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Takeaway: Removing short DFRG from Best Ideas, short EAT from Investment Ideas. Relegating both to the Short Bench.

DFRG, EAT: Covering Our Shorts Given Strong Knapp Sales - 1

Last night, Malcom Knapp released sales results for September, estimating that same-restaurant sales increased +1.7% and guest counts declined -1.0% year-over-year.  The results imply sequential improvements of 110 bps and 100 bps, respectively.

In addition, the underlying trends were strong on the margin, with two-year average same-restaurant sales accelerating 50 bps sequentially  to -0.1% and two-year average traffic accelerating 30 bps sequentially to -2.3%.

Following our recent note calling out the positive correlation between same-restaurant sales and PCE excluding food and energy, we were waiting for one incremental data point to support our view that sales were turning.  Knapp delivered that.

Given the improvement we are seeing in these numbers, we are making a tactical move and covering our two remaining shorts in the casual dining space - DFRG & EAT.

We added DFRG to our Best Ideas list as a short on 06/05/14 at $27.27 per share.  Since this time, FY14 EPS estimates have been revised down from $0.97 to $0.90 and the stock has acted accordingly (down ~28%).  While we continue to believe DFRG has structural problems, we are going to stay tactical with this name.  Improving industry sales could delay its demise for several quarters.  We continue to believe DFRG is not the growth vehicle the bulls believe it is and would look to short it again on any notable strength.

We recently added EAT to our Investment Ideas list as a short and believe we may have pulled the trigger a little too early here.  There is no doubt that EAT will benefit from the current sales environment and while we believe the company has issues going forward, we need to see sales turn before we dust off the full-blown bearish playbook.  This is another name that we anticipate revisiting on the short-side in the intermediate-term.

With that being said, we are relegating both of these names to our Short Bench and will be actively looking for opportunities to once again get active on the short side.

Call with questions.

Howard Penney

Managing Director

Fred Masotta

Analyst