BKC is talking today about a major new remodel program.  The new look “epitomizes the new design with a contemporary industrial palette of metallic and black accents, complemented by finishes that resemble brick and concrete.”  Over time, the company will remodel its restaurants globally toward a more "sit-down" experience.  The remodels are expected to cost around $300,000 to $600,000 per restaurant. 


In the US, this will be nearly impossible to achieve given that most franchisees can’t afford to spend that kind of money if they can’t get credit!






In a difficult demand environment, YUM’s 3Q EPS numbers look like they are immune to reality.  Yesterday, YUM reported 3Q EPS of $0.70 (excluding special items) versus the street at $0.58.  In short, when demand for your core products is declining at the pace YUM saw in 3Q, the only way you can beat numbers to this degree is by pulling the goalie (financial engineering and reducing G&A aggressively).


I actually had a client say to me (who had no ax to grind on the stock), do you think they did this just to “rub it in” to those that are negative on the company – of which I am one.  When you dig deep into the trends of the quarter, it’s hard not to come to that conclusion.


YUM reported a 3Q EPS that was over the top, given the magnitude of the miss in top line sales.  US same-store sales declined 6% versus a consensus decline of 1.9%, but restaurant levels margins rose 3.2% (given the fixed cost nature of this business, this is nearly impossible to do).  China same-store sales were flat (implying a 250 bp sequential decline in 2-year average trends) and YRI same-store sales were flat relative to consensus expectations of a 2.3% increase.  YRI’s 2-year same-store sales trends declined 50bps from last quarter.  Despite the top line miss in same-store sales, on a consolidated basis, restaurant level margins rose 3%. 


Every restaurant operator on the planet is looking at these numbers in amazement or with a healthy degree of skepticism.  I understand the company benefited from a decline in food costs, but discounting and the negative leverage on declining same-store sales should mitigate some of the benefit.  Helping margins has been the 10 consecutive quarters of declining payroll and benefit expense as a percent of sales (6 quarters in the US).  This consistent decline in payroll as a percent of sales in the US is unheard of, particularly when sales are declining.  This is not a sustainable trend.


More to the point, despite beating the street by $0.12 this quarter, they only raised guidance by $0.04.  That alone speaks volumes to the real trends that YUM is seeing.  The company’s new guidance implies YUM will earn $0.46 per share in the fourth quarter, $0.10 below the street’s estimate going into the quarter.  The strength of Q3 is offset by the weakness in Q4.  If 3Q was such a great quarter, why is there no follow through into Q4?  Unfortunately, we now know that the company’s “quarterly” guidance must be taken with a grain of salt.  Should we read into this that Q4 is going to be another blockbuster quarter?     


Over the past two years, YUM has been unable to sustain any sales momentum at any of its brands in the USA.  In the current quarter, Pizza Hut’s 13% decline in same-store sales is disturbing (blame-the-ad-agency once again).  While YUM did not disclose the performance of KFC and Taco Bell, we can only take from that to mean that those concepts are not meeting expectations either.  I am interested in learning on the earnings call if there is any follow through on the trends at KFC given all of the hype over the new grilled chicken product introduced earlier this year.


Using the company guidance of just three months ago, we were modeling a 27% tax rate for the quarter (to get to the guided full-year 25% tax rate).  They came in at 20%!  I know this number can be very fluid, but again the magnitude of the divergence is massive (added at least $0.05 to 3Q EPS relative to my estimated 27% tax rate).  This is definitely financial engineering at its best.  Lower taxes make it easier for management to raise guidance for the year and safely beat the 10% EPS target needed to get paid bonuses.


Lastly, in Q2, the company lowered its full-year US operating profit growth guidance from 15% (including G&A savings of about 9%) to high single digit growth, which implies all of the growth is expected to come from cost saving initiatives.  If management maintains this guidance, YUM’s U.S. operating profit growth will be down to up slightly (I am currently forecasting -5% given the positive comparison from 4Q08), which again points to no follow through in the coming quarter off of this 18% growth.



Make The Turn

“The bend in the road is not the end of the road unless you refuse to take the turn.”

Macro markets bend, big time. They can bend up into the right. They can bend straight down. Refuse to make the big turns, and they can bend you right over.
I missed out on the upside associated with yesterday’s market turn. I was too early in introducing my call of a Bombed Out Buck. Too early, in hockey at least, is called being offside. In Asset Management, it’s called being wrong.
I’m in Pittsburgh this morning. I’ll be at the Penguins/Coyotes game tonight. NHL referees will have whistles at the game. I blew one on myself yesterday. Once the SP500 successfully broached my immediate term TRADE line (1042), and the VIX broke my intermediate term TREND line of support (26.13), my proactive plan became that the plan needed to change. Resistance, as we real-time risk managers like to say, became bullish support.
As the Buck Burned to a fresh 2-day low, US Equities REFLATED to fresh 2-day highs. We’ve been staring at this road map for US Equity returns since March. The inverse correlation between US Dollars and most things priced in Dollars remains crystal clear. That wasn’t the turn I missed.
The turn I missed was onto a road that currently doesn’t exist, yet…  
That turn is onto the long hard road of a US Dollar breaking out above my immediate term TRADE line of $77.07. If that happens, the 2-day REFLATION rally you just saw in US stocks is going to quickly revert to something that resembles the 4-day correction that preceded it (down -4.3% from the SP500 YTD high).
The simple change of plans yesterday was to stop shorting stocks and ETFs. “Let the fire breathe”, as my Dad would say. With the SP500 trading below its YTD closing high of 1071 and above my prior resistance level of 1040, that road’s bend is not over. It’s one that needs to keep bending before we can see what’s around the corner…
Yesterday’s SP500 closing price of 1054 is a lower-high. The US Dollar Index current price of $76.21 is a higher-low. On the margin, the bend in this road is bearish. Lower-lows for the Burning Buck and higher-highs for the SP500 would bend me back to the bullish side. From here, I’ll need to be mentally flexible enough to bend both ways.
So what was yesterday’s change of plans? As I said, I didn’t make any short sales, but I did continue to sell down my gross long exposure. I don’t manage money anymore, so there are really two ways that I expressed that:
1.      I raised my position in US Cash in the Asset Allocation Model to 66% by cutting my 10% position in Gold down to 4% (being long US Dollars here is the idea)

2.      I sold 3 long positions in our Virtual Portfolio, taking my total number of long positions down from 23 to 20 (I maintained 11 shorts)

I’m not going to be too hard on myself. In an up market, my risk management in 2009 on the short side of the Virtual Portfolio has been solid. Currently, out of my 11 short positions I only have 1 that has gone more than 4% against me (USO is -4.07% versus where I shorted it late last week).
In preparation to Make The Turn, here are some risk management points to consider in terms of US market internal factors:
1.      Volume: flashing +16% on my daily volume study, it was a solid reading. Not hyper bullish, but definitely not bearish.

2.      Volatility: VIX breakdown of the aforementioned TREND line (26.13), but closed above the immediate term TRADE line (25.32); tough spot…

3.      Range: down to 50 SPX points versus 58 points 2 days ago is, on the margin, bullish (tightening ranges generally are)

4.      Spread: the Yield Spread continues to test the lowest levels it’s seen since May; compression is bearish, on the margin, for Financials (BAC down yesterday)

5.      Breadth: the week-to-date change in our S&P Sector studies has been bullish, moving 7 Sectors out of 9 back to  bullish TRADE and TREND

6.      Risk/Reward: the daily setup moves to the bullish side with SP500 upside to 1071 and downside at 1042 (+1.5% vs. -1%)

What will perpetuate a bottoming process of the Bombed Out Buck?
1.      Consensus: being on the road can be painful, analytically, because some hotels only have CNBC (everyone on the manic channel gets the Burning Buck now)

2.      Fed Heads: rhetoric is slowly shifting to the hawkish side (see the Kansas City Fed Head’s comments last night)…

3.      Higher Prices: with Gold hitting new YTD highs, and the Russian stock market up +105%, Bernanke can’t call this perpetual deflation with a straight face

Despite fear-mongering the American people into group-thinking that we had to move to an “emergency rate” of ZERO percent, Ben Bernanke and his US centric politicized mandate still refuses to Make The Turn that Glenn Stevens and the Australians did yesterday.
ZERO percent is not a perpetual return on investment that either the American citizenry of savers or the Chinese government will continue to bend over for. “The bend in the road is not the end of the road, unless you refuse to take the turn.”
Mom and Dad, Happy Anniversary.
Best of luck out there today,




EWG – iShares Germany
Chancellor Angela Merkel won reelection with her pro-business coalition partners the Free Democrats. We expect to see continued leadership from her team with a focus on economic growth, including tax cuts. We believe that Germany’s powerful manufacturing capacity remains a primary structural advantage; with fundamentals improving in a low CPI/interest rate environment, we expect slow but steady economic improvement from Europe’s largest economy.

CAF – Morgan Stanley China Fund
A closed-end fund providing exposure to the Shanghai A share market, we use CAF tactically to ride the more volatile domestic equity market instead of the shares listed in Hong Kong. To date the Chinese have shown leadership and a proactive response to the global recession, and now their number one priority is to offset contracting external demand with domestic growth. Although this process will inevitably come at a steep cost, we still see this as the best catalyst for economic growth globally and are long going into the celebration of the 60th Anniversary of the People’s Republic.

GLD – SPDR Gold We bought back our long standing bullish position on gold on a down day on 9/14 with the threat of US centric stagflation heightening.   

XLV – SPDR Healthcare
We’re finally getting the correction we’ve been calling for in Healthcare. We like defensible growth with an M&A tailwind. Our Healthcare sector head Tom Tobin remains bullish on fading the “public plan” at a price.

CYB – WisdomTree Dreyfus Chinese Yuan
The Yuan is a managed floating currency that trades inside a 0.5% band around the official PBOC mark versus a FX basket. Not quite pegged, not truly floating; the speculative interest in the Yuan/USD forward market has increased dramatically in recent years. We trade the ETN CYB to take exposure to this managed currency in a managed economy hoping to manage our risk as the stimulus led recovery in China dominates global trade.

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. We believe that future inflation expectations are currently mispriced and that TIPS are a efficient way to own yield on an inflation protected basis, especially in the context of our re-flation thesis.


USO – US OIL Fund We shorted oil on 9/30. The three Fed Heads put rate hike rhetoric right on the table. If the Buck stops Burning, Reflation stops working.

DIA  – Diamonds Trust In the US, we want to be long the Nasdaq (liquidity) and short the Dow (financial leverage).

EWJ – iShares Japan While a sweeping victory for the Democratic Party of Japan has ended over 50 years of rule by the LDP bringing some hope to voters; the new leadership  appears, if anything, to have a less developed recovery plan than their predecessors. We view Japan as something of a Ponzi Economy -with a population maintaining very high savings rate whose nest eggs allow the government to borrow at ultra low interest levels in order to execute stimulus programs designed to encourage people to save less. This cycle of internal public debt accumulation (now hovering at close to 200% of GDP) is anchored to a vicious demographic curve that leaves the Japanese economy in the long-term position of a man treading water with a bowling ball in his hands.

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. Yields are going to continue to make higher-highs and higher lows until consensus gets realistic.


RBA Governor Glenn Stevens sent a clear message today by raising the benchmark rate by 25 basis points despite no evidence of inflationary pressure on the near horizon and stubbornly high unemployment . That message is simple: with the Australian economy still standing firmly on its feet, the time for emergency measures has passed. Unlike the state of “permanent emergency” that Japanese bankers operated under in the first half of this decade, and in which the US appears to be hunkering down for an extended stay, the Australian central bank’s approach has been surgical.  The equity markets responded approvingly to the action, with the ASX All Ordinaries rising by 40 basis points while the Australian dollar, already up nearly 28% against the US greenback, rose to USD 0.8914.


There is no question that leaving rates lower for a prolonged time could only encourage Australian consumers to keep spending, as well as help the still recovering real estate markets, but the discipline that Stevens and his team are displaying now is admirable.  Perhaps overseeing an economy that is so sensitive to commodity price fluctuations due to robust mining and agricultural export makes Stevens particularly focused on avoiding inflation.  Or perhaps seeing his nation avoid recession due to the hard-line policies of the past (recall that his rate raises in 2008 had some political hacks calling for his head) has provided him with the confidence to make choices looking towards the future rather than politics of the present.  Whatever the sources, his professional integrity and proactive stance sits in stark contrast to many of his G20 peers.


Although we sold our position in Australian equities yesterday, we continue to rate the market there as one of the most structurally sound and will remain focused on opportunities to go long again as dictated by price action.


The week ahead may well provide us with several catalysts for entry points.  This evening Housing Finance figures for August will be announced, while tomorrow night the unemployment rate for September will be published  --with consensus forecasts anticipating a 20 basis point increase to 6% over August.  Stevens has already signaled a willingness to raise rates into rising job losses but, with the overhang from lost construction and real estate jobs and a strengthening currency to weigh on exports, some investors may get cold feet. We will not.



Andrew Barber






RT is scheduled to report fiscal first quarter 2010 results after the close tomorrow.  At the risk of sounding like a broken record, my expectations for RT are similar to what I expected out of DRI last week.  Revenues are likely to come in below expectations.  Earnings should be in line with the street’s estimate of $0.09 per share.  Full-year EPS consensus numbers could be at risk but management’s full-year EPS guidance of $0.50-$0.65 will likely remain unchanged.  RT is the second best performing casual dining stock over the past three months, up nearly 27%.  It’s unlikely that performance will continue.


For the last two quarters, RT’s same-stores sales growth has improved rather significantly on a sequential basis, and the company even outperformed the casual dining industry as measured by Malcolm Knapp during its last reported quarter.   Even if this outperformance continues, RT’s same-store sales growth is likely to slow sequentially in Q1 as the industry on average decelerated 150 bps during the quarter.  If investors are anticipating another quarter of sequential improvement, they are likely to be disappointed.  The street is estimating that company same-store sales will be down 3.7% versus -3.2% in Q4, which points to a slight slowdown on a 2-year average basis, but based on industry trends, I would expect that sales could come in below that number. 


During the last two reported quarters, RT has also delivered substantial YOY EBIT margin growth (in the 250 bps range).  Like its peers, RT has been able to offset its declining sales in the back half of FY09 by cutting costs in other parts of the P&L. Specifically, the company reduced its annualized costs by $45-$50 million, with the bulk of these cost savings implemented during 3Q.  These cost saving initiatives will continue to benefit the company on a YOY basis during the first half of 2010, but the comparisons get much more difficult beginning in fiscal 3Q.  To that end, EBIT margins should continue to improve during Q1, but I would expect this trend to reverse as early as Q2.  The magnitude of EBIT margin declines, however, will be much greater come Q3.


The biggest red flag for RT continues to stem from its increased discounting.  As RT’s CEO Sandy Beall stated last quarter, the company's first priority is to "get bodies in seats.”  RT’s recent same-store sales growth outperformance has been driven by traffic growth.  Although it is important to get people in the restaurant, RT’s average check and restaurant margins are coming under increased pressure.  Despite favorable YOY commodity costs, the company’s cost of sales as a percent of sales increased more than 240 bps in fiscal 4Q09.  Going forward, the company expects this trend to continue and is guiding restaurant margins down 50-150 bps as a result of RT’s value promotions and its impact on food costs.  Again, this is despite management’s expectation that actual food costs should remain favorable for the year. 


So, same-store sales are getting less bad and food costs are coming down.  This typically points to increased profitability for a restaurant operator.  In RT’s case, restaurant margins are still coming down.  What will happen if same-store sales growth decelerates and food costs become less favorable?  Based on what we are seeing, same-store sales could easily get worse in the near-term.  RT is locked in on 95% of its costs through the first half of 2010 and will soon extend its contracts for the remainder of the year. Although actual costs may not move higher this year, RT is training its consumers to come in for low-priced meals and food costs will eventually move higher.


On a more favorable note, RT will likely have continued to strengthen its balance sheet during the quarter by paying down more debt after already reducing its total debt by $112 million during fiscal 2009.  The company expects to pay down $80-$100 million of debt during fiscal 2010.  This number is easily achievable and could move higher, particularly following the company’s announcement of a common stock offering.  The company plans to use proceeds to pay down debt.



Game Time Change: SP500 Levels, Refreshed...

Yesterday, I stated plainly that I was not a buyer of weakness (provided that the SP500 remained below 1040). With the dominant driver of the REFLATION trade burning lower again this morning (US Dollar down -0.52% at $76.26), that obviously makes me wrong.


The best way to solve for being wrong, is to change the Game Time playbook. Here are the facts that have changed in the last 24 hours, to the bullish side for US Equities:

  1. The VIX is breaking down through its intermediate term TREND line of support ($26.16)
  2. The SP500 is making a charge for intraday breakouts above important immediate term TRADE resistance lines (1042 and 1047)
  3. The US Dollar is making lower-lows on the day

So – what am I doing? Definitely not shorting strength!


I am, however, tactically making long sales and taking down my US Equity Exposure. At the start of the day I had 23 longs and 11 shorts. Now I have 20 longs and 11 shorts (sold PSS, AMGN, and QGEN).


While the USD is down, its making a higher-low. While the SP500 is up, its making a lower-high (YTD closing high = 1071). If those facts change, I’ll change my Game Time playbook again. Risk Management is a real-time, multi-factor, exercise.



Keith R. McCullough
Chief Executive Officer


Game Time Change: SP500 Levels, Refreshed...  - a1


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