We’ve been writing on the divergence between FSR and QSR of late but yesterday it was the divergence between BKC and YUM that caught my eye.  Yesterday, both YUM and BKC reported calendar 4Q09 EPS and the street’s reaction is clear in the table below. 


YUM greatly underperformed, declining 5.5% on a big uptick in volume as compared to its 30 day average.  On the other hand, BKC significantly outperformed (especially given that the S&P 500 was down 3%), closing up 2.9% also on strong volume.  Just looking at the short interest alone, the street was expecting something different, as reflected in YUM’s short interest at 2.1%, only slightly higher that MCD’s at 1%.  The BKC number, however, is a surprisingly high 11%.  Clearly, part of yesterday’s move in BKC was short covering, as the quarter was not that bad.  Investor reaction suggests that it was better than YUM’s.





While movements in the stock tell us something, the fundamentals seem to confirm it in this case.  YUM, MCD, and BKC, have all seen sharp declines in their U.S. comparable-store sales trends.  It is interesting to note that BKC’s U.S. & Canada two-year comparable-store sales trends actually improved on a sequential basis in 2FQ10, to -0.7% from -0.8% in F1Q10.  YUM’s U.S. comparable-store sales continued to decline on a one and two-year basis in 4Q09 at -8% and -3%, respectively.  This implies a 150 bp sequential decline in two year trends from 3Q09.  MCD’s two-year comparable-store sales trends also deteriorated in 4Q09 but remain positive at 2.6%, down from 3.6% two-year trends in 3Q09.


The respective management teams’ comments on recent conference calls were also informative; MCD and BKC expressed some optimism about trends in January whereas YUM implied no improvement in its U.S. QSR trends.  MCD stated that trends in January were better than in December when the impact from weather was factored out (which they estimated to be -3%).  BKC’s management labeled January a “bifurcated month” where the first two weeks were marred by bad weather but the last two weeks saw traffic bounce “back to positive again” in the U.S.  YUM did not sing to the same tune on their conference call, stating that they would not comment on sales trends in the middle of the quarter in the absence of “a very significant change in results”.   YUM emphasized that Pizza Hut has seen a “dramatic” improvement following the recent focus on value but did not give any update on trends in KFC and Taco Bell, which implies that we won’t see much of a pickup in underlying trends in the first quarter of 2010 from the 4Q09 trends of -8% and -5%, respectively (though comparisons do get easier).


YUM’s international trends have been a cause for concern.  On a sequential basis, for 4Q09, two-year comparable sales trends deteriorated for YUM’s China and International divisions.  Again, based on management’s comments, we are not expecting much of an improvement in the first quarter.  While the respective companies’ reporting methods do not allow for apples-to-apples comparisons of international trends, MCD’s APMEA trends have also shown softness, reflecting weakness in China, but two year trends improved in the fourth quarter from the relatively softer level in 3Q09.  MCD’s two year trends in Europe slowed slightly in 4Q09, but remain above 6%.  BKC’s EMEA/APAC and Latin America trends improved during the quarter on a two-year comparable-store sales basis.


Earlier this week I suggested that YUM’s aggressive capital spending in China over the last four years is starting to have an impact on the sustainability of the current growth rate.  The company went to great lengths on its earnings call to dispel this notion.  Time will tell.


SKX: Inching Closer to a New DC

In an 8K released last night, SKX made the long awaited announcement that they have finally secured land to develop their new distribution center.  While much of the attention on the stock has shifted towards the success of its Shape-Ups shoes, supply-chain inefficiencies and its related drag on profitability has seemingly faded into the background of late.


With land secured, the company can now move forward in developing its new DC, which management has maintained will be accretive day 1. One thing to keep in mind here is that while this is indeed a positive from a longer-term sustainability perspective, the company will incur duplicative costs near-term. Once the new DC becomes operational, however, the costs eliminated and efficiencies gained from the transition will be a material positive (see notes below for details). The question now appears to be one of duration and whether the tailwind from Shape-Ups sales will persist as the company spends to build its business. If sales from Shape-Ups start to fade as SKX undergoes this transition later in the year or early in 2011, the upward trajectory in SKX’s margins could come to a end – abruptly.


Here are a few highlights from the 8K filing along with notes on the topic from our meeting with management a few months ago:

  • “The purpose of the JV is to acquire and to develop real property consisting of approximately 110 acres situated in Moreno Valley, California (the "Property"), and to construct approximately 1,820,000 square feet of buildings…” 
    • HE: at this size, capacity will be ~30% larger than the 5 building capacity currently in place.
  • “The Company, through Skechers RB, LLC, will make an initial cash capital contribution of $30 million
    • HE: This is within (below) the range of $35-$40mm mgmt expected to spend in add’n to what they’ve already spent on equipment for development –
  • “In the event that either the construction loan is not finalized or construction does not begin by June 1, 2010, the JV is null and void and the parties are entitled to receive return of their initial capital contributions in the form contributed.
    • HE: Management mentioned only 3-weeks ago out at ICR that they expect to break ground in March –
  • The base rent shall be $933,894.44 per month during the Lease.

Notes from recent meetings with management:


DC Transition Update:

  • Latest timing expected to be 3Q of F10 or 1Q of F11
  • Already spent $40mm in equipment (currently sitting in storage)
  • Will have to spend another $35-$40 in 2H F10 towards installation of equip, software, & programming (CapEx)
  • Will be located in southern California
  • Will be accretive day 1
    • Due to the savings from consolidating 5 buildings to 1 = $5-$7mm in transportation savings
    • Massive reduction in head count ~900 @ $50k/head = ~$45mm in payroll savings
      • 1 employees currently in 5 buildings
    • New equipment will be able to move 60-70mm pair of shoes /yr
    • ~$75-$80mm to depreciate over a 12-year period = incremental $6-$7mm in D&A
    • Currently have 1.4mm sq ft. in capacity in 5 buildings currently could hold 13-14mm pair
    • 30 containers a day delivered with 6k pair each

The Week Ahead

The Economic Data calendar for the week of the 8th of February through the 12th is full of critical releases and events.  Attached below is a snapshot of some (though far from all) of the headline numbers that we will be focused on.


The Week Ahead - zz1

The Week Ahead - zz2




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"The fourth quarter was a tough one for us, and we're disappointed.  While the first half of the year was solid, the continuing deterioration of the economy resulted in less visitation and lower play per customer. We started to feel the economic downturn in late summer and we increased our marketing efforts. As a result, we maintained or increased market share in many of our larger markets, but our margins declined."

- John Giovenco, Pinnacle Entertainment's interim chief executive officer


Highlights from the Release

  • "As we enter 2010, we are focused on our commitment to increasing shareholder value. We're concentrating on operating efficiency and, in particular, effective marketing. We're evaluating our underperforming and non-strategic assets; reducing corporate overhead costs; taking a disciplined approach to capital spending; and developing Sugarcane Bay and Baton Rouge in Louisiana."
  • "To achieve these goals, we redesigned both our Sugarcane Bay and Baton Rouge projects, resulting in a reduction of more than $100 million in Sugarcane Bay's cash construction costs; restructured corporate and property marketing to result in a significant net reduction in headcount; subsequent to year-end decided to put our Atlantic City assets up for sale; listed the company airplane for sale; hired two highly experienced general managers for Boomtown New Orleans and Lumiere Place; moved to consolidate our three Las Vegas offices into one; reduced corporate overhead; and plan to institute a new compensation program that rewards executives for increasing long-term cash flow and EBITDA. We believe these actions will improve operating results."
  • "Separately, the board has engaged the international recruiting firm Heidrick & Struggles to help conduct the search for a new executive to succeed Pinnacle's former chief executive officer... The search is well underway, and we will announce a resolution at the appropriate time."
  • "Banc of America Securities LLC and J.P. Morgan Securities, Inc. have been selected as Joint Lead Arrangers for this new credit facility, which has a maturity date of March 31, 2014. Commitments from banking institutions toward the new credit facility have been received in the amount of $375 million. The Company expects that the new credit facility will close in the next few business days."
  • Property specific commentary:
    • "L'Auberge du Lac's market share improved to 52.6% in the period from 50.2% in the prior-year period. While the overall regional economy was softer in the 2009 fourth quarter compared to the 2008 period, unemployment statistics remain more favorable in this region than the nation as a whole."
    • "Market share at Lumiere Place climbed from 17.1% in the 2008 fourth quarter to 20.5% in the 2009 period."
    • "Boomtown New Orleans was affected by market softness as reduced Katrina relief efforts and related spending, reduced construction activity, reduced discretionary income, and weaker economic conditions have dampened operating results throughout the region. As such, marketing efforts by the competition have increased dramatically. The Property's increased marketing programs did not produce intended results"
    • "These results reflect the opening of expanded and enhanced casinos at two competing facilities, as well as softer general economic conditions. As a result of competitive pressures in the market, 2009 fourth quarter results at Belterra reflect increased marketing spend to compete against the augmented competition."
    • "We were able to maintain market share; however, revenues in the Bossier City/Shreveport market were down 13% for the fourth quarter of 2009 compared to the prior-year period."
    • "Boomtown Reno has been affected by significant competition from northern California Native American casinos, as well as weak economic conditions in both the region and northern California. Employee headcount as of December 31, 2009 has decreased 11% from December 31, 2008. The Company has targeted additional areas at Boomtown Reno to further reduce costs in 2010."
    • "Revenues have decreased due to a recent decline in the value of the Argentine peso, as well as weakness in the Argentine economy. The decrease in Adjusted EBITDA reflects the currency decline and inflation of certain costs, principally payroll costs."


  • Other properties start to feel the pressure of the recession at the end of the 3rd quarter and in response they increased marketing. So they had a double hit to earnings, lower revenues and higher marketing
  • Attacking costs at the corporate and property level, continuing to reduce headcount throughout the company
  • Recently the board separated the roles of Chairman and CEO.  The committee is currently interviewing CEO candidates


  • How much costs can they take out of corporate and property level expenses?
    • More of a question on can marketing become more efficient.  So costs will get reduced as a function of increasing efficiency (marketing is the largest cost opportunity)
  • Pricing on bank facility will be at L + 400 bps based on current leverage levels, may close today or Monday. No LIBOR floor (now its 23bps).  Intention is to close the facility at $375MM in size. Covenants in new deal will be more "accomodative" to their current operating plans
  • Spent $75MM on cash capex in 4Q09, $57MM was River City. $9MM on Sugarcane & Baton, rest was maintenance
  • 2009 cash spend $213MM, $157 on RC, $15MM Sugarcane Bay & Baton Rouge
  • Belterra: What happened there? What are they doing to improve things, given that the competitive environment isn't going to change?
    • Had increased competition with several boats (Lawrenceburg) in the area and increased marketing costs in response - to a level that they shouldn't have
    • It all comes down to spending marketing dollars in an effective way, have been focused on implementing those processes over the last two months and will see some results
  • How to think about cannibalization from River City on Lumiere Place?
    • View those two properties as a singular portfolio.  Don't worry about the cannibalization, but rather how much they can do as a whole.
  • AC: hope to sell it as soon as a reasonable bid comes in. They just put it up for sale
  • CEO search has been narrowed to a smaller group of people including some internal people
  • Why move forward in Baton Rouge, given how under pressure that market has been?
    • Feel like they have a locational and product advantage
    • Economic pressures are likely to be short term in nature and by the time they open there should be a different environment
  • The R/C will not entirely complete their financing needs, but it is a large part of it. Still need some capital which they will get to on an opportunistic basis
    • Sugarcane is not quite fully financed at this point either (self imposed liquidity needs)
  • Impact of low hold on L'Auberge? $1.5MM
  • River City opening will not impact corporate overhead
  • New CEO will be more of an operating than a development guy/or gal
  • Total capex spend for 2010: $35-40MM of maintenance, completion of RC + Sugarcane & Baton Rouge and some smaller projects
  • Are they going to move the corporate office closer to their operations? No, they already have leases in place, and would need to relocate everyone
  • Why haven't they hired investment bankers to pursue strategic opportunities
    • Think they can do a better job operating their assets and thereby grow their share price
  • Free play in Indiana?
    • Monitoring it, but no idea of the chances
    • Tables games at Betteroff would have a negative impact on them
  • Have until March 31 to submit a construction contract for Baton Rouge and have no intentions to extend that deadline
  • Bossier City, what to they attribute their success to in that market?
    • Have good efficient marketing
  • Try to keep the Sr. Secured leverage low
  •  No more room on the Sugarcane budget

Unemployment: Better Than Feared

With the volatility index (VIX) and NYSE volumes +21% and +41%, respectively (yesterday), the fear factor associated with the unknown was real. Now we all know what we didn’t know. The US unemployment rate dropped, sequentially, by 30 basis points (month-over-month) to 9.7%.


The reality is that both, relative to freak-out expectations, and on an absolute basis, this morning’s US unemployment report was better than feared. That, however, doesn’t mean the stock market has to go up.


My US Strategy partner, Howard Penney, and I made a call earlier this week that whether this report was better or worse than expectations, that the US Dollar was going to go up and the US stock market was going to go down. Some people quibbled with the math behind our conclusion, but that’s ok – that’s what makes a market. Today, on a better than feared unemployment report, the Buck Breakout continues and stocks remain weak.


A lot of people are used to seeing better than feared economic reports support higher stock prices. To some extent, its Pavlovian. The US economy is not in a “great depression”, even though those who short sold last year’s generational stock market squeeze are rightly depressed.


Everything that really matters in our macro model happens on the margin. Relative to bombed out expectations, the last 6-9 months of economic data has been much better. Now, relative to complacently high expectations, the next 3 months of data might just keep coming in as just that – complacently high.


Better than anything that resembles a required “emergency level of zero percent” Federal Funds rate, will continue to pressure Bernanke to see the data for what it is. This, relative to expectations, is the real reason why stocks are deflating. As the Fed prepares to remove the “extended and exceptional” language from their currently politicized monetary policy, the Buck Breakout will continue to manifest to the upside, discounting the same.


It’s somewhat unnatural for the manic on CNBC to understand this concept; but better than feared economic news can be bad for stocks, indeed. The US stock market’s REFLATION trades that we were riding last year (based on a Burning Buck) are completely unwinding as real-time risk managers come to grips with the reality that ZERO is not a perpetual monetary policy – not with GDP up +5.7% y/y, CPI +2.7% y/y, and the unemployment rate rolling over at least.



Keith R. McCullough
Chief Executive Officer


Unemployment: Better Than Feared - unemploy



What Is It That You Do?

Keith and I were discussing the Economic Club of Washington this morning.  At a certain point we both looked at each other and said, “What is it that they do?”.  Neither of us really had an answer.  So being the useful analyst that I am, I went to this great research tool called Google and looked up its website.  I thought the Membership Guidelines were most interesting:


“Economic Club membership is limited in number and includes CEOs of local corporations, managing partners in leading law and accounting firms, executives of top consulting, technology, and research organizations, and national heads of associations and other entities in healthcare, insurance, culture and education and other businesses and professions.”


Ok, got it. It’s an old boys club of group thinkers.  But still, what is it that they do?


Further, in the Membership Guidelines some clarity on the Club is given:


“Members convene five times a year for a luncheon or dinner at which they can bring a limited number of guests at a reasonable fee.  Events are held at the city’s leading hotels.  By tradition, one dinner each year is black tie.”


That certainly provides a bit more clarity.  The old boys club of group thinkers also get dressed up and goes to nice hotels.  Well, that is something I suppose.  But still, what is it that they do? 


The About Us section gives us a little more direction for this question.  It states that the Club has two primary purposes:


“First, it offers a forum in which prominent business and government leaders can express their views on important economic issues of the day and how those issues affect the region, the Nation, and the world.  Second, and equally important, it generates and promotes a greater sense of community among business leaders, government officials, and members of the diplomatic corps.”


Roger. The fancy pants old boy group thinkers get together and pontificate in front of each other.  Ultimately, of course, what this type of activity leads to is additional behavioral economic tendencies.  The two that come to mind are herding, when individuals act together without planned direction, and status quo bias, which occurs when people tend to not change an established behavior unless the incentive to change is compelling.


So, it seems, the Economic Club of Washington, or the Club as they call, does do something.  It provides case studies in behavioral economics.  If we can recognize that early, that is not a bad thing.


The danger of course is that when someone like David Rubenstein (“Ruby”), the Co-Founder of the Carlyle Group and the President of the Economic Club of Washington, makes public statements that other individuals may invest in based on his Perceived Wisdom.  As a case in point, his recent statement on emerging markets from Davos in late January:


“Emerging markets are the most attractive places to invest and rebounding more rapidly.”


Sadly, Ruby top ticked that one.  As we wrote this morning in the Early Look:


“Per my friends at Bloomberg, "emerging market equity funds lost $1.6B in weekly withdrawals" so far this week. That's the biggest weekly outflow in 2 years.”


We now know what the Club does and we also understand their output. The Club produces contrary indicators. 


Ruby, any good asset allocation ideas that we can take the other side of?



Daryl G. Jones
Managing Director

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