Casual Dining – Ugly is as Ugly gets

Yesterday we posted a bleak Macro view of the consumer. What we left out was the impact of the October stock market crash on spending.

As you can see from the commentary below the trends in 4Q08 are very bad. Complicating the bad consumer environment is management missteps. (1) MRT was still buying back stock in 3Q08 and is planning on adding capacity in 2009. (2) MSSR also plans to add 5-6 units next year. (3) Poor RUTH, they are just trying to stay alive. There is no reason to own RUTH, MRT or MSSR.

You can throw a dart at a dart board to find a good short in this group, but to me LNY, DIN, RRGB, CPKI and PFCB stand out.
RUTH – Madison Dearborn to the rescue, but still on the Bankruptcy watch list

RUTH is on our short list of Bankruptcy candidate, but it should be noted that a very larger shareholder has capital and access to those that have capital.

In 3Q08, RUTH’s same-store sales decreased 6.9%. The average check fell 1.5%, driven by menu mix shift and year-over-year pricing of approximately 2% - RUTH saw a 5.2% reduction in traffic. Same store sales in 3Q07 declined 0.4%.

This is where its gets really ugly - October comps at Ruth's Chris declined approximately 15%. On the call the company said “If we assume company operated, comparable restaurant sales at the Ruth's Chris Steakhouse decreased 15% for the entire 13 week period, we would expect earnings per share between zero and $0.02 (street at 0.17) for the fourth quarter and between $0.33 and $0.35 for all of 2008 (from prior guidance of $0.55-$0.60).

MSSR – Management does not get it

More of the same…. October same store sales were horrible and they are still growing too fast
MSSR reported 3Q08 EPS of $0.09 vs. street at $0.11. Same-store sales declined -5.5%, with traffic declining -9.8%.

On the conference call the company said that October same-store sales declined approximately 10%. Management offered that if same-store sales trends do not change for the balance of 4Q, 4Q EPS would be $0.15-$0.20 (street at $0.29), and for every 1% change in quarterly same-store sales, there is a $0.02-0.03 impact to earnings.

MSSR is a classic case of watch what I do not what I say! Management provides the customary balance sheet commentary; “Given the recent credit market crisis, we have focused on maintaining maximum financial flexibility and ensuring that our balance sheet remains financially sound, including managing our debt level and limiting our new unit development for next year.”
But in the next breath MSSR’s management says we still plan on opening 5-6 new units in FY09 (a slowdown from FY08’s 11 units). WHY?

MRT – In a very difficult position

Morton's Steakhouses 3Q08 same-store sales declined 7.6%. This includes the benefit of a pricing impact of approximately 3.5% in the quarter. The balance of the change was driven by menu mix and decreasing guest traffic. This compares to strong comparable restaurant revenues of +7.3% in 3Q07. MRT commented that same-store sales for the month of October declined 15%.

The Company currently expects 4Q08 revenues to range between $98 million and $100 million, which reflect a 9% to 11% same-store sales decline.

The Bitterest

“By three methods we may learn wisdom: First, by reflection, which is noblest; Second, by imitation, which is easiest; and Third, by experience, which is the bitterest.”

After experiencing my worst performance day of 2008, yesterday was indeed my “bitterest.” In thinking through my mistakes, I would be a hypocrite not to cite the same wisdom of a philosopher whose thoughts summarized where I thought this US market could go next. Confucius emphasized transparency and sincerity. I have no excuses this morning. I was leaning far too bullish on the edge of another bear market trap. I was sucked into the vacuum of politically inspired hope. Hope is not an investment process.

So what do I do when I am wrong? Point fingers and whine about it? No. I take a good long hard look in the mirror and stare at who made the call. Then, I review my notebooks, calendar catalysts, and macro models. Then I start over, remembering that as Confucius said, “no matter where you go, there you are…”

As the facts changed yesterday, I did. As the S&P500 broke my “Braveheart line in the sand”, my first move was to get smaller. We now issue our ‘Hedgeye Portfolio Allocation’ levels to you every morning at the top of the ‘Early Look’. What is that exactly? Good question. That’s $100,000 in an E-Trade account that I put there at the beginning of the year (when that’s all the FDIC would insure, and my best “idea” was being in cash). In that account, I don’t trade around in any stocks that our sector analysts are writing about. I predominantly use it to manage portfolio level asset class allocations using indices and exchange traded funds.

Getting smaller is what I always do when I am wrong on the fundamentals. That’s another piece of portfolio management wisdom that I had to learn the hard way. When I was younger, more brash, and inexperienced, I would sometimes add to my losers, irrespective of my potentially being dead wrong on the fundamental change in facts. That was, is, and will continue to be, the gravest capital mistake you can make in this business.

“Getting small” means selling down gross exposure. Yesterday I took my 33% allocation to US Equities down to 20%. I sold my SPY’s (S&P 500 index), and our Research Edge Macro clients saw that, real time, on the ‘Hedgeye Portfolio’ portal. I am 100% accountable to being transparent to our subscribers. Wall Street doesn’t do that. That’s their problem, not mine. The “New Reality” that I spoke to yesterday is going to demand transparency/accountability from market participants in the very near future.

The US Futures are getting smacked around again this morning, and they should. Albeit on low volume (bullish signal), yesterday’s technical breakdown in the US market was a bell ringer for anyone with a legitimate risk management process. For me, losing over 200 basis points of performance in one day is unacceptable. When that happens, it’s always because I am leaning too far to one side of the boat and the market breaks what I refer to as the “shark line.” If you have ever been shark fishing, you know how scary it is to be on the edge of the boat with a live and large monster still in the water – that image is what you should be thinking about when the S&P500 gets there. Yesterday I called it “line in the sand” because I was getting too cute with a Braveheart metaphor, but it’s the same idea, and the same line – the one you don’t want penetrated. This morning my model flashes that line in the S&P500 at 977.

Everything that matters in my risk management model occurs on the margin. If we close above 977, it’s bullish – below that shark line, your longs get eaten. Last night, Asian and European stock markets reflected the quantitative waters being bloodied. I have more red in my notebooks this morning than I have had since mid October. Is it time to panic? No. Is it time to take a deep breath and find your bearings? Big time.

Hong Kong led Asia lower, closing down a stiff -7.1%. One of the positive moves I made in the last 48 hours was selling our EWH (Hong Kong etf) into the strength of its 6 day +30% up move. Chinese stocks outperformed last night, closing down -2.4%, and we remain long its domestic market via the FXI etf. India closed down for the second day in a row, finishing -3.8%, and we are hedged in Asia this morning via our long standing bearish position in the India Fund (IFN). Not surprisingly, after squeezing the shorts for a +35% one week move, Japanese stocks were shark bitten last night, closing down -6.5%. I am embarrassed for not being short EWJ (Japan) here.

European markets are trading down -4% across the board. We are long Germany and Switzerland (EWG and EWL), and short the UK (EWU). The main reason why I was amped up and leaning over the boat’s edge yesterday was that the Europeans were, and are, going to be cutting interest rates this morning – AGGRESSIVELY. If the reaction to the most aggressive European rate cuts that we have seen in 2008 is negative, I will change my positioning in Europe alongside those facts. Countries that are on my short list are Italy, Austria, and Spain. These countries have leverage characteristics that are to be shorted. I want to own liquidity – and as boring as they are, the Germans and Swiss give me that, on a relative basis.

I’ll take a man or woman of wisdom onto our team all day long over a whiner. Citi and Goldman are firing another 12,000 people right now. There are plenty of winners in that group that we are interviewing. The problem with ‘Investment Banking Inc.’ is their Captains, not their people. Captains who whine and point fingers don’t have a process for winning.

The best thing about today is that yesterday is behind us. My feet were on the floor 3 minutes earlier than they were yesterday. My chin strap is done up. No matter where we go from here, “there you are.”

Good luck out there today,

Long ETFs

JO – iPath Coffee – Heavy rains in Vietnam’s highland region continue, increasing harvest delays.

EWL –iShares Switzerland- Swisscom AG traded down yesterday after reporting Q3 profit decline of 32% y-o-y, and warned that the Franc’s rise it may prevent it from reaching its full-year sales target.

EWA –iShares Australia- Employment numbers came in surprisingly strong, with over 34,000 jobs added in October. The Central bank expanded the list of securities it accepts for repurchasing operations to include AUD commercial paper, asset-backed commercial paper and high rated debt securities rated AAA.

EWG – iShares Germany – Porsche will seek enforcement of an EU court ruling that Germany must amend the law that gives the state of Lower Saxony control rights over Volkswagen as part of its plan to take full control over the company. Adidas was down almost 10% today after reporting earnings for the third quarter.

FXI – iShares China – Obama’s public stance on Yuan policy is placing pressure on policy makers in advance of December’s U.S.-China Strategic Economic Dialogue. Among many heavy industrials curbing production, Aluminum Corp. of China, today announced it has idled 38% of capacity.

VYM – Vanguard High Dividend Yield ETF – The Ambac ratings downgrade to Baa1 by Moody’s sparked higher corporate CDS prices globally on anticipation that some holders will be forced to unwind positions hedged by the insurer.

Short ETFs

UUP – U.S. Dollar Index – The Euro declined against the dollar on anticipation of EU rate cuts.

EWU – iShares United Kingdom – BOE CUTS BENCHMARK RATE BY 150 BASIS POINTS TO 3% U.K. House prices fell at the fastest pace in at least 25 years according to monthly HBOS data - the average cost of a home dropped 14.9% y-o-y in October the most since the index began in 1983.

IFN – The India Fund – Wholesale inflation numbers registered at 10.7%, higher than anticipated by Indian leaders, which suggests that rate cuts could continue.

Keith R. McCullough
CEO & Chief Investment Officer

Obama Treasury Secretary: The Top Contenders

Now that Senator Obama has become President Elect Obama, it is time to start analyzing his potential choices for his economic cabinet, particularly Treasury Secretary. There seem to be three names being considered most widely for the position: Larry Summers, Timothy Geithner, and Jon Corzine.

To start with last first, we think Jon Corzine would be an incredibly short sighted choice and the market would likely react negatively (Keith would). While Corzine undoubtedly has financial wherewithal given his former tenure as co-CEO of Goldman Sachs, that is also his most substantial issue. The credibility of “Investment Banking, Inc.” is non-existent among the investment community. In addition, the public broadly would likely react very adversely to a Corzine appointment given his Investment Banking background.

Conversely, Timothy Geithner is actually a rather interesting choice. He is currently the 9th President of the Federal Reserve Bank of New York and, in this role, also serves as the Vice Chairman of the Federal Open Market Committee (FOMC). Prior to joining the New York Fed he served as an Under Secretary in Treasury to both Secretary Rubin and Summers, so has ample experience at Treasury. Additionally, he has never been a card carrying member of Wall Street’s elite. The key criticism of Geithner would be, at 47 years of age, whether he has the experience to manage the current crisis.

The other noteworthy candidate being bandied about is Larry Summers. While Larry Summers doesn’t necessarily embody the image of change as he was President Clinton’s last Treasury Secretary, his credentials are impeccable. Summers is the son of two economists and the nephew of two Nobel laureates, Paul Samuelsson and Kenneth Arrow. He was also one of the youngest professors ever tenured at Harvard at 28 years old. He has been the President of Harvard, Chief Economist of the World Bank, and was Secretary of the Treasury under Clinton from 1999 to 2001. He is an ardent supporter of free trade and would offer an immediate voice of credibility and moderation to the Obama administration.

Our vote goes to Larry Summers for another tour of duty as Treasury Secretary given his expertise and leadership background. In our view, Summers gets it. We have long been critical of Hank “The Tank” Paulson. On October 30th 2008 at a forum in Boston, Summers stated, “Frankly, policy has been a day late and a dollar short for 15 months now.” We couldn’t agree more. It is time for proactive economic policy once again.

Daryl G. Jones
Managing Director

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S&P500 Levels Into the Close...

I am finally getting tagged for a loss here today, and unless we see this 977 line in the S&P500 sand hold, our newfound bullish momentum is going lose some of its snort.

Refreshing our model for 3PM, here's the math for the SPX:

BUY "Trend" line = 977.14
BUY "Trade" line = 939.11
Sell "Trade" line = 1033.24

As the math changes, I will. I am not seeing the follow through to the upside that I was looking for today. Where they close this market is the price that will matter most.

WRC: A Tough Shot…But I’m Taking It

There are few events more volatile in this space than a Warnaco EPS report. Several people asked me what I’d do in advance of the numbers. Here’s my 2 cents…
This is a tough shot, but I’m going to take it. I remain quite negative on the 2-year margin outlook, but have burned myself on more than one occasion in being early on this call. But why negative now? A few considerations…

1. My model has revenue growth going from a 20%+ growth rate to a single digit rate – something I think it will be tough to beat organically with its current portfolio.

2. I maintain my view that WRC has passed too much of its incremental FX benefit to the EPS line over 5 years instead of reinvesting back into the business. With margins going from 2% to 10% over that time period, I’m confident that we’ll see a big swing the other way next year when an Obama administration inevitably takes up interest rates, and the dollar along with it. I can’t find another company with poorer positioning that WRC.

3. Aside from a sharp deceleration in revenue and margins, WRC is about to comp against 4 quarters of the biggest improvement in the company’s cash conversion cycle in its history.

4. 12% of the float is short, which concerns me – but we’re seeing it at 20-30% for better quality companies.

5. WRC beat every one of the past 9 quarters by an average of 42%. Do you think that just MAYBE the street is expecting another one? I can’t rule out a beat – though anything near recent magnitude is not gonna happen. Better yet, a guide down is increasingly likely.

6. Why should this name trade at 6x EBITDA – at the peaky end of retail today?

7. No covenant issues right now as first tranche of debt is not due until 2012. But cut margins in half (which is entirely possible) and we’re talking a very different story…


The benefit of the loss limit removal is pretty apparent for PNK’s Lumiere Place and the stock is acting well following the news. However, Pinnacle’s Admiral President may be a stealth beneficiary of the referendum that passed yesterday. We could see a new President upriver in St. Louis. In our June post, “ADMIRALING PNK’S PRESIDENT OPPORTUNITY”, we wrote about the option to move the President near the Chain of Rocks Bridge and farther away from Lumiere Place. I believe this option is more likely after yesterday.

As previously calculated, the total investment for a “new” President would likely be in the $50 million range. The President would draw from a new geographic area while Lumiere Place would certainly capture some or most of the President’s customers with no additional capacity. Assuming a combined $25m in additional EBITDA from the move, the incremental value of the President would be worth around 6x EBITDA less the investment, or a net of $100m.

A $1.67 in incremental value per share is not small change now with PNK trading at just $6.50 per share. Another potentially attractive option could also be pursued. A gaming license in a limited license jurisdiction like Missouri’s with no loss limit in place is surely worth $100 million. I don’t foresee any liquidity issues for PNK, but the sale of the license could alleviate any deteriorating financial condition.

PNK suddenly has some operating options in St. Louis and its financial situation is probably more flexible than it appears to the Street. Look for an in-depth discussion of this flexibility on the call tomorrow.
I personally own shares of PNK

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