Wendy’s is a name that has divided the street of late.  A recent upgrade has put some support under the stock but, overall, the intermediate term carries a fair degree of uncertainty for the concept.  Longer-term, a more focused management team thanks to the long-overdue sale of Arby’s.  Below, I go through some key initiatives being enacted by management and give my take on whether or not the initiative is progressing well or has positive implications for future earnings power.


Improvements completed to the core menu:

  • Value, with the introduction of the My 99 Value Menu
  • Salads, with the introduction of four premium entrée salads
  • Fries, with the introduction of natural-cut fries with sea salt

HEDGEYE VIEW - A much needed upgrade that will benefit the perception of the Wendy’s brand!


Improvements in the pipeline to be done by year-end:

  • Working to improve the core hamburgers line - Dave's Hot 'n’ Juicy cheeseburgers will be introduced 2H11. 
  • Working to improve chicken sandwiches; In 4Q11 will see the introduction an entirely new line of chicken sandwiches known as the Gold Chicken line, including new flavors and toppings, such as bruschetta with diced tomatoes, chopped basil and balsamic glaze. These sandwiches will also feature a new butter-toasted bun. 

HEDGEY VIEW - This will be critical in developing incremental customer visits in 2H11.  This should be a positive for comps as it is rolled out across the system. 


Current sales trends as of the end of 1Q11:  North America company-owned same-store sales turned positive in April, up 0.5%.  Furthermore, the U.S. was stronger at up 1.1%.  In the current quarter, Wendy’s restaurants are promoting the Bacon Mushroom Melt Hamburger or Flavored-Dipped Chicken Sandwiches.  In June, Wendy’s introduced the new Berry Almond Chicken Salad and Wild Berry Tea.


HEDGEYE VIEW - I continue to believe that current trends remain in the 2-3% for WEN USA.  Using a strategic pricing model initially implemented in 2010, WEN plans to raise prices in 2011.


REMODELS - An important part in pulling all the initiatives together will be upgrading the asset base of the concept.  Management has been working on several new restaurant designs, with the intention of beginning the remodel process in 3Q11.  They are currently testing four new restaurant designs and expected to have at least one of each open by late September, with expectations for an aggressive rollout program to begin in 2012.


HEDGEYE VIEW - I believe that the customer feedback is not working and that management is going back to the drawing board.  I also believe that the success of the MCD units in Tampa, Florida has had an impact on what features management is ultimately seeking to implement at the remodels.



BREAKFAST - Wendy’s is trying very to participate in the fastest growing day-part of the QSR segment.  Management has last communicated that they are making excellent progress on Wendy's breakfast program, and they are very encouraged with both sales and customer reaction to our new breakfast products.”  Currently, the company is testing its products in six markets and has recently reduced couponing. 


The breakfast expansion timeline:

  • In 2H10 management launched the new breakfast menu in four test markets: Kansas City, Phoenix, Pittsburgh and Shreveport.
  • In the first half of 2011, expanded breakfast into two additional markets: Louisville and San Antonio. 
  • Over the balance of 2011, the intention is to have more breakfast markets added. 
  • By the end of 2011, the intention is to have the breakfast menu in about 1,000 restaurants including approximately 600 franchise restaurants.

HEDGEYE VIEW - Longer term, we believe breakfast represents an opportunity to grow incremental system wide sales.  In the short run, while customer awareness, trial and repeat purchase rates are all improving, the current level of sales are not supportive of a major roll-out, which could cause the company to fall short of the 1,000 unit goal. 



SUMMARY - I like the long term potential for the Wendy’s as a standalone concept.  While 2011 is a transition year, a short fall in a couple of the growth initiatives could lead to a short fall for the company being able to hit the double-digit EBITDA growth in 2012.  At the very least it puts incremental pressure on core menu initiatives to incrementally more successful to make up for the short fall in the other initiatives.





Howard Penney

Managing Director


The Macau Metro Monitor, June 16, 2011


MELCO CROWN GAINS CONTROL OF MACAU PROJECT Melco Crown Entertainment, WSJ, Channel News Asia

MPEL plans to pay the affiliate of eSun US$260 million for a 60% interest in the Cyber One Group, the developer of  Macau Studio City (MSC), and will further pay New Cotai--an arm of U.S. investment firms Oaktree Capital Management L.P. and Silver Point Capital L.P which owns 40% of MSC--US$100 million in cash in three installments over two years.  According to a person familiar with the situation, under a previous deal, MPEL was to receive 10% of mass GGR and 5% of VIP GGR. 


MPEL CEO Lawrence Ho said, "We believe Macau Studio City’s existing land grant and previously completed site work will allow us to significantly expedite its construction timetable.”


ESun said a default notice from the Macau government regarding the lack of progress on the project was among its reasons for wishing to settle a multi-year dispute among the involved parties.  Meanwhile, CapitaLand has sold its 20% interest in MSC to eSun for HK$658.7 million (S$104.5 million) to help resolve any disagreements.  According to the terms of the settlement, the eSun-led joint venture and New Cotai will settle legal proceedings initiated against each other in Hong Kong without admitting liability, eSun said.


Singapore Tourism Board's director of integrated resorts/business tourism development, Carrie Kwik said, "Marina Bay Sands Pte. Ltd., the successful bidder of the Marina IR, is not allowed to sell, transfer or dispose of its estate interest in Marina Bay Sands within the exclusivity period of 10 years. The approval of the Singapore government must be sought if the IR operator were to consider any sale or subdivision of the IR after that period."


A Marina Bay Sands spokesman said Leven's statements were "inadvertently made without reference to certain restrictions set out in the development agreement between Marina Bay Sands Pte. Ltd. and the Singapore Tourism Board."


Claims Drop 13k, Remain Flat on a Rolling Basis

Initial claims fell 13k last week, dropping to 414k.  The 4-week average was unchanged, and claims remain higher than they were at the beginning of the year.  We show below initial claims with the S&P and XLF.  Over the last several years, the indices have climbed when claims are dropping, and held flat or pulled back when claims stagnate or rise.  The tight correlation between market performance and Federal Reserve purchases is ominous heading into the end of QE2.















2-10 Spread 

We track the 2-10 spread as a proxy for NIM.  Thus far the spread in 2Q is tracking 11 bps tighter than in 1Q.  This week's spread level of 259 bps compares to 257 bps last week.  






Financials Subsector Performance

The chart below shows the price performance of subsectors over four durations.




Joshua Steiner, CFA


Allison Kaptur

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

  • SBUX is broadening consumer access to mobile payment with the launch of a Starbucks for Android app.
  • SBUX is shifting its source of milk for its NYC stores from Elmhurst Dairy in Queens to a non-union plant out of the City by the end of this week.  The decision has been met with strong opposition in the City with elected officials and workers claiming that the move will cost 700 people their jobs.
  • DIN was upgraded to Overweight from Neutral at JP Morgan. 
  • The space outperformed yesterday with BAGL, SONC and WEN the standouts.  We would use this strength to pare back positions and even increase short exposure where appropriate.
  • The UN Food Price Index is 20% higher than the level it was at during the 2008 crisis levels.  The vast majority of global respondents to a survey by international aid agency Oxfam said they are no longer eating the same kind of food they did two years ago. 




Howard Penney

Managing Director

PSS: Draconian



The bottom line is that the liklihood for this company to look materially different -- in 6-12 months -- perhaps smaller, but more profitable and less levered, is quite high. Though we still have lease accretion/dilution math to crunch, in looking through the decision tree, we don't see how the recent turn of events can be viewed as anything but positive. 


After the last quarter, we expected draconian change at PSS. We simply did not think that Matt Rubel leaving would be it.


The circumstances were pretty clear to us. Matt has his plan, and wanted to make certain moves in the wake of the company's performance over the past year. But the Board felt differently. Our sense is that the Board was looking for more draconian change, rather than tweaks to the strategy. 


The last thing that Matt wants, or needs, is being at odds with the Board of his Company. Let's face it...he's a pretty strong personality.


We've been pretty adamant that at his age (53) he has at least another job left in him. We thought that he'd capitalize on that AFTER a meaningful rebound in the stock. But with a $10mm peck on the cheek on the way out, it definitely helps ease the pain.


Our strong sense is that he'll relax for a few months, and will be picked off to run a company that is not so limited in growth potential.


One thing we'll give the Board credit for is not sitting idle while the stock so grossly underperformed. We were not privy to the the precise discussions behind closed doors, but at least the Board asked the right questions. The result is clear. This happened after only 6 quarters of meaningful underperformance. Maybe I was numbed by the pain of seeing Boards like Liz Claiborne sit there with blinders on through 17 quarters of Chinese water torture.


So what does all of this mean for PSS?

  1. Yes, this is a game changer to any investment thesis. The interim CEO is a lawyer, who will bide time until either a) someone is brought in to really move the needle with changing this business model (think Crocs), or a) the company is bought by a financial buyer.
  2. Why a financial buyer today and not yesterday? The reality is that any buyer would need complete buy-in from Matt as well as the team he assembled -- who is loyal to him. That's a risky proposition given the culture that Matt instilled in this company. But with the Board doing the dirty work, the risk profile goes down for a financial buyer to come in and either break it up (think Fortune Brands) or keep PSS intact yet grossly cut the store base
  3. Some hypothetical math...
    • let’s do some simple math. Core Payless accounts for $2.5bn in revs, with PLG at about $1bn. But PLG accounts for about $70-$75mm in EBIT. Yes, that means that core Payless stores are currently churning out about $70mm/year based on our model. $70mm on $2.5bn in sales? That’s a 2.8% margin business, which is simply awful for a model with relatively low operating asset turns.
    • The Hypothetical… So, if we’ve got 4,800 stores running at an average margin of 2.8%, do you think they’re all running at that rate? No. In fact, one of the most poorly understood parts of retail (due to GAAP reporting standards) is the massive gap that exists between a given company’s better vs. poorer performing stores. Our sense is that about a third of Payless stores are dilutive to the P&L, and upwards of half that number are cash-flow dilutive. If we assume that these stores have sales productivity that are 2/3 that of the average PSS store, and that 800 are taken out, it gets us to about $275mm in revenue lost, but $25-$30mm in EBIT gained. Our math might not be spot on, but we think it’s directionally accurate. In this situation, we think the Street would look right through a special charge – even if it’s all cash.
    • Most people would argue that this math is a bit extreme, as its clearly many times what management has referred to in the past as % of stores that are cash flow negative. But we think this is the new normal -- and we think that Board is inclined to agree -- or at least seriously consider the possibilities. A consistent low growth, high inflation environment is a game changer for evaluating the quality and consistency of a portfolio.
    • We noted after the last (disastrous) quarter that this kind of math is useless if the CEO and the Board ignore it. We did not think it would be ignored at PSS. But perhaps not acted upon so soon.
  4. With a $10mm charge in the quarter, and the high probability that the company will sweep everything under the carpet this quarter certainly does not bode well for 2Q earnings. But the reality is that since the last miss, the amount of call volume I had on this name has been close to nil. Am I suggesting that this is the kind of event where Matt Rubel leaving will be a stock-popping event (ie Bill McComb at LIZ)? No. But in going through cash flow scenarios, I question how this could really be bad for shareholders unless the Board brings in someone who tries to follow Matt's plan and the shoes simply don't fit.

The bottom line is that the liklihood for this company to look materially different -- in 6-12 months -- perhaps smaller, but more profitable and less levered, is quite high. I cannot envision that with such poor sentiment on this name that this won't play out as a positive. 


We already get to meaningful support for the stock in the high-single digits for Saucony and Sperry alone. The next -- and very important -- question is 1) how many stores should be closed, 2) how many CAN be closed, 3) what is the financial cost to get out, and 4) will that be accretive or dilutive after netting it against the improved cash flow. This is not a 'back of the envelope' analysis. Stay tuned...we'll be back with more details. 




New Start

This note was originally published at 8am on June 13, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“If we are to build a better world, we must have the courage to make a new start.”

-F.A. Hayek


Last week I received a tremendous amount of positive feedback on my note titled “American Optimism.” So I’d like to start this week off by thanking you for inspiring me. I am very bullish on the prospects of building a better world – I am very bullish on change.


Interestingly, but not surprisingly, Hayek wrote the aforementioned quote in the concluding chapter of “The Road To Serfdom” (page 237) in 1944. His summary thought stood in the face of British-style Keynesianism that had dominated the economic theory of his time.


What was Keynes’ response to Hayek’s conclusions?


Bruce Caldwell (who edited the most recent edition of “The Road To Serfdom”) captures the moment best in his Introduction:


“John Maynard Keynes read the book on the way to the Bretton Woods conference, and delighted Hayek when he wrote him that it was “a grand book” and that “morally and philosophically I find myself in agreement with the whole of it; and not only in agreement with it, but in a deeply moved agreement.” (Letter, John Maynard Keyens to Hayek, June 28, 1944)


Alrighty then – we have a consensus!


Last week, the most bullish week-over-week moves in all of Global Macro came right where I think the prospects for change are going to be measured – in the real-time price of the US Dollar Index.


I’m not so concerned about US stocks being down for 6 consecutive weeks when it’s crystal clear that Growth Slows As Inflation Accelerates. What I need to see change (to get bullish on stocks) is a Deflating of The Inflation (Hedgeye Q2 Macro Theme).


With the US Dollar Index UP a full +2% last week to $75.60, here’s what happened to things priced in US Dollars:

  1. US Stocks = DOWN -2.3%
  2. WTI Crude Oil = DOWN -0.9%
  3. Copper = DOWN -1.4%

Le Mucker’s SERIES 66 TEST QUESTION: Which of those 3 things matters most to the US Economy?

  1. La Bernank says stocks
  2. Le Consumer says gas prices
  3. Le Industrialist says cost pressures

I’ll go with #2 and #3.


If you want a New Start in this country you have to see a Deflating of The Inflation. Otherwise you’ll continue to see a slowdown in 70% of US GDP (Consumption) and margin compression at the companies who are supposed to employ these consumers.


The Stagflation is not hard to understand (Growth Slowing below the rate of Inflation). It just isn’t palatable for the Keynesian Kingdom to accept responsibility for it. That would be called holding themselves accountable.


Until I start seeing data that implies that both of these things are occurring at the same time:

  1. Growth is slowing at a decelerating rate
  2. Inflation is accelerating at a decelerating rate

Why would I stop protecting my family’s hard-earned wealth?


Being in Cash in 2011 has obviously beaten 48 of the country stock markets in the Hedgeye Global Macro Stock Market Index for the YTD (there are 66 country indices in our Index). And, depending on where you bought them (or what index you are in – both the Nasdaq and Russell 2000 are DOWN for 2011 YTD), the +1% YTD return in the SP500 has been slim pickings!


Here’s how the Hedgeye Asset Allocation Model was positioned going into and out of Friday’s US equity market swoon:

  1. Cash = 52% (UP +3% week-over-week after selling ½ our US Equity Allocation on mid-week strength)
  2. International Currencies = 21% (Chinese Yuan and US Dollar – CYB and UUP)
  3. Fixed Income = 18% (Long-term UST Bonds and US Treasury Flattener – TLT and FLAT)
  4. Commodities = 3% (Gold – GLD)
  5. US Equities = 3% (US Healthcare – XLV)
  6. International Equities = 3% (Germany – EWG)

And no, being in 52% Cash wasn’t enough!


On a week-over-week basis, I lost money in 4 of 6 of these asset allocation positions:

  1. US Dollar (UUP) = +1.5%
  2. Long-term Treasuries (TLT) = +0.8%
  3. Chinese Yuan (CYB) = -0.4%
  4. Gold (GLD) = -0.7%
  5. Healthcare (XLV) = -1.1%
  6. Germany (EWG) = -2.7%

It’s a good thing I have shorts – and there’s plenty to be optimistic about on that front. There’s always risk to be managed somewhere.


My immediate-term support and resistance ranges for Gold, Oil, and the SP500 are now $1525-1538, $98.60-100.45, and 1255-1298, respectively.


Best of luck out there this week,



Keith R. McCullough
Chief Executive Officer


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