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Restaurants – What to do –Quick Service!

From a macro stand point we are at 96% cash. From a sector stand point we suggest that cash is also king but staying with low expectation names is a must. The largest players in the QSR segment have been an island in the storm for most market participants. They are also the names with the biggest expectations; growth had been driven by the strong international markets and the weak dollar. Those that have been hiding in a China story are about to see the other side of that trade. The other big negative for the larger QSR names is valuation. YUM and MCD are trading at or near historically high multiples. One last thing, the credit crunch will hurt most of these companies, as franchisees will have a more difficult time getting capital and the cost of capital is rising.

Once again, I am ranking the names in order of yesterday’s stock price performance worst to best:

TAST – A BKC franchisee that owns two regional brands with significant exposure to Florida. TAST has a leveraged balance sheet, with rising food and labor costs. On current numbers the stock is trading at 7x NTM EPS.

WEN – Looking for more clarity as we move into 2009, but it will face some challenges getting incremental customers in 2009. Could be a good place to hide, as expectations are low and the brand is strong

CKR – A regional player with a management team more concerned about the luxuries in life, like a private plane. CKR will be fine but will never get any respect because of management.

JBX – A strong, well run company. Unfortunately, $0.40 to $0.50 of JBX’s EPS growth comes from selling stores to franchisees. Once management get off this drug it’s safe to get in.

KKD – The shrinking violet…..

DPZ – Anything with leverage will get crushed and they have got it. Top line trend appear to be improving.

BKC – The best days are behind them and the street is universally bullish. I’m not a fan. A large part of the company’s success is the resurgence in the advertising campaign and that is definitely cyclical.

YUM – Where do I begin with this one? Without China there is not much here, because the U.S. business is a disaster. Management has leveraged the balance sheet at just the wrong time!!

SBUX – It’s been beaten and beaten again. We are closer to the bottom than the top. Not much management can do to offset the macro. Definitely low expectations

MCD – I still contend that 2009 is shaping up to be a disappointment for MCD. Definitely high expectations!


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.

Cash Only

The Definition of Insanity: “Doing the same thing over and over again, and expecting different results”
-Albert Einstein

“The Question” is, who is that quote more appropriate for this morning, the buy side, sell side, US government, or financial network media? From the hallowed halls of the hedge fund community to some of the squirreliest of squirrel hunting market pundits with an internet connection, I have seen my fair share of emails over the course of the last 9 months, suggesting that I was the one losing my mind out there. I guess that’s what makes a market.

At the counter of Dunkin’ Donuts in New Haven this morning, there is a sign that reads “Cash Only!”, and that’s about as appropriate a summary of this morning’s note that I can come up with. I issued an exposure update on the portal yesterday outlining my portfolio positioning: 96% Cash, 3% Gold, 1% Stocks. That didn’t change into the market’s close. That position made money in the largest US stock market crash day since 1987, and since that cash position pays month end interest today, it will again by the time the game clock runs out at 4PM EST. US Dollar denominated cash remains king.

Proactively preparing for risk is what we do, and whether or not my team gets credit for stepping up and taking the shot that few had the platform or conviction to take, at a bare minimum, my son Jack will be able to tell his buddies one day that his Dad protected and preserved his family’s capital on September 29, 2008. The best things in life are worth a lot more than money. A healthy family and home head up my list.

So what next? Let’s take a walk down the risk management path and keep doing what we do, proactively preparing for potential outcomes, rather than reacting to them. In the US, with the “evil doer” short sellers out of the market, market players still blew through my downside S&P target yesterday. As a result my levels of downside support are now as follows: S&P 500 (SPX) 1,074, Nasdaq (COMP) 1,931, and Russell 2000 (RUT) 627.

Volume and volatility shot straight up yesterday, so if you are freaking out with a VIX level of 47, you are giving in like most did in 1987 - at precisely the wrong time. Proactively prepare. Stay focused. Don’t do the same thing over and over again, and expect different results. Flexible and objective minds will prevail as the proverbial tarp of negative energy lingers overhead. Get yourself into a position of confidence and strength. Now it’s time to play offense. Take your competition right out of the game.

Asian trading closed pseudo constructively. Don’t forget that Asian stock markets have, in some cases, lost 1/2 to 2/3 of their value since the “it’s global this time” Investment Banking Inc. peak. The US market has only dropped -29% since October 10th, 2007, and organic growth prospects here are considerably darker than in countries whose per cap GDP is under $1,500/person.

Japan hit a three year low last night, closing down another -4.1%, and I’ll be locking in that gain on the short side sometime today, prices pending. Hong Kong rallied into the close and finished up on the day. With China closed, this was a positive divergence that the global equity market needed to see. We’re looking to get invested again and we’re revisiting China as a potential opportunity on the long side. The Chinese stock market has lost almost 70% of its value in less than a year, and they moved to the capitalist side of the global market share ledger last week by both cutting interest rates and allowing short selling. Additionally, China’s primary input cost, commodities, had their biggest down day yesterday since 1956.

Back to the US, the short sellers come back to the market on Friday as the short selling ban is lifted. That reality, alongside the US unemployment report and post quarter end hedge fund redemptions, provided the basis for the “Beware October 3rd, 2008” (www.researchedgellc.com, 9/19/08) note I went out with. The S&P 500 has dropped -12% since the market closed that day. For the 1st time this year, I am hoping that my call for an October Friday crash was 3 days too late.

Good luck out there today,

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The Mother of Bankruptcy Rate Decouplings

Apparel/footwear retail bankruptcies completely decoupled from banks, non-apparel retail, and just about every other consumer sub-sector. That will change.

Bank failures are taking center stage in the news, which is more than fair. But what about retail bankruptcies? The two charts below illustrate the change in retail bankruptcies we’ve seen over time. Is it me, or is anyone else floored that retail bankruptcies have trended up along with the cycle and are now running close to record pace through 1H08, but the number of textile and apparel retailers remains early nonexistent. I don’t care what anyone tells me, the declining rate over the past five years has been due to a sourcing-induced margin bubble. This is absolutely done, as I’ve stated in much of my apparel macro work.

There is no fundamental reason why apparel should be exempt from a retail bankruptcy cycle. We’ll start seeing more of them go under.


That’s right buy back stock! Apparently the management of MRT thinks it’s a good idea to spend its capital buying back stock. On Friday, MRT filed an 8K stating “The Fourth Amendment to the Credit Agreement includes changes which provide flexibility for the Company to repurchase up to a maximum of $20.0 million of the Company’s capital stock over the term of the Credit Agreement (subject to approval by the Company’s Board of Directors) by increasing the existing $10 million cap on such stock repurchases by an additional $10 million.”

Maybe I’m too negative, but MRT does not need to be buying back stock. Adding additional leverage on the company’s balance sheet will only limit the duration the company has to navigate the current cycle. Increased leverage removes operating flexibility at a time when operating flexibility is a premium. It is important to note that MRT’s EBIT has declined over 25% over the past 12-months.

It’s amazing to think that news like this is still possible!

  • Even with a significant decline in capital spending MRT is not generating any free cash flow.

Fewer Cranes in the Skyline

The 50 Billion Dirham lending facility created by the Central Bank of the United Arab Emirates last week helped ease concerns over short term liquidity issues in the Dubai real estate markets but it has not been able to stem the concerns over slowing development going forward. Local media outlets have recently begun to feature bearish sentiment from developers like Mohammed Nimer from the Moafaq Al Gaddah property development department, while bank analyst estimates for property value declines range from 5 to 15% in the near term.

The declining share price of local construction and development firms are only the most visible manifestation of the cooling pace of new building starts –from scrap prices in the US driven by Gulf rebar demand to worker remittances critical to the Philippine economy, the massive Dubai construction boom of the past decade has truly been a global phenomenon. Though UAE leaders are anxious to project the image of an economy insulated from global turmoil by the flowing torrent of petrodollars, stock investors enriched by that same oil money have begun taking their chips off the table.

Andrew Barber

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