The most bullish thing a market can do is go up, and yesterday we hit another higher high.  The S&P 500 closed up 0.7%, very close to its 52-week high.  On the MACRO front, existing home sales declined for the third straight month, but were slightly better than expected. The markets took another ‘less bad’ data point as more evidence of economic recovery.


February existing home sales were 5.02 million vs. consensus 5.00 million and January reading of 5.05 million.  Single family sales decreased 1.4%, while condos/co-ops increased 4.8%.  The months’ supply increased to 8.6 from 7.8.  Also the March Richmond Fed manufacturing survey index increased to 6 vs. consensus 5 and a prior reading of 2.  The RECOVERY trade continues to live on. 


Earlier, today it was reported that mortgage applications in the U.S. came in at -4.2% last week as demand for refinancing dropped by the most in a month.  The housing numbers continue to disappoint!


Treasury Secretary Geithner testified before the House Financial Services Committee on housing financing.  As we posted yesterday, the three key take takeaways were:

  • Geithner says it’s not realistic to abolish the GSEs now or at any time in the future.
  • Geithner supports the idea of having an independent agency oversee consumer protection and thinks it’s a terrible idea to put consumer protection within the Fed, as the Dodd bill now proposes.
  • Geithner was asked by Rep Scott Garrett (R-NJ) whether GSE is Sovereign Debt, and he squirmed just like Bernanke did when asked the same question. Ultimately, Geithner said “GSE debt is not sovereign debt, but it is debt that the United States is going to stand behind”. Sounds like he’s having his cake and eating it too.

The Dollar index had another strong day, improving 0.4% and is up 0.8% in early trading today.  The Hedgeye Risk Management models have levels for the Dollar Index (DXY) at:  buy Trade (80.39) and sell Trade (81.06). 


With the dollar down and the VIX broken on all three durations - TRADE, TREND and TAIL - the RISK trade is up too; yesterday, the Russell 200 outperfromed the S&P 500 by nearly 40bps.  The Hedgeye Risk Management models have levels for the Volatility Index (VIX) at:  buy Trade (16.06) and sell Trade (18.39). 


The advance/decline was positive at 1360, up 380 from the prior day, and volume continues to be very light.  Looking at sector performance, every sector was positive, with five sectors outperforming the S&P 500.  The three best performing sectors were Materials (XLB), Industrials (XLI) and Technology (XLK).


The XLB benefited more from the RECOVERY theme, than the rising dollar hurting the index.  The SOX is driving the performance of the XLK of late.  Yesterday, TSM increased its estimate for global semiconductor market output to grow by 22% in 2010 from the previous forecast of 18%


Yesterday, Healthcare (XLV) underperformed slightly from the big gains last week as President Obama signed into law the healthcare reform bill.


Oil prices are trading lower with the strong dollar.   The Hedgeye Risk Management models have the following levels for OIL – Buy Trade (80.08) and Sell Trade (83.53). 


Gold prices are trading lower as the Euro zone news lifts the dollar.  The Hedgeye Risk Management models have the following levels for GOLD – Buy Trade (1,093) and Sell Trade (1,120).


In early trading, copper is trading lower also as the dollar is trading higher.  The Hedgeye Risk Management Quant models have the following levels for COPPER – Buy Trade (3.33) and Sell Trade (3.42).


In early trading, equity futures are trading below fair value in sync with the European indices after Fitch downgraded Portugal's credit rating.  As we look at today’s setup, the range for the S&P 500 is 17 points or 1.2% (1,160) downside and 0.2% (1,177) upside. 


Today's MACRO highlights are:

  • Feb Durable Goods
  • Feb New Home Sales
  • DOE Crude Oil Inventories


Howard Penney

Managing Director













Confidently Skeptical

“All you need in this life is ignorance and confidence, and then success is sure.”

-Mark Twain


In writing the March 6, 2009 Early Look (when the S&P 500 was at 683) I used the following metaphor for how most people feel about the US stock market:


“It's human nature to lose confidence when you become seriously ill.  You feel worthless and it feels like anything you say is meaningless and everything you do is pointless.   Everything you do is just plain wrong!  Yes, that is ANXIETY!  Anxiety robs you of your personality, kills your confidence and thus, you lose your identity.” 


The good news is your confidence and personality gradually return, building up in layers, until eventually you feel like the person you were before you became ill.  In the end, you grow into a stronger person. 


So over a year later that is where we find ourselves.   After the government spent trillions of dollars we don’t have, we are stronger, more confident and no longer anxious.  The statistics are remarkable - the S&P is trading at 1174 - up 74% from the March lows and the NASDAQ is up 90%. 


The most bullish thing a market can do is go up, and yesterday we had yet another higher high.  As the technicians say, “the S&P 500 remains within an entrenched up channel.”  Yesterday, the S&P 500 was up 0.7% driven by the slightly better than expected existing home sales (although the absolute pace is anemic), the continued firming of prices in the steel sector, and improving trends in Semiconductor and Machinery names to help support the RECOVERY trade. 


In just a year, we went from a state of high anxiety to a state of confident hopefulness that events and trends in 2010 will be favorable. Market performance is telling us that there is a "public confidence in the economy."  That statement seems so ironic when the public has no confidence in the current administration, and FED officials and the Treasury cannot even admit to the extreme level of indebtedness of the US government. 


There is actually little confidence, exemplified by the confidence numbers.  The ABC consumer confidence numbers declined last week to -44 from -43, and according to a Bloomberg survey, by an almost 2-to-1 margin the average American believes that the economy has worsened rather than improved during the past year.


As negative as every consumer survey is, the performance of Consumer Discretionary (XLY) constituents speak to a consumer that says one thing and does another.  From Tiffany’s to Red Lobster, the trends are getting better, not worse.  The market is headed higher because corporate profitability and cash flow are improving as every CEO finds him/herself in a save-my-butt-and-improve-profitability situation.   


If you are in the camp that interest rates and inflation are headed higher, on the margin the improvement in corporate profitability will slow.  We have been very careful to pick our spots in what to be LONG in this market, and that is not going to change.   We are better off today, relative to the high levels of anxiety back in March 2009, but there are enough global MACRO issues that could cause another ANXIETY attack at any time.


While we shorted the S&P 500 last week, I’m thankful we covered the position on Friday.  As we wake up today, we are now officially at ZERO percent allocation to both US and International Equities. 


Overbought is as overbought does!


Function in disaster; finish in style!


Howard Penney

Managing Director


Confidently Skeptical - Obama HC2


Barclays Capital's Broda Discusses Greece Sovereign Debt

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Minyanville's Harrison Discusses Outlook for U.S. Stocks


Given that SONC just preannounced its 2Q sales trends two weeks ago, the company did not say anything too incremental on its earnings call today.  Management would not comment on quarter-to-date trends but said it is comfortable with its 2H10 system same-store sales guidance of flat to -5%.  During 2Q, SONC estimates that its same-store sales came in -4% to -5%, excluding weather. 


Management stated that average check turned slightly positive during the quarter, which seemed somewhat expected given that the company lapped the implementation of its Everyday Value menu.  Management went on to clarify that the improvement in check did not come in January when it lapped the Everyday Value menu but instead, check turned slightly positive in February, which it attributed to the new promotion of free add-on onion rings with the purchase of the Steak Melt Toaster.  The company is running a similar promotion in March and thinks it should continue to drive average check higher going forward.


Sonic also commented on a change in compensation structure for its partner drive-in managers, which will cost an additional $1-$1.5M per quarter in labor expense.  As of April, most partner managers will transition to a more normal, stable compensation structure that includes a higher, more competitive base salary along with an incentivized bonus based on individual sales and profit performance.  Management explained that this provides more stable income for managers, which helps with retention, while still allowing for unlimited upside earnings potential.  When asked on the call, if this new compensation structure could cost more to the company when same-store stores growth and profits move higher, management joked that it would welcome that problem and discussion when it happens.



Notes from the call:




  • Difficult quarter for the average drive-in
  • Inclement weather in core markets
  • Recession taking hold much more intensely in core markets (lagging balance of country)
  • 1/3 of system in Texas and Oklahoma
  • Double-digit declines in state and local sales tax collections
  • Weather impact: analytical firm examined results, temperature, snowfall and concluded that 2/3 of decline in winter quarter was due to the harsh weather
    • SSS, ex weather, would have been -4% to -5%
    • Despite challenging environment, check turned positive for the first time in a good while
    • A year ago, everyday value menu was rolled out which impacted traffic
  • New promotions should lead to positive check going forward




Sales and profit growth

  • Value equation was previously focused on price
  • Going forward in FY10, more focus on the customer while maintaining achievements in price
    • Brand and business will be the better for it


4 components of strategy

  • High quality customer service experience at each drive in
    • Customer feedback has been sought out
  • Focus on product improvements in core menu items
    • LTO’s, core menu improvement, unique entrees and desserts et cetera
  • Marketing to drive home points of differentiation
    • Skating car hops etc.
  • New media reallocation of marketing dollars to maximize media impressions in trade areas of every store in the system (slight shift from national to local)
    • National spend will be $70m (one ad per hour)
    • Reallocation will be determined based on penetration and other metrics


Development growth has been challenged

  • Weather
  • Credit market
  • Franchisees uncertain
    • But continuing to reinvest in their assets
    • Remodels are high ROI opportunities
    • License incentive agreement for relocations or rebuilds expired, but investment continues
      • 150 or 4% of chain over the last two years
  • Sales and profit environment will lead to fewer than expected
    • 80 to 90 openings for FY10
  • First year sales continue to be strong
    • Opening volumes of 1.5m
    • 84 drive ins in new markets open for 1 yr
      • 1.4m average volumes
  • Continue to see construction prices fall and interest rates are low
    • Franchisees taking more time than usual to negotiate best deal so near term openings will continue to be constrained
  • Rate of closings remains low
  • Franchisees remain healthy





Sales deleveraging had impact on margins


Opened 17 drive-ins


Food improved slightly, commodities should be slightly lower in 3Q, higher in 4Q – flat 2H10

  • Higher costs with real ice cream and improved foot long chili cheese cone

Pricing: 2.5% price increase through 3Q (lapping 1.5%) may take pricing driving a 4Q cumulative increase of 1-1.5%


Higher labor costs


Other operating expenses were impacted because a large portion of them are fixed

  • Expecting improvement in 2H10


2010 Guidance:

  • EPS of $0.55 to $0.60
  • Restaurant level margins deteriorate slightly
  • SG&A $65-66m
  • DA $42-43M
  • Interest expense of $37-38m
  • FY10 positive operating cash flow of $25-30m, $52-53m in principal payments
  • Capex $25-30M
  • $100m in excess cash on hand
  • FCF flat to slightly positive





Q: Refranchised sales, were they in specific markets and what was the timing of those sales

A: Atlanta markets and a handful in Dallas. Lower performing and better performing drive-ins



Q: Change in partner compensation again? 1.5m on incremental labor expense? The upside is unlimited?

A: Sales and profit deterioration in partner drive in, disproportionate. Met with managers and supervisors and have given them chance to take different compensation structure. More predictable. Partner during summer months earn more in summer than winter. The idea is to provide stable compensation while retaining the upside that comes with driving the profits of the business.


1.5m in additional costs per quarter, health insurance, FICA, more stable based salary. We’d hope that this will result in a decrease turnover experience. Historically base comp has been on the lower end of market



Q: dollar amount received for refranchised stores?

A: slight loss on those transactions, lower performing and a small number of better performing drive ins. Partly why 2Q other revs came down. It’s also seasonal.



Q: G&A bad debt?

A: 1m increase attributable to bad debt. 3Q expectations for bad debt are built into 65-66m SGA annual guidance



Q:  Improvement in back half…where are we today? Within range of 0 to -5% to give that guidance?

A: When the weather has been comparable to the prior year (2Q and 3QTD) we are within that range.



Q: Bad debt expense…uncollectibles from franchisees? What’s that like yoy?

A: Some increase in delinquencies, small number of franchisees…not significant.  Majority of franchisees are in good shape



Q: Cash build, future uses. Talk about the decision not to buy back stock this quarter

A: Continue to evaluate that on a regular basis.



Q: Competitors with beverage innovation – big piece of your business – talk about % of sales from beverages vs 2 yrs ago…strategy?

A: Beverages are the best part of our business and beverage sales have held on better than other parts of the business.



Q: Ex-weather implying business improved, where is check, traffic?

A: As quarter progressed, lapped happy hour, we saw check turn positive. Not up by a huge amount but it is positive.



Q: Long term EPS growth target?

A: Key to growth is SSS turning positive. That’s our focus. Long term target is more contingent on SSS.



Q: Bad debt. What options do you have? Is it tacked on to rate you can charge franchisee over time? You write it off in entirety, future cash flows from that franchisee?

A: Through Feb 28th, we have recorded an appropriate amount. If business improves, it will decline. It is a larger amount than is typical. Suspect all franchisors have bad debt over time. This is a large amount attributable to terrible winter. Working out things with a franchisee on a case by case basis



Q: Given the new initiatives, how did you test the programs, which will be most meaningful?

A: Not possible to test some strategies (dollar marketing shift). The most important of the initiatives is improving product and service. People have to have a good experience and they have to enjoy the product.  Those are high priority and have to be steadfast. Creative and allocation of dollars are somewhat more transitory.  Those can change in a couple of quarters depending on market demands.



Q: Any impact from MCD dollar menu at breakfast?

A: No



Q: More color on COGs flat yoy in 2H. Product quality improvement, free tater tots in March, commodities flat? How do you get to flat?

A: Cost of goods being down in 3Q and up in 4Q include quality improvement. We did some discounting and promotions last year.  Some promotions are replacing promotions from last year



Q: Given more tip dependency on part of car hops, how are they dealing with SSS decline?

A: Don’t have exact figure but more skating gets more tips. Probably has been some offset but difficult to quantify.



Q: Turnover for car hops?

A: Declined slightly.



Q: Promotions with onion rings and tater tots, has this cannibalized combo meal sales?

A: there has been some trade-off but these promotions go out with a full price drink so penny profit isn’t diminished.



Q: How much of sales guidance in back half incorporates employment stabilization? Holding current rates steady?

A: Second quarter ex weather was at low end of range. Initiatives give us confidence that we should be able to offset or improve on current sales trend.



Q: New bundling with the free side, is there any trade away from value menu into that promotion?

A: Not sure. Value menu as % of sales has declined. Not promoting it this year vs last year. A year ago, customers wanted to know if we had a value menu. Now they seem to want a deal on regular items.



Q: Tweak value menu in light of moves by BKC and MCD?

A: We’d like to play on playing field where we have advantage – ice cream, conies, tater tots, onion rings. Not battling competitors on everyday value



Q: Do I have to request free attachments or is it automatically offered?

A: Offered if you order sonic cheeseburger



Q: What is the change in average check with change in promotion?

A: went slightly positive from negative.



Q: How important is it to broaden drink platform from happy hour and diversify away from high fructose corn syrup?

A: Drink sales are strong at breakfast…very big throughout day. Breadth of product offering is constantly being examined. Including types of drinks offered and times of day they are promoted.



Q: Store closures…would have expected more on franchisees, is there consolidation between franchisee base?

A: Historically that’s happened. Franchisees buying from company and each other. When a store gets in trouble it’s usually sold. That’s partly why closures are lower than one might expect.



Q: Average check now vs mid-07?

A: Running ~$5. Was around $5.35, $5.40.



Howard Penney

Managing Director


McCarran Airport released bad traffic numbers - down 6.2% in February. However, a Feb CNY and the easiest comparison of the year could contribute to positive growth.



Enplaned/deplaned passengers declined 6.2% y-o-y in February 2010.  The comparison was easy as air traffic declined 15.2% in February 2009.  Nevertheless, we believe revenue, assuming normal hold percentages, could actually grow over last year.


Due to the shift of Chinese New Year from January last year to February this year, the table game comparison is ridiculously easy.  Table drop and revenue declined 37% and 35%, respectively, in February 2009.  Slot hold percentage was a little low last year as well, easing the comparison.


In total, we think revenues could grow in the low single digits, again assuming normal table and slot hold percentages.  We would caution that due to the inclusion of the Chinese New Year in this month increases the volatility, substantially reducing the predictive power of our model.  In any event, we believe revenue growth anywhere near flat or higher will be viewed favorably.




FEB STRIP REVS COULD STILL BE POSITIVE - mccarran traffic chart feb

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