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DRI – ESTIMATES MAY HAVE GONE DOWN TOO MUCH

The likelihood that consensus has gotten too bearish on DRI is high. The world knows that sales trends in casual dining are very tough in October and November and there is no reason that things will get better in December. However, the holiday season is upon us and more people will be coming out of their holes and shopping for family members. They might be spending significantly less this year but they will be shopping and getting hungry. Our model suggests that estimates are about 5% too low.

The consensus numbers suggest that current sales trends will continue for the balance of FY 2009 for DRI. Although I would agree that in the current fiscal quarter (2Q09) sales trends will decelerate further as September and October have proven to be more difficult than the summer from a traffic standpoint, I think casual dining companies will get some relief in early calendar 2009. It’s unclear what the Obama administration will do to help the beleaguered consumer, but help is on the way. We know the new administration is working on a plan to hopefully be in place shortly after he takes office in January.

Casual dining stocks have been in liquidation mode for the last three months. Yes, sales trends are bad but negative sentiment begets negative sentiment. Over the past three months DRI is down 49% and down 40% year to date. The stock now trades at 6x EPS with a 5% dividend yield. One of DRI’s most important competitors, EAT, is down 68% this year and trades at a 7% dividend yield. EAT trades at 5x EPS! Neither of these companies is going away, but the market seems to think otherwise.

My number one concern about DRI continues to stem from the company’s new unit growth targets and overall use of cash, which I don’t think properly reflect the current environment. Last quarter, management acknowledged the tough environment saying, “There's no question it has been a difficult quarter and given the difficult economic environment, it looks like it is going to be a challenging year. Our current sales and earnings outlook reflects that.” The analyst community does not agree with management! I think management’s EPS guidance and same-store sales target of flat to up 1% for FY09 is aggressive, but I think numbers will look better than what the street is forecasting.

Despite these challenging times when operating profit growth declined at each of the company’s core concepts, Red Lobster comparable sales declined for the third consecutive quarter with traffic down about 5.5% in 1Q and LongHorn posted a 4.9% same-store sales decline with traffic down about 7%, DRI maintained its FY09 unit growth targets (75-80 new restaurants, or 4%-5% unit growth). Total capital spending for FY09 will be north of $600 million. In addition, given where the company’s stock price is and management penchant for share repurchase, they are still buying back stock. Given the times, it’s an aggressive use of cash at a time when cash is king!


It's Time For Leadership

“He who thinketh he leadeth and hath no one following him is only taking a walk.”~ Anonymous

For whatever reason, there remains a tremendous amount of media driven hope that those who have “leadeth” us into this financial disaster are still capable of leading us out of it. After watching Vikram Pandit being interviewed by Charlie Rose last night, I can assure you that I will not be following this man anywhere. Hope is not an investment process.

After seeing the S&P500 rip the shorts for a +14% three-day move (we made the call pre-market open on 11/21 for S&P500 848, and it closed yesterday at 857.39), the Street’s perpetually bullish narrative fallacies have already swallowed the mainstream media into their groupthink. We took our ‘Hedgeye Portfolio Allocation’ in US Equities down to 6% selling into it. These networks had zero leadership to help them proactively predict this financial tsunami. They understood as little about the October 07’ top as they did last Thursday’s capitulation low. You have no reason to trust their attempt at synthesis as credible. Do so at your own risk.

I was on the road for the last 6 days, so if I am a little snarly this morning, I beg your pardon. Being away from my Bloomberg TV in the mornings and being forced to consume CNBC is as painful an exercise that I can implement into this stage of my daily life. Charlie Gasparino and Dylan Radigan are no leaders of mine. These people actually “thinketh” that they “leadeth”... for those of you who have played competitive sports, I am sure you can appreciate where I am coming from. There is nothing worse than people acting like Captains who were never voted to be by their teammates.

The Chinese are providing the real economic leadership in this interconnected global economy. Yes, this may very well be temporary… and no, this is not an un-American comment. What is un-American is what the said fiduciary “leaders” of our economic system have done to it. Pandit had to be acting last night – here’s a man who sold his hedge fund to Citigroup shareholders for over $800M, right before it blew up, and sat across from Charlie Rose telling him that weakness in Citigroup’s stock was due to “short sellers!” Clearly, “Mr. Vikram” (that’s what his new best friend Alalweed calls him) has no idea what real leaders who can hedge and make short sales in this profession do. He wouldn’t make such an embarrassing comment otherwise.

This overdose of American groupthink really has me concerned. That’s why I have moved back to 71% Cash. That said, I am more comfortable being long China today than I was yesterday, and we will be adding to that invested exposure. The Chinese “mavericks” are marching to the beat of their own drummer, and there are well over a billion people following them. This morning, China cut 1-year interest rates by over 100 basis points down to 5.8%. So now we have ourselves what most capitalists want to see – a government who is liquid long cash, cutting taxes, cutting interest rates, and creating stimulus. This is economic leadership that I can follow.

Now don’t fret, there is always hope that American Capitalism can renew her faith. I think it’s very possible, and this week’s changes to the economic leadership lineup is the first step in the right direction. This morning Obama looks like he is going to appoint The Man, Paul Volcker, to head up the Economic Recovery Advisory Board. Now we have Summers and Volcker, two players we have been championing this country to draft for the better part of the last 6-9 months, playing on the same line! This is progress. This is economic leadership that I can follow.

You see, most of the moves the Chinese Capitalists have been making in the last 3 months are being made because they proactively prepared themselves (and their balance sheet) to be in a position of strength. The scraps that remain of a failed economic Bush team are simply a function of the reality that is born out of attempting to lead a global economy reactively. Last Thursday, at S&P500 752, it felt dark in this country, because it was. Yesterday’s Federal Reserve pledge of $800B is called more leverage. We can call it the “TALF”, the “TARP”, or whatever sounds like a plan… but the plan now is that the plans are going to change. Change is good.  

We are short the US Dollar via the UUP exchange traded fund, because predicting the current American losing team’s “leadership” is easy. When in doubt, instead of a good hockey Captain saying “shoot it out”, Paulson calls for “lever it up.” This is what people who believe in themselves to a fault do. They make the capital mistake of repeating their 1st offense, over and over and over… expecting different results.

Post yesterday’s socialist call to arms, America’s balance sheet is levered almost 55x with a capital ratio of under 2%. Hank “The Market Tank” now has this fine country’s Federal Insurance Deposit Corporation (FDIC) backing his cronies bonds (Goldman Sachs) in exchange for a compromise for US homeowners. At every turn, this team’s solution has been to behave reactively and throw more debt at the problem. This is no leadership of mine.

The US Dollar has lost over 3% of its value into and out of bailing out the Pandit “Bandit’s” Citigroup, and the firm Hank levered up when he lead it. US currency weakness is a global market vote of confidence, and it’s not a good one… but for the revisionist historians, it’s probably the right one. Fixing this old boy team’s mess is going to take time and leadership. “He who thinketh he leadeth and hath no one following him” is finally going to take a walk.

Every great investment in leadership starts with a new beginning. On this American Thanksgiving, let’s be thankful for that.

Enjoy your time with your loved ones,

KM

Long ETFs

TIP –iShares Lehman TIPS Bond --10 Year Yields dropped 11 basis points to 3.01 yesterday, near the 2.99 all time record set last week. 

OIL iPath ETN Crude Oil –Front Month Light Crude futures rose to 51.86 per barrel on Chinese rate cuts this morning.

EWA –iShares Australia – The OECD released a report estimating that Australia will emerge from recession in 2009 with a forecast GRDP rate of 1.7% due to lower rates and increased exports.

EWG – iShares Germany  --Inflation contracted in 5 states including Bavaria -where data show it at 1.5%  down from 2.7% last month. Porsche SE reported a 15% Year-over-year for the four months through November and indicated that the Volkswagen (EWG: 13.6%) ownership increase may be delayed by credit market issues.

FXI –iShares China –The People’s Bank of China lowered the benchmark one-year lending rate by 108 basis points to 5.58%, the lowest level in more than a decade. The deposit rate was also reduced to 2.52%.

VYM – Vanguard High Dividend Yield ETF –S&P data showed US equity dividend declining at the fastest pace in 50 years led by financials which accounted for 6 of 8 dividend suspensions or cuts in the S&P 500 month to date

Short ETFs

EWU – iShares United Kingdom – GDP declined by 0.5% in Q3 according to data released today, the first quarter-over-quarter decline in 16 years while consumer spending figures declined by the most in a single period since 1995.

UUP – U.S. Dollar Index – The pound declined to $1.5416 this morning on UK GDP declines.

EWJ – iShares Japan –Fitch reduced its Credit Rating for Toyota Motor Corp (EWJ: 5.61%) to AA from AAA with a negative outlook.

FXY – CurrencyShares Japanese Yen Trust – The yen rose to 95.16 USD and 123.46 EUR this morning as traders are focused on the scope of the US recession.

Keith R. McCullough
CEO & Chief Investment Officer


A POSITIVE CATALYST? THAT WOULD BE A GAS!

It’s been no secret the Research Edge crew has been negative on consumer spending. Our view on falling housing prices, rising employment, the wealth effect, and a rising savings rate has been pretty consistent. For the regional gaming players, the three macro factors that matter are local housing prices, unemployment levels, and gas prices.
  • Housing prices have been running down YoY mid to high teens since January and have fallen every month since January 2007. In fact, the last month where the YoY change in housing prices increased sequentially occurred way back in November, 2005. Assuming housing prices stay at current levels, prices will fall 3-4% in 2009.

    Unemployment, of course, is accelerating, up to 6.1% in October and 1.3% higher than last year. Enough with the bad news. Gas prices are plummeting which is good for the regional casino business. If they stay at this level, gas prices will be down a whopping 35-40% in 2009 vs. 2008.
  • So I’ve run the regressions and I have a macro model based on the three factors. If we hold gas prices and housing prices constant as discussed, and assume an average 7% unemployment rate in 2009, regional same store revenues are projected to be flat. I’ve charted consensus same store revenues for ASCA, BYD, PENN, and PNK which look surprisingly reasonable. Analysts project positive same store revenue growth for only PNK and ASCA due to the removal of the loss limit in Missouri while BYD and PENN are projected to be negative again.
  • The regional gaming stocks are dirt cheap. Any indication that revenue trends may stabilize in 2009 should be a huge catalyst. Gas may be the stabilizer to offset the continued softness in housing and rising unemployment.
Regional gaming revenues negatively correlated to gas prices
Analysts' 2009 projections actually look reasonable

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J Crew Needs Macro...And A Referee

Q&A
Unknown Speaker*
So we're supposed to sit here and believe that you just got the memo in October about inventory?
I mean correct me if I'm wrong. I thought we were down comp in Q2. So when do we finally get some kind of confidence that you guys are ahead of the game and that we don't have a Q1 that looks like this?

What is one thing we can hang our hats on to let --

Unknown Speaker*
I think there is more but Jim will explain the answer to that. Because unless you're in our business I'm not sure you understand how it works. But Jim you want to answer that.

Unknown Speaker*
But weren't you the guy who told us there was a recession back in January?

Unknown Speaker*
Hey listen -- no, no, let's play polite here okay? Seriously there is no reason for that.
We're trying to do the best we can do. I don't ask you to buy our stock and you don't have to. But let's play this game professionally and politely? Okay --

Unknown Speaker*
Fair enough, so give us something that shows us that you have got inventories down for spring.

Unknown Speaker*
All right, you want to listen to the answer now.
Inventories vs sales vs margins vs capex are all just flat-out wrong. This chart is noisy, but it tells a lot. Email or call for more color.

Eyes on the Curve: Still upward sloping, but...

In the morning meeting today, Keith highlighted as a marginal negative the yield curve. On November 10th, 2-year treasuries were trading at a yield of 1.27% and 10-year treasuries were trading at a yield of 3.82% for a spread of 2.55%. As of yesterday, 2-year treasuries were yielding 1.31% and 10-year Treasuries were yielding 3.35% for a spread of 2.04%, so in the space of two weeks the spread between 2s and 10s has narrowed by 51 basis points.

When we highlighted the yield curve on October 30th, 2008 in our note, “Yield Curve: Steep and Steepening”, the spread was 235 basis points and while the curve continued to steepen immediately following that note, yields at the long end of the curve have started to come in once again.

On the margin, this is incrementally negative and foretells, once again, of a slightly tighter credit environment and an economic recovery that could take some time to play itself out. That said, the curve is still upward sloping, which implies that interest rates should rise in the future as growth begins to reaccelerate.

We will continue to have our Eyes on the curve.

Daryl Jones
Managing Director

EYE ON GERMANY: RELATIVE STRENGTH

German GDP for Q3 released today in final form today showed a year-over-year increase of 1.3% suggesting degree of resilience that may make the official forecast of 0.2% GDP growth in 2009 plausible. The “five wise men” government advisory panel’s more pessimistic annual report delivered on the 12th predicted increased unemployment and recommended rate cuts –but even they only foresee flat GDP for next year rather than the negative being factored in other countries.

Two other glass-half-full data points emerged today:

· Q3 data released today by the Federal Statistics office indicated that the balance of trade is contracting; however the numbers suggest that the overall health of the economy remains sound. Exports for the quarter totaled 294 billion EUR, a decline of only 0.37% from Q2 and a year-over-year increase of 3.16%, While Imports totaled 257 billion EUR - an increase of 3.81 over the last period or 5.21% year-over-year.

· The GfK Marktforschung monthly survey of financial services, consumer and savings climate was released today, with the response of German consumers surveyed coming in at 2.2, up from 1.9 last month and much better than the average economist estimates of 1.7. Clearly, the mood of German consumers heading into the holidays will be significantly better than that of many of their neighbors.
We continue to be long Germany via the EWG ETF. As we have stated often, we believe that the German is significantly sounder structurally than other major EU economies and we like it on a relative basis.

Andrew Barber
Director

Early Look

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