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LIZ: Initial Take… I Like It

Overall…good stuff. Had a write down, and they guided low. But they will beat – as in this Q for the first time in 2 years. People are underestimating the ‘balance sheet repair’ factor.
The crux of my call on LIZ is that 1) the aggregate value of the pieces are worth at least 3x the current EV, 2) contrary to market conjecture, LIZ will not go under, and will not even breach a covenant, 3) the Street is underestimating the levers at LIZ’ disposal, and effective immediately the 2-year downward spiral in estimate revisions is finally over. Ultimately, investors will re-focus on the equity value of LIZ in ’09 as the balance sheet is fixed, and estimates for ‘09/’10 will approach $0.75/$1.00. This can’t sustain a sub-$3 stock for too long…

The quarter reported this morning largely synched with my thesis. Here are some key points.
1. Adjusted EPS of ($0.04). Horrible numbers, but better than my estimate ($0.07), the Street ($0.09) and guidance. Again, the downward spiral of revisions is over.

2. LIZ paid down $175mm in debt in the quarter due to lower capex and aggressive working capital management. This does not include the extra $90mm in tax refund LIZ received in Feb, or the $83mm net proceeds from the Li&Fung deal.

3. The company is likely to use these proceeds to take down debt further – to under the $600mm mark (from near $900mm previously).

4. LIZ is on track to realize $70mm from recent 8% corporate headcount cuts.

5. Guidance is very tepid. Actually, it is nonexistent for ’09. The company noted that it will have an operating loss in 1H, and is planning its business accordingly. I’m not suggesting that its business is good, but guess what folks… with that statement LIZ is speaking to its creditors – not you or me! It is planning its business around expectations for an operating loss – but will come out better.

6. The company recorded a $382mm impairment charge associated with its US business. This was news to me. LIZ noted that it was required to do so bc the current market cap declined to a level below book value, and LIZ had to mark to market. I’m all for marking to market. But my sense is that when the actual cash flow from these assets is realized in hindsight the book value will prove too low.

PNK BLOWS THE DOORS OUT

PNK delayed the filing of its 10k but the reasons appear harmless. The company needs more time to determine the amounts of various impairment charges it plans to record in Q4. Impairment charges are all the rage in gaming these days and PNK has its share of impaired assets. No doubt, the land in AC ranks near the top.

More importantly in my opinion, PNK looks like it will beat revenue and EBITDA estimates for the 2nd straight quarter. Not only did the $45.6 million in adjusted EBITDA beat the Street, but they blew it out. We estimate the street was projecting about $37 million in comparative EBITDA. Revenues were certainly impressive at $259 million versus the Street at $254, but margins were the real driver. Margins were 300 bps higher than expectations, due in part to the ramp-up at Lumiere Place and better flow through of the strong revenues in Louisiana.

PNK continues to buck the gaming and consumer trend. Is it sustainable? Probably not at the same rate but gas prices remain low and the regional markets seem to have stabilized. Indeed, pure gaming is proving less discretionary then many other forms of consumer spending. At some point the energy industry may be a drag on the Louisiana economy but we haven’t seen it yet.
I personally own shares of PNK

MGM: NO REAL SURPRISES HERE

MGM filed a Form 12b-25 Notice of Late Filing with the SEC. In the document they indicated:

1. The instability of the credit markets and the overall economy combined with the recent $842 million drawdown has delayed MGM’s ability to assess its financial position and thus, its ability to file.
2. MGM was in compliance with its financial covenants under its credit facility as of 12/31/08.
3. MGM will likely not be in compliance with those covenants in 2009.
4. The 2008 financial statements will likely contain an explanatory paragraph with going concern language.
5. The company will record a pre-tax gain of $87 million related to repurchase of debt at a discount.

The biggest takeaway in this SEC filing is that MGM likely won’t be filing Chapter 11 any time soon. MGM is negotiating a waiver or an amendment with the banks on the leverage covenant. The question is do the banks really want to throw MGM into bankruptcy? Do they really want to own the assets? The likely answer is no on both so they may be pretty flexible with regards to the covenant.

The other useful piece of information was the gain on the repurchase of MGM’s bonds. We calculate the company spent $125-140 million to buy back $215-230 million face value of bonds. Obviously, these were deleveraging transactions.

What a week for MGM shareholders. Every day it seems like there is a new development to spook the markets. First, it was the drawdown. Then, the Las Vegas Sun published an article discussing the Chapter 11 potential. Finally, MGM filed a sparsely worded SEC document with that scary “going concern” wording but containing no information that should surprise people.

With limited information flow, panic has set in. However, MGM has some remedies that will come to light when they finally release earnings in mid-March. Let’s just wait and see.

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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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