After a melt-up day on Monday the S&P 500 finished up 0.31% in fairly light trading on Tuesday.  There was no dominating theme running thru the market yesterday.  From a MACRO view the market has seemed to discount the heightened global economic recovery theme that fueled Monday’s rally. 


Tuesday’s MACRO data points were not as convincing as Monday’s and in some cases were downright bearish.   After rising for 10 consecutive months, pending home sales declined 16% month-to-month in November vs. expectations for a 2% decline.  While the number was explained away as an anomaly as the early November extension of the first-time homebuyer tax credit was not in place to provide any meaningful support. 


Also on the MACRO calendar, factory orders rose 1.1% in November, above consensus estimates for a 0.5% increase. While durable orders were unrevised at up 0.2%, core capital goods orders were revised up to 3.6% from 2.9% in the advance report. In addition, core capital goods shipments were revised up to 1.1% from 0.8%; orders for non-durable goods rose 1.8% in November, the fourth consecutive increase.  Inventories rose 0.2% in November following a 0.6% gain in October. 


After the close the ABC consumer confidence reading came in at -41 versus last week’s reading of -44.  The index has not seen a reading of better that -41 in nearly two years.


While the MACRO calendar was mixed, the sectors levered to the RECOVERY trade were the outperformers.  Defensive sectors were among the worst performers, with the Utilities being the worst performing sector for the second day in a row.  The underperformance of the Utilities is consistent with our “Rate Run-up” theme for 1Q10.


Yesterday, the Financials was the best performing sector on the day.  Life insurers and Bank stocks were another bright spot with the BKX +2.24% and now up 4.51% over the past two days.  Within the XLF, COF was up +3.9% (A Research Edge top pick) and C +3.8%, BAC +3.3% and WFC +2.8% also outperformed.  MS is now up 8.09% in the first two trading day of the year. 


After underperforming on Monday, Consumer Discretionary was the third best performing sector yesterday.  Consensus is building that December same-store sales are going to be stronger than expected and some key sell-side upgrades helped the retailers outperform. 


The range for the S&P 500 is 12 points or 0.25% upside to 1,385 and 1.0% downside to 1,125.  At the time of writing the major market futures are trading lower on the day.    


Copper rose O.22% yesterday and is trading up 1.77% in early trading today.  Copper is trading higher for the fifth straight day on speculation that demand will improve as the U.S. economy continues to show strength.  The Research Edge Quant models have the following levels for COPPER – buy Trade (3.31) and Sell Trade (3.47).


GOLD trade up yesterday by 0.33%, but the dip mentality prevails.  The Research Edge Quant models have the following levels for GOLD – buy Trade (1,084) and Sell Trade (1,137).


Crude oil traded up 0.32% yesterday to 81.77 - a 14-month high – as cold weather in the U.S. and signs of economic recovery are helping demand.  The Research Edge Quant models have the following levels for OIL – buy Trade (78.74) and Sell Trade (83.04).


Howard Penney

Managing Director















The Macau Metro Monitor.  January 6th, 2010



The government of Macau recently announced that it plans to invest a further MOP 126.4 million in the tourism industry by the end of March, under policies that were to expire at the end of 2009.  From August to December 2009, the city invested approximately MOP 28.6 million in guide services and business tourism events.  The New Year’s Day holiday, lasting from January 1st through January 3rd, saw 279,000 tourists travel to Macau, 3.71% more than in the same period of 2009. 




Recently published regulations on VIP gaming in Singapore impose strict measures on high-rollers and gambling junket organizers alike.  VIP gamblers will need to provide their name, home address, ID or passport number, and other details.  Junket organizers and agents must submit detailed financial disclosures, pay for background checks to be completed, and submit to finger and palm printing, among other requirements. 


While not unexpected, the rules are indicative of the regulatory environment awaiting LVS, Genting Group, and any other prospective player in the Singapore gaming market.  Despite this, the effective tax rate on VIP gaming revenue of 12% (compared to 39% in Macau) should help Singapore to be competitive in the Asian VIP market.  Casinos in Singapore will be free to pay out higher rebates to the VIP players who visit, as well as higher commissions to junket organizers who hurdle the requirements of the authorities.

BBBY: Trying to Find a Coupon

Bed Bath and Beyond is expected to report results tomorrow after the close and we’re expecting another solid quarter.  Recall that this has been a name we’ve liked for some time now, mostly due to the company’s “mean reversion” opportunities.  An improving economic backdrop, the elimination of the company's most direct competitor, and the bottoming of the worst period in modern history for home furnishings consumption have all been key to the fundamental recovery in BBBY’s earnings and subsequent share performance.  Along the way, earnings have handily beat expectations for the past few quarters, even as expectations have gradually risen along the way.  This quarter is no exception, with the Street looking for $0.43 (up from $0.38 when the quarter began).  However, we still believe there is even further upside, with our model shaking out at $0.46. 


It is important to note that BBBY’s 3Q results are comparing against the single worst quarterly same store sales performance in the past 10 years!  As such, we are forecasting a 3% comp increase against the 5.6% decline last year (which may be conservative given this actually implies a deceleration on the two-year).  While any of us of can open a spreadsheet or review a transcript, the importance of fully understanding what exactly was taking place at the end of last year is key to near-term results.  The promotional environment over the 3Q/4Q period last year was especially aggressive, driven in part by overall economic uncertainty but more specifically by aggressive couponing brought on by the Linens ‘N Things demise.  As a result, BBBY’s gross margins were hit by 280 bps (largest drop in the entire housing bubble) as the company attempted to remain competitive and garner share in the midst of severe sales declines and the Linens’ liquidation.  Try finding a coupon now.  I actually did try and it’s not as easy as one would think, even with internet sites such as 


Fast forward a year and we are now in a much more rational promotional environment.  BBBY’s couponing has subsided measurably, aiding gross margins and to a lesser extent SG&A (direct mail costs reside on this line).  Last quarter marked the company’s return to gross margin expansion after 10 consecutive quarters of declines.  We maintain that the single biggest factor that is misunderstood in the BBBY story is how long the gross margin recovery can last.  It is simply not a 1 or 2 quarter process in our view.  As such, gross margin expansion should continue for at least the next 12-18 months driven primarily by BBBY’s improved competitive position (it is now the only stand-alone game in town), substantial reduction in the use of irrational couponing, tight inventory control, and improving sales trends as pent-up demand in the home furnishings category fuels improving demand.


Adding a modest 5% square footage growth rate (yes, management is conservative but it serves well for the EBIT recovery story) and a growing cash balance expected to be near $1.5 billion (no debt), BBBY is a much more stable cash flow generator than the Street gives it credit for.  There are currently 9 buys, 15 holds, and 1 sell rating on the company.  Clearly this is still room for sentiment to improve here.  Tomorrow after the close solid results should further bolster our positive bias on the shares.   If there is one surprise to come, we still think it will be a firmer commitment to the buyback.  With $900 million remaining under authorization the company has barely bought a share back since the couponing began…


Eric Levine


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Ruby Tuesday is scheduled to report fiscal 2Q10 earnings after the close tomorrow and I am expecting EPS to come in a penny better than the street’s estimate of a loss of $0.02.  Fiscal 2Q10 marks RT’s last quarter of relatively easier comparisons from both a top-line and EBIT margin perspective.  I am expecting company-operated same-store sales growth to come in -2% relative to the street’s -2.7% estimate.  On a 2-year average basis, this assumes a 50 bp acceleration from the first quarter, a level that is even with that of the casual dining industry as measured by Malcolm Knapp.  As it relates to YOY comparisons for both RT and the industry as a whole, if RT’s trends improve by the same amount on a 2-year average basis as the industry in RT’s fiscal 2Q, the company’s gap to Knapp will narrow on a sequential basis to about 3% from 4% in 1Q10.   For reference RT’s performance has gotten better on a sequential basis relative to the industry for the last six reported quarters.


Even with the relatively easier EBIT margin comparison from 2Q09, I am expecting about 70 bps of contraction in 2Q10 (following a nearly 100 bp improvement in 1Q10).  In the back half of the year, however, margins will come under increased pressure as RT will be lapping two quarters of 200-plus bps of YOY improvements.  Making the second half more difficult is the fact that RT will be lapping lower SG&A spending as a result of the company’s increasing its span of control for both regional and area supervisors in the back half of last year and lower depreciation expense from the 3Q09 closures. 


Relative to RT’s full-year guidance, I am comfortable with the company’s ability to achieve EPS of $0.50-$0.60; though I think the lower end of the range is more likely.  Management gave same-store sales growth guidance of -1% to -3%.  Again, I think the lower end is more likely and could even be at risk as it assumes more than 300 bps of sequential improvement in 2-year average trends from 1Q10 to 4Q10.  For reference, same-store sales comparisons get relatively more difficult in the back half of the year so even if 2-year trends continue to improve, numbers will likely begin to come down on a 1-year basis in 3Q10.


This improvement in top-line trends will have a lot to do with how the overall industry fares going forward (we will have to see if the better November trends are sustainable), but RT is also lapping its significant promotional efforts from January 2009 in fiscal 3Q10.  In the last couple of quarters, RT’s top-line outperformance has been driven by traffic growth.  This growth has come at the expense of average check growth.  On RT’s 1Q10 earnings call, management stated it still has a goal to increase average check to the $12.50 to $14.50 range from the current mid-$11 range and that with customer traffic up, the company can now work on increasing average check.  It will be important to see if the company can continue to sustain traffic growth with average check growth and the true test will come in 3Q10. 


One area of management’s guidance that my numbers don’t currently match up with is the company’s outlook for restaurant level margins to decline 50 bps to 150 bps.   I am modeling closer to a 160 bp decline in margins for the full-year.  Obviously, where these numbers come in will be driven largely by how same-store sales trends play out for the balance of the year.  RT’s restaurant level margins have declined on a YOY basis for the last 11 quarters.  The YOY declines have continued despite the sequentially better same-store sales numbers because the company’s food costs as a percentage of sales have come under increased pressure from the company’s discounting and promotional efforts.  If the company is able to increase its average check and traffic in the back half of the year, then it will take some of the pressure off the food cost line and subsequently, restaurant level margins.


Fiscal 2010 should be another year of strong free cash flow for RT.  This free cash flow along with the $73 million in proceeds from the company’s equity offering in 1Q10 should allow the company to achieve its goal of paying down $165 million to $175 million of debt during the year.


RT has grossly outperformed its peers in the last year and that is with the group on average trading up 76%.  In the last six months, this outperformance has narrowed with RT up 10.7% versus its peers +9.6% move.  With RT’s top-line outperformance relative to Knapp Track likely to narrow from 1Q10 levels and margin comparisons getting more difficult in the back half of the year, I think it is unlikely that RT’s stock will have another year of outperformance.


RT - EARNINGS PREVIEW - RT stock price chart

Financials Breaking Out: Can They Hold?

On our Macro Morning Call (available now, daily, by podcast – email ) last week, we talked about contrarian moves that might catch people off-side’s in the first few weeks of the new year. One was a final meltup in the SP500.  Another was a potential reversal (to the upside) in the US Financials.


Today we are seeing the Financials (XLF) play catch-up with the SP500. The XLF is up +0.75% in a flat tape, outperforming all of the sectors in our 9 sector SP500 Risk Management model.


Most importantly, the XLF is breaking out above our intermediate term TREND line. That line = $14.65/share. The question now is, can this mean reversion move in the XLF hold its gains? If it can, into and out of Friday’s employment report (ahead of JPM kicking off the sector’s earnings next week), this will get very interesting, very quickly.


Don’t forget that the XLF has underperformed the SP500 by 1100 basis points since it put in an intermediate term peak in mid-October. There are plenty of reasons to fear the financials, not the least of which are Macro Themes we’ve been beating on like Re-Regulation.  Today, consensus favorite, Meredith Whitney, is trying to add to well placed fears in the money centers and brokers by taking down her numbers again in Goldman Sachs.


Last month, we launched coverage of the Financials sector with a bearish immediate term view on the money center banks and a bullish view on Capital One (COF). In the long term however, Josh Steiner and I think that the financials should hold their long term TAIL of support (outlined in the chart below at $12.16).  


In between now and then, the best risk-managed approach to this sector will be to let real-time prices tell you where to bob and weave. Watch this $14.65 line in the XLF very closely.



Keith R. McCullough
Chief Executive Officer


Financials Breaking Out: Can They Hold? - XLF



Kraft Foods announced this morning that it has agreed to sell the assets of its North American pizza business to Nestle.  Among other brands, the sale includes the California Pizza Kitchen trademark license and is expected to close in 2010. CPKI stated in a press release that it is “excited about a new relationship with Nestle and look forward to working with them in further developing the brand in the grocery channel."  Although CPKI management went on to say that it expects a smooth transition to Nestle, I would expect some disruption around the company’s royalty business until the transition is complete.  And, longer term, the future of this part of CPKI’s business could be in question as we do not know if or how the trademark agreement will change with Nestle or how the brand will fit into Nestle’s portfolio.  With Nestle being a European company, albeit with a presence in the U.S., I am concerned that the CPK brand may not get the same focus as it did from Kraft, which could impact both the marketing and execution of the frozen pizza products.


Royalties from the Kraft licensing agreement only represented about 1% of total sales in 2008, but it is a fast growing, high margin business for CPKI.  In the most recent quarter, Kraft royalties grew 35.2% and this follows 40% growth in 2008 and 30% growth in 2007.  It was only two months ago on CPKI’s 3Q09 earnings call that CEO Rick Rosenfield said “Our Kraft business continues to perform well with its expanded product line of pizza and pizza-related items. And despite an influx of competition and escalating marketing initiatives, our Kraft royalties were up 35.2% in the period. We continue to be encouraged by our prospects in the grocery aisle and feel that we have a distinct advantage by having our frozen products identified with our successful restaurants.  Moreover, we have a great relationship with Kraft and expect them to spend a significant amount promoting the CPK brand this year. Larry and I are working cooperatively with them on several initiatives to increase brand awareness of both our frozen product line and full service restaurants themselves.” 


His point about Kraft spending a significant amount behind the CPK brand is an important one as Kraft was required to spend a percentage of net sales on advertising and promotion of California Pizza Kitchen’s licensed products. One of the key questions for CPKI is whether this part of the agreement remains intact under the new agreement with Nestle.

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