WEN – Coming Out Party

I truly believe that Roland Smith, CEO of Wendy’s, has the opportunity to become a legendary CEO in the restaurant industry and that I have a ringside seat to monitor the progress. I can’t tell you how many times we have seen this story play out in the restaurant industry. For one reason or another a brand is mismanaged for an extended period of time and business deteriorates to disastrous levels. After a period of time the right CEO comes along and mixes the right combination of people and processes, throws in some clever marketing and the mismanaged brand is golden again. Taco Bell, McDonald’s, Burger King, Chili’s, Bob Evans, IHOP, Red Lobster, Jack-In-the-Box and Olive Garden at one time or another have felt the pain of mismanagement. Today, Wendy’s, Starbucks, KFC and Applebee’s are currently feeling the pain of mismanagement.

As an investor, there is huge upside in finding the next brand that is going to move from the mismanaged category to the operating flawlessly category. I really believe that Wendy’s is the brand with the most upside potential, but it will not come easy. Any brand turnaround has to start at the top in the executive suite, so confidence in Roland is key to this story. While my relationship with the new CEO is brief, my relationship with others in the Wendy’s community is deep and long. For now, the team seems to be behind the new CEO and the other executives he has brought on. Below are some of the changes he is trying to make and the metrics that need to be monitored. The one warning that needs to be emphasized is that if Wendy’s is going to be successful, another brand is going to lose. Right now, all eyes are on Burger King as the brand with the most risk associated with a resurgent Wendy’s.

Recently, WEN announced in its 3Q08 earnings release its goal to drive an incremental $100 million in operating profit at its Wendy’s concept and to reduce corporate G&A by $60 million over the next 2-3 years. This week, the company presented to the investment community a roadmap of how and when it expects to achieve these goals.

Improve Wendy’s store-level operations and margins:

In the next 3 years, the company expects to drive an incremental $100 million in EBITDA at its Wendy’s brand and improve restaurant level margins by 500 bps. For reference, Wendy’s company restaurant margins have declined by over 400 bps in the last 6 years. Additionally, there is currently a 600 bps difference between company-operated and franchise-operated store margins from an EBITDAR standpoint (with the franchise-operated units leading the system) so there is considerable room for margin improvement at Wendy’s company-operated units.

The company expects to increase its restaurant-level margins to 16%-17% by the end of 2011 from its depressed 2008 estimated 11%-12% level with a 160-180 bps improvement in both 2009 and 2010, followed by a 150-170 bps increase in 2011. About half of this margin growth, or 230-250 bps, should be driven by labor efficiencies. Another 90-100 bps of savings should come from lower food costs. Better management of repair and maintenance is expected to drive an additional 60-80 bps increase in margins with the remaining 80-100 bps of growth expected to come from reductions in other costs, such as supply synergies and occupancy.

Right-Size Combined Corporate Structure:

WEN expects to drive $60 million in G&A savings by the end of 2010. The bulk of these savings will stem from reduced headcount and the company’s new shared service center, which will eliminate replicated key functions at both brands. Importantly, the company has already achieved $20-25 million of these projected savings in 2008, largely from reducing redundant top-level employees. The remaining $35-$45 million of savings should result from the 2009 opening of the company’s new shared service center, the implementation of a purchasing cooperative at Wendy’s and the completion of an IT project.

These two goals alone are expected to increase WEN’s EBITDA by $160 million over 3 years. The company is also focused on driving improved same-store sales growth at both brands, which is integral to the company reaching its $160 million profit growth goal, particularly as it relates to significantly growing margins at the Wendy’s concept. WEN outlined two other key goals, which included reducing its company-operated unit growth to increase free cash flow and developing a long-term strategy for international growth.

SP500 Levels: Don't Be Shorting Obama Here!

Everything in markets has a price. Just to recap where my head has been at on pricing Obama into expectations, here’s what I wrote before I sold down our Asset Allocation to US Equities to 9%:
Fri 1/2/2009 2:46 PM

“At 928, the SP500 is riding the wave of her intraday highs here…. and this is a great spot to be making sales. We’d been making the call to buy them for over a month now, so with the SP500 +6.5% in less than 3 trading days, this is your payday. Not making sales anywhere north of the 922 line would constitute getting “piggy”.

Today, is Thursday Friday January the 15th, and that Mr. Market has issued us a -12% drop in the SP500’s price from the date of that note (“SP500 Levels: Making Sales”,, 1/2/09). As a result, I have built my Asset Allocation back up to 25% in US Equities, which is close to its highest level in well over a year. Like all Americans, I love a sale – why some money managers love to buy everything on sale other than stocks is entirely their issue to deal with, not mine.

As prices change, so do expectations. The only factor to solve for other than price and expectations is duration. Now that we are t-minus two trading days until Obama rebrands American credibility and attempts to rebuild the trust that we all believe she deserves, we have ourselves an opportunity to earn a positive return on the long side again.

Anywhere under the 836 SP500 level that I issued in this morning’s Early Look = BUY. If you want to get all crazy and call the end of the world like your average run of the mill member of the Groupthink society, go right ahead. I have outlined the SP500 levels associated with both a 2 and 3 standard deviation move versus my expectations in the chart below – those are very hard circumstances for me to see, but because they are less probable certainly doesn’t mean they cease to exist.

A 2 standard deviation immediate term meltdown in the SP500 gets me SP500 813, and a 3 standard deviation move takes me to 776. While 776 would still confirm the intermediate bullish “Trend” of the US stock market making higher lows (since the November bottom), I don’t think I will see that print.

If you’re shorting stocks here, you’re shorting Obama January 20th. I bought QQQQ yesterday for the first time since we opened the firm, so you know where I stand. To borrow a call from the beloved sell side, “ I am reiterating my buy rating” - BUY American, and be patient on price.

Keith R. McCullough
CEO & Chief Investment Office

Inflation Is not Reflation...

This is the chart that decided the fate of Goldman’s commodities trading prop desk. This the chart that peaked alongside Putin Power. This is the chart that the Depresionistas call “deflation”.

Deflating the bubble of commodity price speculation this is, indeed (see chart). After energy prices got hammered for another -9.3% move in December, the US Producer Price Index continued its decline, albeit at a lesser rate. This month’s PPI was -1.9% versus last month’s -2.2%. That’s deflating, indeed, but at a lesser rate…

The one thing that gets us out of an asset price deflation is re-flation. FDR knew this (so he re-flated gold), and Paul Volcker knows this today. Some people think re-flation = inflation. It doesn’t have to. It’s all about what happens next.

If you show me a price tomorrow that’s higher than today’s – that’s re-flation. In order to build the confidence of the conservative American capitalist, everything needs to re-flate from an acceptably conservative price. Until we get this Crisis in Credibility to morph into the expectation of re-flating prices (like we did in late November, post Obama’s election), this market will continue to trade below immediate term support.

Keith R. McCullough
CEO & Chief Investment Officer

Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.

US Unemployment: The Crutch

Even JPM’s CEO, Jaime Dimon, is on his conference call this morning throwing out his estimate for US unemployment Armageddon – do people actually think the man modeled the numbers himself? I certainly hope he tried … using the JPM analyst projection of yesteryear would be reckless…

The crutch of “the economic crisis” is being used all over corporate America – “its happening to everyone… it’s not our fault… pay me my bonus for outperforming on a relative basis”… “but let me set the expectation by which I need to outperform”…

Those who were blind to the realities of today all of a sudden think they see the light of consensus proactive prediction. They are predicting that it “gets worse from here.” It’s all so embarrassing and sad all at once. Until we unload this groupthink culture that corporate America has levered herself up long with, this country is going to remain in a Crisis of Credibility.

Initial jobless claims for the last week registered at 524,000, up from the prior week’s level of 470,000 (an upward revision from the initially reported 467K) and above the four week moving average of 519,000. The fact of the matter is that these weekly numbers are bad, but not worsening from their November-December peaks. The sequential acceleration of job losses is slowing.

As the world’s prices churn, so will expectations. If we get one more week of a jobless claims number that’s below those of 2008’s peak (see chart), I think we can proactively look forward and begin to predict a better January employment report than is currently expected.

Jaime Dimon, after all, is one of many setting expectations abominably low.

Keith R. McCullough
CEO & Chief Investment Officer

One on Ones

One on Ones - asset allocation011509

“It is a capital mistake to theorize before one has data. Insensibly one begins to twist fact to suit theories, instead of theories to suit facts.”
-Sherlock Holmes

For those of you who have not had the “privilege” of sitting across the table from one of America’s corporate executives in a Wall Street organized “one on one”, you aren’t missing anything. Although “access” to these “one on ones” are effectively one of the few things that the Street still overcharges the investment community for, like most of the wares that the sell side shops them, they eventually become overvalued.

The sell side’s job, after all, is to sell you stuff. The promise of “one on ones”, I think, is to break the barrier of Regulation FD, and really cozy up to what the CEO or CFO of a public company’s body language looks like. These are helpful, particularly if you fancy yourself as the Sherlock Holmes of the investment business. Make no mistake, most of us who were overcompensated in this business over the last decade actually did think, at some point, that we were worth every penny of our “expert” interrogation tactics… but at what point in the last 6-9 months did investors with this vaunted “access” realize that they were overpaying for a company exec to give them erroneous macroeconomic outlooks? At what point did all the “smart” money in the room start acting on facts that were based on false premises?

As my partner, Tom Tobin, who runs our Healthcare team likes to say, “Wall Street is mostly about storytelling”… and at the end of the day, that’s the truth. People are always “twisting fact to suit theories”, and/or their books. Consider this contrasting narrative fallacy: A) at this time last year the likes of Dick Fuld and Jaime Dimon started to talk about the “worst being behind us” versus B) this week’s Wall Street conferences from New York to California where my team is enlightening me with the following corporate executive outlook – “the worst of the economic crisis is to come.” You seriously cannot make this stuff up.

It “is a capital mistake to theorize before one has data.” If there is one lesson I continuously have to relearn in this business – that’s it. Every mistake that I make in terms of an entry or exit price in an investment can always be traced back to either 1) not maintaining the discipline of data dependence or 2) depending on someone who has bad data! Capital markets and the prices born out of them don’t lie, people do. So be very careful in believing everything you hear in those “one on ones.”

I had a “one on one” with my alarm clock this morning and then went through the Asian data. It was terrible. Japanese machine orders tanked to the lowest level recorded, well… since they started keeping records in 1987. At down -16%, that is one more piece of toxic backward looking macro data. On the forward looking front, Japanese stock prices got hammered again for another -4.9% down move. Yes, stocks are leading indicators, and those facts have deteriorated in Asia from the day that the Crisis of Credibility went global in India with Satyam Computer’s multi-billion dollar fraud.

Frauds are problematic for those investing based on what said “authority” is telling them is going on with their business. Is there corruption, crime, and crisis to consider in Asian equities? You bet your Madoff there is! We continue to be short South Korea via the EWY exchange traded fund – I’d love to have a “one on one” with one of them 2007 “its global this time” bullish investors and hear their views on how trustworthy those South Korean numbers are. The KOSPI index got crushed last night, adding to Asia’s bearish immediate term momentum, closing down -6%.

Despite Thailand cutting interest rates by 75 basis points yesterday, and injecting 116B in Thai Baht of a stimulus package overnight, stocks in Thailand closed down another -3%. India’s stock market, which we continue to be short via the IFN etf, continues to act horribly. It closed down another -3.5%. Don’t forget that “being long India” was one of Vikram Pandit’s “best ideas” before his hedge fund, Old Lane, blew up. God help us all if he was building that investment thesis on the back of “one on ones” with CEOs like that of Satyam Computer.

Frauds and plunging stock markets aren’t good, so don’t expect me to wake up to this data and tell you that it is. Neither are crashing currencies. The Russian Ruble was devalued again by their government this week – now its lost -27% of its value since oil prices peaked last summer. The Russian stock market is starting to collapse again. It is flashing a negative divergence versus the rest of Europe as we await the ECB’s decision, trading down another -3.2%. The RTSI Index is now only 4% away from its 2008 capitulation low – this is the first of the large economy stock markets to test making lower lows. Keep it front center on your risk management screens.

Managing risk is what I do. That’s why I am still carrying a 54% position in Cash in our Asset Allocation Model. When the global data gets this bad, you want to have some powder dry. Part of managing risk, is not getting short squeezed -  a lot of people don’t get that. The levered long community is still busy trying figure out to not be perpetually net long, never mind attempt to understand a proactive process by which they don’t sell the freak-out lows and buy the euphoric highs.

With all that is going on globally, and the lack of transparency implied with foreign stock markets having a Crisis in Credibility of their own, I think the best risk management move you can make right now is to buy American. As always, be very patient on price. I put up a note on the portal yesterday issuing a downside support level for the SP500 at 836. At that level or below it, at least start covering your short positions. If the US market makes lower lows coming out of the Obama inauguration next week, I’ll be the first to admit that I started buying too early. Until then, I am data dependent.

Best of luck out there today,

One on Ones - etfs011409


Full details are not in yet but apparently there was a serious fire at the residence tower at the Four Seasons Macau. The fire has spread from the 20th floor and higher. The tower was expected to contain 1 million square feet of luxury apartment hotel units and open in Q3 2009.

On the one hand, the fire could be perceived as a negative since this will likely delay cash flow from the sale of those units. On the other hand, it is unclear whether they have the regulatory approvals to sell residential units anyway. Further, to the extent they can collect insurance proceeds quickly, any cash would help this liquidity strapped company.

We will have more details as we get ‘em.

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