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Chart of The Week: Volatility Breaks

While the hearts and minds of the obvious are getting all beared up, volatility continues to break down. This week’s crash in the VIX was a critical one in our macro model, and it should not be ignored.

The VIX was down -17% on the week, following its -9% week over week fall in the week prior, taking its 2-week crash to -26%. This is why the shorts are being squeezed most materially where they were making most of their money in the months prior – small caps.

This week alone the Russell 2000 had a +3.8% move. With the larger cap Dow being a proxy for “liquidity”, and closing down -0.6% on the week, the real liquidity needed in the US market place was that for the shorts to cover in illiquid small cap shorts.

Everything that matters in our macro models happens on the margin. On this margin, volatility is declining at an accelerating rate, while positive breadth continues to expand. If you add some volume to this Christmas cocktail, you have yourself a relative performance party that few can afford to miss.

Our breakdown level for the VIX is now $51.15 – see the chart below – that’s the bear hunter’s bulls-eye, where support has quickly morphed into stiff resistance for a growing community of consensus bears.

US Market Performance: Week Ended 12/19/08...

Index Performance:

Week Ended 12/19/08:
DJ (0.6%), SP500 +0.9%, Nasdaq +1.5%, Russell2000 +3.8%

DEC08’ To Date:
DJ (2.8%), SP500 (1.0%), Nasdaq +1.9%, Russell2000 +2.8%

Q408 To Date:
DJ (20.9%), SP500 (23.9%), Nasdaq (25.9%), Russell2000 (28.5%)

2008 Year To Date:
DJ (35.3%), SP500 (39.6%), Nasdaq (41.0%), Russell2000 (36.5%)


ASCA, BYD, LVS, MGM, and PNK all have potential debt covenant issues in 2009. BYD and MGM are in the unique position of having the combination of sufficiently lenient credit facility covenants and significantly discounted subordinated debt. Both companies can de-lever by borrowing off their credit facilities to buy back discounted sub debt and retiring it. Both can also sell assets and use the proceeds to retire sub debt subject to certain conditions.

By way of example, MGM borrows $100 million from its credit facility and buys $154 million par value debt trading at 65. The company would have to pay taxes on the gain of $54 million at the ordinary rate, say 35%. Thus, on a net basis, MGM would be deleveraging at $35 million ($54 million less taxes of $19 million) for every $100 million in bank borrowing used to repurchase sub debt. Nobody likes to pay taxes but the penalties of a covenant breach are much more severe.

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Galaxy and SJM, the Hong Kong listed Macau stocks, have been ripping as of late with the US listed Macau stocks doing quite well in their own right. Rumors of Beijing loosening visa restrictions have been the main catalyst. Unfortunately, those rumors are probably unfounded. We still believe visa restrictions will ultimately be loosened, but not until mid to late 2009 when the new Macau Chief Executive takes the wheel.

There is potentially a touch of good news on the visa front. Beijing appears to be allowing higher frequency visitation to high net worth players identified by the casinos. This should certainly help the direct credit business but is not the visa panacea sought by investors.


Today French, Belgian and German market regulators extended bans on the short selling of financial equities - on the heels of Switzerland’s Thursday announcement on the same ban for the Swiss stock exchange (SWX). At least 13 European countries followed the lead of the US and UK in September in adopting a ban on short selling. UK, Italian, Dutch, and Austrian bans will expire in the next six weeks; Belgium and Germany said they will extend their bans till late March.

Both the US and China let their temporary ban on short selling expire. We view these as positive capitalist decisions that will benefit the marketplace. In 2009 we’re looking to be long capitalist nations that proactively manage their economies. The EU’s consensus on short selling confirms our bearish views on the region.

Matthew Hedrick


I believe DRI is well positioned to take advantage in a difficult environment.

Going into DRI’s 2Q09 earnings call, I thought the company’s results would be less bad than consensus numbers were suggesting. It turns out that DRI’s top-lines results, particularly at its Olive Garden and Red Lobster concepts, materially outperformed the casual dining industry as measured by Knapp Track.

Earnings preview: Street consensus EPS numbers are too low for the company…..

2Q09 results: DRI reported EPS of $0.44 versus the street’s estimate of $0.30. DRI lowered its FY09 EPS range to down 5%-10% on a continuing operations basis and excluding integration costs from flat to up 5%. Although this is a fairly significant downward revision, prior to the call, the street had not believed this guidance anyway and was forecasting an 11% YOY decline. This more cautious and believable outlook provides some upside to consensus numbers and offers DRI the opportunity to beat numbers going forward should top-line trends stabilize and improve.

Earnings preview: Same-store sales trends are better than consensus (part of the reason why EPS estimates are too low).

2Q09 results: Same-store sales growth came in better than expectations at each of the company’s concepts with both the Olive Garden and Red Lobster substantially outperforming the overall casual dining industry by 610 and 560 bps, respectively. Olive Garden’s same-store sales grew 0.8% and Red Lobster posted a 0.3% increase. Positive numbers in today’s environment represents a win for DRI. DRI’s lowered guidance assumes that same-store sales at the Olive Garden, Red Lobster and LongHorn Steakhouse will decelerate somewhat in the back half of the year to down 2%-4%. Again, this revised guidance reflects a more conservative stance on the part of management and provides the company with a cushion in this challenging environment.

As I have said before, I expect casual dining top-line trends to pick up somewhat in early 2009 from Obama’s planned fiscal stimulus program. All of DRI’s concepts would benefit from such a stimulus plan, but Olive Garden would really stand out as it has outperformed the industry all along. For reference, casual dining same-store sales growth has declined for eight of the last nine quarters while Olive Garden has managed to report consistently positive numbers.

Earnings preview: The company will have positive commentary about the cost side of the equation, especially seafood, chicken and wheat costs.

2Q09 results: DRI lowered its full-year food and beverage cost outlook and now expects these costs as a percent of sales to be up about 50 bps on a reported basis versus its prior guidance of up 70 bps. And, this is based on the company’s now lowered sales guidance. Relative to DRI’s current commodity contracts and hedging strategy, management stated that it must strike a balance between wanting to lock in more costs in order to have better cost visibility and wanting to wait to take advantage of cost favorability. That being said, management stated that it has been successful in extending hedges at more favorable prices. Specifically, the company is 100% covered on its shrimp needs for the year and expects its 2H09 and FY10 results to better reflect the current favorable trends it is seeing on the spot market.
Earnings preview: Industry same-store sales trends in November, while still bad, are less bad than October.

2Q09 results: Same-store sales improved sequentially in November from October at the Olive Garden, Red Lobster and LongHorn Steakhouse. The company’s November comparable sales numbers were helped by an estimated 250 bps due to the timing of the Thanksgiving week, which fell in 3Q this year versus 2Q last year. This timing shift helped the quarter’s results by about 70 bps and is expected to reverse in 3Q. Even when you exclude the benefit, however, same-store sales improved sequentially by about 1.5% at Olive Garden, about 3.5% at Red Lobster and about 4% at LongHorn. October was extremely bad for each of these concepts, but November did turn out to be less bad, which was a definite positive in the quarter. The company attributed the strong November results at Red Lobster to the company’s new wood-fire grill menu items, which were added in November. The wood-fire grill menu launch follows the introduction of Red Lobster’s today’s fresh fish options and continues DRI’s initiative to enhance the brand.

Slowing new unit growth…

Although I have stated before that DRI is well positioned to outperform should casual dining top-line results stabilize, I have been concerned about DRI’s high level of capital spending and aggressive new unit development targets. Today, DRI lowered its FY09 net new unit growth guidance to 70 from its initial plan of 75-80. Even with this lowered new unit growth target, DRI still plans on spending $580-$600 million in capital expenditures in FY09 (about $80M of that spending is on its new restaurant support center), up 35%-40% from FY08 levels. This is still a move in the right direction. Additionally, management stated that it is more focused now on cost management and the deployment of capital in that it is only going to pursue its highest priority sites. CEO Clarence Otis even said that if the environment got appreciably worse that it could lower its future capital spending to only include its maintenance level of spending, which is about $150-$175 million. I do not expect DRI to lower its spending down to that level, but was comforted to hear that management is at least evaluating its current spending levels and recognizes that there might be a need to further reduce its capital spending going forward.