currently under development. LVS has some major projects under construction on lots 5 and 6. Parcel 5 will include three hotels (two Shangri-La Hotels and Traders and one St. Regis), a casino, a retail shopping mall and approximately 320 serviced luxury apartment hotel units. Parcel 6 will be comprised of two hotels (Starwood’s Sheraton brand), a casino and a retail shopping mall. City of Dreams, a project being undertaken by Melco PBL Entertainment, could also see construction disruption. Damages and opening delays are likely.

We will have an update on any damages later today or tomorrow.


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These Senatorial Statements Don't Sound Supportive...

I don't want to breakdown each of these politically partisan statements. If you are watching this on TV right now, you'll notice that both the ranking Republican and Democrat are equally negative on Paulson's plan.

Be careful out there. This is going to take time to fix.
KM

GPS: Gap Doing Something Right???

It’s rare that Gap, Inc gives me an opportunity to pat it on the back for anything, but its deal to buy Athleta for $150mm (about 1.5x sales) makes a ton of sense to me.
  • We’re talking a rounding error to Gap’s P&L and balance sheet – Athleta is only 0.6% of sales – but from a fragmentation standpoint this is the way to go. Aside from certain high-end apparel categories, the athletic space is the only growing category that consistently grows, and the fruits are largely shared by fewer than a dozen brands (Nike, Adidas, UnderArmour, Lulu, Lucy, Champion, Juicy, Reebok, Asics, and Russell). Gap’s core brands, on the flip side, compete with virtually everyone. Not good.
  • This actually gets Gap into a category where it can add some value. In fact, I wouldn’t be surprised if we’re sitting here 3 years out and Gap has grown this into a $300-$400mm brand.
  • Unfortunately for Gap, that’s still a rounding error to its P&L – especially given the margin pressure it has yet to see in its core.
  • Also, I can’t reiterate enough how ridiculous of an idea it is to drive an e-commerce strategy with ALL of Gap’s concepts as part of one customer experience. If I were running Banana Republic, this would take my blood pressure up big time to see customers meshing my assortments with that of Old Navy.
Gap finally getting into a segment of the market that actually grows.
4 (now 5) brands on 1 site... I don't buy it. Crossing over brands marketed to different consumers is a bad deal.

Restaurants/Food – Despite the malaise there are some stock that look good!

Thoughts from Keith's multi-factor model……

Bad break on EAT today, closing below my 18.98 sup line... amazing what any sell side noise is doing to stocks

DIN cracking, looks 15.42 next

PNRA battled it out, and won - looking for an upside test of 60.61

HSY still rides higher on that rumor, looks like $44-45 next; love this name - people hate it

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