Tracking commodity and labor cost trends is even more important as casual dining companies continue to beat EPS expectations on better margin performance.  With top-line trends remaining weak (Malcolm Knapp reported last week that March casual dining same-store sales declined 4.9% with traffic down 6.5%), restaurant operators are focused more than ever on cost management.  Although slowing new unit growth and a renewed focus on operating more efficiently have allowed restaurant operators to cut costs, the YOY roll over in commodity costs has been a necessary component of recent margin and earnings outperformance within casual dining.  During the fourth quarter, average full-service restaurant (FSR) food costs declined as a percent of sales on a YOY basis for the first time since 3Q07 and declined the most they have since 4Q06.  For casual dining margins to continue to improve, it is necessary that commodity prices remain a YOY tailwind in Q1 and Q2 as Q1 same-store sales on average fell 4.3% (according to Malcolm Knapp), and I don’t think we will see a significant improvement in Q2 sales trends from the -3% to -5% levels. 


2009 – EYE ON FOOD COSTS - FSR Food Costs


Despite the food cost favorability in Q4 for casual dining companies, QSR companies on average have seen their food costs as a percent of sales increase for seven consecutive quarters.  QSR margins have been somewhat insulated from these commodity increases as sales have held up relative to casual dining, but QSR average EBIT margins have started to roll over, posting YOY declines for the last three quarters.  This seems less bad when compared to the 17 consecutive quarters of YOY EBIT margin declines posted by the FSR industry on average.  Casual dining sales are still declining, but they have improved on the margin, with the Q1 same-store sales decline of 4.3% being better than the 6.0% decline in Q4.  As I have said before, these marginally better casual dining sales will take market share from the QSR industry so QSR margins may be less protected from commodity cost variability. 


2009 – EYE ON FOOD COSTS - QSR Food Costs


That being said, food costs remain rather favorable on a year-over-year basis with only two commodities (chicken and pork) currently up on a YOY basis.  Even chicken prices, which are up 4% YOY, are trending down recently and are down 2% year-to-date.  Cattle prices, on the other hand, are still down 1% YOY but have moved up about 5.5% in the last two weeks and are up nearly 4% YTD.  Both soybean and gas prices are still extremely favorable on a YOY basis, down 22% and nearly 40%, respectively, but they have recently increased rather significantly.  Soybean prices are up 13% in the last two weeks and gas prices are up 27% YTD. 


2009 – EYE ON FOOD COSTS - April Commodity update

Cheaper Swedish Meatballs?

POSITION: No Current Position


Sweden (like much of the Eurozone) is experiencing strong deflationary pressure as its recession stokes unemployment and saps output, exports, and consumer demand.  


CPI fell in March to 0.2% Y/Y, the lowest rate in four years, from 0.9% annually in February. Economists forecasted inflation to fall to 0.5%. This deflationary data will surely encourage the Swedish Central Bank (Riksbank) to cut interest rates when it meets next week. In interviews Riksbank Governor Stefan Ingves said he has not ruled out cutting rates to zero to guide the largest Nordic economy out of recession.


Despite Fitch Ratings AAA credit rating on Sweden’s sovereign debt there’s still uncertainty surrounding Swedish banks, many of which were primary lenders to the Baltic states, countries that are now in the deepest recession within Europe. The resulting $100 Billion of Swedish bank write-offs will continue to strain government budgets and lending. The economy has suffered greatly from the pullback in export demand from the Eurozone, in particular in the car industry. Cash-strapped GM and Ford are presently looking for buyers for Saab and Volvo due to unprofitable sales. For a country of 9 Million, the estimated 15-20K jobs GM provides in Sweden is a number not to be overlooked.


From a monetary standpoint, the Central Bank is running out of room to cut the interest rate, which stands at 1%, to help lessen the downturn for an economy forecast to decline 4.2% this year. We do not have a position in Sweden or in Scandinavia and believe recovery in the region and throughout Western Europe should lag the US’s.


Matthew Hedrick


Cheaper Swedish Meatballs? - schwe


POSITION: Long Oil via the etf USO


China is aggressively  lining up its energy needs, with an announced $10 Billion minority stake in Kazakhstan’s state-owned oil company to be finalized during Kazakh President Nazarbayev’s visit to Beijing on April 15th. Russia stands to lose on the deal, both strategically as a former satellite leaves its orbit and competitively as Chinese capital helps increase Kazakh production.


Back in mid February we pointed out the importance of the $25 Billion China lent two of Russia’s main oil companies in exchange for 20 years of supply.  China may now benefit from multiple oil supply lines and the ability to play Russia and Kazakhstan off one another for price if the deal is consummated. Politically Putin & Co. will be reminded that China is wearing the pants.


With $1.95 Trillion in currency reserves, China has the cash to do the deal and may even get it done at a considerable discount due to the price destruction of crude since last summer. Further, the Kazakh economy is desperately in need of international support for its crumbling economy. Kazakhstan’s government has taken control of the country’s largest bank, BTA Bank, and the global recession has eroded demand for Kazakh oil. Should the deal get done, China is setting itself up well for greater control over its energy needs. 


One of our major themes for 2009 is owning what THE client (China) needs. As China ramps up its infrastructure expansion, countries that can supply China with the commodities it needs to grow will benefit, and we have position our portfolio accordingly. 


Matthew Hedrick


Andrew Barber






Singapore exports data underscores expanding demand from the customer


Singapore’s preliminary GDP data for last month paints a grim picture.  At -11.5%, the March figure released yesterday is the worst year-over-year reading since at least 1976 leading to a statement from the Trade Ministry today, following the release of equally abysmal export data, predicting that Singapore’s Economy may contract by 6 to 9% this year. March non-oil exports registered at a modest sequential improvement of -16.97% Y/Y or +22.35% M/M.




As the primary entrepot economy in South East Asia, Singapore has long served as a canary in the coal mine for changing Asia/Pacific trade trends.  Although the misery of global contraction is clearly baked in for Singapore, the regional and product export break out released today suggest that the one place where business is improving is facing the customer –exports to China and Hong Kong both increased by double digits on a month-over-month basis, the second sequential m/m increase for China  bound shipments.




Although the China bound exports of electronics and other consumer products remain in the doldrums, the increase in transport equipment and chemicals clearly supports the thesis that Chinese demand is gaining momentum as Beijing’s massive stimulus program works through the system.  Although we sold our China ETF position last month to lock in profits we continue to be bullish on the path of recovery there and have adjusted our portfolio around the theme of increasing demand there by taking long  positions in commodities and commodity centric economies. 


We do not have an investment opinion on Singapore’s markets.


Andrew Barber

The Good Doctor Copper

We like to follow copper as one of the best leading indicators for a global economic recovery.  As such, copper has earned the nickname, “Dr. Copper” for its ability to predict future economic turns based on its price, not unlike a PH.D in economics.  This is a bit of a misnomer as most economists that we know and follow have a very limited ability of prognostication.  Copper, on the other hand, seems to have econometric models that work.


As we wrote on February 4th, 2009 in a note to clients:


“Second, copper, or as we like to call it Dr. Copper for its economic predictive abilities, is showing price stabilization in the face of negative global economic news.”


Since that time copper has morphed from stabilizing, into a veritable bull market, and is up roughly 40% from our February 4th call out.


Coincident with this increase in copper prices are data points supporting improving fundamentals from The Client (China).  Preliminary reports out of China suggest that Chinese copper scrap supply may drop 700,000+ tons this year.  The implication of this is that copper imports will have to increase, and perhaps dramatically, to offset the decline in copper scrap.   March Chinese copper imports jumped to a record high of 374,957 tons, which could be the beginning of a longer term trend of increased imports from The Client.


Despite these positive fundamental headlines, we don’t recommend chasing the Good Doctor Copper at these levels.  Our quantitative models show copper overbought at the $2.16/lb level, with support at $1.58 - $1.81. which is outlined below.


Daryl G. Jones
Managing Director


The Good Doctor Copper - coppe


One derivative of the financial distress in the gaming industry may be the need for capable casino management.  The ownership transfer to the banks and bondholders of distressed assets and companies, in most cases, necessitates a third party to actually run the casinos.  Additionally, with all of the assets potentially up for sale, private equity appears to be circling the wagon and would certainly need capable casino management.  We’ve argued that the survivors will benefit from potentially fewer competitors and certainly lower quality competition as capex budgets have been slashed.  The survivors could also capitalize on a re-emergence of the third party casino management contracts, something not seen on a mass scale since the explosion of Native American Casinos.

Third party casino management is a terrific business.  It requires little upfront cash and is essentially pure profit, thus it is ROIC enhancing.  The management company generates a fee usually based off revenues (stable) and operating profit (incentive based).   In the charts below, we’ve highlighted some examples of potential contracts using a fee structure of 2% of revenues and 20-25% of EBITDA.  Each example is based on an average type property in the market indicated.  Obviously, the numbers could be much higher.  For instance, Bellagio should generate around $1.1 billion and almost $300 million in revenues and EBITDA, which would produce a management fee of $80 million, under our assumptions.




Private Equity has likely been in touch with some operators already.  The relationship with Private Equity would probably include an equity contribution by the manager to secure the contract.  Given the numerous distressed gaming assets, lenders are probably reaching out to capable operators as well.  The potential operators could include some of the better regional operators such as ASCA, BYD, PNK, and PENN.  These companies generate between $200 (PNK) and $625 million (PENN) in EBITDA annually so clearly, management contracts would be material.  Note also that the examples given are for individual properties.  It is also possible that the operators could procure multiple management contracts, i.e. running the OpCo properties for Station Casinos.

The regional stocks have had huge runs off the bottom in the last few weeks.  Valuations appear reasonable for these mature companies.  However, a new growth vehicle such as casino management could justify higher valuations.

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