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EYE ON EARLY CYCLE STOCKS

As we have said many times, economic bottoms are processes, not points. We continue to receive incremental data points in a number of different industries that suggest sequentially things are getting less bad…
Early Cycle Technology

Today, Research Edge technology analyst Rebecca Runkle noted some news out of Xilinx that supports our thesis that we are beginning to see a bottom process take hold, setting the stage for a market recovery. Xilinx guided Q4 revenues (Mar09) to a 13-18% sequential decline vs prior guidance of a 15-25% decline. They also commented that gross margin guidance of 61% to 63% and operating expense guidance of flat to slightly down sequentially remain unchanged. From a timing standpoint demand metrics fell off a cliff in late 2008. While the spigots were turned off in Q4 the global inventory build was not as big as when the dot.com bubble burst. Xilinx is a component company selling into the supply chain, where the data points (while still ugly) are beginning to be less bad.

Also, Dell CFO Brian Gladden said today that the company’s performance in January was not down as dramatically during January vs. December period as it was during October from September. He commented that the government business is relatively strong, while the large enterprise business is the weakest.

Early Cycle Consumer

Restaurant industry resource Malcolm Knapp’s reported January same-store sales numbers showed once again that the lights went out in December but came back on in January. Same-store sales growth came in down 4.1% with traffic down 6.0%. Although these are not strong results, on the margin, they show a definite improvement from December’s 9.5% comparable sales decline and 10.5% traffic decline.

We’re bullish on Brinker (EAT), and talked about that stock on our morning client call…

DELL, XLNX, and EAT are up +8%, +4%, and 2%, respectively, today for fundamental reasons that shouldn’t be ignored.


WEN – BACK AS A COMPETITOR

WEN held its first post-merger quarterly earnings conference call yesterday. On its call, the company was able to boast its new management teams for both the Wendy’s and Arby’s brands and corporate, the fact that it is still on track to deliver $160 million in annualized incremental EBITDA by the end of 2011, and most importantly, that its Wendy’s company-operated same-store sales improved rather significantly to up 3.6% in the fourth quarter from down 0.2% in 3Q08. The bull thesis on WEN continues to stem from the fact that for 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. WEN’s 4Q results, primarily at its Wendy’s brand, demonstrate that the company is making progress toward moving to the more positive side of that continuum.

WEN management attributed the Wendy’s same-store sales improvement largely to the company’s successful launch of its Value Trio of sandwiches being offered at $0.99. Wendy’s launched the three value offerings in September and has seen sequentially better results since then. As the first chart below shows, Wendy’s increased focus on value enabled the company to finally post same-store results in the fourth quarter that were in line with those of its two main competitors after a long period of underperformance. The second chart below was included in Burger King’s investor presentation last week and really highlights Wendy’s underperformance relative to both BKC and MCD over the past three-plus years. If the Wendy’s line was updated to now reflect its 4Q U.S. same-store results, it would show a tick up to 2.8% on a 2-year basis. Although this would still fall short of both MCD and BKC’s 2-year performance, on the margin, it is an improvement. I think this second chart is important, however, because BKC included it in its presentation to highlight BKC’s relative performance, particularly as it relates to its outperformance of Wendy’s. For some time now, Wendy’s has not been a formidable competitor. As a result, BKC has most likely been more focused on gaining share from MCD, but in 4Q08, Wendy’s posted a higher comparable sales growth number than BKC in the U.S. Wendy’s sequential improvement is evidence that the concept is gaining share (the restaurant industry is a zero sum game), and that share gain appears to be coming at BKC’s expense.

Wendy’s same-store sales growth has been fueled primarily by its new value items, which have increased traffic, but at the same time, the company’s percent of sales being generated by its $0.99 menu has declined to 15% from closer to 20% a year ago. The company was able to achieve this by removing certain items from its $0.99 menu and subsequently raising the prices on those items. This lower 15% of sales level puts Wendy’s more in line with the 12%-13% and 13%-14% ranges given by BKC and MCD, respectively and will further help with the recovery of restaurant margins at Wendy’s.

WEN first stated its goal to generate $100 million in incremental annual EBITDA at Wendy’s by 2011 back in November. The company stated yesterday that it is still on track to improve the concept’s restaurant margins by 500 bps with about half of that amount coming from labor savings. Specifically, in the fourth quarter, Wendy’s delivered about 100 bps in restaurant margin improvement from labor efficiency and other restaurant operating expenses. These improvements were offset by higher food costs in the quarter but management stated that its food costs have started to decrease on YOY basis in 1Q09. Of the 500 bps, the company expects to generate less than 100 bps of savings from lower food costs. From a timing standpoint, WEN expects to achieve 160-180 bps of the total 500 bps of restaurant margin improvement in 2009. Management stated that although it is seeing a decline in commodity costs from its initial guidance of up 2%-4%, its margin guidance does not include the expectation that food costs moderate so any further decline in commodity costs would provide upside to that 160-180 bp range.

WEN also stated that it is on track to deliver on its goal to reduce corporate G&A on an annualized basis by $60 million by the end of 2010. Importantly, by the end of 2008, WEN had already realized over $25 million of this $60 million target, which is better than the $20M-$25M it outlined in early January.

The primary risk to the WEN story stems from the underperformance of the company’s Arby’s brand. During the fourth quarter, Arby’s system same-store sales declined 8.5%. Management attributed the poor performance to significant discounting being pushed by its competitors as Arby’s has an average check of about $7.50 versus its sandwich category competitors’ focus on $5 price points. The company thinks that its recently launched Roastburger sandwiches and other initiatives will help to drive frequency among its core users (which represent 50% of Arby’s sales). Additionally, Arby’s is testing new value items that it plans to roll out later in 2009. Although the Arby’s concept does not need to outperform in order for WEN to work, if Arby’s does not experience any improvement in sales trends, it could prove to be a drag on company earnings. Specifically, management commented that its mid teens EBITDA growth relies on positive comparable sales over the next couple of years.

Eye On Early Cycle Stocks: The Good News...

EYE ON EARLY CYCLE STOCKS

As we have said many times, economic bottoms are processes, not points. We continue to receive incremental data points in number of different industries that suggest sequentially things are getting less bad…

Early Cycle Technology

Today, Research Edge technology analyst Rebecca Runkle noted some news out of Xilinx that supports our thesis that we are beginning to see a bottom process take hold, setting the stage for a market recovery. Xilinx guided Q4 revenues (Mar09) to a 13-18% sequential decline vs prior guidance of a 15-25% decline. They also commented that gross margin guidance of 61% to 63% and operating expense guidance of flat to slightly down sequentially remain unchanged. From a timing standpoint demand metrics fell off a cliff in late 2008. While the spigots were turned off in Q4 the global inventory build was not as big as when the dot.com bubble burst. Xilinx is a component company selling into the supply chain, where the data points (while still ugly) are beginning to be less bad.

Also, Dell CFO Brian Gladden said today that the company’s performance in January was not down as dramatically during January vs. December period as it was during October from September. He commented that the government business is relatively strong, while the large
e enterprise business is the weakest.

Early Cycle Consumer

Restaurant industry resource Malcolm Knapp’s reported January same-store sales numbers showed once again that the lights went out in December but came back on in January. Same-store sales growth came in down 4.1% with traffic down 6.0%. Although these are not strong results, on the margin, they show a definite improvement from December’s 9.5% comparable sales decline and 10.5% traffic decline.

We’re bullish on Brinker (EAT), and talked about that stock on our morning client call…

DELL, XLNX, and EAT are up +8%, +4%, and 2%, respectively, today for fundamental reasons that shouldn’t be ignored.

Howard W. Penney
Managing Director

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EYE ON INDIA: RATS FLEE THE SINKING SHIP

Headlines for Indian news services today were a litany of woes as the terrorist attack on the Sri Lankan Cricket squad helped drive treasuries and equities lower while the rupee registered an all time low against the Dollar. Meanwhile, the decision by regulators to allow a sale of scandal battered Satyam BEFORE the criminal fraud probe is complete and BEFORE a public restatement of company financials in order to “restore confidence” appears to be having the opposite effect.

Bloomberg news reported today that a number of foreign hedge funds are shopping large stakes in public companies to private equity investors due to the lack of liquidity in the private markets. This decision to cut bait and run no matter what the cost by the fast money crowd does NOT represent a contrarian bullish inflection point: when those investors leave there is no new money waiting in the wings to sweep in. These outflows of foreign capital represent capital that is leaving for good.

Import and Exports

Trade data released yesterday paints a grim picture with exports declining by 15.87% Y/Y and Imports sliding by 18.22%. Declining global demand makes the outflow data unsurprising, but the import data was more significant. This sharp decline in imports cannot be simply chalked up to lower commodity prices: total Oil imports by volume, for instance, have declined by 13.5% over December and 6.62% Y/Y. Real domestic demand appears to be weakening at a faster pace than external demand for Indian goods.

The argument that India should be relatively resilient since it is less dependent on exports than other South Asian economies is absurd. Essentially the tortured logic behind that thesis leaves the remaining India Bulls arguing that the fact that major segments of the population are illiterate subsistence farmers is really a positive. Real math indicates that the recently released 5.3% Q4 GDP print is not anomalous and the first two quarters of this year could easily register at significantly lower levels: a far cry from the double digits that the Singh administration has been counting on to deliver on its promises in an election year.

We continue to expect the situation in India to deteriorate economically and politically. We covered our short position in India (IFN) yesterday. We are not short the Rupee currently, but will seek opportunities to re-short into strength.

Andrew Barber
Director

US Bond Bulls Beware: Chinese headlines like this aren't a coincidence...

From Nikkei: "China considering purchase of crude oil as a way to diversify holdings away from US Treasuries"

EYE ON AUSTRALIA: HATS OFF TO GLENN

The RBA governor leaves rates unchanged…

Glenn Stevens is unique among central bankers worldwide: he is enjoying the results of both disciplined fiscal policies through the credit boom and prudently measured responses to the bust.

The decision to keep rates flat at 3.25% today represents an acknowledgement that the Australian economy is as strong as it can be given the external factors beyond the government’s control. That is not to say that the situation for the land down under is rosy, but simply that any further rate cuts right now would be superfluous at best (Australian mortgage rates are at historic lows and consumer credit is not frozen like in the US) and at worst could spur inflationary pressure. For now, Stevens has decided to keep his powder dry and wait.

We finally went long the Australian equity market via the etf EWA yesterday, and expect that the relative strength of the economy there, combined with increasing commodity demand from an emerging China, will provide significant upside potential. It is at times of extreme stress such as the one we find ourselves in that the incremental advantage of good leadership is felt in the fullest. Stevens has proven himself to be a solid leader.

Good on Ya’ Mate!

Andrew Barber
Director

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