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Volkswagen: Driving out the shorts...

Just as were finishing our morning coffee at 5:46 a.m. this morning Keith fired the Macro Team a question, “What is going in Germany?”. After a few minutes of digging, the answer was fairly obvious, Volkswagen was up 93% and Volkswagen is the largest component of the DAX. These gains came on the back of Porsche’s Oct.26th announcement that is plans to increase its stake in Volkswagen to 75%.

Going into this “event”, as the butterfly wing nut “event driven” hedgies like to call such things, Volkswagen was the most heavily shorted mega cap stock on the DAX. As of October 23rd almost 12.9% of Volkswagen common stock was shorted. Porsche owned 42.6% prior to its announcement and 75% as of its announcement Sunday night, the implied short interest was more than 50% of free float as of Monday morning.

Ironically, the shorts initially focused on Volkswagen because of its relative strength. Unlike the Japanese and Korean auto manufacturers that are grappling with heavy dependence on a single slowing market (and unlike the toxic sludge that is all that’s left of the major Detroit companies), Volkswagen had a comparatively robust balance sheet and franchise. In the minds of the “event driven” club, this meant that the stock price had further to fall, so… they ingeniously all piled in together hoping to ride it down on the “macro” story.

The average European market “event driven” hedge fund that is still bothering to report to the service we subscribe to was down -16% for the year last week. This one short squeeze “event” should “drive” that number a few points lower.

Keith and I learned a lesson early in our careers, beware the short squeeze. Indeed.

Daryl G. Jones
Managing Director

"They" are right freaked ahead of Halloween, shocking...

Surely, you’ve seen today’s US consumer confidence levels – they hit a record low, and the information starved media pounced on it. Was this a surprise? Apparently to some, unfortunately, it was!

Touching the 845 level, the S&P500 bottomed intraday shortly after this revisionist historian data was released. If you sold that low, you probably fee shame here – I would. Manage risk proactively rather than reactively - that’s been as clear a lesson in 2008 as any.

Interestingly, 5000 consumers answered the confidence survey this month. The responses that they provided were more negative than the answers that their parents gave in 1980 when CPI inflation levels were approaching a 13% increase year-over-year and the revolutionary Iranian government was holding 52 American citizens hostage. The responses they provided this month were also more negative that the responses that their grandparents gave in 1975 when US unemployment levels reached 9% and Saigon fell to the North Vietnamese army.

Historical context is always critical. People are right freaked out here. I used to be, but with the S&P500 45% higher. Buy low, sell high.

Keith McCullough & Andrew Barber.
Research Edge LLC

BWLD – Going Against the Grain

BWLD reported 3Q08 same-store sales up 6.8%, with menu pricing up about 3.5%, which implies 3%-plus traffic trends. Cost of sales declined 90 bps, primarily as a result of its increased menu pricing and a decrease in the cost of fresh chicken wings (averaged $1.17 per pound versus last year’s average cost of $1.24 per pound). Management reiterated its FY08 guidance of 15% unit growth, raised its revenue growth to more than 25% (from 20%) and widened its EPS range to up 20%-25% (from 25%). On top of that, the company is now expecting more of the same in FY09 with 15% unit growth, revenue up 25% and EPS up 20%-25%, and management said it is being conservative as a result of the current environment. The FY09 revenue and EPS guidance relies on BWLD’s ability to achieve its 15% unit growth so the company has shifted its strategy to increase the ratio of company-owned units.

Any one of these prior statements is completely unheard of in the current casual dining environment. Most operators are reporting significantly negative traffic trends and increased pressure on the commodity front. No other casual dining company is forecasting 25% EPS growth in FY09 on top of 25% growth in FY08. And, most other casual dining operators are slowing development targets for FY09 and/or shifting more of their growth to franchisees.
  • Taken at face value, all of this should translate into outperformance for BWLD, but I have my concerns outside of the fact that the company opened up the lower end of its prior EPS guidance. For reference, it appears that this lower EPS range and 3Q earnings miss is due largely to higher impairment costs as a result of BWLD’s Don Pablo’s relocations and facility remodels/upgrades (which should begin to normalize in 4Q).
  • In today’s environment, BWLD’s 6.8% comparable sales and 3%-plus traffic growth are nothing short of amazing, but I was surprised that even with such strong top-line results that the company was not able to achieve leverage on the labor line. Management attributed this deleveraging to higher management wages and higher training costs from increased openings and stated that it expects to get leverage on the labor line on a YOY basis in FY09. I am not convinced BWLD will be able to achieve this YOY improvement because they are only expecting modest same-store sales growth in FY09 (versus the 6.8% in 3Q) and the acceleration of company-owned openings will continue into 2009.
  • I also think BWLD’s FY09 guidance is aggressive as its 15% unit growth although more weighted toward company-owned growth still assumes 50 franchise openings, which may be difficult given the current credit environment. Management stated that it thinks it is being conservative but also said that despite the fact that BWLD’s franchisees have a very strong development pipeline, “they have commented that they have seen perhaps a slowing in some of their financing.” BWLD is accelerating its company-owned growth at a time when most of its casual dining competitors are slowing growth. Although BWLD’s recent results are not comparable to other casual dining operators, I never like to see a company significantly increase its capital expenditures as a percent of sales (particularly in today’s difficult environment) because it has the potential to put increased pressure on returns.
  • 4Q08 trends:
    BWLD said its same store sales-to-date in the fourth quarter are up about 3%. This represents a significant slowdown from 3Q08’s 6.8% number and BWLD is facing an easier comparison from 4Q07 of up 3.4% relative to 3Q07’s 8.3% number. Additionally, menu pricing is running up a little over 3.5%, which implies slightly negative traffic.

    BWLD’s YOY commodity favorability as it relates to the cost of fresh chicken wings also appears to be going away in 4Q as October and November wing prices are averaging $1.24 per pound, flat with last year.


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DPZ – Comments from Analyst day

At the DPZ analyst day management was commenting on the impact of industry competition. A throw away comment was the impact of WMT advertising of cheap pizza. Because of WMT advertising strategy, DPZ management thinks consumers begin to think “how cheap can I buy pizza.”

I only point this out because WMT is now running commercials on how cheap breakfast is at WMT compared to the QSR industry….

BYD: I LIKE THE GGP NEWS

Last night General Growth Properties announced that the company is selling the Fashion Show Mall and The Shoppes at The Palazzo to satisfy debt obligations. Both of these malls are located on the Las Vegas Strip. GGP is also a 50/50 JV partner in another Strip project: Echelon.

BYD’s decision to delay Echelon put the company on the right side of the liquidity trade. I continue to believe the project will not be restarted for a considerable period of time, at least not until 2010. GGP is likely to join MHGC as a FORMER Echelon partner with BYD. This can only delay Echelon which is a positive for BYD shareholders and debt holders.

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