I spent a hot Tuesday in Atlantic City. This may sound strange but it was refreshing to hear doom and gloom commentary from Company and Property level management personnel. There is no false optimism here. I may be falling for the contrarian just to be contrarian perspective but the Buyside, Sellside, and even industry professionals all seem to hate Atlantic City. Unlike Las Vegas, estimates have come way down and revenues and margins have been under pressure for awhile. Don't get me wrong: June was not good and the smoking ban will hit the market hard come October 1st. However, the big Pennsylvania impact will abate soon and AC could actually benefit from the Staycation effect discussed in my last portal posting.

The price of the Trump bonds are clearly not reflecting that the sale of the Marina will close. The bonds currently trade at 62.25 despite a deleveraging $316 million pending sale. Richard Fields and Coastal Marina can walk away from the deal for just $15 million which doesn't sound like a lot. However, the lawsuit between Trump and Fields would be reinstated upon termination. This lawsuit has legs and is a reason to believe the deal could go through. Not making a call yet on the probability of this transaction closing but I'll have more on this one later.

How did Borgata manage to build The Water Club for just $400 million. This is a beautiful facility with 800 rooms, an unbelievable spa, meeting space, five pools, additional retail, and a new restaurant. In my career I've enjoyed calling out questionable capital projects in this industry. I've got to say, though, this is the first project I've seen in awhile that looks like it could actually hit the magical 15% ROI. Boyd Gaming has been an easy target for the shorts and I've been there along with them. Despite my negative view on Echelon (not the quality of the facility but the ROI potential) and continued headwinds in the Las Vegas locals business, the free cash flow yield of over 20% is hard to ignore, particularly considering the potential of The Water Club. Not sure if we are there yet on BYD but stay tuned. It's getting interesting.

EYE On Demographic Trends

According to NPD, most casual dining users can be found in two age groupings - 18-34 and 35-49. Collectively, these two groups account for approximately 50% of all casual dining visits.
  • While 18 to 34 year-olds comprise only 24% of the total U.S. population, they account for 26% of the total occasions at casual dining restaurants. The 35-49 age group accounts for 24% of casual dining visits.
  • While the number of people in this demographic is still growing year-over-year, it's at a decelerating rate. Beginning in 2009 the trends for this key demographic begin to flatten out and actually decline over the next five years.
  • The current consumption recession is putting significant pressure on an industry that has excess capacity. It appears that the demographic trends will complicate this issue.

EYE ON - Alcohol Consumption At Restaurants

Following the release of Constellation Brand's 1Q09 earnings, a Wall Street Journal article cited comments made by a vice president of the company that as a result of tougher economic times, consumers are changing their drinking habits by drinking less in restaurants and bars and more at home. This decreased alcohol consumption at restaurants will hurt casual dining operators as alcohol is typically a high-margin menu item that raises companies' average checks.

Specifically McCormick & Schmick's said on its 1Q08 conference call that its beverage sales had fallen 4.5% YOY on a comparable basis, which they indicated was a small decrease relative to a more significant decrease in on-premise liquor consumption in the broader economy. Alcohol sales, predominantly from the company's bar, represented about 28% of MSSR's 2007 sales and contributed higher gross margins than food sales.

Morton's, which generated about 29% of its 2007 sales from alcoholic beverages, however, stated that it has not seen any discernible changes in its beverage check, which is a good sign as the company is betting on continued strong off-premise consumption with 44% of its restaurants now outfitted to include its Bar 12-21. Additionally, all new restaurants will be built with the Bar 12-21.

Liquor sales are a significant contributor to the overall profitably of most casual dining restaurants. On top of everything else, the last thing the industry needs is declining liquor sales.


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A theory is only as good as statistics can prove. The theory that people will prefer Staycations over vacations in periods of escalating travel costs can also be applied to regional gaming operations. Based on a theory that higher airfares to Las Vegas may cause gamblers to stay closer to home I've taken a look at the math.

The following chart details the results from regressing quarterly YoY change in regional gaming revenues to quarterly changes in average Las Vegas airfare for the last 10 years. Airfare proves to be a statistically significant causal variable in explaining a decent percentage of the move in gaming revenues. Because of the potential that the independent (airfares) and dependent (revs) variables are autocorrelated with economic growth, I needed to control for this. In other words, a strong economy could be the driver of both higher LV airfares and higher regional revenues rather than the original thesis. Even when including the economic proxy variable, airfares remain a statistically significant explanation of movements in regional gaming revs.

As can be seen below, the Airfare t Stat remains significant (greater than 2) even after the economic variable is introduced in the multiple regression. R Square is .3 so LV airfare (variable 1) and the economy (variable 2) together explain 30% of the variance in regional gaming revenues.

Maybe there is hope for the regional gaming stocks after all. They could use the help. The precipitous fall in these stocks has driven Free Cash Flow Yields to almost 20%.

SBUX - The Proper Medicine; Shrinking to Better Profitability

Last night SBUX announced that it was going to close approximately 600 stores in the U.S. This represents a significant increase from the 100 store target the company previously announced. These stores account for about 8% of the U.S. Company operated store base. Approximately 70% of the stores targeted to be closed were opened since the beginning of fiscal 2006 and they represent about 19% of the stores opened from 2006 to 2008. The vast majority will close in Q4 of fiscal '08 through the first half of fiscal '09. In addition, SBUX reduced the number of planned new U.S. company operated stores to fewer than 200 for 2009 (down from about 250).

I have said before that SBUX's shareholders are paying dearly for the ill-conceived capital allocation decisions over the past three years. In the coming quarters, SBUX shareholders will be richly rewarded as the company corrects the excesses of the past and makes smarter capital allocation decisions for the future.

I love the shrink to grow stories, as the benefits to the P&L are immediate. First, by closing 600 stores that are losing money, EBITDA will improve. Second, 10% of the store base should see improved sales and profits due to the excess capacity taken out of the system.

This is a significant inflection point for the company.

CKR - Taking the High Road

The restaurant industry is facing significant challenges in 2008 and many in the QSR segment are addressing the issues by discounting. CKR chose not to discount and instead, raised prices 4%, which helped both blended same-store sales growth and average unit volumes.
  • In the most recent quarter, management reduced G&A expense slightly (down 10 bps YOY as a percent of sales), but there appears to be room for further cost cutting. And with Ramius LLC's recent letter raising concerns over CKR's high G&A expenses (relative to its competitors), management appears motivated to bring these costs down in the near-term, with CEO Andrew Puzder citing that keeping G&A under control is one of the two big strategic initiatives within the company (the other being managing commodity costs).
  • Looking out over the next few quarters, things should to improve for CKR as the company is lapping some easier revenue and margin comparisons in 2Q and in the back half of the year. CKR's refranchising efforts at Hardee's really picked up in 2H08 with the company refranchising 60 restaurants in 3Q and 30 in 4Q, which negatively impacted company-operated revenue growth. Although the company plans to refranchise additional units in FY09, there are only 40 units remaining under CRK's current refranchising schedule so the negative impact on revenues will be minimal relative to last year. Management continues to maintain that each refranchised restaurant reduces G&A spending by about $22-$24 thousand and that the costs are eliminated immediately when the stores are sold, but these savings have not yet helped to bring the company's overall G&A spending down to a more reasonable level.
  • From a margin standpoint, CKR should see some benefit in 2Q because it will be lapping the initial spike in food and packaging costs that it experience last year, particularly at Hardee's (up 130 bps YOY as a percent of sales on a consolidated basis and up 200 bps YOY at Hardee's in 2Q08). Increasing beef costs should offset some of this year-over-year favorability, however, as the company mentioned that it is already seeing beef prices rising in 2Q, which was not an issue in 1Q. The company's stance on discounting ( we will not deal with the issues by trying to drive business through discounting our products, serving inferior products or massively couponing ) should also help protect margins going forward as long as its ongoing price increases don't hurt traffic growth, like we saw at SONC and CBRL.

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