Employing Liberty

This note was originally published at 8am on May 06, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“Freedom and liberty are now words so worn with use and abuse that one must hesitate to employ them.”

-F.A. Hayek


Earlier this week I gave some air time to Hayek’s chapter titled “The Abandoned Road.” The aforementioned quote comes from the same book (“The Road To Serfdom”). As you think about what Big Government Intervention has done to the US Dollar and The Correlation Risk it perpetuates in markets this morning, don’t forget that the Jobless Stagflation you see emerging from the Fiat Fools finest isn’t employing a sustainable economic recovery.


Both of these Keynesian ideologies are crocks:


1. Fiat Debt - that central planning policy of printing short-term debt (beyond 90% debt/GDP) to solve long-term liabilities is the best path to prosperity

2. Dollar Debauchery - the notion that having an implied monetary policy to devalue the currency and inflate is going to end in “price stability”


What we have here folks is The Price Volatility.


We’ve seen a version of this movie before. Not unlike the Keynesians begging The Bernank to provide markets with “shock and awe” interest rate cuts to zero percent in 2008, this time our professional politicians on Wall Street and in Washington have begged for The Quantitative Guessing.


What has that done for the country?


Well, consider the order of events (causality) that drove The Correlation Risk to lead to the largest weekly decline in oil prices since, you guessed it, 2008:

  1. The Bernank panders to the political wind at the April FOMC meeting keeping all rate hikes off the table
  2. The US Dollar Index proceeds to test its all-time lows in the last week of April (same levels reached in Q2 of 2008)
  3. Energy stocks hit YTD highs on April 29th (month end)

Then, the US Dollar stops crashing (USD = UP +1.6% for this week-to-date)… and commodities start crashing…


Nice. What else happened?

  1. US stocks are down every day since April 29th…
  2. Silver prices have their biggest down week since 1975…
  3. The Volatility Index (VIX) is up +23.4% for the week-to-date…

Cool, right?


The Keynesian Kingdom calls this The Price Stability.


Let me tell you what a small business owner (me) thinks about price volatility - I am less confident to run out and hire people.


That’s why you see weekly US jobless claims breaking out to the upside again (474,000 this week versus 429,000 last week). That’s why you see the Bloomberg weekly consumer confidence reading drop to minus -46.1 this week versus -45.1 last. That’s what volatility does to real businesses with real people making real life risk management decisions.


What’s the answer to this colossal problem of common sense? Get out of the way.


That’s right, the potty trained Risk Managers in financial markets can handle the truth. We are accountable for getting run-over in our long Gold and Oil positions this week. We can handle it – Yes We Can.


As Hayek astutely observed in 1944: “Perhaps the greatest result of the unchaining of individual energies was the marvelous growth of science which followed the march of individual liberty from Italy to England and beyond.” (“The Road To Serfdom”, page 69)


He was talking about the 150 years of industrialization in this world pre WWI (see Chart of The Day below, which I think I have been using in every client presentation for 2 years). The Federal Reserve Act of 1913 doesn’t look so swell for the median global inflation rate on this chart. That’s when the Fiat Fools took over from the Gold Standard … and the financial engineering revolution began.


Fully loaded with yesterday’s drawdown in oil prices, don’t forget that the all-time high price for a barrel of oil (nominal) on an annualized basis was $101/barrel in 2008. Correcting to the all-time high yesterday isn’t called a crash – it’s called a reminder.


Yesterday was one more reminder that we have a choice in this country. We can take our “free” markets back – but first, we have to re-teach ourselves what Employing Liberty’s definition to our lives and markets really means.


What to do from here?


Well, after badgering myself about it at the YTD top, I’m still short the SP500 (SPY) but think it has every opportunity to bounce to another lower-long-term high. My immediate-term TRADE lines of support and resistance for the SP500 are now 1331 and 1351, respectively.


I took down our exposure to Commodities this week to 12% in the Hedgeye Asset Allocation Model by selling our long position in Corn (CORN) and then taking our long Oil and Gold positions to 6%, respectively. If Oil can’t hold its intermediate-term TREND line of support of $98.63 in the next three trading days, I’ll likely sell it all too. The market owes me nothing in this or any other position.


Gold looks much different than Silver or Oil at this point (lower VOLATILITY studies across durations in my models and less concerning PRICE/VOLUME factoring). My Immediate-term lines of support and resistance for Gold are now $1482 and $1523, respectively.


Happy Mother’s Day to my Mom, Mrs. Scott, and Laura, and best of luck out there today,



Keith R. McCullough
Chief Executive Officer


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Wendy’s/Arby’s reported a disappointing quarter this morning.  Significant upside remains with the sale of Arby’s being the most important catalyst to this effect.


Wendy’s/Arby’s reported a poor quarter this morning.  Consolidated EPS came in at $0.01 ex-items versus consensus $0.02.  System-wide comps for Wendy’s came in flat versus consensus at +0.3%.  Arby’s North America system comps came in at +5.5% versus expectations of +2.1%.  1Q restaurant operating margins at Wendy’s and Arby’s were +13.4% and +10.6% versus consensus of 14.6% and 11.5%, respectively.  Arby’s has been on the block since January so, accordingly, much of the focus coming into the quarter was on the performance of Wendy’s.  MCD printing a strong first quarter was possibly a hint that comps could be disappointing and they were: Wendy’s company-owned comparable restaurant sales, in the first quarter, contracted -0.9% year-over-year.   Consensus was looking for +0.4%.  As the chart below indicates, Wendy’s company-owned comparable-restaurant sales still registered a sequential improvement in two-year average trends from 4Q10 and April is comping at +0.5%. 





April 2010 saw Wendy’s company-owned comparable restaurant sales decline 0.50% which, given the overall 2Q comp, implies that there was a significant fall-off over the following two-months in terms of comparable restaurant sales.  With this in mind, I would expect 2Q11 to come in closer to +2.5% to 3%.  Management reiterated FY11 guidance of +1% to +3% comparable sales growth at company-owned Wendy's restaurants.


Restaurant margins were a pressing concern coming into the quarter and the results showed that beef costs severely impacted margins at both WEN concepts.  As I wrote above, restaurant margins missed by 120 basis points and 90 basis points at Wendy’s and Arby’s, respectively.  At Wendy’s, the 200 basis-point year-over-year decline in margins was attributable to incremental advertising to introduce Wendy’s new breakfast in new markets and 80 basis points due to higher commodity costs. 


The overall commodity basket is now forecasted to grow 5-6% in 2011 due to an increase in beef costs of 20%.  In March, the company had guided to total commodity inflation for 2011 of 2-3% on the back of beef cost inflation of 10-15%.  Along with this revision, management has revised its EBITDA estimate for 2011 to be in the $330-340 million range versus the previous range of $345-355 million.  While management has stressed that 2011 represents a “transition” year for the company, it is clear that WEN is going to suffer more than most through the inflationary environment in 2011. 





Looking forward, two things stand out.  The first is the outlook for Wendy’s and the second is the sale of Arby’s – a move I have advocated ever since the acquisition (which I opposed).  Wendy’s is introducing Dave’s Hot ‘n’ Juicy cheeseburgers in the second half of the year.  Currently in seven test markets, WEN has high hopes for this launch as they see significant increases in hamburger unit sales.   Overall for 2011, I expect the commodity environment to pose a strong headwind for the company but the increased focus on the core menu, complimented by an increased focus on Wendy’s following the sale of Arby’s, should bring about significant progress at Wendy’s.


The sale of Arby’s was a welcome progression in my eyes and one of the main factors that convinced me that management means business in this particular turnaround effort.  The primary benefit of a sale would be management’s undivided attention being dedicated to Wendy’s.  Secondarily, the sale would deleverage the company’s balance sheet.  The $200 million of capitalized lease obligations on Arby’s balance sheet would be off the company’s books and this, along with the cash proceeds from the sale, would afford the company increased financial flexibility going forward. 


The 300 basis point upward revision in commodity inflation expectations is weighing on earnings potential for the year but the overall transition to a more focused and profitable company seems on track.  As Wendy’s new menu items continue to gain traction, management becomes more focused on operations at one concept, and the company has a healthy balance sheet to enable it to invest in the brand, I expect WEN to be a top-performing QSR stock over the next couple of years.



Howard Penney

Managing Director


Underperforming the regionals.




  • CZR reported net revenues of $2,179MM (down 0.4% YoY) and Adjusted Property EBITDA of $469MM (down 2.6% YoY)
  • "First-quarter net revenues decreased....due to reduced visitation by our rated players and the temporary closures of our four properties in the Illinois/Indiana region as a result of weather conditions and flooding, the effects of which were partially offset by the full-quarter impact of Planet Hollywood revenues in first quarter 2011."
  • "Streamlining marketing efforts was a first-quarter focal point. Following an increase in marketing spend during the first half of 2010, Caesars Entertainment began the gradual process of refocusing its customer reinvestment late last year. Year-over-year marketing spend was lower in the first quarter of 2011 than in the year-earlier quarter."
  • "We achieved significant progress in operating efficiencies, guest service and development activities in the first quarter.  Our efforts to reduce expenses led to margin improvements in certain Midwestern properties."
  • "On the growth front, Caesars Entertainment is pursuing development opportunities where we believe significant value can be created. We announced an alliance with Suffolk Downs racetrack in Boston that would expand our distribution should gaming be legalized in Massachusetts. In Las Vegas, strengthening market fundamentals prompted the decision to complete the Octavius tower at Caesars Palace and begin work on the LINQ retail, dining and entertainment project. Financing associated with the Octavius and LINQ projects was completed subsequent to the end of the quarter."
  • "We expect the LINQ and Octavius projects to increase visitation to our properties on the Las Vegas Strip"
  • "Finally, we believe strongly that the recent federal indictments of illegal online poker operators should convince Congress to allow American citizens to play online poker and to allow American companies to compete in a multi-billion-dollar industry.  By acting now to legalize a game enjoyed by millions of adult citizens, Congress can clarify ambiguous federal laws, generate tax revenues for federal and state governments and bring thousands of jobs to this country."
  • "Trips by rated players decreased 8.0 percent from the year-ago quarter, while spend per rated-player trip increased 3.7 percent. These results are indicators of a still weak economy in certain regions in which we operate. Cash average daily room rates saw an increase of 5.8 percent while occupancy percentage increased 3.8 percentage points."
  • Las Vegas Region:
    • "Visitation by our rated players rose 8.7%"
    • "Amount spent per rated-player trip increased 1.0%"
    • "Hotel revenues increased 17.4%... as our cash average daily room rates increased 7.6% and occupancy percentage rose 4.4%"
  • Atlantic City Region:
    •  "Visitation by our rated players decreased 5.8%"
    • "Amount spent per rated-player trip decreased 1.6%"
    • "Hotel revenues decreased 2.4%... as our cash average daily room rates decreased 5.4% while occupancy percentage generally remained flat."
  • "For the remainder of our United States markets, visitation by our rated players for the first quarter 2011 decreased 13.6 percent, while spend per rated-player trip increased 4.4 percent."
  • "Recent flooding of the Ohio and Mississippi Rivers has caused closures of certain of the Company's facilities."
    • "Horseshoe Southern Indiana reopened May 4, 2011 after flood-related closures, while Horseshoe Tunica, Tunica Roadhouse, Harrah's Tunica and Harrah's Metropolis are currently closed due to the flood waters."
    • "In 2010, the five properties contributed approximately 9.4 percent and 8.8 percent, respectively, of the Company's Net Revenues and Property EBITDA. We believe that the financial impact of these closures will be immaterial to our 2011 overall results of operations after taking into account our insurance coverage; however, the timing of the receipt of insurance proceeds is currently unknown."
  • "During the quarter ended March 31, 2011, the Company realized cost savings of $66.2 million and has estimated cost savings yet to be realized of $157.4 as of that date."



  • Active in seeking to grow their business internationally - focused on licensing and management projects using their CZR's brand especially in Asia
  • Total rewards marketplace will allow their members to use their points online
  • CZR portfolio has grown through acquisitions of other brands and therefore they had a decentralized management system. Their reorganization will allow them to centralize a lot of functions in an effort to save costs and become more efficient.
  • Despite a decline in trips per customer, they have seen an increase per visit and more cost efficiencies
  • Completed the purchase of $108MM of CMBS notes
  • $20.8BN of face value of debt at the end of the quarter
  • Their RevPAR increase in Vegas was generated without introducing resort fees
  • Rated trips from lodgers were flat but non-lodger trips declined 6% in AC.
  • Las Vegas is showing continued strength and feel confident that they will continue to see increased YoY results through the balance of 2011
  • The movement of the brands online represents the next big phase of growth for CZR's



  • Rated play is 75-80% of their total play - which is consistent with a quarter ago
  • No change in their no resort fee strategy in Las Vegas
  • Doesn't think that promotional spend has changed dramatically for them and the market in general - they are just trying to be more effective in their promotional strategy
    • The promotional and marketing expenses where a large part of their cost savings - $40MM or so annually of savings in promotional is a good estimate for the year.  They began their cost cutting effort in earnest in 3Q2010.
  • This will be the last quarter where they have the benefit of the YoY comp in Vegas with PH.  Ex PH they would have been flat in Vegas.
  • They feel really good about the way business has been building in Vegas. PH continues to ramp.
  • No material hold impact across their entire portfolio
  • Weather impact - less than $10MM in the Q
  • Market share losses?
    • They are ok with the market share numbers - especially in Midwest. More concerned about EBITDA share and keeping their more profitable customers.
  • Better guests are spending a little more and those gaming dollars are generated a little more efficiently.  Had been a little unfavorable in the past.  Have turned the spiget down or off on unprofitable or marginal business.  Vast majority of their declines in trips are from the unprofitable or marginal guest. They are really more focused on that higher end player. 
  • Gas prices: thinks it's more meaningful for the marginal guests.  They are not enthusiastic about higher gas prices, but so far so good - no impact.
  • Capex: $350-380MM (ex LINK) ... 75% of that is maintenance projects. CMBS property capex is $40MM. $100MM of LINK capex will occur this year - mostly on Octavius Tower
  • The performance of the Vegas portfolio was rather uniform. No real difference between the high and low end properties.  PH continues to ramp though.
  • CMBS paydown in the quarter? Felt that the yield reduction was attractive
  • Same Store property RevPAR in LV was ~9%
  • They charter about 5,000 flights a year from markets where there aren't existing flights to get gamers into some of their markets. They have cut this back a little due to higher fuel prices and weaker consumer spend.  While they cut it back a little, they would like to increase it over time.
  • The so called promotional environment has many layers and so it's not accurate to make blanket statements to characterize the environment. They look at changes and cuts at the micro level.
  • Expect that their operating expenses can continue to come down - especially with the reorganization under way

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