The 7-Year Itch of reliquifying $550 billion in levered loans from the 2003-2008 PE shopping spree is in full force. It needs to be medicated.
One of our key themes in 4Q09 was the ‘7-Year Itch’, the crux of which is that the spend-a-thon that occurred in the private equity world from 2003-2008 at peak valuations and peak margins needs to reliquify to save pro-cyclical buyers from their own bad bets. The tally is a frightening $550billion in levered loans that need to come to market.
With the Piggy Banker Spread (between 10s to 2s) near all-time highs, the average CEO just having seen their net worth pop by over 50% from a scary bottom, and the Mensa Society running our investment banks showing their propensity to dole out the big bonuses for performance that is grossly misaligned with what is needed for a healthy US financial system, it should not come as a shocker that deal activity is ripping.
Can you please quantify ‘ripping’ McGough? Ok.
But it’s not all positive, folks. In fact, over the past month, we’ve seen 15 IPOs and 16 debt offerings pulled. One of the more notable retractions is this morning’s announcement from Blackstone that Travelport is not ready for Prime Time (actually, they’d argue that Prime Time isn’t ready for them).
What is almost ready for prime time is a BX short, which has a broken TREND line on Keith’s models of $13.97. Stay tuned on that one.
Despite the stock’s slight outperformance in the last month (+4.6% vs. the QSR group’s average 3.1% move higher), JACK’s fiscal 1Q10 EPS results came in below expectations at $0.43 relative to the street’s $0.45 estimate. Not only is JACK one of the few companies to miss from an earnings perspective in calendar 4Q09, but the quality of the earnings reported is low as the company benefited from a lower tax rate, a $1 million insurance recovery payment, a $2.5 million mark-to-market adjustments on investments supporting the company's non-qualified retirement plans and a $4.3 million decline in facility charges related to impairments (though the quarterly gains from the sale of company-operated units were lower in the quarter).
Investors were obviously not happy with the magnitude of same-store sales decline expected during the first quarter as the stock traded down nearly 8% when JACK reported fiscal 4Q09 results and guided to a -10% comp at Jack in the Box company restaurants in fiscal 1Q10. Unfortunately, management’s guidance proved not conservative enough as first quarter same-store sales declined 11.1%, implying a 130 bp decline in 2-year average trends from the prior quarter. Based on same-store sales trends of -9% in the first four weeks of the quarter, management’s 2Q10 outlook assumes a -8% to -10% comp at Jack in the Box. The company’s guidance also reflects the impact of the unfavorable weather it has experienced in many of both brands’ markets, particularly in Texas for Jack in the Box, which represents 30% of the concept’s company restaurants. The low end of this 2Q10 guidance range implies another 10 bp sequential decline in 2-year average trends.
Comparable store sales at Qdoba declined 1.7% in the quarter, better than management’s guidance of -5%. Specifically, same-store sales improved throughout the quarter and even turned positive in the second half of the first quarter.
DON’T MESS WITH MACRO
Management largely attributes the divergence in trends at Jack in the Box and Qdoba to the improvement in consumer confidence among higher income consumers relative to lower income consumers. CEO Linda Lang stated that the issues at Jack in the Box are macro-related as the high rate of unemployment among its key demographics, particularly young males and Hispanics, continues to put pressure on sales, as does its significant geographic exposure to California and Texas. She also pointed to continued aggressive industry discounting and lower grocery prices as detrimental to trends at Jack in the Box. To that end, Jack in the Box has focused more on value offerings, causing average check to decline during the quarter for the first time since 2002.
In response to a question about whether the weakness at Jack in the Box is more brand-specific or macro driven, Lang stated, “We really believe that the challenges that we’ve had with regard to Jack in the Box is macro related and it’s related to the high unemployment among the core consumer, both the general market consumer, that younger, lower income consumer, as well as the Hispanic consumer. From our research, we’re executing very well in terms of the guest experience. From our attribute ratings and our new product research, they’re scoring very well. I can tell you the grilled sandwiches, the early indication is that the consumer is very positive with the launch and scored very high in terms of quality ratings as well as value ratings, so we know that from a consumer standpoint that value is very critical, not only for the bundled meal deals but also the premium products. So we purposely re-recipe the grilled sandwiches so that we could launch them at a $3.99 price point and we think that’s really key to delivering a great product that’s differentiated, premium positioned but also a good value. So this isn’t -- we do not believe that this is a brand issue whatsoever.”
Although Jack in the Box is facing macro headwinds right now as its key demographics are clearly under pressure, as shown in the charts below, I think it is risky for a CEO to say none of the problems are concept-related as it does not leave investors feeling confident about a company’s ability to better navigate through a tough environment.
RESTAURANT LEVEL MARGINS
Despite the 11.1% decline in same-store sales at Jack in the Box, restaurant level margin only declined 30 bps in the quarter as the company benefited from a 7% decline in commodity costs. Margin compares get more difficult as we trend through the balance of the year and the commodity favorability is expected to moderate in the second quarter and negatively impact margins in 2H10. Increased discounting and bundling offerings will only add to this margin pressure. For reference, management maintained its full-year 15% to 16% restaurant operating margin guidance despite lowering its same-store sales outlook at Jack in the Box to -5% to -8% from its prior -3% to -7% range. Full-year commodity costs are now expected to decline 1% versus the company’s initial expectation for flat costs.
Other interesting takeaways:
Jack in the Box extended its value message to its breakfast menu, which has subsequently helped trends at breakfast.
Jack in the Box has experienced a steady improvement in traffic and sales trends since the end of November, which it attributes to a reallocation of media spend to communicate concurrent messages focusing on both value promotions and premium new products to drive traffic among a broader range of consumers.
Hedgeye CEO Keith McCullough handpicks the “best of the best” long and short ideas delivered to him by our team of over 30 research analysts across myriad sectors.