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MCD – Perspective on the executive changes

After the close, MCD announced that Ralph Alvarez has decided to retire as President and COO for health related reasons.  Importantly, Mr. Alvarez was the clear heir apparent to become the next CEO of MCD.  While I can personally sympathize with his orthopedic issues, his sudden resignation and stepping down from the board of directors seems somewhat odd.


To put this resignation in context there are some things to consider:


(1)    On December 8th MCD will report its second straight months of declining same-store sales in the USA.


(2)    I continue to contend that the largest new product in the history of the company (McCafe) is not going well, but it might be too early for someone to take the fall for this.  Think Don Thompson!


(3)    If he was such a great asset to the company why is he leaving the board?


(4)    There is a big void to be filled by his potential replacement!  I’m betting on Denis Hennequin, President of McDonald’s Europe!


(5)    MCD accelerated unit growth in Europe and MCD’s Europe Chief Financial Officer Jerome Tafani  said, "the trend in sales

we have seen up until October is not going to change in the coming months." 


Despite Ralph’s personal headwinds the timing and magnitude of this move does not completely rest comfortable with me. 


We will have our estimates for MCD November sales trends out shortly.   


Nearly every restaurant operator is benefiting from lower food costs, so what is the differentiator to any given stocks’ outperformance – top line sales!


In the second half of 2009 to date, the casual dining stocks as a group have declined 7.6%, excluding Landry’s performance, which is up nearly 150% as a result of CEO Tilman Fertitta’s purchase offer and Pershing Square’s subsequently taking a 9.9% stake in the company.  Outside of LNY, the top performers since June 30, 2009 have been (in order of best to worst) CBRL, BWLD, CAKE, PFCB and BJRI.  These are also the only names in the casual dining group that have posted positive stock performance thus far in 2H09, which represents a big shift from the first half of the year when only LNY’s stock declined from December 31, 2008 with the group, on average, up nearly 84%. 


When I looked at this list of outperformers in 2H09 to date, the first thing that jumped out at me was the fact that three of the names have a high concentration of their restaurant base in California with CAKE at nearly 20%, PFCB at about 16% and BJRI at over 50%.  Based on what we have heard about recent trends in California, particularly as it relates to the 12%-plus unemployment rate in the state, it is somewhat surprising that these California-centric names have outperformed.


The more important similarity among the group is, however, that despite some of these companies’ exposure to California, all of these names, except for one, have outperformed the industry benchmark on a comparable sales basis as reported by Malcolm Knapp in the most recent quarters (as shown in the attached charts below).  We all know the industry performance is not good, but having less bad results points to share gains and helps to explain, for the most part, the companies’ relative stock performance.


CBRL, which is up nearly 35% since June 30, continues to widen its gap to Knapp, outperforming by more than 6% in it last two reported quarters.


BWLD’s (up 22.8% over the same timeframe) gap to Knapp has come in somewhat in the last couple of quarters but the company still posted same-store sales trends that were 7.6% better than the industry average in 3Q09.


CAKE, up 8.8%, has not outperformed the industry average by the same magnitude as CBRL and BWLD, but the company has performed better than the average in each reported quarter of 2009 (by an increasing amount each quarter) after underperforming the average for all of 2008.


BJRI, up 1.2%, has maintained its 5%-plus gap to Knapp in the last two reported quarters despite the sequential decline in its same-store sales growth trends on both a 1-year and 2-year average basis.


So who does that leave out?  PFCB is up 1.7% in 2H09 to date and is the only casual dining name (again outside of LNY) that has posted positive price performance since June 30 with same-store sales trends at its main concept (the Bistro) that are underperforming the industry benchmark.  And, that underperformance increased by about 150 bps in 3Q09 on sequential basis from 2Q09.  Same-store sales growth in 3Q09 decelerated sequentially from 2Q09 on both a 1-year and 2-year average basis. 


Some might point to the improved margin trends at Pei Wei and to the concept’s recent same-store sales outperformance to explain the company’s relative stock performance, but it is important to remember that the Bistro still accounts for about 75% of total company sales.  There is no reason to believe that Bistro trends will turnaround prior to the industry so I do not think it is reasonable to believe that PFCB will be able to maintain this stock price outperformance much longer. 












The Research Edge Consumer Team is hosting a Holiday Party on December 9th



Please join the Research Edge Consumer Team for Holiday cocktails in Midtown on December 9th.  It’s hard to believe another year has almost passed and as a result it’s time to celebrate!  In appreciation of your support throughout the year, we look forward to seeing you at Bar 44 (located in the lobby of the Royalton Hotel, 44 West 44 Street b/t 5th and 6th).  Please stop by at any time between 6:30-8:30pm.  We will have an area reserved on the right side of entrance across from the lobby bar.


If you are able to join us, kindly RSVP by Dec 7th. We look forward to seeing you next week.



Research Edge Consumer Team,

Todd, Anna, Brian, Eric, and Howard

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As the story goes according to the Fed, inflation is under control, productivity is improving, not withstanding Friday’s minor blip, there have been no major setbacks for the US market since March 9th, the dollar’s decline is orderly, home prices are generally on the mend and unemployment is high across the country but initial jobless claims appear to be less than toxic.  Even better, there appears to be unlimited demand for US government debt at the lowest yields on record.  


This appears to be the recipe for keeping the market rocketing ahead. 


As Keith said in today’s Early Look – “Remember, when it comes to keeping rates unreasonably low for an unsustainable amount of time, ‘to go beyond is as wrong as to fall short.’ It’s time for He Who Sees No Bubbles to pull up a price chart of gold, the Yen, or short term US Treasuries this morning and wake up.”


With the market making higher highs, I ask myself, is it me or does the market need to reset the most basic relationship between inflation and the structural/secular trends imbedded in today’s prices or does the “new normal” make the old theories and old relationships meaningless in today’s environment?


One thing that has not changed during the recent “boom-to bust” market cycle is that demand elasticity is incredibly high, even for non-discretionary items, such as gasoline and food, and prices for both are rising—that is inflationary!


One rule that will not change is that the burning buck is inflationary.  Look no further than two non-discretionary items – gas and food. 


The consumer is not dumb! 


Howard W. Penney

Managing Director





ISLE missed consensus EBITDA projections but whisper numbers were lower. A little better cost management but same old top line sluggishness with no improvment post quarter end.



"In an environment plagued with low consumer confidence, our ongoing improvement initiatives are proving successful.... While we will continue to save where it makes sense, it is important to reaffirm our commitment to the long-term success of our business. We carefully evaluate making major changes to the customer experience which could negatively impact our business for years to come. Additionally, we completed the sale of a majority of our Blue Chip operating casino assets this week, completed our exit from the property in Grand Bahama last week, and expect to liquidate our remaining United Kingdom net assets before the end of our current fiscal year. We remain focused on exploring new domestic management and development opportunities."



ISLE reported revenues that were slightly above consensus and EBITDA that was below.  However, after trading off 13% since Nov 20th, investors were clearly bracing themselves for more disappointing results.  It sounds like most of the cost cutting efforts are complete and from now on it's really about being able to drive revenues.  The news there isn't encouraging.


Some markets performed better than others:

  • Colorado and Missouri benefited from regulatory reforms.  The Caruthersville rebranding to Lady Luck and new initiatives in Kansas City also benefited results in those markets.

Other markets remained challenged:

  • ISLE's facilities in Iowa were negatively impacted by new competition, Lake Charles was highly promotional and Florida continues to suffer from the uneven playing field between tribal and commercial properties.




  • The issues continue to be less consumer spend per visit and lower amount of high rollers
  • Unemployment is a huge issue and many of the areas in which they operate have unemployment rates above the national average
  • Continue to pursue management contracts and accretive tuck-in acquisitions
  • Unusual items: $6.8MM receivable representing the recovery of some collectibles that had previously been written off; had a favorable impact from several state income tax audits.
  • Debt: $54MM of R/C, $821MM on T/L, $357MM on bonds, $6MM of other
  • Capitalized interest was less than $25k in the quarter



  • Iowa suffering from competitive issues and I-74 bridge is still out of commission mid week - which is when they suffer the most.  Bridge construction is ongoing, originally it was supposed to last 3 months, now its more like 6 months
  • Pompano: marketing promotion went south.  Cost them $500k of EBITDA ... "too successful" with redemptions.  Won't do anything with that property until there is some tax relief.  There will be a special session in a few weeks but gaming won't be on the table.
  • Colorado: Most of the increase has come from table games, while slot revenues are largely flat.  Will continue to do what they can to remain competitive in that market.  Hoping that ASCA's Blackhawk grows that market.  
    • Will not committ $50MM
  • Exceeded expectations in paying down debt this year, how are they thinking about allocating the scarce FCF?
    • ISLE's focus during the last several months is to preserve cash flow, pay down down, and stay within the limits of the credit facility.  Longer term they know that there are some properties with deferred maintenance needs and some capital investment opportunities.  When they are more comfortable that things have really stabilized or have started to improve that's when they will start investing more in their properties
  • Thoughts on an equity deal?
    • Have looked at every avenues available to them and over the next few years they will need to term out maturities (maturities in 2012 need to address that by 2011).  Have and are considering all forms of capital including an equity raise to address the terming out of maturities 
    • Basically, they will be opportunistic
  • Active in several discussion on several different fronts (re: developments) but greenfield opportunitites probably make less sense
  • Pompano and Lake Charles were the primary drivers of heightened promotional spending.  Houston had the highest RevPAR decline in the week leading into Thanksgiving... expect some weakness there as a feeder market
  • Have been receiving payments from Pittsburg for the last 6 months (when they were looking to do a deal with the Penguins).  They are owned $10MM, used a higher discount rate before because of collectibility issues
  • State tax adjustements?
    • Settled a liability in LA for less than what they had reserved for
  • Got 2MM GBP for the sale of the UK assets
  • Bahamas impact in 2H2010 should be neglible.  There will be a little carryover into 3Q2010, just got out of the contract this month
  • Normal tax rate = 37%
  • Lake Charles: What are they doing at the property level to improve results?
    • Changed the top three managers in the last month.  Promoted from within (other properties)
    • Stabilized margins? Ran at 17% last year which is closer to where they should be
  • Colorado: Is ASCA really growing the market with their hotel?
    • They are seeing some improvement from August, which was disappointing.  Their hotel occupancy was in excess of 90%.  Looking at opportunities to freshen the slot product to grow slot revenues
  • Pompano: They are entering their strongest period now, but they aren't giving any guidance
  • Had a timing change in corporate expense because they issued restricted stock three months earlier but tracking where they expected for the year
  • Bank leverage calc: 3.7x
  • How are trends in Nov?
    • Haven't seen a whole lot of change in trends since the end of the quarter.  Earlier commentary on spending per trip still holds.  Don't expect to see much change for a while.  Retail revenues is still off 12% (ex-Missouri)
  • Because of the change in regulation in Missouri, there has been a migration to retail play because you no longer need to have a card - "ie be a rated player"
  • Davenport: City would like someone to come in and make a significant investment in the market (Cumming Study indicated that someone would spend $150MM to build a land based property).  They have no appetite, but if they find someone that does and wants to compensate ISLE than they wouldn't stand in their way
  • Slot spending?  Included in maintenance.  They will spend $8-10MM in the balance of the year in slots.  When will they decide what to spend in FY2011?  
    • Wouldn't expect a material increase in maintenance going into next year
    • More opportunity to refresh floors in Blackhawk and Lake Charles
  • Iowa: 4 proposals?
    • Last IRGA meeting, spoke about doing tours of applicants properties in spring of 2010 and then making some sort of decision afterwards
  • Big project in Biloxi?  Still a priority when things recover?
    • No it's third on the list after Black Hawk and Lake Charles
  • Thinks that there is a healthy debate on what to do in Florida, and thinks that the compact will not get approved in current form
  • Covenant is 7x now and drops to 6.75x in 6 months

Don't be SHY: Call Them Bubbles

Last week, as this chart of short term US Treasuries was making its final ascent up into the right of it’s crest, we called it one of the 3 main bubbles that He Who Sees No Bubbles (Bernanke) is not allowed to see:

  1. Gold (immediate term bubble)
  2. 2-year Treasuries (intermediate term bubble)
  3. Banker Bonuses (long term bubble)

So, don’t be shy about this – just see this for what it is and get hedged (SHY is the short term Treasury ETF that we shorted). With 2 year-yields testing 0.65% last week, it was mathematically impossible for yields to go much lower (unless we become Japan, which I guess is possible), particularly if you believe that maintaining a ZERO percent policy on US interest rates isn’t perpetual.


In fact, the only other times that 2-year yields have been this low are December of 2008 and all the way back in 1938 (the early months of 1939 and 2009 were not pretty for equity returns as yields moved higher from their lows).


In the chart below, we have shown the SHY breaking its immediate term TRADE line (today). This raises a critical risk management signal in our macro model. It is both early and leading in terms of its indication. We will have to see if this immediate term breakdown in short term Treasuries holds.


He Who Sees No Bubbles has a unique problem with his vision – he cannot see what he is responsible for creating. Greenspan had really big glasses, but admitted in October of 2008 to missing this altogether as well. This is not new. Cheap money for a select few has plenty of unintended consequences.



Keith R. McCullough
Chief Executive Officer


Don't be SHY: Call Them Bubbles - SHY


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