Obama's Push...

This is more of the same because Geithner and Volcker signalled the same in their hearings earlier in the week - but Team Obama is definitely pushing out expectations re the duration of the bailout (see what our friends at Street Account are confiming below). The market rallied a bit on this hitting the tape, but I think you do the opposite - sell any bounce, until we stress test that 800 line in the SP500.

1/23/2009 10:02:57 AM President Obama says on target for goal of approving economic rescue package by mid-February -- wires


Opportunities like this don’t come around too often. I’ve never seen a gaming stock trade so far below what I would consider to be its true value. BYD’s net free cash flow yield (NTM) hovers around 40%. On 2010 numbers, the yield climbs to 50%. Even if I stress test the model and take EBITDA down 20% from my current 2010 projection of $485 million (includes 50% of Borgata EBITDA), the yield is still an astonishingly high 35%. The $485 million is already 21% below the level achieved in 2007.

So what explains this absurdly low valuation? Investors may not believe the numbers. I think I’ve addressed that concern by haircutting EBITDA another 20%, which still yields a very cheap stock. Second, investors believe that BYD will bust a covenant and possibly go bankrupt. We’ve run the numbers. As we pointed out in our 01/17/09 post “BYD: A NOT SO RISKY BUSINESS”, BYD has a number of levers to pull to avoid breaching the leverage covenant should business deteriorate below our projections. Management is not concerned.

Once through 2009, it is smooth sailing on the covenant sea. The maximum leverage restriction actually escalates from 6.5x in 2009 by 0.25x each quarter of 2010. Meanwhile, BYD will be generating positive free cash flow each quarter beyond Q1 2009 and reducing debt, even under dire projections. After taking EBITDA down another 20% in 2010, BYD still doesn’t bust the leverage covenant.

So if you’re willing to bet on BYD as a going concern how do you value the stock? I’m a cash flow guy so I’d rather look at multiples of free cash flow. EV/EBITDA is also appropriate. But there is more. BYD still owns the Echelon parcel, 65 acres right on the Strip. I know I’ll get push back on this but if you believe BYD is a going concern you have to include land in the value. I know of 3 groups/companies that would pay $5-10 million an acre for that parcel in a heartbeat. That’s $325-650 million in asset value that is not currently generating cash flow. By the way, BYD’s market cap is only $415 million. In a pinch, BYD has a huge cash source without changing the ongoing cash flow stream.

The first grid provides a valuation analysis based on per acre land assumptions and varying EV/EBITDA multiples. The second grid values BYD on a multiple of free cash flow, which is more appropriate in my opinion. The last grid assumes that 2010 EBITDA falls 20% below our expectations. Even under this assumption BYD appears grossly undervalued.


RUST - asset allocation012309

“Iron rusts from disuse, stagnate water loses its purity and in cold weather becomes frozen, even so does inaction sap the vigor of the mind”
-Leonardo da Vinci
One thing Research Edge can’t be accused of is inaction or playing it safe.  In the midst of a consumer recession, a financial depression and the worst market in a lifetime, we set out to build a new financial services firm.  Our version of the “New Reality” financial services firm puts our clients first, without them, we have no business. 
Every day of the week we are making calls, and in some cases they are “bold” calls – a client’s description not mine!  We believe the only safe thing to do is to take the shots that need to be taken.  Play it safe and you will stagnate.  I was taught early on that taking calculated risks is the essence of hard work.  In 2009, this is the difference between working for you and working for the government.
While many of the same Wall Street traditions still live on, it’s just not the same.  Surprisingly, I learned last night that there is still way too much research capacity on the street.  Darden Restaurants is a $3.7 billion company with 19 publishing analysts and 9 firms attending the annual analyst meeting that don’t cover the company. My guess is that a majority of the people on “the street” attending this conference are less focused on the business of making clients money, and are more focused on whether their employer is solvent or not. 
As far as I’m concerned, the largest US financial services firms have already been nationalized and now it is just a matter of a formality.  The debate over the status of some of the financial services firms reminds me of last year’s debate over whether GM is bankrupt or not!  Of course it was bankrupt, and yes, the government is running our largest financial institutions.  If we can get past this, we can focus on the “new normal” state of the economy and consumer spending. This implies that the market can focus on the facts and not speculate about what could happen.  Yes, some of the facts about the economy are ugly, but looking beneath the surface there are some real signs of life. 
As I thought about the firms attending the Darden analyst dinner last night, I realized that none of their firms allow their clients listen to their morning meetings, which is the cornerstone of our Tier 1 Macro product.  In addition, every day the market is open the collective analysts at Research Edge can give you two dozen things to think about, and we only have six publishing analysts. 
Shortly, I will be publishing our S&P 500 sector view which comments on the trends in the S&P 500 and the nine major sectors.  As we look at the S&P 500 today, it’s quantitatively broken in terms of both the “Trade” and the “Trend”. The financials are the only sector to have broken the November 2008 lows, as reality has set in.  Healthcare and utilities look the best, with the XLV (Healthcare Sector etf) having a great day yesterday.  The “re-flation” trade and the aspirational consumer are sitting on the sidelines – think wants versus needs.  Excluding Apple, nearly every technology company is a closet “industrial” company, and most are seeing cyclical weakness.  See the RE Macro Sector view PDF for more details. 
Relative to our constructive commentary on the consumer discretionary sector we were hit with a body blow as the economic backdrop remains ugly, which was highlighted by the initial jobless claims rising by 62,000 to 589,000 in the week-ended January 17th, matching a 26-year high!  This makes the “E” in “M E G A” a little harder to swallow.  We will see what next week brings.  As the facts change, so do we.
Function in disaster and finish in style!
Howard Penney

RUST - etfs012309

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EAT proved again that it is managing the aspects of its business that it can control in today’s difficult economic environment. The company experienced sequentially worse same-store sales results in fiscal 2Q09 across all of its concepts with the overall company down 4.5% (following a -3% number in 1Q). Despite this sequential quarterly slowdown, which was felt across the casual dining industry (on average, 4Q casual dining same-store sales declined 190 bps from 3Q according to Knapp Track data), EAT’s fiscal 2Q09 restaurant and operating income margins improved about 140 bps and 130 bps, respectively, from the prior quarter. Additionally, although the company did not provide an update to its previous guidance, which included the expectation of a 2%-4% decline in same-store sales and a 15%-25% decline in EPS, management stated that relative to its internal targets 2Q results came in better than expectations from a cost perspective, and that was with comparable sales coming in lower than the company’s guided range. The company attributed this better margin performance to better cost control across the business. Specifically, the company benefited from better management of food costs, increased labor efficiencies and more disciplined G&A spending.

Management said that it is managing its business under the assumption “that this could be a protracted economic downturn...rather than just being a short-term blip.” To that end, management recognizes the need to make some real changes to its business, with value being the key to those changes. Management acknowledged that “faster and cheaper is the American way” so it is reviewing all aspects of its business to see how it can increase turnover times, decrease labor costs, create exciting new food products, etc. Specifically, management recognizes that the gap between QSR and casual dining has widened in terms of check averages and with faster and cheaper being what people want that EAT is effectively fighting against QSR for market share. This does not mean that EAT wants to compete on price with QSR, but instead that it needs to improve the relative value of the entire Brinker dining experience based on pace and convenience, better food quality and service, facility relevance, price and overall customer satisfaction at a lower cost. Ultimately, management knows that it must get more people into its restaurants.

After examining its entire restaurant portfolio, EAT announced that it will be closing 35 underperforming restaurants, which is expected to boost operating margins by 30 bps. Most of these closures are expected during 3Q with some to follow in upcoming quarters as current leases expire.

EAT had already significantly cut its capital expenditures in fiscal 2009 (down $99.6 million YOY in 1H09 from its reduced new unit development), but management again lowered its capital spending guidance to $110 million from its prior range of $135-$140 million. The company decided it would be prudent to push out the timing on some of its Chili’s reimages to provide increased financial flexibility relative to its current declining sales trends. Management is also committed to using its free cash flow and cash proceeds from the sale of Macaroni Grill to pay down debt and has suspended its share repurchases to further preserve its strong balance sheet in this difficult environment, in which it has little visibility of when trends will materially improve. That being said, EAT stated that after a weak start to January, that sales trends “have firmed up” in the last two weeks. Although two weeks do not make a trend, on the margin, some stabilization is a positive as it relates to recent results.

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Chinese Retail sales data for December showed a decline to 19% year-over-year, the slowest rate of growth since November 2007, as shoppers in China start to show some of the same reluctance to spend as consumers globally. Visually, the chart below illustrates a divergence between one, two and three year change in growth rates that is pronounced and distressing. By stepping back and doing a common sense gut-check however, 19% Y/Y starts looking very positive on the margin while continuing to support the investment thesis of relative strength. On a pound-for-pound basis, the impact of easing and other stimulus packages could have greater effect on retail sales in China, where consumers are less burdened by personal debt.

This is not a contrarian view. Reports in the Wall Street Journal and International Herald Tribune this morning commented on Wal-Mart and other large retail chains’ plans to continue expansion on the mainland in 2009 –clearly 19% year-over-year is also enough to motivate them to invest in China.

Our China thesis holds that growth there will be helped tremendously by increasing domestic demand, as it will in derivative economies like Taiwan where exports to the mainland account grew to almost 20% of total exports BEFORE the recent political “panda diplomacy” thaw took effect.

Andrew Barber

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