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Riding Out the LO Gravy Train!

The big news overnight and into this morning is that all parties that may be involved in a deal to acquire LO (directly or not) acknowledged through press releases that in fact the parties are underway in discussions yet noted that there is “no certainty that any deal will take place”.  This not-so-new-news (rumors have persisted since March of this year of a deal between RAI and LO), is bolting LO as high as 5%+ intraday (to $66) as of this writing.

 

We are riding out our long position in LO, which we initiated as a Best Idea Long on 2/26/14 at $47.74, to a price target of $80. We expect to see RAI and LO work closely to get this deal done, and attach an 85% probability that a deal in fact gets done.  Assuming yesterday’s (7/10) closing price of $63.09, we assume there’s an additional 26% upside to our target, and ~ 8% of downside to $58 should a deal not get done.

 

Facts Around a Deal:

  • British American Tobacco (BAT) owns 42% of RAI and would have to approve any merger. The company has indicated it wishes to maintain its existing stake
  • Imperial Tobacco Group may be a key buyer of select RAI brands to assuage any U.S. antitrust concerns.  As is, RAI+LO would command 67% of U.S. menthol market – definitely an antitrust flag, so we expect divestiture from RAI’s menthol properties
  • Imperial targets from RAI’s menthol brands could include Kool, Winston and Salem, or ~5% of its business. [For more on Imperial’s Positioning see Imperial Sweetens Potential RAI-LO Deal]
  • Whispers are Imperial may have $7B to spend – it’s interested in building out a U.S. business
  • We suspect that RAI’s new CEO Susan Cameron (announced in late April) was positioned by the board to get a deal done (and transform the company) rather than simply accept a buy-out from BAT

 

RAI+ LO:

  • RAI+LO would have annual sales of $13B and market cap of $56B, or 42% share of U.S. tobacco, second to #1 MO at 51%
  • Per the chart below we expect LO’s blu business to propel the entire business to a higher growth rate over the next 5 years
  • The tobacco group (PM, MO, LO, RAI) is currently trading at a forward P/E of 16.8x vs 13.2x 5-YR historical average
  • Superior fundamentals of LO’s menthol business, leading share of e-cigarette category in blu (45% across all channels), and the synergies involved in a combined RAI+LO (estimated ~ $500-$600M) should command/propel a higher P/E multiple as tobacco moves into an even more tightly consolidate industry = additional pricing power to defend declining volume trends
  • We suggest LO should command a P/E of 17x to 18x
  • We expect LO to command at least $80/share. Below is a sensitivity chart to assess various ranges based on 5-yr forward EPS estimates and discount rate applied

Riding Out the LO Gravy Train! - z4

 

Howard Penney

Managing Director

 

Matt Hedrick

Associate

 

Fred Masotta

Analyst 


June: The Ugly Duck of 2Q

We were recently given a look at June sales and traffic trends from Black Box Intelligence which were, in aggregate, disappointing for casual dining industry.  Both same-store sales and traffic declined during the month.  Before we delve further into the details of the release, we thought it'd be useful to highlight the changes in same-store sales estimates from the beginning of 2Q (April 2nd) to today (July 11th).

 

The street took up 2QC14 SSS estimates over the course of the quarter for the following companies: BWLD, CAKE, CHUY, DFRG, KONA, RRGB, RT, TXRH.

 

The street took down 2QC14 SSS estimates over the course of the quarter for the following companies: BBRG, BJRI, BLMN, BOBE, CBRL, DIN, DRI, EAT IRG, RUTH.

 

The street left 2QC14 SSS estimates unchanged over the course of the quarter for DENN.

 

We continue to like DFRG on the short side and believe same-store sales estimates, which have risen over the course of the quarter, are too aggressive.  In particular, we have serious doubts that Grille and Sullivan's will post a +3.4% and a +0.1% comp, respectively.

 

Despite a rather disappointing quarter, revisions to same-store sales estimates were fairly mixed leading us to believe that expectations are too high for several companies.  Casual dining stocks have underperformed both the SPX and XLY, in aggregate, over a 1YR, 6M, 3M, 1M and 1W duration.

 

June: The Ugly Duck of 2Q - ch1

 

June: The Ugly Duck of 2Q - 5

 

June was the worst month of the quarter, with same-store sales and traffic down -0.10% and -1.7%, respectively.  The underlying trends were similarly concerning, with two-year same-store sales and traffic down -0.1% and -2.1%, respectively.  Notably, each month in the quarter was worse than the prior.  This is consistent with the discounting trends we've seen in the industry.  As food cost pressures continued to build throughout the quarter, casual dining companies decreased their level of discounting in order to protect margins.  In turn, traffic suffered which leads us to believe it's a "pick your poison" environment for casual dining operators right now.

 

June: The Ugly Duck of 2Q - chart2

 

June: The Ugly Duck of 2Q - 44

 

Weather, which was the scapegoat in 1Q14, can no longer be used as an excuse.  Rather, we point to a number of issues including stagnant wages, rising gasoline prices and what we've deemed "casual dining's secular decline."  Overall, 2Q14 was a disappointing quarter as same-store sales increased +0.3%, while traffic declined -1.4%.  These results are, however, an improvement over a tumultuous 1Q14.

 

Black Box also noted that the best performing region was Mountain Plains (SSS +2.1%; traffic -0.6%) and the worst performing region was NY/NJ (SSS -2.6%; traffic -3.5%).

 

Trends in the casual dining industry have been rather unsettling to us.  While the bulls blamed weather in 1Q and predicted a strong 2Q, that clearly didn't materialize.  In fact, we'd argue that looking at our proprietary Casual Dining Index, same-store sales estimates of +1.4% in 2Q14 are far too high.  Unless estimates come down further, this should make for some interesting earnings releases!

 

June: The Ugly Duck of 2Q - chart4

 

Call with questions.

 

Howard Penney

Managing Director

 

Fred Masotta

Analyst


RH Black Book: Real Estate Deep Dive

Takeaway: Join us for a call to debate the key issue today facing RH – real estate. Our deep dive will show why we think this story is far from over.

Please join us on Thursday, July 17th at 11:00 am ET for a call titled RH: Real Estate Deep Dive. We’ll be releasing our 2nd  Black Book on Restoration Hardware, specifically outlining the key issues that we think are critical to the investment thesis and the stock at this point in the company’s growth trajectory.  The reality is that some of the key factors to this story deserve greater scrutiny today than they did just $30 ago. 

 

We’ll hit on several topics, but the key focus on Thursday will be real estate. The crux of our commentary will focus on the likelihood of success in RH’s build-out of its large format Full Line Design Galleries. We’ll outline the biggest opportunities, potential risks, and whether or not the company is set up to execute on this opportunity. Ultimately, we’re going to flush out the real estate profile and potential store growth in the same way and using the same tools many retailers use to analyze their own store growth opportunity.

 

KEY TOPICS WILL INCLUDE:

1) What does RH’s addressable market look like, and how will that evolve over the next 5 years?

2) How many markets in the US can support a Full Line Design Gallery at the sales productivity standards that RH is setting for its’ new stores?

  1. We’ll drill down on specific markets that have been announced, but will also analyze in great detail other markets that we think are likely candidates that the company has not yet announced.
  2. We’ll look quantitatively at the underlying economics of each FLDG market.
  3. We’ll break out ‘fill in’ markets versus new markets.
  4. The costs of the properties is evolving. How this is impacting RH’s ROIC?

3) A look at trends we’re seeing in anchor tenant space, and why we’re seeing more premium space available than most people might think.

4) Category expansion, and which categories present the biggest opportunities (and potential risks) at retail.

5) How much of a risk is a housing downturn to the RH story?

 

Participant Dialing Instructions

Toll Free Number:

Direct Dial Number:

Conference Code: 275779#

Materials: CLICK HERE


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Retail Callouts (7/11): FL, LULU

Takeaway: FL - Lorna Jane may help fix womens/apparel issues at FL, but we're not overly excited

COMPANY HIGHLIGHTS

 

FL, LULU - Australia's Lorna Jane Attracts Some Big-Name Suitors

(http://online.wsj.com/articles/australias-lorna-jane-draws-some-big-name-bidders-1405008369)

 

  • "Lorna Jane, an Australian maker and seller of women's workout clothing that is up for sale, has attracted buyer interest from Foot Locker Inc. and private-equity firms, according to people familiar with the matter."
  • "Manhattan-based Foot Locker and private-equity firms Advent International and Bain Capital are among potential buyers submitting first-round bids for Lorna Jane, some of the people said. Lorna Jane hired investment bankers Credit Suisse  to sell itself, the people said."

 

Takeaway: FL has a lot of cash to play with and Lorna Jane could help reinvigorate two of FL's biggest issues womens and apparel. If a deal were to go through, it's likely that Lorna Jane would function as a stand alone banner - we can't justify $90 yoga pants on Foot Locker shelves. Adding the brand's 169 stores into the fold would account for 5% unit growth to a base that has been shrinking organically for the last 8 years, and 3 percentage points of growth to the top line. But, it's hard for us to get overly excited about a brand that did under $1mil per store in 2013 (150 Stores, $138mm in sales) when LULU is pumping out $5mil plus through its box. Yes, the brand has limited awareness in the US and the Yoga market shows no signs of slowing so there is some runway for growth, but not enough for us to get overly excited about this potential deal.

 

OTHER NEWS

 

EBAY, AMZN - ChannelAdvisor Reports June Comp Sales

 

Retail Callouts (7/11): FL, LULU - Chart1 7 11 2014

 

GPS - Gap Inc. Reports June Sales

(http://www.gapinc.com/content/gapinc/html/media/pressrelease/2014/med_pr_june_sales_14.html)

 

  • "Gap Inc.’s comparable sales for June 2014 were down 2 percent versus a 7 percent increase last year. Comparable sales by global brand for June 2014 were as follows:
    • Gap Global: negative 7 percent versus positive 5 percent last year
    • Banana Republic Global: negative 7 percent versus negative 1 percent last year
    • Old Navy Global: positive 7 percent versus positive 13 percent last year"

LEISURE LETTER (07/11/2014)

Tickers: PNK, ISLE, PENN, GLPI, LVS

EVENTS

  • July 14: AC June revenues
  • July 15-17: Pre-RCL earnings Hedgeye Cruise pricing survey
  • July 16:  LVS 2Q call (430pm)
  • July 23:  TRIP 2Q call (430pm)
  • July 24:  
    • WYN 2Q call (830am)
    • PNK 2Q call (9am)
    • LHO 2Q call (930am)
    • PENN 2Q call (10am)
    • HOT 2Q call (1030am)
  • July 25:
    • PEB 2Q call (9am)

COMPANY NEWS

PNK expects its 2Q Consolidated Adjusted EBITDA and Income (loss) from Continuing Operations to include unusual expense items that aggregate to a range of $8-10 million.  The unusual expense items relate to the rollout out of the Company's my choice player loyalty program at its Ameristar branded properties, Colorado lobbying expenses, and severance expense.

Takeaway:  PNK had mentioned on its Q1 conf call that it expects a $5m charge only related to the loyalty program integration at its ASCA properties.  At some point, analysts will have to start including these regularly occurring "non-recurring" expenses in EBITDA.  No wonder margins continue look better. 

 

ISLE – after the close, the Company announced a strategic realignment including the departure of Dale Black, who served as CFO since 2007, replaced by Eric Hausler, who currently serves as Chief Strategic Officer, a role that will be eliminated going forward. Executive Chairman Jim Perry will step down and Robert Goldstein, currently the Vice Chairman of the board, has been named (non-executive) Chairman of the board. ISLE expects these actions to reduce annual corporate expense by approximately $2.5m exclusive of severance costs.

Takeaway:  If the company were about to be acquired, one would think C-Level management would stick around for the vesting and higher take-out value on their equity interests. This also signals the need for ISLE to reduce expenses further.

 

PENN & GLPI – District Judge Eliza Ovrom on Thursday extended her stay of an Iowa Racing and Gaming Commission order to close the casino until she rules on Argosy's appeal.  Previously, Judge Ovrom granted the casino a 10-day stay, which allowed it to stay open past the July 1 deadline until Thursday. At the conclusion of a hearing Thursday morning, Ovrom said she hoped to issue a ruling early next week.

Takeaway: Positive for PENN as this is not included in guidance

 

LVS – CEO Sheldon Adelson has continued his anti-online gambling crusade by hiring former GOP congressman Connie Mack of Mack Strategies to lobby against Internet gambling legislation. Mack will go to bat for Adelson and his Coalition to Stop Internet Gambling and will be tasked with lobbying in support of the Restoration of America’s Wire Act, the federal bill introduced by Sen. Lindsey Graham (R-S.C.) and Rep. Jason Chaffetz (R-Utah) over three months ago. Mack joins a lobbying lineup that includes Steptoe & Johnson, Capitol Counsel, The Keelen Group and the Lincoln Policy Group.

Takeaway: Mr. Adelson's battle against online gaming continues.

 

BYI (SHFL) – Macau’s Court of Second Instance dismissed an appeal from SHFL Entertainment (Asia) Ltd, which sought an injunction against Paradise Entertainment Ltd and its subsidiaries’ assertions of monopolistic rights over “multi-gaming” in the Macau market. The injunction sought to prevent Paradise Entertainment and its subsidiaries from claiming monopoly rights over multi-game electronic table game products in Macau and to restrain them from any unfair competition.

 

WYNN & 1128:HK (GGRAsia)The head of Macau's Commission Against Corruption confirmed the agency is "analyzing some details" about land granted to Wynn Macau for its Cotai project after U.S.-based International Union of Operating Engineers called on the Macau authorities to investigate how Tien Chiao Entertainment and Investment Co Ltd secured rights to Cotai land before it was granted to Wynn Macau. While WYNN says it hasn't been contacted by authorities, and it doesn't anticipate any delay to the Cotai project, which is scheduled to open in H1/16.  

Takeaway:  More scrutiny behind a complicated Cotai deal but Wynn is apparently not a part of the investigation.

INDUSTRY NEWS

Chinese Money Laundering (Xinhua) China's central bank is looking into allegations by a state broadcaster that Bank of China, the country's fourth largest lender, has been laundering money offshore for clients. 

Takeaway: Could money laundering by Chinese big banks be the next area of Chinese Central Government crackdown?

 

Margaritaville Tulsa (Tulsa World)  Construction on the Muscogee’s $355 million Margaritaville casino is running behind schedule, and is now on track to open sometime in 2016 rather than mid-2015.

Takeaway:  Even fewer new slots for 2015

 

Gaming in California's Wine County – A group of Native Americans, the Mishewal Wappo Tribe of Alexander Valley, filed a federal lawsuit in 2009 asking for recognition of their tribal status. The group's 350 members, most of whom live in Sonoma County today, say they are descendants of the Wappo people, who once inhabited parts of Sonoma, Lake County and much of Napa Valley, and that they were unfairly stripped of tribal status. Tribal leaders insist they simply want recognition. But winemakers worry such status would allow the tribe to petition for lands and eventually build a casino in Napa County. If the tribe wins, it would become a sovereign nation, and any lands they were granted by the federal government or that they purchased would be exempt from local land-use and zoning restrictions. Motions to dismiss the Wappo's claim have been denied. Last July a federal judge affirmed a ruling that Napa and Sonoma counties had no standing to fight recognition of the tribe, escalating widespread apprehension that a casino could find a home in Napa’s agricultural region

Takeaway: Nearly 3 million people visited Napa Valley in 2012 and visitors spent an average of $714 per day, including $260 on lodging, $148 on restaurants and $107 on wine purchased at wineries. Lodging guests typically stayed in the valley for 2.9 days on average. 

MACRO

Hedgeye remains negative on consumer spending and believes in more inflation.  Following  a great call on rising housing prices, the Hedgeye

Macro/Financials team is turning decidedly less positive. 

Takeaway:  We’ve found housing prices to be the single most significant factor in driving gaming revenues over the past 20 years in virtually all gaming markets across the US.


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