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Casual Dining Exposure Exposed…

The charts attached below show casual dining restaurants’ exposure to the better and worse performing regions of the U.S. relative to the national average from a comparable sales growth perspective in August and September 2008. For reference, in September, none of the regions had positive comparable sales growth so the outperformance and underperformance is relative to the average 4.1% same-store sales decline. CHUX, CPKI and RUTH have the most exposure to the underperforming regions of the U.S. while SNS and TXRH have the highest proportion of their restaurants located in the better performing regions.

SINGAPORE SLING

Singapore’s Trade ministry released Q3 GDP data today showing a 0.64% year-over-year decline and the second consecutive decline on a quarter-over-quarter basis. The ministry also lowered their growth forecast for next year to a 1% contraction as demand for export is expected to continue to decline –increasing the likelihood that the Central Bank will pursue a weak currency strategy. If that is the case they are already off to a great start, Singapore’s currency has slipped 11% against versus the US dollar since July.

We like to keep an eye on Singapore. As one of the last true city-states they provide a fascinating economic vantage point into south Asia. If prospects are diminishing so rapidly for this mature economy, it raises question about the rosy growth assessments that central bankers in some of their large developing neighbors still espouse.

Andrew Barber
Director

EYE ON EUROPE: DISCORD & DIVERGENCE

NTC business condition survey data was released today for the Eurozone showing a sharp decline to 4.1 43.61 on a year over year basis to the lowest levels in a decade. Economic contraction, particularly in the manufacturing sector, is increasing the pressure on ECB policy makers to lower rates further. The decline in manufacturing is also exacerbating the tension between EU partners - with French President Sarkozy taking a particularly shrill stance with the creation of a €20 billion fund to defend his nations “strategic companies” from ``foreign predators''.

Importantly, today’s NTC data also revealed that German industry came fared significantly better than the Eurozone aggregate with manufacturing coming in at 42.88 and services at 48.31. We continue to believe that, on a relative basis, the German economy is more stable structurally than the other major economies in Europe and remain long the German equity market via the EWG ETF.

Andrew Barber
Director

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TBL: A Rare Comment from FL

"One of few positive call outs on the product front - 6 inch boot from TBL has come back very strong (ASP $145)." I continue to like TBL.
"One of few positive call outs on the product front - 6 inch boot from TBL has come back very strong (ASP $145)." I continue to like TBL.

Studying History

“No matter how busy you may think you are, you must find time for reading, or surrender yourself to self-chosen ignorance.”
-Confucius
 
I have been spending an inordinate amount of my time away from my screens this month, studying and reviewing economic depressions and crashes. What are they? What causes them? How long can they last? I know – nice life man…  reality is, however, that Jeremy Grantham’s thesis continues to play out. Right brain management (patient and objective study) is crushing the lefties this year (reactive Hank “The Tanks”). Studying is where my most productive time can be spent.
 
Proactively preparing yourself for predictable behavioral patterns generally puts you in a situation to take advantage of an opportunity. If I wasn’t in print with warnings of this crash, you could chalk me up as just another revisionist historian chirping in your inbox this morning. Unfortunately for all of us, that’s not the case. My being right was never going to equate to a positive surprise in the US unemployment rate, but hopefully it has convinced you that being liquid long cash had some strategic benefits to your balance sheet.
 
As of yesterday’s close, peak to trough declines in the S&P500, US Consumer Discretionary, and US Financials are now at -52%, -65%, and -75%, respectively. Them be crashes folks – and they aren’t all equal. Some of these moves have lasted longer and fallen further. Waking up this morning and being “bearish on the US consumer stocks” is no more unique than being bullish on “Chindia”, private equity, or petro dollars was 12 months ago.
 
In September I moved to 96% cash. As we moved into and out of the October 27th low, I began to patiently deploy some of that cash into equities. While my holding a 62% position in US Cash this morning (see Hedgeye Asset Allocation model above) should hardly be construed as “bullish” positioning relative to other Wall Street “Strategists”, I continue to believe that tremendous short term “Trade” opportunities will present themselves on the long side of this market. Squeezes are more pronounced in bear markets than bull ones. This morning I see another one coming and I will be using any weakness to cover/buy stocks. I have an immediate term squeeze target for the S&P500 of 858 (+14% higher).
 
Last week, my investment process called out 9 specific reasons why the S&P500’s October low of 848 could hold. As of the last few trading days, clearly that has been proven wrong. Bottoms are processes, not points Keith. Don’t mess with Mr. Market. He will run you over.
 
Other than being in sunny California opening our new office, the best news for me is that I didn’t buy the S&P500 until this week. I bought SPY (S&P500 etf) into the close yesterday (see Hedgeye Portfolio). Rather than focusing on my playing Jack Sparrow or Cinderella Man pre-open, you are always best served to watch what I do when the game is on with our virtual portfolio – actions always speak louder than words. I hold myself accountable to both.
 
As I was driving over the Golden Gate bridge after the close yesterday, I reminded myself that being down -4% in my S&P500 position when the US market has lost -18% since last Friday is no reason to beat myself up. I do plenty of that when you aren’t looking. I thought about doing that again here in print this morning; but now is not the time. Now is a time for leadership. So let’s get back to the history books.
 
Throughout 2008 I have discussed that 2007-2009 will look most like the 1 period of consumers savings rates replacing their levered up spending ones. While no period of US economic history is a carbon copy of another, the durations and depths of peak to trough price declines can be studied. The Dow peaked in January of 1973, and picked-up its most bearish price momentum into year end of 1974 (-45% peak to trough). There are only 2 other worse peak to trough declines in the Dow than that one – the September 1929 to July 1932 period (-89%), and the other “Depression” within the Great Depression from March 1937 to March 1938 (-49%).
 
In my macro model, yesterday’s combined volatility (VIX) and volume (NYSE) readings implied another immediate term selling capitulation. Fear of another Great Depression is here. This fear is based on fiction versus fact, and you need to have yourself another cup of coffee this morning and wake up to that reality if you already haven’t. Grantham’s October investor letter walked through some of the math on the 3 most relevant equity bubbles in the 20th century (1929, 1965, and Japan’s 1989). These are the only peak to trough corrections that have exceeded 50%. Yesterday’s S&P500 -52% peak to trough print felt like it should have – a crash. But wait … it’s we’re in a different century this morning. Yes, indeed folks, we are. This is “The New Reality.” Don’t get sucked into the vacuum of the media’s manic narrative fallacy.
 
The most relevant difference between this century and the last one is China. They have the cash now; we don’t. They own our debt; we don’t own theirs. China’s stock market didn’t make a lower low last night - America’s did. Chinese stocks are now trading +15% above their 2008 lows, and Asia traded up across the board overnight… hmmm… how could that be? Shouldn’t Asian trading take America’s lead? Isn’t the USA the land of the financial Gods? Uh, no… not so much anymore.
 
The Saudi’s are being held ransom for $25M by Somali pirates this morning. All of a sudden cartoon characters like Chavez, Ahmadinejad, and Ortega don’t have any leverage with oil trading under $50/barrel. The financial genius of “The Pandit Bandit" should try wearing a black pirate’s patch over his eye when he walks into this so called “Citigroup board meeting to discuss strategic options.” After seeing what’s become of his “bullish on India” call, he’ll already have a limp. I’ll provide the script and a parrot. “Argh! Hi there mateys'… we’re right screwed here again... prepare the anchor… it’s time to take what money we can and jump ship.”
 
Again, pay less attention to Captain Jack Sparrow than studying history. The world doesn’t have the liquidity problem that it had 3 months ago. “Investment Banking Inc.’s” handshake has a credibility one. This storm of confidence is rightly held, but like those of 1932 and 1974, it will creatively destruct. “The New Reality” is here. New leaders are emerging. Be patient, study, and take your time. Never mind the levered long activists and the “lefty reactivists” - they are preparing to walk the plank. And yes, they are depressed.
 
Have a great weekend.


Franchisees Are Really Feeling the Pinch

Papa John’s announced yesterday a number of proposed domestic franchise system support initiatives in response to the current economic challenges. These initiatives include:

1) Providing continued cheese cost relief to the system in 2009 by modifying its cheese pricing formula
2) Providing additional national marketing support in 4Q08 and FY09
3) Offering expanded royalty relief and local marketing support for struggling franchisees or markets
4) Convening a lender’s summit, principally of regional banks and other lenders, to educate them on the Papa John’s model with the goal of expanding credit availability to franchisees
5) Providing company loans to operationally strong franchisees to help them to acquire troubled franchise groups
6) Suspending the 0.25% royalty rate increase, which was scheduled for January 2009, in the first six months of 2009
PZZA estimates that the incremental costs of these support initiatives will be about $3 million in 4Q08 and $8-$10 million in FY09. The ultimate impact for 2009, however, will depend upon the actual number of franchisees who choose to accept the proposed support program. Although this type of support will broaden PZZA’s short-term exposure to the current environment, the company “believes the support program will produce long-term shareholder benefits by mitigating potential unit closures and strengthening [its] brand during these challenging times.” The need for these support initiatives highlights the fact that it is primarily the franchisees (across the restaurant industry) that are enduring the total profit impact from lower consumer spending, rising commodity costs and the tightened credit markets.

Franchisor financing of its franchisees is becoming the trend recently with more restaurant operators communicating the need to provide assistance in today’s environment. And, a prolonged downturn will likely force more companies to make announcements similar to that of PZZA. Domino’s said on its most recent earnings call that the company is “wading through uncharted waters and we are not going to let our A and B franchisees fail if there are ways we can be helpful with some short-term financial support and solutions.” Management went on to say that although it does not want to be a bank, it would provide some level of bridge financing to help facilitate the acquisitions of its weaker franchisees by stronger franchisees as the company would rather see a deal get done than a store closure. Domino’s would also offer some deferral of costs, royalties or other payments to a franchisee that is in turnaround mode if it would prevent that franchisee from failing. At the time Domino’s made these comments, it was only highlighting its options, but the fact that the company communicated them to the investment community signals that some of its franchisees were in desperate need of financing. That being said, I would not be surprised to hear how the company proceeded with these short-term financing initiatives on its fourth quarter earnings call.

Just yesterday, JBX announced that it provided bridge financing to a small number of franchisees in 4Q08 in order to get more of its company stores sold as the company is the midst of a massive refranchising program, which is being slowed somewhat by current credit conditions. JBX plans to accelerate the pace of its refranchising efforts over the next five years to reach its goal of franchised ownership in the range of 70% to 80% by the end of fiscal year 2013 (from 38% franchise ownership at the end FY08). In order to remain on target, JBX said it is comfortable providing bridge or mezzanine financing to its franchisees to facilitate the completion of transactions on a go forward basis.

As I said before, based on the likelihood of a prolonged economic downturn, I would expect more restaurant operators to announce financial support initiatives for their franchisees, including deferred royalty payments. Two obvious candidates are DIN’s Applebee’s franchisees and YUM’s KFC franchisees. A select number of Applebee’s franchisees are struggling to make ends meet and are aggressively cutting costs. Everyone knows the problems with KFC. Like many other restaurant companies today, KFC’s same-store sales continue to decline (down 4% in the most recent quarter) as costs climb higher. More unique to KFC, however, is the fact that the concept has been struggling from a profitability standpoint for the better part of the last two years so the current environment is only worsening an already difficult situation. At some point, franchisees are going to demand relief.



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