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September Casual Dining Trends – Plain Ugly

Casual dining same-store sales declined 3.8% in September with traffic falling 6.5%. The casual dining industry has not experienced a traffic decline of this magnitude going back to 2000, and now this is the third consecutive month of 6%-plus declines. Looking at the chart below, I think Burt Vivian, president of P.F. Chang’s China Bistro, described it best yesterday, “In short, July and August were not pretty. September was just plain ugly.”

SKX: Predictably Disastrous. Numbers Still Too High

No, Skechers is not missing and guiding down because of a ‘weak retail environment’ or ‘tough consumer’ as management suggests that they are. It is because the confluence of factors that allowed this company to triple its margins over 4 years has hit its breaking point. Its’ sales/inventory/margin triangulation has shifted into the worst place possible (see Exhibit below) and I think it is destined to stay there for quite some time. Unfortunately, the company still does not believe it. They did not set expectations low enough. I won’t touch this stock until it approaches $5.

I’ll repeat the narrative I threw out to clients on September 3.
A) Over the past four years, a shift in fashion towards low profile (SKX sweet spot) accelerates growth and propels margins from 0% to 9%.

B) Low profile growth finally losing share to Performance – starting this fall.

C) Along the way, SKX opens up more high-fixed –cost company-owned retail stores to get product to consumers despite less interest from retail.

D) SKX broadened wholesale distribution to more marginal channels (Goody’s, Mervyn’s).

E) SKX is taking its next leg of growth overseas. Grows more aggressively into Hong Kong and Macao with a goal to triple sales there in 3-years. Maybe they should have thought of this 3-years ago before a 20% run in FX? FX moves are always hindsight 20/20, but this is another example of a poorly managed company in this space deploying capital reactively. Proactive always wins in my book. I think Skechers’ recent announcement that it is expanding its Asian JV with the Onwel Group is another nail in the coffin.

F) SKX has become more litigious, suing a smaller brand after years of fighting against economic harm from knocking off styles.

G) In August, SKX bid for Heely’s. C’mon team Greenberg…Are you serious??

H) We have not even started talking about losing space in Asian factories to more established brands, and increased cost pressure SKX will see starting in 1Q due to higher FOB costs (freight on board – or total fully loaded import cost). This will be a margin crimper.

There’s no doubt in my mind that margins are getting cut in half here – as I’ve noted since my initial June 4th note (SKX: Can It Really Be This Simple?).

I’ve got EPS going from $1.70 in ’08 to $0.85 in ’09, and EBITDA declining by a similar magnitude. The bottom line is that I would not even think of buying this stock until it was at a 3x EBITDA multiple on my numbers. That equals $5.10.


In my 8/31/08 post “HOT: WHERE DO ESTIMATES GO W/O NYC AS THE SAVIOR” I predicted 2009 consensus EBITDA and EPS estimates needed to come down by 10-15% and 25%, respectively. Today, HOT provided guidance 13% and 23% below estimates, respectively, so pretty close. However, given the very difficult comparisons facing the company in the first half of 2009, and difficult 2 year comps for most of 2009, I’m beginning to think the guidance is not conservative enough. Management has not exactly been stellar in their predictions.

  • Here is the eye opening statistic that forces me to really question the 2009 guidance. Q4 REVPAR at Branded Same-Store Owned Hotels in North America is now expected to decline 9% to 11%. Yes that is against a tough comparison. However, it is such a sharp deterioration from +3% in Q2 and flat in Q3 that it brings into question why management settled on only a 5% decline next year.

  • From a company perspective, HOT is clearly underperforming MAR. This is understandable due in part to the lack of hotel ownership in MAR business model. However, HOT’s significant exposure to some of the previously “hot” markets of NYC, London, and Hawaii is now a liability. I’ve written posts on each one of these markets over the last two months highlighting HOT’s exposure. We focus a lot on deltas here at Research Edge and the delta in these markets is hugely negative.

  • I’ll have some more to say on HOT in the areas of timeshare and cash flow but for now, I still see downside risk.

Not exactly a stellar record on guidance
Comparisons remain tough throughout most of 2009 on a 1 and 2 yr basis

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PFCB – Fixing what it can control

Sales suck (for everybody), commodities are putting pressure on margins (but some relief is in sight), growth is slowing and your closing unprofitable stores. The balance sheet is strong and you are generating cash! This could be 1 of 20 companies I know!

There is nothing anybody can do to offset the macro environment, except manage the business as conservatively as you can. As Burt Vivian said yesterday, coming out of this cycle PFCB will be a much stronger more profitable company. From my perspective that was the most important comment on the entire call!!
  • That being said, for some time now, I have criticized PFCB’s unit growth initiatives. Through 2007, the company’s capital expenditures as a percent of sales continued to climb at the same time its operating margins were declining rather significantly (fell 70 bps in 2007 following 2006’s 160 decline). In 2008, however, the company slowed its Bistro development targets to 17 from 20 in 2007. Additionally, PFCB lowered its 2008 Pei Wei openings to 25 from 37 in 2007.
  • Although I was happy to see this slowdown, particularly at Pei Wei, I have argued that PFCB should halt Pei Wei’s new unit growth altogether as the concept experienced declining operating margins throughout 2006 and 2007. That being said, I am encouraged to see that PFCB is closing 10 underperforming Pei Wei locations effective immediately, which should also have an immediate impact on Pei Wei’s margins. Management also significantly lowered its new unit targets for FY09 to 6-10 Pei Wei units from 25 in FY08 and 8-10 new Bistros (from 17 in FY08). Although slowing new unit growth will not solve PFCB’s current challenges as it relates to the declining traffic trends being felt across the industry, it should improve the company’s long-term returns.

The Great Swells Of The Sea

Thank God for fire places. I am writing this ‘Early Look’ from a chilly sea view Inn outside of Camden, Maine this morning. The Penobscot Abenaki Indians called this part of the country Megunticook, meaning "Great Swells of the Sea” – what a fitting theme for this increasingly interconnected global market place of macro factors…

Up until I left the hedge fund First Class travel circuit of Four Seasons hotels and sunny Floridian terraces, most of my friends from back home would say ‘hey man, you have this pretty darn good!’ – warmer, yes… but thought inspiring? Not so much… My last Wall Street luxury resort conference was roughly a year ago, and I must say that I am no dumber a man for losing access to those groupthink sessions.

Thankfully, my professional life has more balance now. The hotel rooms are smaller, but they are a lot cheaper! I am staying just outside of the site of the US National Toboggan Championships. I am away from the crowds, thinking about our 2009 investment themes. Understanding that the most common one-liner I hear from investors today is that they are “long term”. It seems reasonable to stop focusing on what we’ve had right in 2008 (being in cash), and looking forward to the future.

The cover of ‘The Economist’ this past week was titled “Capitalism At Bay”; markets around the world have crashed; and we are seeing an auto correlated meltdown across asset classes. From a quant perspective, the only two models that look intermediate term “Trend” bullish are US denominated cash and equity volatility. From a sentiment perspective, the latest and greatest idea out of the “smart money” hotel conference halls is “we’re going to cash” – gee, thanks…

As of yesterday’s close, our ‘Hedgeye Portfolio Allocation’ model was set up as follows: Cash (US$) 74%, Canadian Cash (FXC) 3%, Gold 3%, and Equities 20%. While yesterday was not an up day for us in the Portfolio, I don’t feel shame. Rather, I feel quite excited about the prospects of getting fully invested, albeit patiently.

In the US, stocks remain to be rented, not yet owned. Buying into the swells of the seas worked for us from the October 10th lows, and I think it will again from the current ones. Yesterday’s breakdown of our critical support line in the S&P500 was undoubtedly bearish for the immediate term “Trade”. That support line of 948.11 now becomes resistance, and it should be respected. If we can overcome it, it’s as clearly bullish as it was bearish. That’s math.

In terms of downside support, we are using 870.08 in the S&P500 as our buy/cover signal line. Look for us to take both our gross and net long positions in US stocks up as the waves of fear roll onto the desks of the levered long community. The freak-out volume is out of the way. The last two trading days have flashed NYSE volumes that are ½ of that seen earlier in the month when credit spreads were much wider, and liquidity tighter. Volatility (VIX) is testing 70 for the 4th time in October, and it actually looks like it could take a peak at 77.89. I would love to see that shark jump out of the water. That level would really get me invested in America’s waters.

Asian markets looked horrendous across asset classes last night. From currencies to commodities and stocks, the waters have swelled. The South Korean won lost another -3.4% and the KOSPI stock market index got hammered for another -7.5% dunking. We haven’t seen these levels in Korea since the Asian Crisis in 1998. Are they “bearish enough” in Asia yet? You tell me…

We liked China yesterday, and we like it more today. Lower prices are what true capitalists seek. Both China’s currency and stock market flashed another positive divergence overnight in Global equity trading. The Shanghai composite Index closed down -1.1% at 1875, and with 1866 as our signal line to buy, you can expect us to be adding to our FXI (Chinese etf) position today (provided that it’s down). This morning, China’s Premier, Wen Jiabao, is supporting our new investment theme that we have been discussing in recent weeks, signaling that ramping up domestic consumption will offset their well publicized industrial growth slowdown. Buy Low.

There isn’t much to get excited about in Europe, yet… We are long Germany, and that’s been a mistake, so far… German stocks are trading down again alongside the region as the Euro continues to get drowned by deleveraging across eastern european countries. The Russian stock market actually stopped going down this morning, and that’s the 1st positive divergence that it has flashed in forever. That said, the Russian Trading System has lost almost 70% of its value since May of this year, and now we have ex-Soviet states like Belarus requesting emergency bailout money from the IMF this morning.

Belarus and Hank “The Market Tank” Paulson aren’t the only ones looking to bailout their comrades. Iceland, Pakistan, Hungary, and the Ukraine have all asked for similar bailout support from the International Monetary Fund. Can someone remind the said macro key-note speaker savants from the podiums of Four Seasons past that “it is global this time”? Investing in these illiquid cesspool economies is not an investment theme coming out of Camden, Maine.

While Greenspan reminds Americans that he has no accountability mirror this morning and testifies in front of the House that the solution to part of the leverage mess that he helped create is to RE-REGULATE markets, take a deep breath, and think. Credit spreads are tightening and the yield curve is steepening – these are great signs for the American capitalists who have cash. The “Great swells Of The Sea” are yesterday’s news. Let people reactively manage the past as you proactively look forward to the future.

Stay warm,


Following my trip to Macau, I’ve gotten more positive on the long-term prospects of Macau. I’ve written numerous posts discussing why this is, so I won’t waste space here. Despite the favorable outlook, I certainly recognize the uncertainty surrounding the Macau marketplace. For this reason, it seems to make a lot of sense to look at the value imbedded in WYNN’s Macau concession. Specifically, I believe there is significant option value in Wynn’s opportunity to build on the Cotaii Strip should: a) Macau continue to grow and b) Cotaii be a successful destination within Macau. I vote yes on both counts.

Clearly, this analysis could be used for any of the other 5 concessionaires, but WYNN is the only company with the financial resources to make it happen. Besides, an option in Steve Wynn’s hands is worth much more than any other operator in gaming.

Based on the following assumptions, I estimate straight equity value related to Cotaii of $4 per share:

-8x terminal multiple of EBITDA
-20% discount rate
-$2bn total investment cost
-$350m in EBITDA

However, I calculate an incremental option value of $2 per share for total Cotaii value of $6 per share. With WYNN’s enterprise value trading at only 8x core EBITDA, I do not believe any of this value is reflected in the stock price. Nor is any value, option or otherwise, associated with likely future Macau development in the stock.

Conservative assumptions still yield significant value

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