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I like cash flow, especially if it's free. Buying the regional gaming operators at a forward free cash flow yield over 15% has historically generated outsized returns. I understand that FCF yield is a function of price so the two often move in opposite directions. However, even buying in at the beginning of the valuation cycle rarely has lead to significant losses. By my calculations, the regional gaming operators (ASCA, BYD, ISLE, PNK) are trading at an average forward free cash flow yield of 18%, very attractive indeed, especially in light of the historical precedent. The last time yields crossed the 15% threshold was the 9 month period from December 2002 to August 2003. This turned out to be a very opportune time to invest in the regional stocks. Buying the index at the average price during this period would've yielded a 125% return over the next 9 months. Even if one bought at the peak, the return would've still been 100%. Looking back even further to the elongated period of high free cash flow yields 8/98-7/2001, buying in at almost any point would've generate positive returns over the subsequent 12-18 month period. Can money be made in the current FCF cycle? Only time will tell but history and valuation support the long view. We've got our eye on PNK.

VFC: Short

On days like today, when my macro view puts me in sell mode, I'm looking for names to short that are up. VFC gets today's nod.

Of course, it's always accommodative to have the dynamic duo of Barron's and Cramer recommending you buy it within the last week. Cramer is really having some performance problems by the way.

With only 2.3% of the shares held short, this company has been one of Wall Street's favorites in Consumer land. The problem there is implied, and creates opportunity to the downside, particularly when the Street's Q3 estimates are as far away from reality as they are from ours. There are 10 sell siders with estimates on VFC - no one has a sell on it, and an all time high of 67% of ratings are either BUY or Overweight (according to Factset).

Capital Research filed on it, and their 5.6% ownership in the company looks ripe to be sold down if we are right on the Q3 miss.

*Full Disclosure: I am now short VFC in my fund.

(chart courtesy of stockcharts.com)

Wyndham (WYN): Shorted On Strength Today

While it's not going to be as profitable a short as it was when I shorted it into JP Morgan's analyst positive recommendation last year, this is still an overvalued hotel stock, levered to the time share business, who's going to miss the Street's expected numbers by a wide margin if my Partner, Todd Jordan, is right on the sector call.

WYN still has relatively low short interest, at 4.4% of the float, and overly bullish sell side coverage. I'd short it with a $21.05 stop loss. This stock should continue to make lower highs, and lower lows.

*Full Disclosure: I re-shorted WYN today in my fund.

(Chart courtesy of stockcharts.com

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SONC - More Clarity, More Concerns

In its earnings release, SONC stated that it expects 4Q system-wide same-store sales growth of 2%-4%, with partner drive-ins performing somewhat below this range. On the conference call, we learned the magnitude of this underperformance, with the partner-drive-ins expected to remain 3%-4% below the system average, which is in line with the reported 3Q results (system same-store sales -0.4% relative to the -3.9% partner drive-in number).
  • Partner drive-in traffic was negative in each month of the quarter (almost flat in May), but even with trends improving sequentially (becoming less bad), management indicated that traffic is only growing in the afternoon, which is when the company is discounting the most around its Happy Hour promotion. So the only daypart that is experiencing any traffic momentum is coming at the expense of margins (restaurant margins were down 140 bps YOY in the quarter). The company began in May to adjust its value message by promoting more combo meals and premium sandwiches to drive traffic during the more profitable lunch and dinner dayparts, but I am not sure how quickly this will translate into improved results because the company has built up such a reputation through its national cable advertising as being the place to stop in the afternoon. It will be particularly difficult in the summer months to steer its guests away from $0.99 shakes.
  • More margin pressures. SONC will be facing increased labor costs on two fronts. As I mentioned yesterday, SONC pulled the goalie to make numbers by cutting back on labor to maintain margins. The company attributes part of the fall off in partner drive-in same-store sales to the resulting decline in service, so going forward, management will have a renewed focus on customer service, which will cost money (company expects its overhead costs to increase 8%-10% in 4Q). Additionally, margins will be hit with the second round of minimum wage increases in July. And this time around, these labor cost increases will be felt more proportionately because last year the company raised its prices by 4% to help offset the rising costs. Management also blames this overly aggressive price increase for the slowdown in partner drive-in same-store sales because franchise drive-ins did not raise prices as aggressively at that time. That being said, I was surprised to hear the company is going to increase prices an additional 1%-2% this year. Although the company said it will be more strategic in its implementation of this price increase by doing so on a market by market basis, judging from recent results, the consumer does not seem ready to digest any increase.
  • And if that is not already enough, company margins will be hurt even more by commodity costs. The company did not give too much visibility around FY09 expectations (said it will provide FY09 outlook in early September), but it did highlight the more difficult environment as it relates to locking in certain commodity costs. Management stated that it is currently buying its beef requirements on a month to month basis at double-digit YOY increases, and that although it has historically used longer-term contracts to lock in these prices, that the premium charged to do so today does not make it an economical option (Please see related post Eliminating Some Certainty to the Earnings Model of the Restaurant Industry regarding commodity costs and long-term food contracts).

Eliminating some certainty to the earnings model of the Restaurant Industry

The increased volatility of the commodity markets is adding an increased level of complexity that most restaurant companies would rather not have to deal with. Today, both Darden and Sonic talked about floating some of their key commodity exposures.

Darden announced that given the environment, there is less opportunity to enter into long-term contracts with their food suppliers. Also, Sonic said that the cost of entering a long-term beef contract was prohibitive so they are now floating their beef exposure.

As it relates to Darden, the company will be buying futures contracts in the open market to hedge their exposure to certain commodities. While this is new to restaurants, companies like General Mills, Tyson and Kraft have long hedged their costs. From an accounting standpoint, Darden will be required to mark-to-market its futures contracts each quarter. The volatility of these future contracts will pass through the income statement and may overshadow the company's true underlying operating performance. The company would rather continue to lock in these costs though longer term contracts, but given the volatility of the commodity market, many of the suppliers to the restaurant industry don't want to take that risk. Naturally, this puts some of the risk back on the industry participants to manage the process and consequently, eliminates some of the certainty over commodity costs that many restaurant companies have enjoyed.

FED VIEW: Give Fisher Bernanke's Job...

No change to the Fed Funds rate.

So the easy money game in the US market lives to play another day. Dallas Fed President Fisher dissented. Fisher's timing is right, and Bernanke's continues to be off. Timing is everything. Bernanke remains in a political box, pandering to Washington and Wall Street.

Bernanke's confusion will ultimately breed contempt. Maybe not today, but soon enough. I am actually long the market for a "Trade", but will be selling into strength now. Bernanke wasn't in the area code of being hawkish enough here. It's going to be a long summer...

My call is that if Obama wins, Bernanke will be gonzo in 2009. Fisher wants Bernanke's seat, and he made the right call today by nudging his foot in the door.