The easy call is to be negative on PFCB following the analyst day on Friday. It’s also easy to get bullish.
P.F. Chang’s is, in some ways, a victim of its own success. For most of its life as a public company, the company’s core concept, PF Chang’s has been a concept that has produced very high unit level economics and has operated in the Asian category without any real competition. Over time, this has led the company to become “fat and happy”. The concept’s issues can be traced back to 2007 but, the sluggish economy has somewhat masked those problems. As the economy has expanded and other concepts have seen an improvement in trends, P.F. Chang’s has lagged. If I have one criticism of management that stands above all others, it is that it does not reflect well upon them that the company is only now getting around to focusing on consumer research and the performance of its company excluding any macro drag. The excerpt below, from the transcript of the meeting, illustrates what we mean. It should not take a crisis for the company to be moving in the direction that it is now aiming for.
“One of the things that will be sort of a common theme through today's presentations is, as an organization we've moved from being, I would say, being a little more intuitive to more fact based in terms of our decision making. I mean over the years I think we've – we've tended to be, we tended to have a really good understanding of the industry, a real good understanding of the consumer and our consumer. And we are augmenting that now with a wide variety of actual fact based research studies.”
That said, if the company is heading in the right direction and the stock has been beaten down (which it has), surely it is a Buy here? There seems to be a light at the end of the tunnel but, of course, timing is everything and it is unclear how bright the light is.
Three key point to the Bullish case:
- Strong assets and balance sheet, strong cash flow and international growth opportunities
- Perennial PE target
Three key point to the Bearish case:
- EPS estimates are too high for 2012. In our view, $1.50 in EPS for 2012 is likely and 2013 could also be disappointing in terms of earnings growth.
- It is expensive to bring back the lapsed user and give food away to the loyal customer.
- Valuation (trap)
Valuation can be bullish and bearish at the same time; PFCB is a perfect example of this. From our seat, we feel that it is cheap for a reason. We would be willing to bet that estimates are too high because it’s likely going to cost more than expected to turn the ship around. It can be fixed, but just when the valuation trap will turn into a cheap valuation remains to be seen. We don’t think it happens in the next three months at least.
In the interim the key things to focus on are as follows, along with our take on each:
1. Is management on the right track?
HEDGEYE: We believe so but, again, it is disconcerting that what other industry players have been utilizing for a long time is only being integrated in PFCB’s process now. Performance of P.F. Chang’s brand will be the yardstick to measure how management is performing.
2. How long is it going to take?
HEDGEYE: We estimate two years; management says 2012 is the transition year with high inflation and “wild card” revenue. 2013 will also see a rising cost structure.
3. How expensive will it be to fix the problems, assuming they can be fixed?
HEDGEYE: Very. These undertakings are difficult to get right the first time as well.
Unfortunately there are a lot of variables that are not within their control. As management said last week the "revenue" outlooks is the “wild card” and are unsure of the outcome from the new initiatives the company is embarking on. The road to remedying what ails the P.F. Chang's brand is filled with pot holes. The brand has very loyal customer base, but uncertainties remain around how exactly the company is going to bring back the lapsed user. As we view it, the new “Strategic Platform” they laid out is all about increasing costs and there was no talk of where they might be able to increase efficiencies.
The PF Chang’s “Strategic Platform” to brand revitalization looks like this:
- Eliminate barriers to entry. No entry level pricing on the menu and pricing at lunch needs to come down.
- Elevate the guest experience. Management has added 150 basis points back to the labor line and the brand is in need of an extensive remodel program to serve good food in a clean, inviting atmosphere.
- Operate “with a fanatical focus on guest satisfaction” (same as the second point). They have opened a new store in Providence RI with a new look and feel. There will be 5-8 remodels in 2012.
- Communicate with the guest: “We want you back”. The dilemma for the company is that the P.F. Chang’s brand does not have the density to achieve a national message via television. The alternative is an increased social media exposure and a revamp of the loyalty program. The current loyalty program gives the guest a 10% discount. The company said last week they will be moving to a “surprise and delight” loyalty program (like PNRA).
One the biggest challenges that the company faces is bringing people back at lunch. There is a real price/value issue at lunch with only a 20% difference between lunch and dinner average check. As management says “people think we are serving dinner at lunch”. At dinner, customers share entrees but the lunch menu is not designed in a way that facilitates sharing. The current average check at lunch is $17 and to be competitive it needs to be reduced by $2, according to management. We contend that management is being conservative in this regard; $13 is likely a better level given that many big players in casual dining make lunch available for less than $10. So the dilemma is that with 30% of the business coming at lunch and the concept looking at a $3-$5 decline in the average check, can management menu-engineer items that can survive that type of decline?
I was shocked to learn that the loyal user of P.F. Chang’s comes four times per year; I would have thought it was much more. So, how do you bring in new customers (hopefully younger customers) while at the same time keeping the existing loyal costumer from spending less when they walk in the door?
I don’t want to discount the potential for Pei Wei but management’s strategy for this brand is very confusing. Their consumer research says that Pei Wei also has a price/value problem, and they have recently introduced “selects” with a lower price point to help the sales problem. While it’s still early, sales trends have improved, and management said there has been very little erosion in the average check.
All that being said the company’s commentary on the introduction of the Pei Wei Asian Market was confusing. The new concept (another version of Pei Wei) is geared to a have 500 bps better margins, lower price points, reduce labor costs, flexible floor plan, reduced square feet and more portable food.
The new Pei Wei concept is geared to operate with significantly less labor costs. So what does this say about the current Pei Wei concept of which, by the way, they are opening 16 new stores in 2012? All I can say about Pei Wei is watch what they do not what they say!
I don’t want to buy a cheap stock on the “hope” that I get bailed out by some PE firm. I also don’t want to short a stock that could fall prey to some activists or PE firm taking the company private. Management tried to make a compelling case but, upon reflection, we are staying on the sidelines.
The consumer is not dumb. Restaurant companies with average check issues cannot manage margins and check in such a way that allows them to execute the business perfectly. There is no reason to rush in. Mr. Federico and team still have some work to do and there is much to be learned from the P.F. Chang’s of the future to be constructed in California. The company had it too easy for too long. Now there remains a lot of uncertainty and the onus is on management to reassure investors with results going forward.
Positions in Europe: Short France (EWQ); Short EUR-USD (FXE)
The status quo is not good enough. While heads have rolled in Greece, Italy, and Spain in recent days, and provided some short term bounces in specific capital markets, in our opinion a sustained bullish move will not come for European markets unless Eurocrats directly address: ( 1.) expansion (leverage) of the EFSF; (2.) bank recapitalizations (specifically for banks that cannot raise assets); and (3.) setting the rate of Greek haircuts to capture “voluntary” demand.
In the fray, however, remain much larger unanswered questions: Can EU treaties be amended to allow a country to leave or be kicked out of the Eurozone, but not the EU? Can Greece be ring- fenced as to not create a larger move of contagion across the 17 member states? Can a fiscal union work? Can the ECB’s SMP fend off rising yields in Spain and Italy, and will its secondary bond buying greatly expand and be deemed anything more than a temporary facility?
While there’s indication that Eurocrats (especially German Chancellor Angela Merkel at the top) want to maintain the existing fabric of the Eurozone and preserve the stability in the common currency, dialogue has shifted from top leaders and now core question like assessing if the unity of unequal states under one monetary policy is sustainable. And while there’s renewed talks of Eurobonds (a position supported by George Soros) don’t discount political indecision across borders and fiscally stronger nations’ (Germany, Netherlands, Finland) resolve to reject them (at least initially) as to not see their cost of capital rise.
While we can’t get ahead of the actions politicians will take in the coming months, we continue to take our risk cues from the credit market.
Here we’ve seen yields across the periphery sustain elevated levels, and most worrisome are the recent breakouts in Spain and Italy, both now flirting around the 7% level on the 10YR, economies far larger than Greece, Portugal and Ireland combined, which cannot be contained in the case of a default or cracks across their sovereign debt and banking exposures given the existing size of the EFSF. We’ve also seen no change in the ECB’s position, backed by Germany, that it will directly intervene to support the region via leveraging the EFSF or buying primary issuance.
Given this “treading water” profile of inaction we’ll remain short the EUR-USD via the etf FXE in the Hedgeye portfolio, and remain short France (EWQ). We see the EUR-USD broken on its intermediate term TREND ($1.42) and long term TAIL ($1.40) levels. We’d expect the pair to TRADE over the immediate term TRADE between $1.33 and $1.35, and should it break its downside support level we do not see material support until the $1.21 line.
Below we present our weekly risk monitors.
European Equity and Currency Moves – On a week-over-week basis (Friday to Friday), European equity indices fell largely between -3% and -7%, with the outliers to the downside Austria (-7%, threatened by write off and banking exposure to Eastern Europe) and Cyprus -12.3%. Swiss equities were a relative outperformer, falling only -60bps w/w. YTD notable equity indice declines include: Greece Athex -52%; Austria ATX -41%; Finland OMX -32%; Portugal PSI -31%; and Italy FTSE MIB -28%. The EUR-USD finished down -1.6% w/w.
European Sovereign Yields – European 10YR yields were mixed last week. Greek yields declined -27bps; while Spanish yields gained +60bps and Italian +13bps. As always, we’re keying off the 6% Lehman line as a critical breakout line. Italy and Spain are holding tight above the 6% for the last four weeks.
In its SMP bond purchasing program, the ECB bought €8 Billion in secondary bonds last week (vs €4.5B in the week prior), taking the total program to €194.5 Billion. Look for Super Mario (Draghi) to increase buying alongside heightening Italian yields.
European Sovereign CDS – European sovereign swaps mostly widened last week. Spanish sovereign swaps widened by 8% (+36 bps to 463) and French by 12% (+25 bps to 227).
European Financials CDS Monitor – Bank swaps were wider in Europe last week for 39 of the 40 reference entities. The average widening was 8.1% and the median widening was 13.6%.
And just this morning Bank of Spain nationalized Banco De Valencia, a small Spanish bank, yet nevertheless is likely an initial sign of more to come.
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POSITION: Long Healthcare (XLV)
After covering our US Housing short (ITB) this morning, that makes me long-only on US Equity Index and Sector ETFs. To be clear however, I’m seeing this as another immediate-term Short Covering opportunity – nothing more.
Here are the lines that matter most right now across the 3 durations on our risk management model:
- Immediate-term TRADE oversold = 1187
- Intermediate-term TREND = 1203
- Long-term TAIL = 1270
If this market fails to recapture its TREND level (1203) this week, I’ll be giving you lower-lows of immediate-term TRADE support. But, for now, 1187 is the line and we want to be managing our net exposure accordingly. On the bounce we re-hedge.
The highs for both 2011 and Q4 look likely to be in. Bad Santa.
Keith R. McCullough
Chief Executive Officer
No change to November forecast of HK$21-22 billion
As expected, average daily table revenues slowed considerably this past week to HK$664 million from HK$715 million the first 2 weeks of November. Again, the motorcycle Grand Prix race is usually a VIP business killer and last week was no exception. We didn’t see a big migration over to Cotai as we expected due to the congestion on the peninsula, however, although it could’ve been masked by low hold on Cotai. Since the slowdown was anticipated, there is no change to our HK$21-22 billion (+25-31% YoY) GGR projection for the full month of November.
In terms of market share, both Wynn and MPEL improved from low hold in the first two weeks but still below recent trend. SJM remains well above trend due to high hold. LVS share actually fell slightly sequentially from last week but remains above trend. Given the enhanced junket commission and credit structure especially with Neptune in place as of November 1st, we would expect continued share increases for LVS.
Keith shorted PENN in the Hedgeye Virtual Portfolio at $35.29. According to his model, there is TRADE and TREND resistance at $35.91 and $37.44 respectively.
A long-time regional gaming darling by Wall Street, PENN has lost some of its luster and is facing some formidable challenges—cannibalization, a large capex budget, new competition, and slowing growth. Contrary to what management said on its 3Q conference call, PENN seems to be feeling the heat from the new Rivers casino that opened in mid-July. As the chart below shows, PENN’s market share in Illinois has tumbled to its lowest level since June 2009 (Joliet fire) and its total gaming revenues in the state fell 10% YoY in October.
In addition, PENN’s two largest properties by revenue generation—Hollywood Casino at Charles Town Races and Hollywood Lawrenceburg—have seen growth stagnate recently. Since the table anniversary, Charles Town and the West Virginia market have only grown in the low-single digits. The same can be said about table games revenue at Hollywood Casino at Penn National Race Course, which after a fast start, has stabilized at $3MM/month. Performance may decline at that property in the coming months as more competition comes online in the Delaware River Valley e.g. Revel, Arundel Mills, Valley Forge.
It doesn’t help PENN that overall regional gaming performance has gotten off to a miserable start in 4Q. While the bulls will point out that an unfavorable calendar in October (one less Friday vs a year ago) accounted for the underperformance, we believe even if state revenue numbers improve, PENN will likely be a laggard rather than a leader.
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