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European Risk Monitor: Headline Risk Prevails

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

 

Below we show our weekly European Risk Monitor charts that indicate more of the same trend: default risk across the European peripheral—especially in Greece, Ireland, and Portugal—is elevated to levels that defy historical examples, including a breakout above the 300bps line in CDS that has expediently led to default.

 

As we’ve been noting in our research, despite the inability of the PIIGS to see material improvement in their fiscal imbalances via austerity measures, the EU along with the IMF continue to subsidize country shortcomings, which portends some combination of additional bailout packages, more favorable debt terms, and support in the common currency over the intermediate term. We stress that Eurocrats will ultimately Extend & Pretend to insure the union of unequal countries remains intact. This includes sugar coating words like restructuring and kicking the debt can further down the road.

 

Given, we see intermediate term TREND support for the EUR-USD around $1.40, with immediate term TRADE line resistance up at $1.46.

 

Headline risk remains a governing (and volatile) factor across Europe. Over the weekend we got confirmation that Greece will receive its next loan tranche from the IMF, which is contributing to the EUR-USD swift upward move today. Additionally, news from Portugal that the opposition Social Democrats defeated the ruling Socialists under PM Jose Socrates is positive for the region and currency on the margin.

 

Matthew Hedrick

Analyst

 

European Risk Monitor: Headline Risk Prevails - cds1

 

European Risk Monitor: Headline Risk Prevails - yields 2

 

European Financials CDS Monitor – Bank swaps in Europe were mixed to wider last week.  20 of the 38 swaps were wider and 18 tightened:

 

European Risk Monitor: Headline Risk Prevails - t1

European Risk Monitor: Headline Risk Prevails - t2

European Risk Monitor: Headline Risk Prevails - t3


RT - PUTTING SANDY ON NOTICE

Late Friday, Becker Drapkin Management LP and Carlson Capital LP formed a group holding 5.6% of RT, with the intention to nominate three people to the board of Directors.  Other that the wanting board representation, their strategy to create shareholder value was not made public.  RT put out a canned response saying the board and management "are committed to maximizing the long-term value of our company for the benefit of all of our shareholders and are always open to hearing the views and opinions of shareholders as to how the board and management can continue to create such value."

 

I had been thinking at $9.50 RT might be interesting again on the long side, but I did not have the catalyst to see what would get the stock going again.  As of Friday’s close, RT was trading at 5.6x EV/EBITDA, which represents great value, but without a catalyst it’s a value trap.  The question is this: do we now have a catalyst from which we can see some upside.

 

From where I sit, there are three key reasons why RT might be attracting some activist shareholders.

  1. Attractive real estate assets and the potential for G&A rationalization.
  2. The company recent sales trends have put into question management current strategy.
  3. The CEO of RT is a controversial figure in the industry.

 

THE REAL ESTATE - Of the 656 Company-owned and operated Ruby Tuesday restaurants as of June 1, 2010, RT owned the land and buildings for 48% or 320 restaurants, owned the buildings and held non-cancelable long-term land leases for 215 restaurants, and held non-cancelable leases covering land and buildings for 121 restaurants.  The company also owns its Restaurant Support Services Center in Maryville, Tennessee.  The potential value from the Real Estate could approach $5-$6 per share, but – as is often the case – the narrative likely makes for a better story than what the reality of monetizing the assets would be.

 

CURRENT SALES TRENDS - RT reported a decline of 1.2% in same-store sales for 3Q11, using the weather, the economy and higher gas as an excuse for the recent shortfall in sales.  As a result, 2-year trends decline by 220 bps in the quarter.  Clearly, the improvements in the trends at Chili’s and Applebee’s are having an impact on RT top line results.  The idea of trying to provide “an ultimate $25 high quality casual dining experience” for $15 is not resonating with consumer when Chili’s is

focused on selling lunch for $6. 

 

CREATING SHARHOLDER VALUE - Managements’ key strategy for increasing shareholder returns is through new concept conversions; converting low volume Ruby Tuesday restaurants to other high-quality casual dining concepts.  The strategy is to run the entire company on what's right for each individual market instead of being a strong regional brand.  As Sandy Beall said on the most recent conference call “it’s more of a roll-up or collection of communities in our company.”  I’m not sure the use of the term “roll up” is appropriate or one that conjures up a high quality strategy to create shareholder value.

 

I take this strategy to mean that management wants to make the Ruby Tuesday concept less competitive in the marketplace, with fewer units which mean less convenience for consumers and the concept’s share of marketing voice will be declining.  Essentially, management does not put a lot of value in the Brand Ruby Tuesday’s, so why should the investment community?  Put another way, if you are Chili’s or Applebee’s, you are thrilled that there will be fewer Ruby Tuesdays.  I understand the thought behind improving the productivity of the existing assets, but it’s hard to see how RT will build any scale with the current approach.

 

The other part of the company’s strategy to create value is through increasing revenue and EBITDA through franchise partner acquisitions.  Overall this has limited upside, due to the fact that market is not placing a very high multiple on the cash flows of the existing Ruby Tuesdays business so why increase you exposure to that business. 

 

I think the current group of activists share holders has an uphill battle from here although, depending on your broader market view, buying RT under $10 could yield some positive returns.  As you can see from the charts below, the biggest issues RT faces is the stiff competition coming from Chili’s and Applebee’s.  In a zero-sum game if the #1 and #2 brands are taking market share, a substantial piece of that probably coming from Ruby Tuesday’s. 

 

The rhetoric from the activist group will definitely put a floor on the stock around $10 and the bull case will anchor on how they are able to influence Sandy Beall and management’s strategy.  The upside may be limited, depending on how Sand Beall behaves following the press release on Friday.  My gut reaction tells me that he will put up a fight and does not want to be pushed around.  Sandy has controlled this company, and the board, for years so giving up some control will not be easy decision for him.  I would think that bringing some fresh thinking to the board will be good news rather than bad, but whether or not Sandy Beall agrees with me is the only thing that matters.

 

RT - PUTTING SANDY ON NOTICE - B G pod 1

 

RT - PUTTING SANDY ON NOTICE - B G pod1 2yr

 

 

Howard Penney

Managing Director


TALES OF THE TAPE: SBUX, YUM, THI, WEN, DRI, CBRL, RUTH, DIN, BJRI

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

  • SBUX was raised to “Outperform” at BMO Capital Markets.  The price target is $45 per share.
  • THI has reached an agreement with former President and CEO Don Schroeder “with respect to his relationship with the company”.  Schroeder is assuming an advisory role.  Under the terms of the agreement, he will also receive C$7.5m severance.
  • WEN Chief Marketing Officer Ken Calwell, has been hired as president of Papa Murphy’s International, which operates the Vancouver, Washington-based take-and-bake pizza chain.
  • DRI, CBRL, RUTH, DIN and BJRI traded lower on accelerating volume.  In QSR, COSI, SBUX, and JACK also underperformed on accelerating volume.
  • Late Friday Becker Drapkin Management LP and Carlson Capital LP formed a group holding 5.6% of RT, with the intention to nominate three people to the board of Directors.  I will have a note on RT out shortly....

TALES OF THE TAPE: SBUX, YUM, THI, WEN, DRI, CBRL, RUTH, DIN, BJRI - stocks 66

 

Howard Penney

Managing Director


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THE M3: MGM CHINA

The Macau Metro Monitor, June 6, 2011

 

 

MGM CHINA SAYS NO NEED FOR REFINANCING, EYES COTAI BY 2015 Reuters, WSJ

MGM China CEO Grant Bowie sees no need to issue new equity after its HK IPO.  Bowie said construction on MGM China's Cotai property would likely start next year, taking 27-36 months to complete.  Acknowledging Wynn Macau's good execution of targeting high-end customers to spend more per table and slot machine, Bowie said MGM China can maximize revenue by doing the same.   Bowie added, "I would like our mix to be 50/50 (VIP/Premium mass). I think this is on the two-five year horizon." 

 

Bowie also said MGM China will be seeking other opportunities, whether on the peninsula or potentially in Taiwan if that opportunity were to materialize.  Meanwhile, Pansy Ho has said she expects the Macau government to grant Cotai land rights to MGM China, Wynn Macau and SJM within the year.


WEEKLY FINANCIALS RISK MONITOR: BANK SWAPS SPIKE

This week's notable callouts include domestic swaps increasing sharply and European sovereign CDS backing off for a second week in row.


Financial Risk Monitor Summary (Across 3 Durations):

  • Short-term (WoW): Negative / 4 of 11 improved / 4 out of 11 worsened / 3 of 11 unchanged
  • Intermediate-term (MoM): Negative / 3 of 11 improved / 5 of 11 worsened / 3 of 11 unchanged
  • Long-term (150 DMA): Neutral / 3 of 11 improved / 5 of 11 worsened / 3 of 11 unchanged

 

WEEKLY FINANCIALS RISK MONITOR: BANK SWAPS SPIKE - summary

 

1. US Financials CDS Monitor – Swaps widened across domestic financials, widening for all 28 of the reference entities. 

Widened the most vs last week: BAC, PRU, MBI

Widened the least vs last week: AXP, RDN, TRV

Widened the most vs last month: GS, PMI, RDN

Widened the least vs last month: GNW, TRV, AXP

 

WEEKLY FINANCIALS RISK MONITOR: BANK SWAPS SPIKE - us cds

 

2. European Financials CDS Monitor – Banks swaps in Europe were mixed to wider last week.  20 of the 38 swaps were wider and 18 tightened.   

 

WEEKLY FINANCIALS RISK MONITOR: BANK SWAPS SPIKE - euro cds

 

3. European Sovereign CDS – European sovereign swaps edged off their highs last week, falling 14 bps on average. 

 

WEEKLY FINANCIALS RISK MONITOR: BANK SWAPS SPIKE - sov cds

 

4. High Yield (YTM) Monitor – High Yield rates rose last week, ending at 7.31 versus 7.14 the prior week.  

 

WEEKLY FINANCIALS RISK MONITOR: BANK SWAPS SPIKE - high yield

 

5. Leveraged Loan Index Monitor – The Leveraged Loan Index was down only slightly last week, closing at 1612 versus 1614 the prior week.   

 

WEEKLY FINANCIALS RISK MONITOR: BANK SWAPS SPIKE - lev loan

 

6. TED Spread Monitor – The TED spread rose slightly last week, ending the week at 22.1 versus 21.3 the prior week.

 

WEEKLY FINANCIALS RISK MONITOR: BANK SWAPS SPIKE - ted

 

7. Journal of Commerce Commodity Price Index – Last week, the JOC index continued to bounce along at a low level, rising less than a point versus the prior week. 

 

WEEKLY FINANCIALS RISK MONITOR: BANK SWAPS SPIKE - JOC

 

8. Greek Bond Yields Monitor – We chart the 10-year yield on Greek bonds.  Last week yields fell 48 bps versus the prior Friday, their second down week in a row.

 

WEEKLY FINANCIALS RISK MONITOR: BANK SWAPS SPIKE - greek bonds

 

9. Markit MCDX Index Monitor – The Markit MCDX is a measure of municipal credit default swaps.  We believe this index is a useful indicator of pressure in state and local governments.  Markit publishes index values daily on six 5-year tenor baskets including 50 reference entities each. Each basket includes a diversified pool of revenue and GO bonds from a broad array of states. We track the 14-V1.  Last week spreads were rose to 107 from 101 the prior week. 

 

WEEKLY FINANCIALS RISK MONITOR: BANK SWAPS SPIKE - mcdx

 

10. Baltic Dry Index – The Baltic Dry Index measures international shipping rates of dry bulk cargo, mostly commodities used for industrial production.  Higher demand for such goods, as manifested in higher shipping rates, indicates economic expansion.  Early in the year, Australian floods and oversupply pressured the Index, driving it down 30% before bouncing off the lows.  Last week the series gained 15 points.

 

WEEKLY FINANCIALS RISK MONITOR: BANK SWAPS SPIKE - baltic dry

 

11. 2-10 Spread – We track the 2-10 spread as a proxy for bank margins.  Last week the 2-10 spread tightened 4 bps to 256 bps. 

 

WEEKLY FINANCIALS RISK MONITOR: BANK SWAPS SPIKE - 2 10 spread

 

12. XLF Macro Quantitative Setup – Our Macro team sees the setup in the XLF as follows:  1.8% upside to TRADE resistance, 0.7% downside to TRADE support.

 

WEEKLY FINANCIALS RISK MONITOR: BANK SWAPS SPIKE - XLF

 

Margin Debt Approaching Prior Pre-Crash Highs

We are now published NYSE Margin Debt every month when it’s released.  Last week we got April data (as of month-end). This chart shows the S&P 500, inflation adjusted back to 1997, along with the inflation-adjusted level of margin debt (expressed as standard deviations from the long-run mean).  As the chart demonstrates, higher levels of margin debt are associated with increased risk in the equity market.  Our analysis shows that more than 1.5 standard deviations above the average level is the point where things start to get dangerous.  Currently, we are very close to that level – April margin debt hit 1.49 standard deviations above the average.

 

One limitation of this series is that it is reported on a lag.  The chart shows data through April.

 

WEEKLY FINANCIALS RISK MONITOR: BANK SWAPS SPIKE - margin debt

 

 

Joshua Steiner, CFA

 

Allison Kaptur



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