SONC – Management Not Conservative Enough

Just three and a half weeks ago, SONC issued its FY09 EPS expectations of up 12%-14%. Even in that short time period, management stated today on its earnings call that the landscape has changed rather dramatically. Although SONC did not change its guidance today, management said that current credit conditions could impact its franchise development target of 155-165 new openings, on which the 12%-14% EPS growth relies. SONC then went on to say that a lot of its franchisees are well capitalized. When asked specifically why they are not lowering their EPS guidance to a more cautious range based on the risk to the company’s development schedule, management said, “If we thought we should pull back, we would” so there appeared to be a lot of hedging on the part of management as it relates to current visibility.
  • Prior to today’s call, I thought SONC’s FY09 EPS expectations were aggressive, and although they still seem to be, I did not realize before today that half of this growth is expected to come from refranchising gains. So really only 6%-7% of SONC’s EPS growth relies on operations and those targeted 155-165 franchise drive-in openings. Instead, SONC’s ability to achieve 12%-14% EPS growth focuses largely on the timing of partner drive-in sales to franchisees. Despite management’s assurances that so far no transaction has been impacted by the current credit markets, this remains a real risk for the company.
  • I am also less than confident in SONC’s ability to return to flat partner drive-in same-store sales growth for FY09 following the 3.9% and 6.3% declines in 3Q08 and 4Q08, respectively. Although the company will be lapping easier comparisons in the back half of the year, if current trends continue into 1Q09 and 2Q09, SONC would need to generate 5%-plus numbers in 2H09, which would be a significant improvement from current trends. SONC’s partner drive-in’s average check has been hurt by the introduction of its Happy Hour promotion, which drives increased traffic at the expense of average check and margins. The company will be lapping this introduction in November so that should benefit numbers on a year-over-year basis.
  • SONC’s 1Q09 results should continue to be hurt by lagging sales results because although the company is seeing improved customer service scores, I don’t think SONC will see a quick turnaround in trends in this environment. Additionally, SONC expects its commodity cost to be up high single digits in the first quarter as it is currently experiencing beef prices (12% of SONC’s costs) up in the 30%-35% range.

VFC: Let’s “YouTube” These Guys

Interesting to see the progression of management’s tone on key business drivers over the past 5 quarters. Here’s the progression…From their mouth to your eyes…

Be sure to click on pictures below to enlarge text.
Source: VFC Press Releases and Conference Calls

Oil : Holding the Maginot Line... Buying it for a "Trade"

We added a long position in Oil yesterday in the Hedgeye Portfolio. The commodity was providing us with a strong green buy signal and from a fundamental perspective the ~$70 price per barrel is also at, or near, an important level for some of the major producers around the world. Fortuitously, the initiation of our long Oil position was met with comments from the Qatari Oil Minister overnight that OPEC needs to cut production by 1MM barrels of oil a day or more, so Oil is trading up close to 5% this morning.

According to PFC Energy, the breakeven point is for many members of OPEC is just below $70. The higher cost producers break even points are as follows: Saudi Arabia’s break-even point is $49, Venezuela’s is $58, Nigeria’s is $65. While the OPEC producers break-even at prices below $70, the price is obviously perilously close to levels where the higher cost producers do not break even, so it is a line that is need of protection.

More important than OPEC, as it relates to $70 oil, is Russia. According to the Russian Finance Ministry, the nation’s budget for 2009 breaks even at a price of $70 oil per barrel. Per the International Energy Agency, Russia was the world’s largest producer of crude oil in 2007 (at 12.4% of the world’s total) and the second largest exporter, just behind Saudi Arabia. As a result, this price of $70 becomes a very important number to watch.

The French constructed the “Maginot Line”, which was a long line of concrete fortifications, tank obstacles, and machine gun posts along its border, in the run up to World War II. The concept was based on the success of static trench like warfare during World War I, which enabled the French, generally, to impede German progress. Ultimately, the antiquated defense measures of the Maginot line were limited in their ability to hold back German troops and France, as we know, was conquered by the Germans.

One has to wonder how long the antiquated defense of production cuts will enable OPEC to hold the current attack on Oil’s Maginot Line.

The “Trend” in oil is negative. Buying oil is for a “Trade”. KM’s lines for oil prices are:

Buy “Trade” = $68.94/barrel
Sell “Trade” = $81.85/barrel

Daryl G. Jones
Managing Director
(chart courtesy of

Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.43%
  • SHORT SIGNALS 78.34%

Eye on Regionalism: Italy, "I've got your back"...

Another data point in the narrative of EU divisiveness…

Some key data points arrived this week in regards to Italian economic health. On Tuesday CPI numbers were released for September which came in slightly better than August on a year-over-year basis, though still up almost 4%. Today, industrial activity data for August was released showing an unsurprising drop in both sales and orders.

A more telling measure of Italian economic credibility came from three Libyan government entities: The Central Bank of Libya, Libyan Investment Authority and Libyan Foreign Bank. These three entities boosted their holding in floundering UniCredit to 4.2% and committed to participate to the tune of almost 10% in an upcoming 6 billion Euro secondary. UniCredit, Italy’s largest bank, has seen its balance sheet shredded by the credit markets and has been rushing to shore up capital.

Italy has always been one of the weaker hands at the EU table and their finance industry has a long history of unsavory practices and corruption. The fact that one of their preeminent financial institution is receiving a bailout from a country that has just reemerged from rogue status and remains controlled by an unbalanced megalomaniac dictator (recall our 9/5 post) says a lot. This isn’t Warren Buffet to the Rescue – this is Muammar Qaddafi.

As a point of fact, Libya has a long investment history in Italy. During the decades when the rest of the world shunned doing business with them because they sponsored terrorism. The Libyan government acquired stakes in Italian banks, utilities & sports teams, but the timing of this move coming so closely on the heels of Berlusconi’s pledge to compensate Libya monetarily for colonial period abuse suggests that Italy and Libya are becoming increasingly chummy.

This is unnerving.

Andrew Barber

Europe's Trade Balance Continues to deteriorate...

This chart is not a predictive one; more of a reminder of a "Trend". The EU, in its current organizational form, has never had to deal with protracted economic adversity. The finger pointing has began, but it looks mild relative to what it could be.

DF – November Milk Prices Continue to Decline YOY

The USDA just released the advanced Class 1 milk price for November of $17.33 per hundredweight. This price reflects a 19.2% decline year-over-year, but an 11.6% sequential increase from October’s level. As I have pointed out once before, there is an inverse relationship between the change in milk prices and DF’s gross margins so the fact that the average milk price for the first two months of the company’s 4Q08 have declined nearly 24% should benefit DF’s quarterly gross margins.

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