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ISLE SHOULD BEAT

A stock in need of a catalyst.

 

 

While most regional gaming operator stocks are sitting close to their 3 year highs, ISLE is not.  In fact, ISLE is 23% off its 2011 peak.  With concerns about flooding and gas prices, this is a stock in need of a catalyst.  A solid earnings report might just do the trick.

 

We’ve been a big fan of regional gaming operators for a couple of months now but have emphasized the higher quality names such as ASCA and PNK.  However, a rising tide (pun intended) lifts all boats, and ISLE should benefit from better regional gaming trends as well.  Trading at 7x forward EV/EBITDA, the ISLE boat needs a jump start.

 

We are projecting FQ4 (April) EPS and EBITDA of $0.29 and $63.3 million, 19% and 6% above consensus, respectively.  Q1 FY2012 will likely be messy due to flooding related property closings and business interruption insurance but underlying May fundamentals were decent.  We expect management to make that clear on the conference call.


TALES OF THE TAPE: RRGB, CHUX, DIN, PFCB, MSSR, RT, TXRH, JACK, WEN, RUTH, BJRI

Notable news items and price action from the restaurant space including our fundamental view on select names.

  • RRGB is to test a smaller restaurant prototype.  RRGB’s regular store size is approximately 5,600 square feet; the area of the smaller prototype will be between 2,000 and 4,000 square feet.  d CHUX gained on accelerating volume.
  • DIN has entered into an asset purchase agreement with Apple American Group LLC for the sale of 66 Applebee’s company restaurants located in Massachusetts, New Hampshire, Rhode Island, Vermont, and New York.   The transaction is expected to result in proceeds of $49 after taxes.
  • PFCB has signed an agreement with Alsea to develop 17 restaurants in Argentina, Chile and Colombia in the next 10 years.
  • The tender offer to acquire MSSR has been extended by Tilman Fertitta until July 29, 2011.
  • RT cut to “Neutral” at SunTrust Robinson.
  • TXRH raised to “Buy” at SunTrust Robinson.
  • JACK raised to “Buy” at SunTrust Robinson.
  • AFCE gained 3.9% on accelerating volume.  WEN, JACK, RUTH, BJRI, and TXRH also gained on accelerating volume.

 

TALES OF THE TAPE: RRGB, CHUX, DIN, PFCB, MSSR, RT, TXRH, JACK, WEN, RUTH, BJRI - stocks 655

 

Howard Penney

Managing Director

 


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WEEKLY COMMODITY MONITOR: JACK, CMG, DPZ, PZZA, CAKE, WEN, TXRH, BWLD

Now that 1Q11 earnings are well and truly in the rear-view mirror, the resounding message from management teams is that commodity costs are set to weigh on earnings over the next couple of quarters.  While commodities took a brief pause in May overall, the direction last week was generally to the upside.  Chicken costs remain low on a year-over-year basis, with wing prices declining 1.3% week-over-week while corn prices also declined slightly over the week.

 

WEEKLY COMMODITY MONITOR: JACK, CMG, DPZ, PZZA, CAKE, WEN, TXRH, BWLD - commod

 

 

Cheese

 

Cheese prices outperformed strongly last week as higher feed costs are squeezing dairy profitability to its worse levels since the summer of 2009, according to USDA data.  2009 was the worst year in the dairy industry since the Great Depression.  While wheat and corn did decline week-over-week, price levels remain extremely elevated versus year-ago levels.  The gain in cheese prices is a negative for DPZ, PZZA, and YUM’s Pizza Hut.  While DPZ has cheese prices has a contract that eliminates one third of the cheese market volatility, the current trajectory of cheese prices is negative for restaurant operating margins.  Below is some commentary on cheese prices from management teams:

 

JACK (5.19.11):  Cheese accounts for 6% of our spend and we continue to expect a 15% increase for the year.

 

CMG (4.20.11): As we move into 2011, we’re expanding our use of cheese and sour cream made with milk from cows

 

CPKI (5.5.11): I’m estimating it’ll be around $1.80 on a go-forward basis, probably for the back-end of the year.

 

DPZ (5.5.11): But we've got a lot of things locked in through the end of the year. And really the one to watch as always is cheese and our best bet right now is that it's going to stay relatively close to where it is right now but cheese is the one that often gives the biggest surprises either up or down and that's the one to kind of watch but assuming cheese stays relatively flat from here on out then, the absolute food costs from – through the rest of the year are probably going to stay pretty consistent with where they were in Q1 which to your point means the percentage year-over-year increase will probably ease a little bit over the course of the year.

 

PZZA (5.4.11):  We've got $1.70 or so built in for our full year cheese price. 

 

CAKE (4.20.11): We expect to have slightly lower fresh fish costs, slightly lower cheese prices, than last year.

 

WEEKLY COMMODITY MONITOR: JACK, CMG, DPZ, PZZA, CAKE, WEN, TXRH, BWLD - CHEESE PRICE

 

 

Beef

 

Beef prices are front and center for QSR companies as we head into summer.  Increased traffic on the interstate should yield seasonally higher traffic for most QSR chains but, with gas prices elevated, the challenge facing management teams is meeting customers’ value demands while maintaining margins.  WEN hiked its commodity guidance for 2011 to 5% to 6% from 2% to 3% largely due to higher beef prices.  Elevated grain prices continue to point to higher meat costs as demand remains strong.  Below is some commentary on beef prices from management teams:

 

JACK (5.19.11):  Beef accounts for more than 20% of our spend and is the biggest factor driving the change in our guidance.  For the full year, we are now anticipating beef cost to be up nearly 14% versus our previous expectation of 9% inflation. We expect beef cost to be up approximately 14% to 15% in the third quarter. Our third quarter forecast for beef 90s, in the low $2 per pound range and for beef 50s, we expect prices to average in the $0.95 to $1.05 per pound range in Q3.

 

WEN (5.10.11): Beef accounts for more than 20% of our spend and is the biggest factor driving the change in our guidance.

 

TXRH (5.2.11): Right now, we've got just over 65% to 70% of our commodities are locked for this year and that includes some floors and ceilings on certain commodities and, within that, 90% of our beef is locked and we've also got some floor and ceiling arrangements on some of our beef tips.

 

WEEKLY COMMODITY MONITOR: JACK, CMG, DPZ, PZZA, CAKE, WEN, TXRH, BWLD - live cattle

 

 

Chicken Wings


Chicken wing prices declined again last week, spelling good news for BWLD.  Excluding chicken (wings and broilers), the commodities in our monitor are up almost 43% YTD.  Chicken wing costs are down 38% YTD.

 

WEEKLY COMMODITY MONITOR: JACK, CMG, DPZ, PZZA, CAKE, WEN, TXRH, BWLD - chicken wing

 

 

Howard Penney

Managing Director


European Risk Monitor: All Eyes On Greece

Positions in Europe: Long Germany (EWG); Short Spain (EWP)

 

As we’ve been calling out in our European work, headline risk has been hot and heavy in recent weeks in European capital markets as European leaders and market participants sift through solutions for and the implications of Greece’s fiscal imbalances.  Comments yesterday from Eurogroup head Jean-Claude Juncker that a total restructuring of Greece’s debt is out of the question and that EU leaders will decide on a new aid package for Greece by the end of June bulled up equity markets today (Greece’s Athex closed up +6%), boosted the EUR-USD, and depressed peripheral bond yields and CDS spreads (see charts below).

 

European Risk Monitor: All Eyes On Greece - b1

 

European Risk Monitor: All Eyes On Greece - b2

 

We remain grounded in our position that EU officials will continue to socialize the region’s fiscal ills in order to preserve the Eurozone, support the common currency, and limit cross-country banking exposure losses by granting additional bailout packages and potentially moderating the yield and/or maturity demanded on debt repayments to the bailout facilities by the periphery, a form of “soft” restructuring.

 

In any case, while we think that these support measures and subsidies could potentially bolster European markets and the common currency over the near to intermediate term, longer term fiscal health will not be attained unless a country like Greece is allowed to default and other peripherals are forced to adhere to their deficit reduction targets without concessions.

 

For now, given that EU leadership is content with a policy on debt of Extend and Pretend, our models suggest the EUR-USD has an immediate term TRADE range of $1.41-1.44, with a significant intermediate term TREND support level at $1.41. Should $1.41 break, we see a roughly 4% downside to $1.35 (See chart below).

 

European Risk Monitor: All Eyes On Greece - B3

 

Given Juncker’s statements yesterday and announcements last week from the Greek government of a fifth austerity package, including selling €50 billion of state assets over the next 3 years to help pay down its bloated deficit, the region could see mild respite over the next days and weeks. However, we caution on the precarious nature of headline risk. Just late last week Juncker was insinuating that Greece may not receive the IMF’s next bailout tranche, which sent markets tumbling!

 

As is typical for the start of the week, below we show our European Financials CDS Monitor. It shows that bank swaps in Europe widened for 34 of the 38 banks monitored week-over-week, while 4 tightened (see below). No big surprises here.

 

We’re currently short Spain via the etf EWP and long Germany (EWG) in the Hedgeye Virtual Portfolio. Spain’s fundamentals continue to be overshadowed by political uncertainty (Zapatero’s party lost major support in recent elections), ragingly high unemployment (20.7%), the persistent slide in housing prices, and in our assessment a high probability that Spain misses its deficit reduction target, which currently stands at 9.3% of GDP.

 

On the margin, and despite positive data out of Germany today (Retail Sales +3.6% in April Y/Y and Unemployment down 10bps to 7.0%), we're less bullish on Germany as the high frequency data has slowed in recent months and the Euro region remains mired in sovereign debt contagion.

 

Be vigil or steer clear,

 

Matthew Hedrick

Analyst

 

European Risk Monitor: All Eyes On Greece - b4

European Risk Monitor: All Eyes On Greece - b5


JUST ANOTHER CRISIS … SO WHAT?

This has already been a fascinating day, starting at 5am when the futures were indicating that the DOW would be up over 100 points on the back of news that a new bailout package for Greece could be around the corner.  AT the time of writing, the VIX is up 2%, USD is down 0.5%, the S&P 500  up 0.47% and the Euro is up 0.77%.  The Correlation Risk is being put right back on the table for June.

 

Looking at the data closer to home the economic numbers continue to roll over, confirming that STAGFLATION is a real and present danger and increasing the likelihood that the United States could be heading towards another crisis.  The major data points pertaining to the U.S. economy that were released today were all ugly.  But who cares? 

 

Today’s MACRO data points are ominous for this Friday’s employment report. 

 

 

CONFIDENCE

 

The Conference Board index of consumer confidence dropped 5.2 points in May; the index is now at its lowest level since November.  The Hedgeye Optimism spread continues to contract, as the expectations component led the decline falling to 75.2 from 83.2 (previously 82.6). The present situation component dipped to 39.3 from 40.2 (previously 39.6). Overall, the assessments of future business and labor market conditions fell in May.

 

JUST ANOTHER CRISIS … SO WHAT? - optimism spread

 

MANUFACTURING CONDITIONS

 

The downshift in U.S. growth has caught up to manufacturing sector as the ISM-Chicago index fell by 11 points to 56.6; the decline puts the index below its first quarter average of 70.2. The results look to be more than supply-chain disruptions, as new orders have fallen for three consecutive months, declining 22.4 points.  In addition, the gap between new orders and inventories (a proxy for future production) was -8.1 in May, compared with April’s 12.8. The new orders to inventory/gap turned negative for the first time since March 2009.  This puts STAGFLATION in play for the balance of this quarter and next. 

 

JUST ANOTHER CRISIS … SO WHAT? - Chicago PMI

 

 

HOUSING

 

Today’s Case-Shiller number was disappointing with home prices officially double-dipping in March.  The Case-Shiller 20-city NSA series fell -0.77% in March versus February and -3.6% versus a year ago.  13 of the 20 cities included in the composite hit new lows in March.  Hedgeye’s Financials team has been way ahead of this call, as the chart below shows, and their demand model is calling for an 18% downside in home prices in 2011 versus 2010. 

 

JUST ANOTHER CRISIS … SO WHAT? - shiller corelogicc 531

 

THE FRIDAY JOBS CLOUD

 

Today’s MACRO data points are ominous for this Friday’s employment report.  Manufacturers’ sentiment has been squeezed by higher fuel and food costs and the challenges being posed by the earthquake and tsunami in Japan are not helping.  The recovery that has generated so much optimism in the U.S. has been largely led by manufacturers as exports rose and business investment picked up and could unravel in short order if manufacturing continues to slow.  While housing’s double dip is not attracting much attention, joblessness is still the most pressing of consumers’ concerns.

 

 

Howard Penney

Managing Director


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