Eye On Leadership: Obama Wisely Taps Volcker!

Today President-elect Obama announced the creation of the President’s Economic Recovery Advisory Board, a panel of outside advisers headed by 81-year-old Paul Volcker. [Compared to Secretary Paulson’s (aka Hank the Tank) selection of a 34 year old former Associate level investment banker as the Head of TARP, Obama wisely selected the universally respected Paul Volcker to head this Advisory Board].

As you recall, Daryl Jones’ posted on Volcker from 9/27 (Eye On Leadership: Volcker As Bailout Czar!) in which we laid our support behind “the 6’7, cigar chomping Princeton graduate” to lead financial policy under the new administration. While the Secretary of the Treasury went to Timothy Geithner, it is our hope that the experienced Volcker will be utilized, despite sitting outside Obama’s inner circle of advisors.

Volcker, who is credited for ending stagflation in the 1980s, played an integral role in turning around poor market conditions, recessionary growth, and rampant inflation. Volcker started his career in 1952 when he joined the Fed Bank of New York as a full-time economist. He left that position in 1957 to become a financial economist with the Chase Manhattan Bank, which he held until joining the US Treasury Department in 1962 as director of financial analysis. A year later he was promoted to deputy under-secretary of monetary affairs before returning to Chase Manhattan Bank as vice president and director of planning in 1965.

From 1969 to 1974 Volcker served as under-secretary of the Treasury for international monetary affairs. He played an integral role in 1971 repealing the 1944 Bretton Woods Agreements that pegged currency exchange rates to gold, crafting a new system in which the US dollar became the “reserve currency”.
A Democrat, Volcker was inaugurated by President Jimmy Carter on July 25, 1979 as the new Fed chairman. Known to be conservative, he fit the bill as the bright and able candidate from Wall Street, and made it his priority to end stagflation (a period of inflation with slow to zero growth). On October 4th September PPI showed a rise of 17% y-o-y, the largest increase in 5 years. Called to action, he inherited an expanding money supply that caused a weak dollar and a soaring trade deficit.

Taking charge in October Volcker cut the money supply by increasing the federal funds rate to a record 12% to clobber an inflation rate slightly lower than 9%. Into 1980, interest rates continued to rise and the economy sank into recession. Republican Ronald Reagan won the election in November 1980. By the middle of 1981 inflation topped 9.7% and dropped to 9% at year’s end. By 1983 Volcker’s constraint of the money supply showed positive signs. Despite unemployment of 9.7% in 1982, CPI for all of 1982 fell to 3.8%, from 13.3% in 1979 and the beast of inflation had been beaten.

We applaud President Elect Obama’s choice in Volcker. As we have outlined above, he is experienced, willing to make tough decisions against political winds, and respected far beyond partisan association.

Daryl Jones
Managing Director

Matt Hedrick

SP500 Levels Into The Close...

Buy investments down at the SPX 757 line (like we did), and sell strength up here on a low volume day into the close near the 895 line. See Chart - buy low, sell high.

MCD – Balancing Traffic and Margins

MCD’s decision to take the double cheeseburger off the dollar menu as of next week and raise the suggested retail price on the item to $1.19 is a welcomed move. Despite consistently strong same-store sales growth, MCD has faced declining U.S. restaurant margins for the last seven consecutive quarters.

The dollar menu currently accounts for about 14% of sales and the double cheeseburger has been the menu’s most popular item so a step toward increased profitability on this one menu item will help to improve U.S. margins. Although the higher price could impact traffic, I think it is more important that the company focus on margins. Additionally, maintaining the dollar price point in this environment of higher commodity costs has been the source of much friction among franchisees as they have watched their bottom lines suffer rather significantly despite continued traffic gains. At some point a decision needed to be made around traffic and margins, and MCD’s recent focus on the dollar menu had tilted the scales in favor of traffic at the expense of margins. Some franchisees, however, had clearly already chosen margins as they had already raised the price of the double cheeseburger and some are even charging more than $1.19, but MCD’s decision to follow with a system-wide price increase signals a level of support on the part of corporate.

MCD will be replacing the double cheeseburger with the McDouble on the dollar menu, which will still offer two beef patties but with only one slice of cheese (relative to the two slices of cheese on the double cheeseburger). The recent price of cheese was the primary focus of many franchisees’ argument for wanting to raise the prices of dollar menu items.

MCD’s traffic trends may experience some increased pressure from Wendy’s now that the double cheeseburger is no longer on the dollar menu as Wendy’s has been aggressively pushing its value trio promotion, which includes the Jr. Bacon Cheeseburger, the Crispy Chicken Sandwich and the Double Stack Cheeseburger, all for $0.99. As I posted back on November 5, a survey showed that the new value items are driving same-store sales but not profitability. Sound familiar? As I have said before, the restaurant industry is a zero sum game so if Wendy’s is experiencing a pick-up in traffic, it has to be coming from somewhere. Wendy’s market share gains could be accelerated by MCD’s changes to its dollar menu. That being said, I still think it was the right move by MCD from both a profitability standpoint and a franchise health perspective.


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More bad news arrived for the UK this morning as new miserable economic data points emerged. GDP numbers showed that growth declined by 0.5% in Q3 while consumer spending figures declined by the most in a single period since 1995. Exports declined by 0.31% since Q2, while industrial Production was revised to a 1.1% decrease.

Gordon Brown’s government is now facing a perfect storm of rising unemployment, plummeting housing prices and a nearly completely frozen domestic credit market. It is projected that the plan that Brown and co-conspirator Darling are now proposing will leave the UK with the largest budget deficit among the G7. Academics have seriously questioned the advantages of the administration’s much ballyhooed plan to help close the gap with tax hikes for the rich, recalling the 1970’s when the highest tax rates reached over 80% and capture little or no revenues as rock stars and Duchesses alike lived abroad as “tax exiles”.

Both the FTSE and Sterling have rebounded since initially selling off this morning on this news, but we remain bearish. We are short the UK via the EWU ETF and with a committed negative bias both on a relative and absolute basis.

Andrew Barber


The Washington Post today reported that USDA data is expected to show that more than 30 million people in the US are receiving Federal nutritional assistance. This will be the largest number since the program launched in 1969 – surpassing the previous record levels following Hurricane Katrina in 2005. Additional anecdotal evidence from food panties and other charitable organizations nationwide indicates rapidly increasing demand (coupled with an alarming drop off in donations).

An obvious strong correlation exists between unemployment and food stamp recipients (see graph below). Unemployment hit 6.5% in October and is predicted to increase in 2009. Additionally, despite the recent decline in commodity prices, increased food costs are also weighing heavily as CPI Food and Beverage jumped by 6.1% year-over-year in October.

As we enter the “New New Deal” era we expect that this data will be latched onto by members of the house and senate eager to advance their own policy agendas. Politicians love incendiary data, and what could be more compelling than 10% of the US population on food stamps?

Matthew Hedrick

Andrew Barber


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!

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