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CRI: Why Swing At Such A Bad Pitch?

The main reason I pulled a 180 and got positive on CRI on 6/12 was my view that a long-needed CEO change can get the senior team refocused on actually investing in its brands instead of robbing them of capital and realigning its org chart to facilitate growth – even if it is at the expense of near-term margin. I was pretty confident, in that regard, that new CEO Mike Casey would take advantage of his first quarter out of the box to take down margins by 2-3 points (a level where I think CRI needs to revert to in order to sufficient brand investment capital in place). The 2Q earnings beat certainly proves me wrong there, as Casey printed a decent quarter (and a solid one relative to expectations), when he could have easily tanked the quarter and/or outlook with little recourse.

Does this new team ‘get it’ that it has to play catch-up in investing in its brands to stimulate growth at a consistent rate? This raises an interesting decision tree for me.

If the answer is ‘Yes’ then the timing is still too early on CRI, as there is another guide down to come. Perhaps the sheer magnitude of the changes to come take longer than the 6 weeks since the change was announced. I’m in this camp, and can completely see why it should take time to build the plan – especially given that this plan is likely to not include several senior managers at the company (i.e. Casey needs to walk on eggshells while he cans some colleagues).

If the answer is ‘No’ then this story is back to one where it will rally repeatedly on false starts – only to fundamentally stall due to lack of horsepower to compete. I don’t think this is the case, but tonally – it is THE KEY thing to watch out for. If Casey’s agenda (regardless of how it is discussed on the call) is about ‘tweaks’ to the model instead of material changes in strategic direction, then I’m going to eat crow on this story and head for the hills.

Don't Be Short, Yet...

In the face of ugly “Tech” earnings outlooks yesterday, the Nasdaq opened weak, but failed to “crack” at my code red support level. Instead, the market found its footing again, rallying smartly into the close. As the facts change, I do. The US market “Trade” facts remain bullish as a result, and it looks like the 1 range that I’m in print with is going to be reached. Now what?

Now that the sharks have bloodied the crowd of “hedgie” seals in the short selling waters, and US Financials have been squeezed for a +31% move in 5 trading days, we can recalibrate our sights. Right on time, after the market close, Fast Money’s “Commodity King”, Dennis Gartman, comes out bullish on the Financials “buying the bank index”, and Larry Kudlow cheered him on, like only one of the Hanson Brothers could. This is AFTER a +31% move – gee, thanks Dennis. He should stick to commodities where he has an admirable investment process.

Alongside them, self professed macro savant, Don Luskin (Strategist for Trend Macro), said on Kudlow last night, “absolutely – summer rally… “we have a recovery on our hands…”? This guy must live in a house with no accountability mirrors. He’s been long and wrong for all of 2008, and he still has the audacity to talk down to everyone on Kudlow whenever we have an up day. The only “Trend” I see in Trend Macro’s call is mental inflexibility.

Cart out Gartman, Kudlow, and Luskin, and buy US Financials today at your own risk. I’ve been running net long for this US market “Trade”, but I will not mistake it for a “Trend”, yet… I need to see more cards… but bears beware… the ones that are showing face up on the tape this morning are bullish. We had a big volume day yesterday, with solid breadth, and a breakdown in volatility (VIX). Commodity country tapes like Russia, Brazil, and Saudi Arabia, are breaking down, alongside US Treasuries. I like what I am seeing for once.

On the heels of the Philadelphia Fed’s Charles Plosser talking up the US raising rates intraday, the almighty inflation river card continued to show expeditious deflation. So far in July the CRB Commodities Index down -11% from its high, and the US Dollar is starting to base as a result. You do not want to be short this hand of macro factors. I moved to +49% net long into the close, my most bullish position on the long/short equity side of my book in well over a year.

Rather than chase the aforementioned consensus crew into a group that’s already moved +31%, I like the idea of being long Asian ETFs and related companies. I splurged and bought the Chinese ETF yesterday (FXI), and I think that’s where you want to be ahead of the Olympic catalyst in August. I am still long back door plays on the Olympics like DWA (Kung Fu Panda), and DELL. I have been bearish on Asia since November, so this is a material shift. We called out China and India yesterday as breaking out on short term momentum indicators (see the portal for charts). This morning you see the “why” as India ripped the shorts closing +5.9% on the session after PM Singh won a political crisis confidence vote. Fortuitously I am out of my India Fund (IFN) short position.

On a relative basis to the US, Asia has sober monetary policy combined with legitimate organic economic growth. Only part of the stock market value proposition could change for me here in the US if Bernanke goes ahead, provides some leadership, and raises rates. On the US economic growth front, I am still begging for scraps as to where we’re going to find it, sans the “Blue Magic” Wall Street leverage. Heck, even George Bush is calling out Wall Street as being “drunk” at this point. When Bushy finds the fundamentals, it means they are not trivial anymore folks.

A +6.5%rally in the S&P 500 in 5 trading days is not going to bring back easy “Access to Capital”. As 10 year yields tick up again this morning to 4.14%, “Cost of Capital” continues to rise; meanwhile, the worrisome sound of “Re-regulation” of the US Financial system is in motion. So tread carefully up here on the momentum “Trade” high wire. Long Financials? Not here. But don’t be short this market, yet…

Good luck out there today,


Wyomissing, PA is certainly not the most convenient place for a management meeting but it was well worth the $50 in gas to spend time with these value creators. For those of you who don’t know, Chairman and CEO Peter Carlino has generated more shareholder value per share in the last 10-15 years than any other management team in the gaming business. If I had any doubts about his desire to charge forward following the merger termination, they were quickly squashed. Now, armed with $1.4bn in new liquidity "wrestled away" from Fortress and Centerbridge, PENN can capitalize on an environment that appears ripe for some more value creation. Assets and gaming companies (including PENN) are cheap and there is literally no competition on the buy side. I’m not sure that sellers will be lining up to give away assets at fire sale prices. However, this is a patient management team that will not rush to spend its new found largesse just because it's burning a hole in its pocket. Creativity may be the key to “wrestle assets away” from unwilling sellers. There are a few companies that may soon have a gun to their heads to sell assets. You can be sure PENN will be there to “help” them out.

I’ll have more posts on this topic and a few other others regarding PENN coming soon to a portal near you.

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Aussi Inflation Abating

Australian wholesale inflation came in significantly lower than anticipated yesterday at 1% vs. a median forecast of 1.6%, sparking a market rally in advance of the CPI number on Wednesday. This is one of the main reasons why Asia acts better than Europe. Rates hikes have been more vigilant across the region, particularly by Aussi central banking head, Glenn Stevens.

Reported inflation in July could come in lower than consensus expectations, globally. I think this is one of the primary reasons as to why the shorts are being continuously squeezed this past week, and why the top side of my short term trading range can be achieved.

Chart by Andrew Barber, Research Edge


This post highlights some of the ideas we have been talking about on the “RED” side.
  • YUM – Yum has several attractive attributes making it an appealing investment vehicle: international opportunities, the Dollar doldrums, and significant cash to return to investors. YUM has consistently posted strong results in both its China and YRI segments, which has helped support the stock despite the U.S. business being in a secular decline. As China is becoming a more important part of the story (made up 5% of operating income in 2000 and expected to represent about 25% in 2008), I voiced some concerns about the company’s new dependence on China growth. Although these concerns did not manifest in 2Q08 as same-store sales were up 14% in China, it should be noted that on the same day YUM reported its results, Chinese 2Q GDP was reported at +10.1% (making it the second consecutive quarter of decelerating economic activity). And YUM is up against difficult comparisons in 2H08 in China with management stating “we cannot expect mid teens same-store sales growth and 30 to 40% profit growth to continue.” Additionally, the company’s currency benefit has grown over time for both China and YRI and helped segment operating profit growth by 12% and 9%, respectively, in 2Q08. Investors have become accustomed to these high, double-digit reported operating profit growth results and this favorable currency impact may not be around forever.

    The U.S. margin story is also concerning (and that might be an understatement as the business is in a secular decline) as YUM raised its FY08 U.S. same-store sales guidance but took down its operating profit target, which implies the company will see more, less profitable traffic as a result of its Why Pay More initiatives at Taco Bell and its pasta introduction at Pizza Hut.

  • CMG – Right now, CMG is the only restaurant company with double digit EBIT margins and given the current economic environment, CMG's same-store sales are in a class of their own. Over the past two quarters the company has posted same-store sales of 10.6% and 10.2%, respectively. Looking out over the balance of 2008, CMG's same-store sales are likely to slow to mid-single digit growth. In 1Q08, CMG did benefit from an easy 8.3% comparison due to a tough winter last year. For the next two quarters comparisons get more difficult at 11.6% and 12.4%, respectively.
  • RRGB – RRGB will now be the poster child for how difficult the operating environment is. In 1Q08, RRGB's traffic declined 0.4% despite incremental advertising (and up against easiest comp from 1Q07 of down 3.6%). Despite a Q1 miss, management raised their guidance but mainly to reflect the acquisition of 15 restaurants from franchisees. Since then, the company announced that recent top-line results may trend to the low end of its previously guided full-year sales assumption.
    I continue to be concerned about the company’s aggressive price increases, which could be detrimental to traffic. The company will be running at about 6% price from late June through mid-August and average at about 4% for the year. I am also not yet convinced that the company’s increased advertising spending will yield the necessary returns. Additionally, RRGB is accelerating its capital spending in a very difficult operating environment and not bringing the cash home to shareholders.

  • SONC – SONC’s primary issues result from the company’s new reliance on discounting (Happy Hour promotion) to drive traffic. Management indicated that traffic is only growing in the afternoon when the company is discounting the most, and restaurant margins have suffered as a result (down 140 bps YOY in 3Q08). The company’s margins will also be hit by minimum wage increases and the company’s renewed focus on customer service as the company had recently cut back on labor expenses, which resulted in lower partner drive-in same-store sales. The company also stated that its overly aggressive price increases in the past led to the deteriorated traffic results at its partner drive-ins so the company will not be able to use price to help protect margins going forward. And then, there are rising commodity costs. Management stated that it is buying its beef requirements on a month to month basis at double-digit YOY increases. Needless to say, SONC’s margins are being hit from all directions.
  • CBRL - During the late 1990's, as CBRL endeavored to maintain its strong, historical rate of growth, a number of issues led to a deterioration in the company's financial performance. Increased capital spending strained the CBRL system. More importantly, aggressive menu pricing and tight management of restaurant expenses threw the consumer value out of balance. The decline in operational performance, coupled with declining customer counts caused a significant decline in profitability.
    Now, the same management team is aggressively raising prices again at a time when the typical CBRL customer can't afford to fill his tank with gas (87% of the company’s restaurants are located along interstate highways). CBRL reported its 6th consecutive quarter of negative traffic, with 3Q08 posting the biggest decline of -3.3%. And the trends are not improving in the company’s most critical summer months with June same-store sales results down 1.2%. As a result, the company lowered its FY08 EPS guidance to $2.77-$2.87 and is now guiding to 60 bps of operating margin contraction from FY07’s reported 7.0%.

  • GMCR –As the company’s growth has skewed more to its Keurig at home brewers and related K-Cups, which have lower gross margins than the most of the other company’s products, gross margins have suffered significantly (down 220 bps in its most recent quarter). At the same time, operating margins have improved as the company has lowered its SG&A as a percent of sales, which is not sustainable relative to the company’s current growth rate.
    The profitability of GMCR’s K-Cups is critical to the company’s overall profitability and on the most recent conf call management did not argue against prices in the wholesale channel at $0.30, with a 20% contribution margin. That implies a $0.06 profit per K-Cup. For licensed roasters, GMCR raised the royalty rate to $0.064 per K-Cup. The conclusion we can draw from this, is that on the surface there does not appear to be enough margin in the K-Cups for the supply chain to make any money.

  • MCD – Everybody loves MCD and the valuation reflects it. In addition to the top line momentum in Europe and Asia, part of the bull case is the company’s move to sell more beverages. I have been saying for some time now that the specialty coffee rollout would not prove to be another silver bullet for MCD’s U.S. business as I do not think MCD will be able to change consumer perception enough to steal meaningful share from Starbucks. Additionally, it will be difficult in today’s environment to convince the average MCD customer to spend $3 for a cup of coffee (as evidenced by SBUX’s recent traffic trends). This new beverage platform requires franchisee investment (costing the entire system more than $1 billion to implement nationwide) at a time when franchisees’ bottom lines are already under pressure from rising commodity costs and increased dollar menu transactions.
YUM USA is in a secular decline
The CMG Story


This post highlights some of the ideas we have been talking about on the “green” side.
  • DPZ - Looking at the overall industry, DPZ was not the only company to leverage its balance sheet at exactly the wrong time; they just took leverage to whole new level and the stock is down over 40% in the last 12 months as a result. The company’s business model generates cash, which should allow DPZ to pay down debt over time and start to reverse its current capital structure in the next 6-12 months. Additionally, overall pizza category trends have ticked up in 2Q08 so as the company’s top-line results improve going forward; investor concerns over leverage should dissipate.
  • SBUX - Starbucks is currently taking the right steps to reverse the issues that stemmed from its excessive capital spending over the last three years, most notably, declining U.S. operating margins and lower returns on incremental invested capital. Although the company’s decision to slow U.S. growth and close underperforming stores is not yielding immediate results (as did MCD’s plan to win strategy in 2003), the current consumer environment is working against the company. SBUX is changing the things it can control, which will reward shareholders in the coming quarters.
  • CKR - I have been voicing my concerns about the level of G&A spending at CKR for some time, highlighting the fact that although the company’s system-wide store count had declined by 8% since 2002, G&A per store had grown nearly 40%. Additionally, CKR’s aggressive capital spending over the past 2 years has not led to incremental returns for shareholders and said that management needed to change its long-term unit growth strategy in order to reverse declining returns.

    Management lowered its capital spending plans at its annual meeting and Ramius LLC’s recent letter to CEO Andrew Puzder appears to have motivated management to focus on bringing G&A expenses down. I am not completely convinced that management will lower both its growth capital spending G&A spending down enough, but they are headed in the right direction. And, 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. 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.
  • HSY – Hershey recently announced its new long-term growth initiatives, signaling that the company is on the path to rightsizing its business model on its own. Prior to the announcement, I had highlighted that the company had been under investing in the business and lowering advertising spend in an effort to keep margins stable. This led to a period of extended market share declines and a severe decline in margins in 2007.
    The company’s new initiatives include increasing total advertising spending by at least 20% in both 2008 and 2009 with a focus on its core brands, which make up 60% of total U.S. sales. This increased spending will further pressure margins so they could get worse before they get better, but it should help drive sales momentum and is necessary to the long-term sustainability of the business model and more importantly, the Hershey brand. Additionally, management is expecting 2009 to be another tough year from a commodity cost standpoint but the company is now managing for the long term, rather than managing expectations.

  • EAT – Brinker is focused on the things it can control and has significantly reduced its planned domestic company-owned restaurant openings. The company only expects to open about 70 restaurants in FY08 and is reducing that number further in FY09 and FY10 to 15 or less. In its most recent quarter, the company’s capital expenditures as a % of sales came down significantly, which I use as one measure of capital efficiency. Additionally, EAT saw an uptick in same-store sales trends at its most important concept, Chili’s. The company is currently making the right capital allocation decisions and has situated itself to outperform its competitors who are still growing despite declining returns.
  • PNRA - We have done a proprietary grass roots survey on the state of the new Panera breakfast sandwiches. We surveyed over 30 stores in the following states - CT, ME, MA, NY, DE, SC, FL, GA, IA, IL, KY, TN, TX, CO and CA. The following conclusions can be made from the survey data: (1) the stores generally indicate the new breakfast sandwiches are well received. (2) In about half the calls, we were given a wide range on the number of sandwiches sold per week - 200 to 500 per week. (3) On the margin, it appears that the new sandwiches are bringing in new people, but there are clearly people switching over from the soufflé.
SBUX - Ugly looking chart
EAT – Finding a bottom!