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Cheese prices bounced once again after a sustained period of trading down.  The level of inflation in cheese has declined greatly but its rebound over the past week was the most substantial of all the commodities we monitor.  All in all, looking at the table below shows more red than blue in the week-over-week column.  Coffee continues to press higher, now up 94% year-over-year as it gained 2.2% over the past week.  I continue to hold a cautious view of chicken producers (SAFM, TSN and PPC) despite corn’s week-over-week decline.  The commodity surged 14% last week and, I believe, is likely to remain at these elevated levels for some time.  This will likely lend support to protein (feed costs) and wheat (substitution effect) prices.




Cheese gained 3.2% on the week. As the chart below shows, cheese prices have come down considerably over the past month.  Below, I gain provide some commentary from management teams from their most recent earnings calls with their views on cheese prices and the implications for their businesses.




"Yeah, so the forward curve and kind of looking at about three different sources right now have cheese actually easing a little bit through the rest of the year. We're at almost $2 right now. And so, our expectation is that we're going to see a little bit of easing, to give you on cheese. We've talked about this in the past, we've got a contract in place that basically reduces the volatility on cheese moves by about a third. So about two thirds of increases or decreases in cheese are passed through to our system.


I think the kind of consensus forecast out there right now for cheese are in the $1.70 to $1.75 range. And – you know so what you're looking at is kind of a $0.25 to $0.30 move and I think we've said in the past a $0.40 move in cheese is equal to a point at the store level P&L."




“We expect the favorable impact of early year sales results to substantially mitigate the unfavorable impact of currently projected commodity cost increases, most notably cheese, throughout the remainder of the year.”


DPZ is 95% franchised and, as such, management claims a degree of insulation from commodity costs.  Of course, to the extent that price needs to be taken and royalties slow, the company is not immune from inflation.  The downward move of cheese over the past month will raise hopes that a price increase can be avoided. 




It’s also worth noting the strong week-over-week move in gas prices.  Demand destruction is coming to the restaurant space this quarter.  Clarence Otis, Darden CEO, said as much on DRI’s most recent conference call.  Companies like CBRL (see post from yesterday), are particularly vulnerable.




Wheat prices declined sharply last week as other grains, such as corn and rice, also saw downward price action.  Media reports today suggest that wheat futures tumbled today as a result of speculation that demand will decline for U.S. commodities as the nuclear crisis seems to escalate in Japan.  Some commentators see this decline as incongruous with the underlying dynamics of the wheat market, given the poor crop conditions currently in the U.S., but if a fall-off in demand were to occur, it could provide relief for PNRA.  The company expects wheat costs for 2011 to be roughly flat versus 2010, as the company currently has nearly 75% of its wheat costs locked in for 2011, modestly below the 2010 price.  





Howard Penney

Managing Director


PENN should be the first of three strong regional gaming earnings releases followed by ASCA and PNK.



We’ve been positive on the regional gamers for the past month or so and we’re confident that PENN’s Q1 earnings release next week will prove us right, at least on the fundamentals.  March was a good month for regional gaming as evidenced by the state released gaming revenues, all of which, thus far, have proven to be sequential upticks from Q4 and January and February.


Our Q1 EBITDA and EPS estimates for PENN of $172 million and $0.42 slightly exceed both company guidance and the Street consensus. Certainly, there are headwinds including high gas prices and unemployment.  However, we expect management will be reasonably constructive about near term trends.  Management rarely exudes bullishness and we don’t expect that they will get expectations too high now either.  Their tone should be nonetheless, positive on the margin.


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Cracker-Barrel is, in my view, the most susceptible of all restaurant concepts to the demand destruction that is caused by elevated gasoline prices.


Cracker Barrel is a struggling concept and the outlook is not looking very positive for the company as gasoline prices head higher and management struggles to generate traffic.  Over the past four years, only three times has CBRL reported positive traffic growth.  It has become a familiar refrain for management there to discuss the need to build traffic. 


First and foremost, the “Seat-to-Eat” initiative has been a disappointment to say the least.  Despite implementation across 70% of the company’s stores, it would be difficult to call the impact of the program anything but negative.  There has been no meaningful impact on traffic from “Seat-to-Eat” and management’s reluctance to disclose any granularity on that topic during the last earnings call is telling.  While the initiative has been much-hyped by management in terms of its scope (29 different operational changes) and significance, at this point I think the cost of retraining 68,000 employees as part of the program may outweigh the benefit, if there ever is one, from “Seat-to-Eat”.  In my experience (admittedly, zero years as a restaurant operator), it has generally turned out that initiatives that are not consumer facing generally take longer to impact the diner’s experience.  While long-term back-of-the-house efficiencies may materialize from the initiative, I fail to see how this will drive traffic of the magnitude CBRL needs.  As Benjamin Franklin said, “Never confuse motion with action.”


Secondly, the vast majority of CBRL’s restaurants are located along interstate highways; a mere 90 of the company’s 597 stores are located near “tourist destinations” or are considered “off-interstate” stores.  As such, CBRL is highly vulnerable to fluctuations in gasoline prices.  The company’s traffic problem, which has been a problem even with the price of gasoline at its most benign, is greatly compounded when gasoline prices are at current levels and above.  Referencing management commentary during the most recent spike in gasoline prices is ample evidence of this; time and again in 2008, gasoline prices were cited as a key top-line headwind.  The chart below shows that CBRL’s traffic trend is tightly linked to vehicle miles driven data as measured by the Department of Transportation. 


While gasoline prices are dipping precipitously today, on the back of a Goldman Sachs report calling for a pullback in oil prices, generally expectations have been for elevated gasoline prices throughout the summer months.  If that were to be the case, it would materially impact CBRL’s traffic during an important time of year. 




Howard Penney

Managing Director

Germany’s Marginal Turn

Positions in Europe: Long British Pound (FXB); Short Spain (EWP)


Not unlike numerous global economies we’re following, the prospect of inflation rising spells growth slowing - here Germany is no exception to the rule. Today’s economic sentiment survey from ZEW that attempts to predict the economic climate six months out registered 7.6 in April versus expectations of 11.3 and 14.1 in March (see chart below). The significant drop follows two previous months of slowing, and we contend is a reflection of the mean reversion trade Germany must transition through after at least a year and a half of white-hot fundamentals.  Despite the marginal change, we remain bullish on Germany from an intermediate term perspective.


Germany’s Marginal Turn - ME1


                        --------Here’s Additional German Data That Looks Less Good On The Margin--------


CPI rose to 2.3% in March Y/Y versus 2.2% in February


Manufacturing PMI slowed to 60.9 in March vs 62.7 in February


Services PMI data appears “toppy” at 60.1 in March vs 58.6 in February, and is bumping up against the heavy and historically significant 60 resistant line. We’re calling for the April number to roll over



                                 --------While Positive German Fundamentals Remain Glaring---------


Unemployment Rate  7.1% MAR vs 7.3% FEB

                -The unemployment change for March was -55K MAR to 3.01 Million (the lowest level since June 1992), beating expectations of -25K


Factory Orders  20.1% FEB Y/Y vs 16.5% JAN

                                    2.4% FEB M/M vs 3.1% JAN


Industrial Production    14.8% FEB Y/Y vs 12.7% JAN

                                                2.4% FEB M/M vs 3.1% JAN


Exports  2.7% FEB M/M vs -1.0% JAN


Imports  3.7% FEB M/M vs 2.3% JAN


Trade Balance  €12.1B FEB vs €10.1B JAN



We are not currently invested in Germany in the Hedgeye Virtual Portfolio as we’re cautious that the DAX is trading just above its TREND line, an important inflection level in our models.  We see a similar set-up with the UK’s FTSE (see chart below).  However, at the right price we like Germany and Europe’s other fiscally sober nations like Sweden and the Netherlands.


Germany’s Marginal Turn - ME2


Overall, German fundamentals and business trends continue to look positive. Exports are expanding, employment has improved, and factory orders and business confidence have come in strong over recent months. Yet, rising inflation is a risk to consider, as is mean reversion from some of the white-hot data. Over the intermediate term, we continue to believe that Germany will be the region’s growth engine (GDP is expected to grow 2.5% this year) and think Germany may also be a defensive play as the region remains mired in sovereign debt contagion. 


We expect that EUR-USD to make gains given the ECB’s hawkish stance on inflation and recent 25bps interest rate hike, especially as US policy continues to debauch the greenback.


Matthew Hedrick


Short Covering Opportunity: SP500 Levels, Refreshed



This is the 4th consecutive down day for the SP500, virtually every sell-side strategist is cutting their US GDP Growth estimates, and the market is now down for the month-to-date. These shouldn’t be surprises. So don’t freak-out here – this is where you get paid to manage risk.


One of the hallmarks to effective risk management isn’t having it in you to short things when they are up – it’s to cover them when they are down. We did that on March 16th and I think it’s a good idea to do that again right here and now. Don’t worry about your cost basis – the market doesn’t care about your cost basis. Worry about what isn’t happening yet - the bounce.


Short Covering Opportunities aren’t raging bull calls to action. In this case I see every opportunity for the SP500 to bounce to another lower-long-term-high and lower-immediate-term high up at 1329. Then you start making sales again.


If 1310 breaks and the VIX breaks out above $18.26 (intermediate-term TREND line resistance), this call to cover shorts will likely be a bad one. Don’t dismiss that the world’s reserve currency has gone no bid. This game of gaming The Bernank is going to be volatile.



Keith R. McCullough
Chief Executive Officer


Short Covering Opportunity: SP500 Levels, Refreshed - 1

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