- On DPZ’s 2Q08 conference call earlier this week, when asked about independent closures, the company’s CEO David Brandon said:
“Our belief, and it’s more anecdotal than it is statistical, is that the pressure that’s happening out there is clearly creating closures. I mean we’re seeing a few of them and we’re stronger and we can buy cheaper and we’ve got a better brand, and a 47-year track record. We are in a position where we feel the pressure with our weaker operators. We can only conclude and we’re witnessing that same pressure translating in an even bigger way to a number of the smaller operators out there. But it will take a couple of quarters for that to show up in some of the data that we can share with you and certainly when it’s available we will be talking about it.”
- DPZ management has stated in the past that overly aggressive pricing actions across the industry are to blame for the fall off in traffic. Although more disciplined pricing should help traffic trends (but not necessarily margins), a reduction in supply could only help as well. I don’t want to root against the small players, but if more independents are forced to close their doors as a result of their not having the scale necessary to deal with both lower consumer spending and higher commodity costs, the bigger chains should emerge as winners.
An interesting call out is the rather meaningful shift we’re seeing over the past few months in Chinese exports by destination. The growth rate in shipments to the US is slowing meaningfully, but we’re not seeing carry through into the EU. The European retail environment has been strong enough to accept price increase to a certain degree, but that’s starting to turn. I’m starting to scout out potential losers vs. winners in Europe. Stay tuned.
First, the consumer environment looks bleak (consumer confidence hit a 16-year low) and consumers have very little disposable income in their pockets. Contributing to slightly better trends in the most recent quarter was the government’s stimulus package, which supported a +4.0% increase in Real Disposable Personal Income in Q2. Second, restaurant operators increased their promotional efforts and consumers took advantage of them.
- According to NPD, customer deal traffic rose 6% while non-deal traffic was down slightly. Looking at Casual Dining, the segment was weak during its core business segments with no growth at the important dinner daypart. Lunch traffic grew significantly with 4% more customer visits this quarter. The increase at lunch included improvement on both the weekday and the weekend time periods.
- Importantly, discounting and Combo Meal visits accounted for half of Casual Dining growth this quarter supported by promotions from major chains and increased visits with kids. The Bar and Grill category posted the largest gains this quarter. The casual dining “varied menu” lost traffic, which suggested a trade off to Bar and Grill. When consumers decided to go out to eat, side dish items were left off, while beverages posted solid growth supported by gains in healthier beverage options. Consumers are also cutting back on consumption of alcoholic beverages.
- Some areas to consider looking forward: 1) it’s unlikely that another stimulus package will be passed by congress to help buoy consumer spending. Fortunately, gas prices have begun to ease up a little, which may help improve consumer confidence and free up some discretionary dollars. 2) Consumers will continue to look for promotions, a trend that was evident over the past three months. It’s critical that restaurant operators engineer promotions to provide attractive offers to consumers (possibly with new offerings) while trying to preserve margins.
- My guess is that EAT’s quarter will look better than most in the casual dining space.
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Conceptually, swapping discounted bonds for a coveted asset makes a lot of sense. There are a couple of issues, however. First, the covenants in all indentures and credit facilities senior to the purchased bonds cannot restrict the use of proceeds from asset sales. Second, as with most casino asset sales there are always tax issues. It is unclear whether the seller would be able to make a tax free exchange but that would certainly seal the deal.
In the following table, I’ve outlined a generic analysis of how this transaction would look to the buyer and seller assuming no covenant or tax issues. Clearly, PENN benefits from buying a property worth 10x EBITDA for 7.5x. The seller sees its leverage fall 4x to 3.3x and is now in a better position to obtain new liquidity from the credit markets.
This is by no means an exhaustive study of “Basset” swaps but it does indicate that there may be options for PENN to expedite an attractive acquisition. Alternatively, the company will be patient to get what it wants at fire sale levels. Presumably, potential sellers will get more desperate as we approach the beginning of what could be a gaming liquidity crisis beginning in 2010. PENN seems to be alone in dealing with this high class problem.
These levered plays on commodity inflation are down -21% and -22% since mid May, when we made our "Fading Fast Money" call (see chart).
It may be time to call your broker and ask them what exactly resides within these ingenious ETF instruments.
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