CKR - Better late than never

Finally, CKE’s management team made a decision that many in the investment community can get behind. Cutting capital spending is a positive development! Unfortunately, in today’s environment the national brands are winning with their discounting strategy. CKE is one to watch.

In April of this year, I argued that CKR’s then current level of capital spending was unsustainable. In contrast to many other restaurant companies, CKR was accelerating, not slowing, new unit growth. My primary concerns stemmed from the company’s decision to increase its unit growth significantly while margins were still under severe pressure, which typically results in lower returns for the entire enterprise. I pointed out that CKR’s aggressive capital spending over the past 2 years had not led to incremental returns for shareholders and said that management needed to change its long-term unit growth strategy in order to reverse declining returns.

On May 3, I posted my concerns about the level of G&A spending at CKR, highlighting the fact that although the company’s system-wide store count had declined by 8% since 2002, G&A per store had grown nearly 40%.

CKR dismissed these concerns.

On June 17, Ramius LLC sent a letter to Andrew Puzder, CEO of CKR, in which it called for the company to 1.) Significantly reduce operating costs, and 2.) Shrink the capital spending plan to improve free cash flow. Ramius’ public criticism of the company’s industry-high G&A costs as a percentage of total revenues and need to cut capital spending apparently struck a chord with management as the company has since made changes to its capital plans. Whatever the motivation, CKR now seems to be on the right track from a sustainability standpoint.

CKR has reduced both its new unit growth and capital spending targets for FY10-FY11 two times since Ramius sent its letter in June (the first reduction coming 2 days later at CKR’s annual meeting). In June, the company lowered its new unit growth plans by 35 units and lowered it again today by another 27 units. Combined with those unit growth reductions, the company has reduced its capital spending plans by $83 million and now expects to spend $193 million in FY10-FY11 ($100M-$110 in FY10 and $80M-$90M in FY11). For reference, that compares to $133 million in FY08 and an expected $120-$130 in capital spending in FY09 (FY10-FY11 guidance represents an expected 10%-20% YOY decline in both FY10 and FY11). A majority of the capital spending reductions are coming out of CKR’s discretionary spending, or from the cut back in new company openings as the company plans to only open 6 new company-operated Hardee’s units in both FY10 and FY11 (from prior guidance of 15) and 22 Carl’s Jr. units in both years (down from 40).

Management went on to highlight that it still has room to make further reductions if need be as nearly 40% of its capital plan is tied to discretionary items which could be further reduced or eliminated. Additionally, the company said it could cut back on its remodel program (although part of the company’s non-discretionary spending plan) on short notice if the environment worsens and deems it necessary. So, if the company needed to completely eliminate both its discretionary spending and remodel plans, it has the flexibility to further reduce its FY10-FY11 capital spending plan to $53.9 million from its current $193 million. Let’s just say it did not sound like the same management team that dismissed my concerns earlier this year, which again is a good thing! CKR is focused on using its increased free cash flow to either pay down debt or build liquidity so it stands ready to accelerate its growth again if high-return sites become available.

Also, post the Ramius letter, management allocates a significant amount of time on its earnings call to going over the company’s recent G&A reductions. G&A is down 2% YTD. Although CKR’s G&A costs are moving in the right direction, its G&A per store is about $45,600, still significantly above the FY04 level of $33,100 that Ramius highlighted in its letter. Mr. Puzder has stated that G&A spending levels in FY04 could not sustain the brand. At that level, he said the company was in “survival mode” and that such spending could not be maintained without deteriorating the brand. Regardless, there is still room for G&A to come down, particularly with the company’s ongoing refranchising efforts.


Monday, 8 Sep 2008 - DineEquity, Inc. Announces Chief Financial Officer Transition
Tuesday, 7 Oct 2008 - DineEquity, Inc. Declares Quarterly Dividend
Monday, 27 Oct 2008 - DineEquity, Inc. Agrees To Sell 66 Applebee's Locations
Friday, 5 Dec 2008 - Southeastern Asset files 13D Reports in DineEquity
Thursday, 11 Dec 2008 DineEquity, Inc. Announces Suspension of Common Dividend

The company declared a dividend in October and then suspended it in early December. During the intervening time period sales for the casual dining industry slowed significantly. The dividend announcement speaks directly to the liquidity issues the company is facing.

There is no reason that DIN should be trading at a premium to any of its peers in the restaurant industry, and yet, the company is trading at 8.7x on a NTM EV/EBITDA basis relative to its casual dining peers at 5.5x.

Lulling Chinese Bears To Sleep

Chinese consumers are paying less at the cash register, AND they are still shopping …

CPI data from China released today came in at +2.4%. This was a positive surprise for The New Reality where Chinese bulls are getting paid.

Lower commodity costs now provide the Central Bank the much needed room to make further rate cuts. The rate of food cost inflation in particular has come down dramatically from the stratospheric levels at the beginning of the year , declining from 23% in February to under 6% in November –the lowest level since January of 2007, when everyone loved China.

Interestingly, Chinese retail sales were +21% y/y in November, only 1% less than October, indicating that the pace of China’s growing consumer culture is continuing to show resilience in the face of the global meltdown.

We think that domestic consumption will provide continued strength to the Chinese economy on a relative basis (unlike their former “BRIC” cohorts India and Russia). With more money to put to work, more room to cut rates and more new consumers coming into the market they are definitely sitting at the head of the table.

We are long the Chinese equity market via the FXI ETF.

Andrew Barber

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Getting Nervous?

My math says SP500 close at/above 875 is bullish.

Bear Mace: Volatility (VIX)

Every time this market has sold off this week, the VIX has not confirmed the newfound ideas of “risk management” that some of the market’s players are implementing. Some people were not cut out to be short sellers – that’s part of The New Reality.

Let’s analyze today’s intraday SP500 selloff versus the fear you should see in the VIX – there was none – nada – zero. The VIX is still down -3% here on the day, and worrying the dizzied bears like fresh fluorescent spray of bear mace.

The chart below outlines both the double top and the recent momentum breakdown in the VIX. At 62.22, I’ll change alongside those facts. The good news, if you’re long, is that those aren’t facts yet – the VIX is at 54, the bears are worried, and they should be. If the VIX breaks and closes below 48.86, I think you’ll be staring a SP500 bull of 1,036 right in the eyes.

Buy low.

King Kong Chart: Hong Kong

The Hang Sang Index close up another 23 basis points last night. While that may not impress on an absolute basis, the ability for this index to hold its recent gains must.

Since it's October 27, 2008 low, the Hang Seng has shot the moon, tacking on a +42% move! No giveback in this market is getting a lot of people to ask us questions now. Ordinarily, I would be selling into these questions, but we do have more upside left here.

Looking at the EWH exchange traded fund, next stop is $11.40/share. If the EWH can close above $12.09, the shorts might be asking me a better question - does King Kong really live?!

Macro matters, and so does China's recent "Re-flation."

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