Restaurants @ Research Edge – My Perspective on Keith’s Trading Calls

Keith’s Trading Call: PFCB looks like McCain, swan diving in AZ; going to 22.72 next

My Perspective: PFCB - I don’t think they are doing enough to offset the macro.

Keith’s Trading Call: SNS looks nothing like CHUX or RT... Looks like it is going to discover the cure for something actually

My Perspective: SNS - The market wants to believe the new CEO (aka boy wonder) can save this ship.

Keith’s Trading Call: RT looks like one of their remodels; bad... and people not coming back

My Perspective: RT - The banks are going to need to step up and save the day.

Keith’s Trading Call: PNRA feels like watching a WWF cage match, broke its nose today off the turnbuckle, but remains conscious

My Perspective: PNRA - In 2009, YOY wheat and gas prices should be favorable, but the consumer is an issue.

Keith’s Trading Call: CHUX looks like it had a shot on the zero line

My Perspective: CHUX - A third tier company in an unforgiving market.

Keith’s Trading Call: DPZ trading with TED spreads b/c of their debt ... nuts, but reality; stock breaking down

My Perspective: DPZ – A good operating model, with a leveraged balance sheet.

Keith’s Trading Call: BWLD - tough day, but hangin' tough... bullish still using a 37.83 line of support

My Perspective: BWLD - Well positioned concept, but I don’t like the move into Las Vegas.

Keith’s Trading Call: GMCR finally broke my line today, $31.36 target

My Perspective: GMCR - The acquisition of Tully’s will buy them time, but long term margin trends don’t look good.

Isreal, post Olmert...

Vladimir Putin is no longer the only former secret agent that has risen to be Prime Minister of a nuclear power; ex Mossad spy Tzipi Livini has accepted Shimon Peres’s call to form a coalition government over the next 42 days replacing the outgoing Ehud Olmert who is facing prosecution for a series of corruption charges. It is clear that Livini will not be able to make the transition without friction as right wing parties have called for early elections instead.

If successful in forming a functioning coalition, Livini will be prime minister of a nation facing multiple challenges beyond the mounting tension over Iranian nuclear ambitions. The Israeli economy, largely dependent on the tech sector and other high value added industries, has begun to feel the impact of a cooling global market with Q2 GDP coming in lower than expected at 4.41% growth year over year. With CPI up 5% for the last 12 months Stanley Fischer, governor if the Bank of Israel, chose to raise the benchmark rate by 25 basis points for 4 consecutive months before pausing at 4.25%.

During the most recent monthly public meeting. Israeli bank leaders have made much noise regarding their limited exposure to toxic US mortgage markets to little avail as investors sold off financials on the Tel Aviv exchange in sympathy with Europe and the US.

The taxpayer bailout of the US financial system is beyond Ms. Livini’s control, but if she can successfully form a functioning government she may help Israeli stocks find their footing as investors decide that the glass is half full after all.

Andrew Barber

S&P 500 1244.11 Is My Line

In the Hedgeye Portfolio, I have been covering and buying so far this morning. Risk management in front of this bailout potentially getting done is the immediate term squeeze "Trade".

The S&P 500 has room to run to the 1244.11 line. That's not my religion. That's what my process tells me. While I don't think they should rubber stamp this fear mongering bailout, that certainly doesn’t mean they won’t. The intermediate “Trend” remains negative.

Now that I am being flashed every 3 minutes by someone new telling me this is a "done deal", the other obvious risk management scenario to keep in the back of your mind is what happens if it the bailout doesn’t get done...

Fire engine chasers are abound out there – be careful on the way up.

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BWLD – Betting on Las Vegas

BWLD announced yesterday the completion of a $23 million asset acquisition of nine BWLD franchised restaurants in the Las Vegas area. The company expects the transaction to be neutral to earnings in 4Q08 and accretive to earnings in FY09.

Based on comments from other casual dining operators, now might not be the best time to enter the Las Vegas market as Nevada is often highlighted as a region of relative weakness. On its 2Q earnings call, PFCB said that Arizona, California, Florida and Nevada accounted for 84% of its total comp decline at the Bistro. Also following its 2Q, CAKE said it is “seeing a bit more weakness in the Las Vegas market.” RRGB stated that California, Arizona and Nevada continued to be under a lot of pressure for them in the most recent quarter, and “it’s probably not getting any worse but it’s certainly not getting any better.” Additionally, my partner, Todd Jordan, is bearish on the Las Vegas market.

For reference, BWLD said that average weekly sales of the acquired restaurants declined about 3% in the 12 month period ending June 2008. In 2Q08, BWLD’s franchised restaurants on average experienced a 5.4% increase in average weekly sales, which highlights the below average performance in Las Vegas.

NKE: Solid Q. But Trajectory Will Change

I expected a good quarter from Nike, and with a 12% move in the stock in the back half of last week (up to $66.66) I think the market did too. While the actual results did not surprise me, the upbeat tone of the conference call definitely did. I outlined the case last week why the stock should not have traded up in advance of this quarter, as the meaningful headwinds the company will face this year will materially alter the quality of earnings as FY09 progresses – which I suspected would begin to be apparent on this call. Now the question is whether I take the tone of the call at face value, admit that there’s not the downside in the stock I initially suspected, and simply cut bait? Or do I use the insight gained from the call, stick to my analytical guns, and stand firm that there are issues that the industry and the company will be talking about in 3-6 months that it is not talking about today. I’m going with the latter.

I’m taking my estimate for the year down by a nickel to $4.09, and while not expensive at $62, I absolutely cannot argue one iota of multiple expansion given the headwinds Nike faces. Performance from this point forward needs to come from pure earnings juice. Again…tough to bank on. Here’s a few things to chew on…
  • 1) A few big positives… a) On the plus side, how can anyone not be impressed with Nike’s order book? The 2-year run rate across all regions is virtually unchanged from 3 months ago – about 10% in aggregate in constant dollars. B) Gross margins +233bps were solid. Ahead of my number (though they gave it back in SG&A). The incremental call out seems to be ‘lower than expected cost increases out of Asia.’ This is one of the factors that I think will change meaningfully over the course of the year.
  • 2) Nike is a ‘Beater.’ Nike beating each quarter is written in the cosmos. It has missed only 1 quarter in 6 years. And that was by a penny. In looking at history, we see that Nike needs a beat of at least +4% for the stock to not go down on the event. It takes a beat of 12% or better to get a post-quarter rally. This time we got +11%. Definitely a net positive, but within historical guidelines.
  • 3) Let’s look at what drove the beat. One region that smoked my expectations was Europe. 20% revenue growth on trailing 6 month futures of 6% is monstrous. It came in double my model. But tough to ignore that 15 points of this growth was due to FX. Also tough to look through the fact that the Euro is at 1.467, and just a few short weeks from having 0% yy change. Check out the chart below showing EPS surprise history vs. FX change. Not good.
  • 4) Nike needs the Dollar’s slide over the past few days to continue. Management noted that its’ model assumes no change in FX. With the greatest global geopolitical/macroeconomic cross currents we’ve arguably seen since the great depression, I cannot imagine FX stays still. Maybe it goes for them, maybe against them – but I’m inclined to think we see increased volatility here. In fact, this is the first quarter in almost 3 years where reported futures were not greater than constant dollar futures in Europe.
  • 5) Not a coincidence that EPS growth is so closely tied to changes in FX (see Exhibit below). Bulls might say that EMEA margins were down 54bps – so how can that mean that FX helped? The answer there is that Demand Creation spend (Olympics and football) was disproportionately high this quarter, as it more than offset the improved gross margin in EMEA. Total margins in EMEA were 24.9% this quarter. Down slightly vs. last year, but let’s not forget that they were in the high teens/20% range before FX ran up.
  • 6) I really really really don’t like the trajectory of the P&L.
    a. Revenue growth just hit 17%. 7 points of which was FX, and another 2-3 was Umbro.
    b. Nike is expecting full year revs in high single digit, in line with LT plan. If we assume that it is not sandbagging, a 9% annual rate, and its guidance for 2Q (where it has solid visibility) then simple math backs us into a 4Q top line that is flat with the prior year at best.
    c. Gross margin improvement just peaked – as it relates to incremental FX-related growth, product cost, and yy compares against pricing and supply chain initiatives put in place last year.
    d. 97% of the industry’s footwear is made in China (bad). Nike is less exposed at about a third, but it also is far overexposed to Vietnam (also a third of its footwear production). Three weeks ago, Hanoi announced 28% inflation – its highest rate in 16 years. In Vietnam and Thailand we’ve seen factory workers strike because mid-teens wage increases are not enough to keep pace with inflation. Ultimate, this has to impact Nike. They’re big and smart enough to pass it through to the rest of the global supply chain, but that process is lumpy.
    e. SG&A is clearly the buffer for the remainder of the year. +29% this quarter, and slowing to a negative number by 4%.
    f. ‘Other Expenses’ turn into other ‘income’ as FX hedges are market to market at more favorable rates.
  • So the bottom line is that we’ve got a global growth story that is facing a slowing global growth environment, increasing risk of global stagflation, and has a P&L trajectory where sales and gross margins are decelerating, but are likely to be made up by SG&A, ‘other’ income, and lower tax rate. That shows the power of how Nike manages its financial model. But I simply do not understand why putting capital to work here at $60 makes sense. I like it closer to a 5-handle.

PPC – Big bird deboned

PPC announced today that it expects to report a significant loss in the FY4Q08. The company attributed the loss to high feed-ingredient costs, but more importantly to weak pricing and demand for breast meat. Our thesis on PPC was based on continued weakness in pricing because that was what the competition wanted – PPC to fail. As an aside, this was also the reason to be long BWLD.
Not surprisingly, Pilgrim's Pride also informed its lenders that it does not expect to be in compliance with its fixed-charge coverage ratio covenant under its principal credit facilities, but expects to be in compliance with all other covenants as of the fiscal year end. Importantly, Pilgrim's Pride believes it has reached an understanding with the agents under its credit facilities to temporarily waive the fixed-charge coverage ratio covenant through October 28, 2008, and to provide continued liquidity under these facilities during this same period.

I see very little value in the equity of PPC. Right now, the banks (Co Bank and BMO) are trying to hang on in hopes that the market recovers. PPC looks to be a big black hole. PPC is bleeding significantly, with debt of $1.5 billion and $1.0 billion dollars of inventory that can only be sold at a loss. The company will have little choice but to shut capacity, or try to sell some assets that are not worth much because they can’t produce products that make money. They only way out of this is for corn to fall below $4.00 and that is not going to happen anytime soon!

Daily Trading Ranges

20 Proprietary Risk Ranges

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