DIN - The Miracle in Glendale

I have got to hand it to Julia Stewart, CEO of DIN; she can spin a good story when she needs to. Two things happened that are completely out of left field and caught me by surprise. First, DIN manages to find a buyer for 110 severely underperforming Applebee’s stores. Second, the company reported that Applebee’s operating margins increased 220 basis points, allowing operating profits to grow by 13.8%. In this environment, this is nothing short of a miracle.

I’m focused on these two events, because it was game changer for the time being. My guess is that when people digest the reality of the situation the enthusasism will wane.

Operating Margins -

For 3Q08 Operating margin improved 220 basis points to 11.4% compared to 9.2% in 3Q07. Food costs increased by 30 basis points and labor decreased by 80 basis points primarily due to a reduction in hourly wage rates and lower management bonus payouts.

The first RED flag – in this environment it is nearly impossible to lower labor costs with a MSD digit decline is traffic trends. The math does not work! The customer experience will be compromised and it’s likely we will see further weakness in same-store sales.

Applebee's also experienced an approximate 170 basis point improvement in direct and occupancy costs primarily related to lower depreciation expense resulting from purchase price allocation adjustments.

The second RED flag – Nearly one year after buying the Applebee’s chain they are still making purchase price adjustments to manufacture improved margins?

Putting it all together, Applebee’s segment operating profits increased 13.8% to $30.0 million in the third quarter. For the Applebee’s chain to show this level of profit growth is truly amazing and completely unsustainable.

Asset sales

DIN also reported today the sale of an additional 66 Applebee’s restaurant, bringing the total to 110 stores, which the company expects to close before year-end. The incremental 66 new stores are being sold to three different franchisee groups and are not contingent on financing. All of the buyers appear to be currently operating of have been involved in the restaurant business. Additionally, it’s likely that all the stores were losing money. That is the good news.

The RED flag – These stores were sold at fire sales prices. Putting any value on something losing money is good news, but the next tranche will not be so easy. At some point unloading a significant amount of stores will require some financing. In this environment access to capital is getting harder and the cost of capital is rising, except for those that can borrow from the FED.


DIN is not out of the woods yet. DIN is levered at 7.1x, slightly below the 7.5x threshold at the end of November 2008. The company is in crisis mode as it is trying to save money by cutting employee bonuses and changing its travel and vacation policies. We already know that casual dining sales trends have continued to accelerate on the downside in September and October. The uptick in profitability at the Applebee’s chain appears to be unsustainable, given current sales trends and commentary from other competitors in the space. The company is desperately seeking liquidity and the realities of today will eventually catch up with the business.

TBL: I’ll Take This Shot

Someone asked me what I thought about TBL here. Not fun in this market to make a call on an EPS event, but as Wayne Gretzky said, “you miss 100% of the shots you don’t take.” Bottom line: I like it.

1) This is a longer term fundamental call that I won’t rehash here…but I like how the company has (unbeknownst to the Street) offensively taken down margins by about500bp by investing in key areas despite a slowdown in its core boot business. I think margins have troughed. Check out prior TBL posts for deets…

2) This name is ripe for our ‘Capitalists Emerging’ theme. No debt, and $2.60/sh in cash on the balance sheet. I still think it is more likely than not that TBL is owned by either Nike or VFC over the next 12 months. No one thinks that the Schwartz family will sell. I disagree.

3) I’m above consensus for the upcoming quarter and year. No, the top line is not knocking the cover off the ball, and FX is no longer helping. But store closures, asset divestitures, and shifting apparel over to PVH in a licensed model should all help on the margin. Recent trends in 4Q have been positive (see chart below).

4) Starting in 3Q, TBL goes against its easiest top line compares vs. last year, and cycles meaningful inventory build in 2H07.

5) Short interest is registering at only 6% of the float, a level not seen since mid-07. This might seem super bearish. But since the last short interest data was released (getting cut by a third), TBL went from $17 to $10.50. I think that the bearishness out there is more than it seems at face value. Comments I hear from investors definitely support that.

Did Someone Steal Mack's Porsche?

“Invest at the point of maximum pessimism.”
-John Templeton

Other than being rich politicians with nice cars, what do Ted Stevens and John Mack have in common? They both got ‘You Tubed’ yesterday, big time! Poor Ted is going to finish up his Senatorial career looking at a different kind of bar exam, while the once revered Mack will be dealing with an oversupply of mirrors that are en-route to his home via FedEx for Christmas, compliments of Research Edge…

I know, I know – be nice Keith… I am; I am getting an early start on Christmas shopping, supporting the economy, ya’ know! As far as I know, Mack isn’t getting a $100,000 wet bar for his house from the Japanese or anything like that… he only had his faithful “Investment Banking Inc” crew issue news release upon news release that his “deal” with Mitsubishi Financial was solid. For the life of me though, I can’t find the Morgan Stanley release this morning that reminds us that Mitsubishi had to raise 990B Yen last night… weird.

After seeing the S&P500 crash for a -45.7% down move since, well… about this time last year… I have witnessed plenty of weird stuff. One of the non-trivial revelations has been that individuals from Washington to Wall Street are being ‘You Tubed’. What does that mean? Well, quite simply, it means that this brave new interconnected world holds transparency, accountability and trust in the palm of its hand. If you sway, if you swear, if you swindle, if you sing – either American Idol or we card carrying members of ‘New American Capitalists Inc’ are going to “smoke you out of your hole” (I had to put quotes on that – Bush needs a shout out once in a while).

Investors in this brave new world have voted. Morgan Stanley got crushed yesterday, because it should have - their largest shareholder needs bailout capital! The smartest freedom fighters of the hedge fund planet who shorted Volkswagen are getting run over by Porsche this morning – not because of “evil doers” – because fundamentals are going to prevail over fear mongering (Porsche wants 75% of the company). This works both ways folks - long and short. This is what makes a market. This is called capitalism.

If you broke down and cried over Hong Kong’s -12.7% decline yesterday, we hope you didn’t sell. Hope, unfortunately, is not an investment process. The Hang Seng exploded to the upside for a +14.4% move overnight, and now you can pick yourself up off your knees and sing halleluiah to the heavens. Even I broke a bit of a sweat looking at Asia 24 hours ago, but somehow I found it within me to heed Templeton’s words of wisdom and “invest at the point of maximum pessimism.” We added to our long EWH position yesterday on weakness.

Overall, we covered all but 4 of our short positions in the “Hedgeye Portfolio” yesterday. We remain short the US Dollar (UUP), which is trading down this morning, finally. Given that “Heli-Ben” will be flying the free money chopper into his FOMC rate cutting meeting tomorrow, it’s about time. We remain short India, via the India Fund (IFN); the BSE Sensex Index in India flashed a very negative divergence overnight, closing down another -2.2% in the face of strength in China, Korea, and Singapore, which all had +3-4% up days. India is a bureaucracy with runaway wage inflation and a pending Presidential election. Is it weird that the new CEO of Citigroup, Vikram Pandit’s, “best idea” when he ran his hedge fund, Old Lane, into the parking garage was “long India”? ‘You Tubers’ think so…

Covering shorts consistently, and profitably, is not one of the Street’s core competencies. While I will happily hand over the keys to the billionaires with Porsches when it comes to levering up a “great long idea” in an up market, I’ll meet them on highway 95 at 430am daily if they want to rev up their short selling engines with me as I am driving through Stamford. Short selling is not something you should do unless you have a tested and tried process. Save the “concentrated activism” horse power for the bull markets guys.

Understanding that moving our cash position to 73% down from 96% in September is critical in contextualizing why I am far less bearish today than I was then (see the new ‘Hedgeye Asset Allocation’ model above), one of the most important macro factors in my asset allocation model that is flashing bullish for stocks is the thawing of credit spreads. We posted a note to our RE Macro clients yesterday titled, “Eye on Credit: Signs of a November Thaw?” (, 10/27/08), and the executive summary point from that thought is emphasized by both the TED spread again this morning as well as liquidity trade currencies (the US$ and the Yen) trading down for the 1st time in a week. Risk spreads narrowing is also being expressed by countries like Russia and Hungary not trading down for once. In fact, Hungary is flashing a positive divergence, trading up +7.1%.

Otherwise, I don’t think a page 1 Wall Street Journal article on “Microsoft’s Africa Strategy” is going to help you much in figuring out this complex global marketplace of factors. I think you are best served watching what people on ‘You Tube’’ do, not what they say. If they say one thing, and do something else… well, they might end up in the slammer, or God forbid, have their Porsche stolen…

My name is Keith McCullough – I drive a Porsche, and I support this message.

Long ETFs

EWA – iShares Australia – The Australian Central Bank bought its own currency today for a third day. Australian interest rate futures are now pricing in a 50 bps cut from the 6.0% rate next month.

FXC – Currency Shares Canadian Dollar Trust – Canada’s major newspaper, The Globe and Mail, yesterday had an article highlighting the weakness of the “Loonie” in recent days, a contrarian indicator in our books. The TSX Composite is currently down -27% for the month, which would be its largest monthly decline since 1919.

EWG – iShares Germany – German consumer confidence advanced slightly yesterday, which was a positive surprise. Volkswagen, which is 4+% of the EWG, is up ~93% on a short squeeze as Porsche increases its stake.

FXI – iShares China – The Yuan is up 0.11% this morning erasing yesterday’s loss and government bonds are up, which suggest signs of foreign currency intervention and is positive.

EWH - iShares Hong Kong - The Hang Seng Index is up 14% intraday, its largest one day raise in over 10-years, and a dramatic snap back from yesterday’s decline. The key driver is HSBC, which is up 10%. The government has also named a task force, headed by Stephen Roach from Morgan Stanley and Victor Fund from Li & Fung Ltd, to respond to the credit crisis.

Short ETFs

IFN – India Fund – The Rupee is up after 8 straight days of selling. The Securities and Exchange Board of India raised the limit for controlling shareholders from 55% to 75%.

UUP – U.S. Dollar Index – We continue to be short ahead of a likely Fed interest rate cut later this week, which we view as negative for U.S. dollar valuation.


How are we looking now? I called out management on their projections for a stable Q3 and a positive inflection point in Q4, which were issued during their Q2 conference call. I try, but I too am unable to predict the future. Visibility in gaming is notoriously cloudy especially when times are tough. Booking windows get even shorter. Management had no business making that prediction.

  • MGM will report Q3 EPS on Wednesday morning. I expect a sequential decline in trends from Q2 and a decidedly more negative outlook for Q4. Will management be so bold as to predict a Q1 positive inflection point? Obviously, MGM is still trying to raise financing for CityCenter and is incentivized to put the best Las Vegas face forward. Hopefully, though, the company will be more realistic this time around.

  • YouTubing: The following are some important metrics and quotes from the Q2 release and transcript that should be updated on Wednesday:

    • CityCenter Residential - 1,421 units sold or 54% of inventory for $1bn as of early August
    • Regarding closure rate for CityCenter residential – “we feel very, very confident in the quality of the customers that we’ve not only signed up but are signing up today as well who are entering into new contracts”
    • $1.65bn in committed financing for CityCenter
    • All in cost of CityCenter of $9.1 billion
    • Capex for “remainder of 2008 and 2009 significantly below recent past”

    We already know business is not good and likely will not recover until mid-2009 at the earliest. For us, the big issues relate to the balance sheet and financing, both for CityCenter and MGM corporate, covenants, and CityCenter residential sales and close rates. MGM has a $1.3 billion bond maturity in 2009 and a $1.1 billion in 2010.

S&P500 Levels Into the Close...

Today's intraday low came on the open at 858.77. We issued a downside support level of 857.86 in our Early Look strategy note... close enough.

Realizing that most don't believe you can make "market calls", I am dedicating my career to taking the other side of that trade. Never let someone tell you that you can't do something.

Our refreshed levels for the S&P500 are as follows:

Buy for a "Trade" = 848

Sell that "Trade" = 921

My name is Keith McCullough, and I support this message.

We’re Liking UA On A Bad 2H

I don’t see how UA hits 2H targets, but that’s hardly an out-of-consensus view. We’ve been warming up to UA…and a bad EPS event might be the opportunity we were waiting for.
As Brian noted in his earlier post (Capitalists Starting to Emerge), we’re a lot less concerned with earnings revisions as we are with which companies will still exist over the next 2 years. Who goes away? Who doubles in size? UA is the latter. I’ve been getting more jazzed about this name (check out our 9/28 post -- I’m Warming to the Armour), and think that any weakness around tomorrow’s earnings event is a great chance to get involved.

We’re 6% below the Street on the quarter, and 12% below for the upcoming 12 months. This is almost entirely due to weak gross margins. It’s been our view for a while that with UA growing into lower margin businesses with dominant competition and high cost of growth, Gross Margins should come down. Well, we’re finally there.

I cannot look through weak GMs by any means, but what I like is that UA has consistently driven its SG&A ratio despite over-delivering on the top line. In other words, it has been adding the assets to fuel the top line, and also has cost levers to pull in case revs fail to deliver. We go over this more in our 9/18 post (UA: Warming Up To The Armour).

It’s tough for me to find a company where I can identify the top line doubling over 4 years. I think that even in this economy, UA will see it. 6.5x EBITDA is not cheap relative to some other names in retail (trading as low as 2.5x-3.0x), but I’ll pay a premium for growth in this environment – especially given that some peers will cease to exist.

Casey Flavin

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