• It's Coming...

    MARKET EDGES

    Identify global risks and opportunities with essential macro intel using Hedgeye’s Market Edges.

My first year in the business was 1987. I started at Morgan Stanley in March 1987 on the program trading desk. It was the part of the firm that was somewhat to blame for the crash in October of that year. I will never forget that fateful day in October 1987, just like I will not forget yesterday. The worst part about days like these is trying to sleep at night while thinking about what to do next. This time I have perspective and plan to put it to use.

Following the crash, the next two to three years were very difficult and a shallow recession followed in the early 1990’s. Back then, the term depression never entered anybody’s thought process. Today, we are going to wake up knowing a recession is inevitable and people are going to be asking the question can we avoid a depression. As a consumer analyst, those terms are just a technical definition, the government will step in at some point, but how much of the damage is already done?

The end of the great consumer credit cycle has led to a consumption recession, to a magnitude of which nobody has ever seen. Ironically, the Casual Dining industry as we know it today did not really exist back in 1987-early 1990’s. Most if not all of the publically traded casual dining companies did not trade back then. Brinker International (EAT) went public in 1984, but that could be the only one. It’s not to say that the concepts did not exist back them, they were just not operated as a public company. Importantly, none of the companies have a process to think about the macro environment and operate in a silo.

Needless, to say the much needed shake out in the restaurant industry is not far off. The following is a brief assessment of the prospects for companies in the industry, starting with Casual Dining. The names are ranked in order of yesterday’s stock price performance worst to best:

CHUX – There are a core group of stores in the South East and New England that will survive. My guess is it will need to close 30%+/- of its total store base. Management is in denial at this point!

DIN – The odds are better than 50% that DIN will be the largest bankruptcy in the history of the industry.

RT – It may not file for bankruptcy, but it will be close. Like CHUX it will need to close 30% or more of its store base.

RUTH – The banks are already calling the shots. B of A will likely give them a waiver, but they shouldn’t. A very ill-timed acquisitioned earlier this year ruined the company.

CAKE – CAKE will be ok, but will need to close 10-20% of its store base. It should close the smaller stores it has been opening over the past three years as the company was pushing the envelope of growth.

LNY – Tilman tried to buy the company, it’s a good thing for him it did not happen. Tilman is a survivor, it just depends on what form the company takes. LNY also needs to shrink.

RRGB – They just recently spent $50 million buying back stock and they borrowed the money to do it! I have little confidence in the management team and the staying power of the concept.

MRT – They just announced on Friday that Wachovia upped its credit line with MRT so they could buy back stock. Are you kidding me!

CPKI – At $14 it looks like a great sale. The business model is better that most in the casual dining space and the balance sheet is strong.

CBRL – A brand that has proven the test of time. Its core consumers remain under significant stress and the fatty nature of the menu will not allow it to broaden its appeal. Balances sheet is stretched, but manageable.

PFCB – A good company, but management has been in denial for the past two years. Pei Wei needs to shrink significantly and might just close completely. The rest of the business is fine, but will take time to get traction again.

DRI – DRI will be fine and gain market share as we come out of the cycle. Unfortunately, they have been slow to adjust to the current cycle, as management continues to add significant capacity. They are starting to hedge commodity costs aggressively, an accident waiting to happen.

EAT – biding time. They have been preparing for this for the better part of two years.

SNS – Not much left here but the real estate.

BWLD – We will all be eating chicken wings and drinking beer. At this point expectations are high for BWLD.

KONA – A survivor, because they have good food and no funded debt.