Bear Hunting

Our senior research sector heads are increasingly convinced that genuine bottoms up Research Edge lies in asking “The Question” – who is first to step away from the Street’s pervasive groupthink? Who asks THE critical question first? My macro question at our morning meeting on Monday was “who is more afraid right now, the Bears, or the Bulls”?

Alpha is generated if you ask the best questions first. Importantly, you can shorten the duration in maximizing that holy grail of alpha the faster you find conviction in THE answers to those questions. My answer to the aforementioned question is that today is much like May, the Bears are NOT Bearish Enough.

Anyone who has studied bears (or lived in Northern Ontario with them in your back yard) knows that they have very short attention spans. As a species, they are very comparable to “momentum” oriented hedge fund traders. Bears can hear things from distances as far as a mile away. They have as Wikipedia appropriately points out, “elusiveness and sharp senses”. Humans are generally as scared of them as bears are from themselves. This is exactly how I feel about the US and Global Stock markets right now. No one trusts anyone and, on up days, the bears are faster covering than the bulls are buying. All the while, save the survival of the fittest, funds managed for weekly and monthly returns are being hunted down, and shot.

Other than using guns, across the ages there have been many other ways that we have hunted bear – knifing, snaring, calling - not all of these strategies are incredibly effective, particularly when everyone is running around yelling at each other. Predictably, as we are seeing in today’s market, politicians have always offered up some ingenious tactics. The most famous might be Teddy Roosevelt’s book titled “Hunting the Grisly”, where Wikipedia again notes that Teddy thought “small terriers could be used against bears, they usually only worked against bears which had never had the experience of being hunted before…the terriers would irritate and distract the bear with their yapping.” Sound familiar?

As of last night, the Democrats official released their US market hounds. Everyone from the self proclaimed savior of “the sister hood of the pantsuit” to the Governor of Montana took to the stage and started barking back at the McCain Bulls. Barrack Obama is a lot of things, but one of them is not stupid. It’s “Macro Time” - get used to his orchestrating this daily market distraction. As an old Chinese proverb goes, ‘one dog barks because it sees something; a hundred dogs bark because they heard the first dog bark.”

Of course, away from trying to figure out whether the Bulls or Bears are more right, the global marketplace will be issued economic and geopolitical facts, daily. Facts are stubborn little critters that can be hidden from the market, until they can no longer be ignored. Last night the Federal Deposit Insurance Corporation (FDIC), which was created during this country’s last economic depression in 1933, sprayed some bear mace in the bull’s eyes, reminding them that we are still in the early stages of the US bankruptcy cycle. Head of the FDIC, Sheila Bair, stated “Quite frankly, the results were pretty dismal, and we don't see a return to the high earnings levels of previous years any time soon.” Good thing she is being “frank”!

There is a front page article this morning in the Wall Street Journal that talks about the reality that US banks actually have debts that come due, and that they’ll need to refinance them at higher rates. Isn’t that a shocking revelation of factual data! Meanwhile Morgan Stanley’s head of foreign currency research is making a “call” that Asian currencies can go down a lot when economic growth slows. Eureka! They didn’t ask the question first, but they are finding the right answers!

I am smiling partly because I can’t believe I spent so much time this morning writing about animals. I am smiling partly, because the expiration date on the cream for my coffee this morning said August 30th – that’s when I get paid my hunters ration of interest income on my most concentrated position, 85% cash. I am smiling because we asked a lot of the right questions 9 months ago, and found conviction in the right answers.

Happy hunting,


This October will bring a very interesting dynamic to the slot machine industry. IGT will cease to install conversion kits on all of its platforms with the exception of the newest, AVP. This looks to me to be a pretty big bet on Server Based Gaming (SBG).

  • Sluggish replacement sales have masked a solid conversion environment over the past 2 years. As can be seen in the first chart, conversion activity has not followed the downward plunge in slot demand. For the casinos, conversions are a big time money saver. Slot boxes last for a long time, game appeal does not. Game conversions run in the $4-5k range versus $12k+ for a whole new slot machine. Obviously for the supplier, a full slot sale is preferable. I attribute the relative strength of conversion sales to the following:

    • Better technology
    • Operators converting ahead of IGT’s dictum (customers were notified over a year prior)
    • Casinos with cash-strapped balance sheets pursuing the lower cost conversion alternative
    • Shorter “game appeal” duration

  • The 2nd chart shows that IGT has a little over 500,000 of the 900,000 slots installed in North America. Only 30,000 of these machines are on the AVP platform, leaving a significant number of machines unconvertible. An IGT bull might say that due to competitive conditions between the operators, casinos will be forced to replace existing games with brand new machines. Alternatively, SBG provides an easy solution whereby new games can be purchased and downloaded automatically on the AVP platform. On the other hand, IGT’s conversion decision now puts almost 500k machines up for grabs. Casinos do not have to replace an IGT machine with an IGT machine. Where there’s a bull, there’s a bear.

  • That’s the IGT story. The BYI and WMS stories are altogether different. At the very least, I think IGT’s decision could spur more conversions for BYI and WMS. More likely, the move opens the door for more market share gains, at full pricing. Again, that’s almost a half of a million slot machines that will ultimately be replaced and not converted.

Slot conversion growth outpaced replacements. A lot of market share up for grabs.
IGT Bull vs Bear

The Bear Hunter Chart: Russia's RTS Index

Russian Bears are on the loose, and those shorting Putin’s RTS Index are getting paid healthy bounties. The Russian stock market got hammered again today, closing down another -4.2%, taking the Index down to 1579. The decline in august alone is almost -20%. Since our "Fading Fast Money" call on 5/21, this levered country play on commodities has lost -37% of its value. Vladimir no likey...
  • This is the RTSI (USD) charted since the day that hostilities with Georgioa kicked into high gear.

    Andrew Barber

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Thailand has seen this movie before...

Thailand's recent economic history is best depicted by the charts below where we have overlaid economic growth with local currency trends. Suffice to say, if history has any relevance, Thailand's near term future looks ominous. My advice would be to consider the tail risks associated with a protracted slowdown Thai GDP very seriously.
  • GDP vs. Currency, since 2003
  • GDP vs. Currency, since the Baht's crash (1998)


The Hedgeye Portfolio is a new product that is currently being beta-tested at Research Edge. One of the holdings within the portfolio is COW, as we remain bullish on Livestock prices. COW is an ETN designed to track the return of a Livestock index as measured by the Dow Jones-AIG Livestock Total Return Sub-Index (weightings are 62% Live Cattle and 38% Lean Hogs).

The USAgNet reported that U.S. pork exports set a record in the first half of 2008, while U.S. beef exports continued to climb closer to the pre-BSE levels reached earlier this decade, according to the latest figures released by the U.S. Department of Agriculture.

According to the USDA, pork and pork variety meat exports in June doubled the volume exported last year, driving year-to-date pork exports up 67% above the first six months of 2007 in terms of volume, and 58% higher in terms of value. During the first half of the year, beef and beef variety meat exports increased 30% in volumes and 39% in value.

Beef exports are exploding at a time when the herd is declining so it does not seem like prices are going lower any time soon.

  • A weak dollar has made US protein attractive in foreign markets simultaneous to the rise of “BRIC” consumers anxious to enrich and diversify their menu –clearly illustrated by these pork export charts.
  • In the case of poke specifically, even if a post Olympic/Georgia slowdown in China and Russia dampens exports somewhat, demand should remain relatively firm for the “other white meat” –aided by the Canadian Government’s effort to reduce their breeding swine population.
The good news: Price should continue to rise
The good news: Price should continue to rise

DRI – Then and Now

Darden preannounced its 1Q09 results earlier today and significantly lowered its full-year outlook. Although back in June on its 4Q08 earnings call, Darden management highlighted the challenging environment as a reason to be cautious, citing higher costs and the expectation for traffic and mix changes to be flat to slightly negative in FY09, based on the magnitude of change in the company’s full-year outlook from then to now, management was not cautious enough.

Most surprising, relative to the company’s preliminary 1Q09 results, was the 2.4% same-store sales growth at Olive Garden, down from the 5.8% number in 4Q08. Olive Garden was facing a tough comparison in 1Q09 from last year when comparable sales grew 4.8%, but the 2-year average also declined sequentially by 1.1%, proving that Olive Garden is not immune to the issues facing the casual dining segment as it had appeared for some time. The more troubling component of the same-store sales result is the drop off in traffic. If you assume price was running up about 3%-4% in 1Q09, traffic fell from up over 3.0% in 4Q08 to negative in 1Q09.

What has changed since DRI’s June 25th 4Q08 conference call?

June 25th: “We are pleased with Olive Garden's strength in this challenging consumer environment and we believe they will continue to deliver industry leading performance during this fiscal year.”

“In fiscal 2009, we expect combined same-restaurant sales growth for Red Lobster, Olive Garden, and LongHorn Steakhouse to be approximately 2%. This includes approximately 2% to 3% of pricing for fiscal 2009 and our expectation that together, traffic and mix changes will be flat to slightly negative.”

Today: "With a more challenging than anticipated economic and consumer environment this quarter, our initial expectations for our same-restaurant sales performance proved optimistic. Our revised earnings outlook for the full year reflects expected first quarter results as well as our expectation that same-restaurant sales will remain under pressure for the balance of the fiscal year." DRI announced that it now expects combined full-year U.S. same-restaurant sales growth in fiscal 2009 of approximately 0% to 1% for Red Lobster, Olive Garden and LongHorn Steakhouse.

June 25th: Excluding the impact of integration costs and adjustments for both fiscal 2008 and fiscal 2009, the company expects EPS growth of 9% to 10% on a 53-week basis and 7% to 8% on a 52-week basis.

Today: Excluding the impact of integration costs and adjustments for both fiscal 2008 and fiscal 2009, the company expects EPS growth to be between 0% and 5% on a 53-week basis and -2% and +3% on a 52-week basis.

What has remained the same?

June 25th: “Looking ahead to fiscal 2009, the strategic priority at Olive Garden remains unchanged, and that is to accelerate new restaurant growth while maintaining same-restaurant excellence. Olive Garden expects to open approximately 40 net new restaurants during fiscal 2009 and ultimately, as we have said before, we believe that the brand has the potential to operated 800 to 900 restaurants in North America.”

“Looking ahead to unit growth, new restaurant plans that Drew and Gene outlined mean that we expect a net new restaurant increase of approximately 75 to 80 restaurants or about 4% to 5%.”

Today: DRI expects to open approximately 75 to 80 net new restaurants in fiscal 2009.

As I said earlier, today’s announcement proves that DRI and the Olive Garden are not immune to the challenges facing restaurant operators today. That being said, DRI needs to re-evaluate its new unit growth targets in light of today’s environment. If the Olive Garden cannot maintain “same-restaurant excellence,” then management should not continue to accelerate new restaurant growth.
Darden’s Olive Garden experienced a significant slowdown in same-store sales trends in 1Q09.

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