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PNK’S Q1 THEME

PNK should post a very strong Q1 that we believe will exceed expectations and last year’s performance.  In fact, the size of the beat could be significant as indicated in the first chart.  We project EPS of $0.02 and EBITDA of $47.5 million versus the Street at ($0.02) and $45 million, respectively.  Our estimates may even prove too conservative.  Look for strong revenue and margins at Lumiere Place and in Louisiana to drive the upside. 

PNK’S Q1 THEME - pnk q1

Management usually puts forward a theme with every conference call.  This quarter the theme could be particularly interesting, and positive.  We’ve talked a lot about the rising cost of capital, particularly for gaming companies that face covenant, liquidity, and/or refinancing issues.  PNK faces little probability of a covenant breach this year but could be at risk next year.  The safety play is to try and extend, amend, or refinance its current facility which matures 12/2010.  That will mean a significantly higher cost of borrowing.  Depending on the agreement, PNK could pay 300-400bps more on the credit facility.  If the company opts for a high yield offering, the interest rate on this type of debt could approach 15-18%.  Of course, there would be no need to tap the high yield market if PNK cancels development.

I recognize this doesn’t sound positive.  However, the takeaway is that the higher cost of capital may force PNK to delay or suspend development on the Sugarcane Bay and Baton Rouge projects.  I think this would be taken very positively by Street.  It would signal to the investment community that PNK is, indeed, return focused (a frequent criticism of management).  With the cost of capital so high, it’s hard to justify investing in the space.

Thus, the theme will not be “our borrowing costs are going up”.  Rather, the relevant theme may be the transformation of PNK into an IRR-focused, free cash flow machine; a pretty powerful theme indeed.


RESTAURANT INDUSTRY MARCH TRENDS – SBUX, MCD AND BKC

Today, there are bullish calls on a number of QSR names, including Chipotle (CMG), YUM Brands (YUM) and a bullish initiation on the Wendy’s’/Arby’s Group (WEN).  CMG was also downgraded today, which seems a bit more justified after the stock’s 30% move in the last month and 42% move in the last three months.

There is also a negative call on SBUX this morning and according to Street Account the analyst cites “competitive pressures.”  I’m not sure if there are new pressures that we did not know about yesterday, or if this is a continuation of the street’s bullish call on MCD, my guess is the latter.  The consensus call on McDonalds is that the company can do no wrong and that the new beverage initiative will be a blow out success.  Specialty beverages are not a core competency for McDonald’s; they are expensive to install and complicate the back-of-the-house operations.  This is very different than improving the quality of the chicken nuggets or adding a salad and snack wraps.  I will concede that the success of the improved core drip coffee business gives McDonald’s some “coffee credibility.”  I believe that selling an upgraded drip coffee that people were buying anyway is different than trying to sell a premium product in a challenging economy. 

STARBUCKS MARCH SALES TRENDS

We have nearly completed a grass roots survey of SBUX March sales trends (not including California and Florida), and they are so good I don’t believe what I’m seeing.  Naturally, I provided a haircut to the numbers, but that would still put SBUX same-store sales (not including Florida and California) at down 2-4%.  Including the other two key states, March comparable sales for SBUX could be down 5-7%.  This would be a significant improvement from the trends in fiscal 1Q09 when same-store sales declined 10%.

MCDONALD’S MARCH SALES TRENDS

An influential McDonald’s sales survey was released last night, which confirms our belief that McDonald’s sales trends are slowing.  The McDonald’s same-store sales chart is using reported numbers, but the timing adjusted numbers for January, February and March would be +3.4%, +6.8% and 4.6%, respectively.  This brings the underlying same-store sales average to 4.9% for 1Q09 vs. 5.0% in 4Q08.  It’s important to note that March and April are the last two easy comps for MCD this year!  Put that into context that the 2 and 3-year average same-store sales trends are already slowing.  This is clear evidence that McDonald’s senior management team is praying that the beverage strategy is a silver bullet for the US business.

As an aside, it looks like Easter hurt the U.S. by 0.5%-1% last year and helped Europe by 2%, so this year March numbers would be helped by about 0.5%-1% in the U.S. and hurt by 2% in Europe, which is why we adjusted the survey’s reported March 5.1% number down by 0.5%.  Even with the Easter timing benefit, however, US 2-year trends slowed in March.


RESTAURANT INDUSTRY MARCH TRENDS – SBUX, MCD AND BKC - MCD US March SSS


BURGER KING MARCH SALES TRENDS


Burger King today reported fiscal 3Q09 worldwide same-store sales of 1.0%, with the US and Canada up 1.6%.  The company stated that earnings were negatively impacted by significant traffic declines in the month of March, across most company-owned restaurant markets, resulting in lower than expected company restaurant margins for the quarter.  I recently highlighted same-store sales trends for the big three and BKC looked to be the loser.  The resurgence in WEN was always going to be bad news for BKC and other weaker competitors in the QSR segment.


RESTAURANT INDUSTRY MARCH TRENDS – SBUX, MCD AND BKC - BKC WEN MCD SSS


Creatively Destructing

"Learning without thought is labor lost."
-Confucius
 
After spending over a decade working in Manhattan, I've gotten used to observing people while they don't think I'm looking. Is there any other way to learn? Surely there is, but for me it's always been most effective to really just watch people and listen.
 
Call it coincidence or whatever it may be, but yesterday as I was walking out of 300 Park Avenue in New York, I brushed sleeves at the elevator bank with none other than the man I congratulated in yesterday's Early Look - Lloyd Blankfein...
 
Goldman's CEO probably doesn't care who I am or what I look like, and for that I am thankful. As my wife will attest, I'm not really into the social climbing thing. As I walked out onto the sidewalk I leaned over to my Partner, Daryl Jones, with a relatively large smile on my face and said " the guy seriously has no idea what's coming."
 
Mr. Blankfein's stock got pounded yesterday, closing down -12% on the day, leading both the Financials (XLF down -7% on the day) and the overall market lower into the close. Despite the one day selloff on the "news" that everyone with a pulse in this business saw coming, the good news for these horse and buggy whip Investment Banking Inc. execs is that they appear to have saved themselves to play another day.
 
Good news? For sure. Everyone needs a banker, at a price; and, provided that the XLF can hold its head above the $9.41 line, my risk management process still has the sector trading +4% above what I call the intermediate TREND line. TRENDs are hard to break. Goldman's TREND line support is all the way down at $90/share and Morgan Stanley's is closer to $20. Are these lower prices? Sure - but there's no stress associated with proactively being able to predict that stocks that have gone straight up will correct.
 
Keeping these horse and buggies alive and operating in this game is actually great news for the rest of us who are going to take market share from them. The American Financial system is undergoing an old school economic secular cleansing that is not unique - it has happened in virtually every other industry, and for Wall Street the time has finally come - Schumpeter called it "Creative Destruction."
 
Yes, as Creative Destruction takes hold, plenty of execs who are wearing horse blinders in these compromised and conflicted business models will be right stressed - as they should be. Ask the "Wealth Management" dudes at UBS how it felt seeing $20B (as in beeelion) in client assets just walk out the door. Learning that one's stress can become your economic reward, is a thought, that we can all respect as being far away from a Capitalist's labor lost.
 
Throughout the US stock market's 24% rally from the March 9th low, we have learned plenty. One of the main lessons learned is that the Three Horseman sectors that are NOT US Financials (XLF), Technology (XLK), Consumer Discretionary (XLY), and Basic Materials (XLB), can lead us higher as the US Financials deal with their own stresses. This, as the great American analyst, Tim Russert, would have said "is BIG."
 
Tech and Basic Materials are two of the things that The Client (China) needs. What we have observed in the last month is a very high inverse correlation between these two sectors and the US Dollar. If Bernanke, Obama, or the Chinese themselves can continue to Break The Buck, these American export businesses can start to crush their Western European and Japanese competition.
 
Competition? What's that? Aren't we trying to compromise and socialize America to smithereens? Thankfully, some will try to... and all the while, this will provide we men and women of American Capitalism Lost the ability to test and toil our new business models while the horse and buggy proprietors aren't looking.
 
One of my favorite quotes is from Henry Wadsworth Longfellow, and it's one that fits this idea of Creative Destruction like a glove: "Heights by great men reached and kept were not obtained by sudden flight but, while their companions slept, they were toiling upward in the night."
 
Now, I hardly consider myself a "great man" - nor do I buy into the notion that Wall Street's billionaire lever it up kings are either. However I do know that it takes a tremendous amount of trial and error to evolve. In The New Reality, where our entire industry is now being paid not to make any more mistakes, this is seemingly the best time to be taking measurable risks.
 
Risk? Yes, ask the short sellers if Squeezy The Shark has been giving them any of that to think about lately. Risk to the downside abates alongside declining volatility. Volatility in this market continues to hit lower lows. The Volatility Index (VIX) flashed no stress during yesterdays overdue US market correction. This remains a very trade-able range where the reward is starting to outstrip the risk on the long side.
 
Yes, if we break down and close through an SP500 level of 821 and the US Dollar starts to appreciate, the stock market will DEFLATE again... but until we see those facts on the front center of our screens, a better question remains - why am I not longer of US stocks?
 
In t-minus 2.5 hours, I'll be answering the opening bell on that question. I'm looking forward to buying from those who don't see me coming, as they creatively destruct.
 
Best of luck out there today,
KM
 

LONG ETFS

XLK - SPDR Technology - Technology looks positive on a TRADE and TREND basis. Fundamentally, the sector has shown signs of stabilization over the last six+ weeks.   As the world demand environment becomes more predictable, M&A should pick up given cash rich balance sheets in this sector (despite recent doubts about an IBM/JAVA deal being done).  The other big near-term factors to watch will be 1Q09 earnings - which is typically the toughest for tech, along with 2Q09 guide.  There are also preliminary signs that technology spending could be an early beneficiary of the stimulus plan.

TIP - iShares TIPS- The iShares etf, TIP, which is 90% invested in the inflation protected sector of the US Treasury Market currently offers a compelling yield on TTM basis of 5.89%.  We believe that future inflation expectations are currently mispriced and that TIPS are a compelling way to own yield on an inflation protected basis, especially in the context of our re-flation thesis.

XLB - SPDR Materials -If the USD goes up, XLB deflates. It's a bull on both a TREND and TRADE duration. The Materials sector is, obviously, a key beneficiary of our re-flation thesis.  Domestically, materials equities should also benefit as the stimulus plan begins to move into action.

USO - Oil Fund-We bought oil on 3/25 for a TRADE and are positive on the commodity from a TREND perspective. With the uptick of volatility in the contango, we're buying the curve with USO rather than the front month contract.  

EWC - iShares Canada-We bought Canada on 3/20 into the selloff. We want to own what THE client (China) needs, namely commodities, as China builds out its infrastructure. Canada will benefit from commodity reflation, especially as the USD breaks down. We're net positive Harper's leadership, which diverges from Canada's large government recent history, and believe next year's Olympics in resource rich Vancouver should provide a positive catalyst for investors to get long the country.   

DJP - iPath Dow Jones-AIG Commodity -With the USD breaking down we want to be long commodity re-flation. DJP broadens our asset class allocation beyond oil and gold.
 
GLD - SPDR Gold-We bought more gold on 4/02. We believe gold will re-assert its bullish TREND as the yellow metal continues to be a hedge against future inflation expectations.

DVY - Dow Jones Select Dividend -We like DVY's high dividend yield of 5.85%.


SHORT ETFS

LQD  - iShares Corporate Bonds- Corporate bonds have had a huge move off their 2008 lows and we expect with the eventual rising of interest rates in the back half of 2009 that bonds will give some of that move back. Moody's estimates US corporate bond default rates to climb to 15.1% in 2009, up from a previous 2009 estimate of 10.4%.

SHY - iShares 1-3 Year Treasury Bonds- If you pull up a three year chart of 2-Year Treasuries you'll see the massive macro Trend of interest rates starting to move in the opposite direction. We call this chart the "Queen Mary" and its new-found positive slope means that America's cost of capital will start to go up, implying that access to capital will tighten. Yield is inversely correlated to bond price, so the rising yield is bearish for Treasuries.

EWU - iShares UK - We shorted the UK on 4/08. We're bearish on the country because of a number of macro factors. From a monetary standpoint we believe the Central Bank has done "too little too late" to manage the interest rate and now it is running out of room to cut. The benchmark currently stands at 0.50% after a 50bps reduction on 3/5. While the Central Bank is printing money and buying government Treasuries to help capitalize its increasingly nationalized banks, the country has a considerable ways to go to attain its 2% inflation target as inflation has slowed considerably. GDP declined 1.5% in Q1, unemployment  is on the rise, housing prices continue to fall, and the trade deficit continues to steepen month-over-month.

EWL - iShares Switzerland - We shorted Switzerland on 4/07 and believe the country offers a good opportunity to get in on the short side of Western Europe, and in particular European financials.  Switzerland has nearly run out of room to cut its interest rate and due to the country's reliance on the financial sector is in a favorable trading range. Increasingly Swiss banks are being forced by governments to reveal their customers, thereby reducing the incentive of Switzerland as a tax-free haven.

UUP - U.S. Dollar Index -We believe that the US Dollar is the leading indicator for the US stock market. In the immediate term, what is bad for the US Dollar should be good for the stock market. The Euro is down versus the USD at $1.3247. The USD is up versus the Yen at 99.1040 and down versus the Pound at $1.4932 as of 6am today.

EWJ - iShares Japan -We re-shorted the Japanese equity market rally via EWJ. This is a tactical short; we expect the market there to pull back when reality sinks in over the coming weeks. Japan has experienced major GDP contraction-it dropped 3.2% in Q4 '08 on a quarterly basis, and we see no catalyst for growth to return this year. We believe the BOJ's recent program to provide $10 Billion in loans to repair banks' capital ratios and a plan to combat rising yields by buying treasuries are at best a "band aid".

XLP - SPDR Consumer Staples- Consumer Staples continues to look negative as a TREND. This group is low beta and won't perform like Tech and Basic Materials do on market up days. There is a lot of currency and demand risk embedded in the P&L's of some of the large consumer staple multi-nationals; particularly in Latin America, Europe, and Japan.


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BBBY: INSIDER SALES WARRANT A DEEPER LOOK

Co-chairman/founder’s Eisenberg and Feinstein sold 2.15 million shares on 4/09, the largest sale by insiders over the past five years.  The shares represent approximately 20% of their direct and indirect holdings, not accounting for any options.  The absolute number of shares is eye-opening by historical standards – even though the entire amount was sold by their trusts with a lesser portion sold by their charitable foundations. Additional executives, including the CEO, also reported sales resulting from option exercises that were all slated to expire by the end of this year.

 

Overall, the 13 insiders retain a 4% position in the company, making them the 6th largest holders of company shares.

 

Alright, let’s face some facts. I’m never thrilled to see that level of sales activity. If they are selling, then why should I buy?  There are three reasons I’m not overly concerned about the activity.

1)      The stock doubled over four months and is up 60% in 6 weeks. If I were them I might sell some stock too.  

2)      History suggests that management has not been particularly good with timing of stock trades (see chart). It’s a good thing that they manage retail stores instead of portfolios.

3)      Lastly, and most importantly, BBBY management, like most management teams I know in Consumer, does not ‘do macro.’  These guys are basing their forecasts on bottom-up models with a loose macro beacon set by Wall Street research. Based on the collective work of our industry and Macro teams, we think that the softline retail supply chain will have a tailwind for much of the next year. I don’t think that management appreciates that yet. See our recent research on the topic for more color.


BBBY: INSIDER SALES WARRANT A DEEPER LOOK - bbby insider chart


LVS: Q1 SHOULD LOOK BETTER THAN WYNN’S

The LVS Q1 shouldn’t be awful.  In fact, it could surprise the Street on the upside.  Our revenue, EBITDA, and EPS estimates are above the Street consensus.  What will drive the upside?

  • Easy comparison – Palazzo generated only $120 and $18 million in revenue and EBITDA, respectively, in Q1 2008 as the property was still ramping.  By contrast, Q4 Palazzo EBITDA climbed to $42 million, a seasonally similar quarter to Q1.  It doesn’t appear the Street is factoring in last year’s slow ramp.
  • High convention exposure – Room rates and occupancy should look very strong relative to the rest of the Strip due to the long booking windows of this business.
  • Macau – The Macau numbers were much better than expected in Q1 and The Venetian grabbed its fair share.  We’ve got a good idea of The Venetian’s Q1 revenues and based on those numbers, property EBITDA should be up significantly from last year’s $108 million.
  • Cost Cutting – LVS is probably much farther along than most people think.  See discussion below.

 


LVS: Q1 SHOULD LOOK BETTER THAN WYNN’S - LVS Q1


We remain positive on the Macau prospects going forward.  Unfortunately, the rest of the quarters won’t look as good as Q1 in Las Vegas for LVS.  Q2 shouldn’t be awful but the convention business seasonally dissipates in Q3.  A pure leisure environment won’t be good for room rates.  The convention business reemerges in Q4 but bookings do not look very good.  This will be a very difficult quarter for Venetian/Palazzo in Las Vegas.

Margins appear to be the most underrated piece of the LVS long thesis.  Sheldon Adelson recently upped the ante from initial targeted cost cuts of $250 million to $470 million.  Relative to the $890 million in total company EBITDA generated in 2008, this is a huge number, maybe too big.  See the chart below.  The Street is obviously very skeptical.  However, the cost cutting strategy appears to be better thought out than we initially thought.  In other words, we’re not so sure that this was just Mr. Adelson “blowing smoke”.  There seems to be more input from the rest of the (remaining) executive team.  Here are some details:

  • $180MM of cuts at the US entity:
    • Cutting everything that’s not making money
    • Cut 285 employees at corporate in the most recent round of cuts
    • Will likely shut down the few retail outlets they operate
    • Lower end customer expects less so in theory shouldn’t really damage the brand or guest experience
    • Replacing “older slot guys” with fresh graduates that are more productive (so 1 for every 3 that are fired)

 

  • $270MM cost cuts in Macau
    • Got rid of 1000 construction workers on Sites 5&6
    • Better sharing of infrastructure btw Sands & Venetian
    • Had over 300 people in the marketing department alone

 

  • $20MM of cuts at corporate
    • Hiring several in house attorneys to reduce the millions spent on outside council


LVS: Q1 SHOULD LOOK BETTER THAN WYNN’S - LVS planned cost cuts


2009 – EYE ON FOOD COSTS

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


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