Going into the quarter, I stated that EAT needed to eliminate some questions around its long-term strategy changes at Chili’s.  Management did outline some of its plans around introducing menu enhancements which will come in stages and will work to remove some menu items while improving its core items.  Specifically, management said that the casual dining space has gotten crowded and the company needs to emerge from the “sea of sameness” by improving execution and providing better food, value and service. 


Based on the fact that the stock is trading down significantly today despite EAT’s reporting better than expected 1Q earnings and sales, my key takeaway from the earnings call is that management did not do a good job laying out its plans for the Chili’s brand.  Instead, most of management’s plans could be inserted into almost any casual dining company’s future plans, thereby only increasing the perception of industry “sameness.”  The fact that the company did not provide updated full-year guidance (and implied that prior EPS guidance is no longer a good number) is definitely weighing on the stock today as well, but the strategy changes at Chili’s will be important on a go-forward basis.


Focusing on execution, value and the core menu is very important and lies within the boundaries of what I think the company should be doing, but Brinker did not provide enough brand-specific initiatives.  It does not show them going for the jugular.  I know Brinker needs to be vague for competitive reasons, but in today’s tough economic environment, investors need more answers. 


We all know that the questions asked during a conference call often highlight investors’ primary concerns, and I was the sixth analyst to ask a question and the first to ask about Brinker’s specific plans for Chili’s.  So I just may be wrong.  People may not be too concerned with what management is saying about Chili’s because it will not matter until the changes yield actual results. 


Sales and margin performance will always drive stock price performance and although Brinker posted sequentially better sales in August and September, these sales numbers were only less bad and margins declined.  And, management hinted that restaurant margins would continue to decline in 2Q.  If Brinker is able to replicate MCD’s success by reenergizing its brand (as management referenced), then Chili’s sales are moving higher and will outperform its peers, but the company did not say anything today that leaves me convinced of this outcome in the near-term. 


Brinker has one of the best management teams in casual dining so it could surprise me, but I need to learn more and as they say, “the proof is in the pudding.”  To that end, Brinker was one of the first casual dining operators to really cut growth.  It was also one of the first to really create a leaner business model by implementing cost saving initiatives.  And, now, EAT is really focused on improving its core business and improving 4-wall execution.  This type of strategy often leads to better margins and returns (as we saw with MCD’s Plan to Win strategy and more recently, at Starbucks).  Although management’s comments did not leave me any more confident about near-term sales trends, EAT will be better positioned going forward based on this unit by unit in-store focus.


Can lawmakers in Washington justify extending the homebuyer tax credits with such obvious abuse from consumers?


While Keith covered the short on the XHB today, we continue to expect that the recent enthusiasm around the housing recovery and the homebuilders will continue to wane.  As such, we will look to an up day to re-short the XHB. 


The trend toward a stabilization of home prices and the improvement in new and existing home sales is self evident, and the consensus belief is that the bottom is in the rear view mirror.  The question at this point is the trajectory of the recovery in the housing market and what happens on the margin.  While there is significant reason to be optimistic about the recovery, the data flow over the next six months is likely to show a slowdown in the magnitude of improvement relative to what we have seen recently.   


The decline in mortgage rates and lower home prices has made housing more affordable than at any point over the past 2 decades. Additionally, the tax credit for first time home buyers has helped create significant incentive to jump start purchase activity.  


Today, it was reported that the National Association of Homebuilders housing market index dipped to 18 from 19 in September, falling below market expectations for a reading of 20.  Home builder sentiment is waning, as the November 30 expiration of the government's $8,000 tax credit for first-time buyer's approaches and there is no resolution for its future. 


The WSJ also notes today that the IRS is examining more than 100,000 suspicious claims for the first-time home-buyer tax break.  This is not a good sign and makes it less likely that the program will be extended. 


Also, construction of new homes rose 0.5% in September to a seasonally adjusted annual rate of 590,000 units; weaker than the 610,000 economists had thought.  The all important applications for building permits fell by the largest amount in five months. 


As an industry, the homebuilders are in the business of building new homes, which helps to support the nation’s economy.  Unfortunately, the bottom line is that we don’t need any more new homes.  Using data from the Mortgage Bankers Association, there are more than 7 million homes that are in some state of distress.  Given the pace of new homes being built, the current inventory of unsold homes and the potential number of homes that are in distress is likely to increase. Put simply: the housing overhang is here to stay. 


With the market now up 62% from the March 9 low, consumers may feel better, but it does not completely offset the fact that unemployment is approaching 10%+ and job security remains  an issue.  Today, most consumers need a substantial discount to motivate them to spend their hard earned paychecks.  Without government tax incentives, the housing market is on shaky ground.  Even if the government comes to the rescue with more aid, it does not fix the heart of the problem – most consumers are having a hard time making ends meet.


Howard Penney

Managing Director




US CPI/PPI: Reflation's Rotation

Our Q3/Q4 2009 call on Reflation Rotation is much like the call that we made on US Housing Bottoming in Q2 of 2009. Back then, we weren’t calling for a booming housing market, nor are we calling for massive inflation readings now. We are simply calling the turn. We call this what’s happening on the margin. In our macro models, this is what matters most.


Now that we have both the September CPI and PPI reports in the rear-view, it’s easier to see the Reflation Rotation that we have been calling for. This means going from the lowest readings of deflation (which you can see happened in July of 2009 in the chart below) to lesser levels of year-over-year deflation.


The green arrow that Andrew Barber and I show in the chart below is our forecast. As we move ahead to the October and November CPI and PPI reports (reported in November and December), these deflation readings are going to continue to REFLATE.


We think the Street is starting to figure this out. New highs in the prices of both TIP and GLD confirm these expectations.



Keith R. McCullough
Chief Executive Officer


US CPI/PPI: Reflation's Rotation - PPIKM

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As I stated last week in my 3Q09 earnings preview (please see October 15 post titled “MCD – The Hamburglar Strikes” for more details), reported September sales trends should be the primary driver of the company's stock price performance.  That being said, I wanted to provide comparable sales ranges for each geographic segment as a benchmark of what I think would be GOOD, NEUTRAL, or BAD results based on 2-year average trends. 


For reference, I think September same-store sales growth could come in below expectations with the U.S. posting a +1% number (really BAD), which would point to continued deceleration in 2-year average monthly trends.  I am expecting September 2-year average trends in both Europe and APMEA to remain about even with August (NEUTRAL), which implies about 10% and 3.5% growth on a 1-year basis, respectively.


U.S. (facing an easy +2.8% comparison from last year):

GOOD: +3.3% or better would signal that the company is maintaining or improving its 2-year average trends on a sequential basis from August.  Although investors were not happy with the August number (stock traded down 2% that day), I don’t think people are expecting any improvement in September.


NEUTRAL: +2% to +3.2% would point to a slight deceleration in 2-year average trends but would not represent another month of significant deceleration like we saw in August when 2-year average trends declined 160 bps from the month prior.


BAD: below +2% would highlight a continued fall off in 2-year average trends in the U.S.  A reported 1% or worse would be really BAD as investors may have gotten over the shock of seeing these reported U.S. numbers in the 1.5%-1.8% range like we saw in June and August, but the company has not reported a number below +1.7% since March 2008 when comparable sales declined 0.8%.  A +1% number would imply a 120 bp sequential decline in 2-year average trends.




Europe (facing a relatively easy +5.0% comparison from last year):

GOOD: +11% or better would signal an acceleration in 2-year average trends.


NEUTRAL: +9% to +11% would point to 2-year average trends that are about even with what we saw in July and August.


BAD: below +9% would imply a slight slowdown in 2-year average trends and anything below 6% would be viewed as really BAD as it would signal a return in 2-year average trends to the low reported June levels.




APMEA (facing a relatively easy +5.9% comparison from last year):

GOOD: +5% or better would signal an acceleration in 2-year average trends.  A +8% or better would be really GOOD as it would imply a return to the 7%-plus 2-year average trend we saw earlier in the year.


NEUTRAL: +3% to +5% would point to 2-year average trends that are consistent with what we have seen in the last 3 months. 


BAD: below +3% would imply that 2-year average trends have slowed from recent levels and would represent a deceleration from June when the company posted its lowest 2-year average result since January 2007.





PENN reports Q3 tomorrow morning. It shouldn’t be that bad despite the regional softness.  We’re still worried about the duration of this downturn.



We’re projecting EBITDA of $160 million which is in-line with the Street, although our revenue projection of $629 million is a little below the Street at $641 million.  Our EPS estimate is $0.36, above the Street consensus of $0.34 due primarily to lower interest expense.


Q3 should not be a make-or-break quarter for PENN.  The stock is appropriately off its recent high of $33.67 (July 28th) due to sluggish regional revenues, despite the up move in the market.  Rather than focus on the Q3 results, we see two main catalysts:

  1. The duration of the downturn – we think well into 2010.  We’ve proven gas prices to be a statistically significant variable in explaining regional gaming revenues.  The easy gas comparison reverses in late November then is quite ugly through the first half of 2010.  Assuming the current price holds, YoY monthly gas prices will show a decline ranging from +50% in December down to +13% YoY in May 2010.
  2. Using their dry powder – PENN has over $1.5 billion in excess cash and credit availability that it could put to work.  Fontainebleau is obviously the odds on favorite.  The good news is that levering up this underleveraged balance sheet probably creates equity value over the near term.  The bad news is that acquisition multiples may be higher than the Street is anticipating and, in the case of Fontainebleau, realized cash flow may be a ways off.

For those of you interested in “YouTubing” management from Q2 please note the following:






  • “So, July is looking pretty nice and we feel comfortable with that, but who the heck knows what August is going to look like. We are in that kind of a mode. So, if we are a little mushy on that kind of question it is because that is all we can do.”
  • “I don’t think we are seeing any rebound on consumer spending anywhere. It is still the same kind of trends. Overall as you look at the first six months of 2009 there are ups and downs through that period and July is more of the same.”
  • “While the current economic environment continues to impact the overall gaming industry, regional market revenue trends remain largely stable…while visitation levels at our facilities remain similar to prior periods, spend-per-visit is lower, reflecting the challenges presented to consumers by current macro-economic conditions."
  • “We are very pleased with their [Lawrenceburg and Joliet] performance and look forward to a good third and fourth quarter there as the July results, as bill highlighted, continue to be online with our expectations.”
  • “It is going to take three or four quarters for Lawrenceburg to get fully ramped up and stabilized. We also have some additional work that we want to do to upgrade the amenities in the pavilion that is going to occur over the next three or four quarters as well. Nothing significant, but we certainly have some restaurants that need upgraded and that is going to be occurring over the next 12 to 15 months, but in terms of when we think Lawrenceburg will be running on all cylinders, it is going to take a few quarters out there for us to expose the new product to as many new consumers as we possibly can and then get all of our marketing programs in place that support the new facility.”
  • “To give you some color on Penn National, I do want to say it appears now, after about two months of operation, that we are not seeing any material impact from Bethlehem in the numbers there. When you add back the 1x catch up regulatory fees we are running at EBITDA margins that are around 20%. I think we can do a little bit better than that going forward as we continue to grow the business. The revenue growth there continues to be good; it is still showing double-digit growth.”
  • Peter Carlino [on the impact of oil in Zia’s market]:  “Last year… In Hobbs, New Mexico we saw the hotels there running 100% occupancies with ADRs above $100.00 because of all of the workers that were coming in there that were correlated to the oil industry. This has been a trend we saw late in the first quarter, continuing in the second quarter, where we are seeing the local market and our feeder markets not nearly as robust as it was a year ago. Things won’t get better until we see oil above $70.00 a barrel. That is an unusual circumstance, because in our other businesses we obviously want to see gasoline prices low and consumers not being faced with that hurdle to get in their car and come visit us, but when the oil industry and the price of a barrel of oil is high it does help us there.”




PENN: A YOUTUBE PREVIEW - penn guidance Q3


  • Excludes expected gain from insurance proceeds related to Empress Casino Hotel fire;
  • Excludes any future Ohio lobbying expense;
  • Depreciation and amortization charges in 2009 of $195.5 million, with $51.2 million projected to be incurred in the third quarter of 2009;
  • Estimated non-cash stock compensation expenses of $31.4 million for 2009, with $8.2 million of the cost incurred in the third quarter of 2009;
  • Excludes potential impact of Company modifying debt obligations;
  • A diluted share count of approximately 107.1 million shares; and,
  • There will be no material changes in applicable legislation or regulation, world events, weather, economic conditions, or other circumstances beyond our control that may adversely affect the Company’s results of operations.
  • “For the year we expect total maintenance CapEx to be roughly $90.5 million and project CapEx will be roughly $216.7 for a total of $307.4. [doesn’t include any spending in Kansas, Ohio, or Maryland.  Also it doesn’t include reimbursements from insurance related to the Joliet fire as we work through replacing the pavilion]
  • Tax rate should be in the 43% range and it shouldn’t pick up in 4Q vs 3Q – it should remain flat.

TIP: Selling Some Inflation Protection

My cost basis in TIP dates back to buying it on 4/3/09 at $100.27. Since this summer I have been carrying a double digit percentage exposure to TIP (Treasury Inflation Protected bond ETF) in the Asset Allocation Model.


Today, with inflation expectations coming my way (see chart), I am selling that exposure to TIPs down to 3%.


Obviously the narrative fallacy shopped by the Depressionistas has been decimated, and so have perpetual expectations of deflation alongside that.


Expectations dominate these returns, not lagging CPI or PPI data. The two positions that I have taken to protect against inflation expectations are long Gold (GLD) and long TIP. I remain long of both… just less of both, as prices melt higher.


I’ll buy TIP back on pullbacks to the following TRADE and TREND lines in the chart below. TRADE line support = $102.89 and TREND line support (intermediate term) = $101.43.



Keith R. McCullough
Chief Executive Officer


TIP: Selling Some Inflation Protection - a1


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