Restaurant Industry Financing Issues

So far this week we have learned that Bank of America and GE Capital will limit new loans to franchisees. We have already articulated how this might impact the MCD franchisee community, but there are others that are clearly impacted too.

The companies that are likely impacted the most are YUM, MCD, SONC and JBX and CKR. Outside of MCD, these companies are all in the process of pursuing rather aggressive refranchising programs. In reference to its goal to reduce U.S. company ownership to below 10% by the end of 2010, YUM management said, “Obviously the credit market conditions have affected refranchising efforts, and as a result the credit markets have increased their equity requirements for the buyer. Additionally, lenders have intensified their review process, which has added time to complete certain larger transactions. In this environment, therefore, it has become more difficult to complete larger deals, so we expect our transactions this year to be skewed towards smaller deals.” And, this comment was made before this week’s announcements regarding Bank of America and GE Capital. Unfortunately, nobody is immune in this environment.

Short Selling Ban, Part V: Is Mr Ed A Bank(er)?

We have been very vocal in expressing our concern with the SEC’s ban on short selling financial stocks. Not only because the ban itself threatens basic free market principles, but the list itself is very arbitrary and includes many non-bank institutions. This morning the SEC updated the list and added 7 names, which included Sears Holdings (“SHLD”) and AutoNation (“AN”).

Is SHLD a bank? Our review of the FDIC website this morning shows that SHLD is not registered as a bank and according to SHLD’s 2007 10-K:

“We compete with a wide variety of retailers, including other department stores, discounters, home improvement stores, consumer electronics dealers and auto service providers, specialty retailers, wholesale clubs and many other competitors operating on a national, regional or local level along with Internet and catalog businesses, which handle similar lines of merchandise.”

In addition, SHLD’s actually breaks out revenue into merchandise sales and credit and financial products. In 2007, SHLD reported $50.7BN in merchandise sales and $0 in credit and financial services revenue. That is not a typo.

SHLD is not a financial company! It begs the question who is adding these companies to the list and why SHLD has been added. SHLD has been out of the credit business for more than three years, the stock is down only 8% on the year, and the borrow fee for shorting are in the mid 20% range (i.e. almost impossible to borrow and thus short). Not a likely target for protection from “evil doers” in our estimation.
Perhaps it was added because SHLD’s largest shareholder is ESL Investments, the hedge fund of former Goldman Sachs luminary Ed Lampert?

In adding both SHLD and AN, which comprise ~64% of the value of ESL Investments collectively, the SEC is doing nothing more than protecting the assets of a hedge fund manager.

We hear Ed is a good guy. We have nothing against him personally, or hedge fund managers altogether. They are the great equalizers of daily trading, provided that they are not selectively banned from the game.

Additionally, Lampert is a Yale guy… so he deserves our partisan Yale Blue bias up here in New Haven. It’s hockey season, and we all stand together in the stands! That said, Keith and I were Yale hedge fund managers too, and no one is giving us this club deal.

Daryl Jones
Managing Director

Wachovia (WB) Down -23% today; it should be down more...

Those "evil doer" short sellers aren’t the ones selling it either. Look at 2yr Wachovia bonds trading at 50 cents on the dollar.

In English, 50% chance of bankruptcy within 2years.

Chris Cox and “Investment Banking Inc.” can ban short sellers all they want. Gravity cannot be banned, in the end...

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Charting Gold: We're still long GLD in the Portfolio

My short term price target in the gold etf (GLD) is $951. The Federal Reserve is going to be forced into the politically pandering the wind here, and cut rates on October 29th. Cutting rates de-values the US Dollar and re-flates hard assets like gold. The CRB index is up +3% for the week to date, and the S&P 500 down almost -5%. The intermediate term correlations between the US Dollar's "Trend" lines and that of US Equities continues to hold.
  • KM
Chart courtesy of

Ugly Chart of the day, the month and Century, to Date...

When we held our preparing for the "Bankruptcy Cycle" conference call on July 16th, 2008, I took plenty of heat from those who couldnt afford for us to be right. Facts are stubborn little critters, in the end.

Here is our US Bank Failure Chart (1), updated for Wamu...

This bank failure chart includes Washington Mutual transaction. The JPM purchase was "facilitated" by the FDIC, which acted as receiver after the bank was closed by the Office of Thrift Supervision yesterday. The FDIC press release explicitly states “FDIC Facilitates Transaction that Protects All Depositors and Comes at No Cost to the Deposit Insurance Fund” in its headline.

By comparison, the last similar purchases brokered by the FDIC were the acquisitions of First National bank of Nevada and First Heritage Bank by Mutual of Omaha in late July. In those transactions Mutual of Omaha assumed all deposits –both insured and uninsured, and purchased the majority of the two failed bank’s assets. The FDIC did commit capital in those instances however, purchasing $862 million of the combined $3.6 billion held by the acquired banks outright, whereas the entire purchase cost of Washington Mutual fell on JP Morgan. As such, the WAMU may not end up officially listed by the FDIC in their closing and assistance transaction list, the list that all other data points on this chart were drawn from -but it’s inclusion here still serves to illustrate the scope of the crises facing the US banking system currently.

Keith McCullough and Andrew Barber
Research Edge LLC

FINL: This One’s A Keeper

This story is definitely looking good to me. Earlier this week I noted my inclination to swap out of FL and into FINL after Nike’s FY1Q09 report. I was concerned about the stocks into the numbers, which turned out to be a bad bet on my part. Good tone from Nike on a good market day sent the group up big. Keith subsequently added FINL to the Hedgeye portfolio after the Nike report. Anyone else who followed him had a good day. As much as I am in tune with (and appreciate) a day’s worth of alpha, I think hindsight 12 months out will show that a buck move here or there will prove to have been a rounding error with this story.

With the numbers I’m seeing out of FINL, my conviction continues to grow in the margin levers as the product cycle turns in favor of the athletic specialty retailers – despite stress in the global footwear supply chain. For the quarter, comps accelerated on a 1, 2 and 3-year basis (+4.7, 0.0%, -2.2%), while gross margins were up 230bps, SG&A down in absolute dollars despite a 3% sales increase, and a 12 day improvement in days inventory on hand – despite facing the toughest yy compare in inventories. Check out the quad chart below. Looks golden.

Going forward, the product cycle should start to improve more meaningfully this fall – thanks to Under Armour stimulating the competitive fires at Nike, K Swiss, New Balance, Asics, and Adidas. This industry competes on product – not price. So a product cycle inherently helps retail in its early stages (i.e. 2001/02). Nike’s US footwear futures and ASP growth support this beginning. I think that we’ll see both traffic and ticket pick up at FINL – ending a 3-year slump in comps. With Paiva gone, Man Alive being downsized, and apparel under control, FINL is focusing back on its core. Good timing. Inventories remain bloated relative to history, and SG&A still has room to come down. I think that this company has the potential to get to a 5-6% EBIT margin within 2 years. Not bad given a 2% print in FY08.

Why do I prefer this one over Foot Locker (i.e. a change of tone for me)? First is that FL’s international exposure concerns me with recent moves in the dollar. Second is that with FINL, you actually get a little square footage growth – albeit low single digits. Lastly, this is a management team that I can actually trust – unlike FL.

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