On 5/19 we published a note titled, “WEN - Undervalued Yes, Where is the Opportunity?” that discussed WEN’s stock and provided a sum-of-the-parts analysis that suggested that the company’s stock was trading below its intrinsic value.


I said at the time, “Over the years, Trian Partners has been extremely successful at creating value from mispriced securities.  In the almost two years since creating the Wendy’s/Arby’s Group, it has now created one of those mispriced equities.  Can Trian and senior management fix WEN again?”


After the close yesterday, Train said in a 13D/A filing that it recently received an oral inquiry from a third party expressing interest on a preliminary basis in a potential acquisition involving WEN.  Our sum of the parts analysis from 5/19 values the WEN at $7.70.  We value the Wendy’s business at $6.30 per share and the Arby’s business at $1.40 per share.  Send me an email if you would like additional details.


Thus far WEN is the third company to announce some sort of value enhancing initiative.  Fist it was CKE, then CPKI and now WEN.  If you are looking for the next possible candidate I would bet on EAT...


Howard Penney

Managing Director


Despite Keith’s selling of EAT in the firm’s virtual portfolio, we remain confident in the long-term opportunities for Brinker shares. 


By now, many of our subscribers are aware of our unique process at Hedgeye that marries Keith’s macro and quantitative views with our company-focused fundamental perspective.  While Keith’s move here is primarily predicated on his broader view of the market, we want to reiterate that our fundamental, long-term view on Brinker shares and the company’s turnaround efforts at Chili’s remain unchanged. 


Specifically, Keith provided the following perspective on his move to sell EAT in the portfolio, “I'm going to take the loss here and sell the stock on an up day. Penney remains bullish for the long term here but is becoming increasingly negative on competitor balance sheets like DIN.”


I would agree with Keith that the MACRO environment will remain challenging in the near-term and overleveraged balance sheets will only magnify those challenges for certain restaurant companies, like DIN, but I would actually point to DIN’s balance sheet issues as a positive for Brinker.  As I outlined in my EAT Black Book, Brinker has a strong balance sheet and one primary reason I think the company will outperform in these challenging times, in the more challenging Bar and Grill segment, is that its largest competitor (DIN’s Applebee’s) does not have the financial capability to compete.  And, as I said earlier this week, I continue to believe it will be important to focus on those companies that are being proactive and creating leaner, more efficient cost structures as they will be better positioned to mitigate margin erosion in a tough sales environment.  To that end, EAT is one name that is pursuing a proactive strategy and remains a core focus name. 


To be clear, when I became more vocal on the reasons to own EAT, I stated that sales trends through the end of fiscal 2010 would be choppy as Chili’s attempts to decrease its reliance on aggressive discounting (and move away from “3 Courses for $20) and as customers adjust to the significant menu changes at the concept.  That being said, management’s efforts to revitalize the brand from both the retail and manufacturing sides puts the company on track to post significant margin growth at about the same time top-line trends should begin to recover, beginning in FY11; though I think the margin story will materialize even without a significant tick up in trends.


There seems to be a lot of confusion among investors about the timing of implementation for POS, KDS and kitchen retrofits and the subsequent 500 bp margin benefit (net 400 bps after depreciation) forecast to materialize by the end fiscal 2013, but management said very specifically at an investor conference this week, “So we do think more than half of the 500 basis points of margin improvement will be in place by the end of fiscal 2011.”  I do not think most investors were forecasting this level of growth in FY11 and management’s comment only strengthens my conviction that the street’s FY11 EPS estimate is too low.


Management seems confident about its potential earnings growth in the next two years.  EAT’s 5-year target to double EPS by FY15, off of the $1.40-$1.44 base, with 10%-12% EPS growth in FY13-FY15 implies 40% to 50% EPS growth from FY10 to FY12. This two-year target assumes 1% to 2% same-store sales growth, which seems achievable; though it does it rely on sequentially better 2-year trends going forward.


I am comfortable saying again what I wrote on April 20th, following Brinker’s fiscal 3Q10 earnings call, “I know things don’t happen in a straight line and there will be bumps in the road, but I want to be a little early on this one.  Once it gets going, it’s gone…”


Howard Penney

Managing Director

Sizing Up China

“China is teeing themselves up to take over the financial world.”

-Keith McCullough, June 10th, 2010


Conclusion: China is starting to look interesting on the long side, as the stock market has priced in slowing economic growth.


Bottoms are processes, not points. With the Shanghai Composite down just over 21% YTD, it’s obvious that investors have been discounting what we are starting to see evidence of: slowing growth. At a point, however, that all gets baked into the market and bottomed-out, downward growth expectations begin to shift on the margin towards upward growth forecasts. Combined with the prospects of a simple intermediate-term mean reversion trade (China has underperformed all major equity indices YTD except Greece, Spain, and Slovakia), it’s easy to see why we’re starting to warm up to China on the long side – of course not at every price. We’ll wait for more confirmation of the Shanghai Composite’s higher-low to begin looking for an entry point.


For now, allow the charts below to tell the story on China and what the forward growth outlook is from here.


No surprise here: Chinese equity markets and Chinese demand for copper (as measured by our proprietary Hedgeye China Market Index) have been a leading indicator for growth. As our index would suggest, GDP growth peaked in 1Q10.

Sizing Up China - GDP


The YTD look at the Hedgeye China Market Index suggests that Chinese GDP growth will decline sequentially from its 11.9% peak in 1Q10. The markets have been pricing this in. At a point, what has been priced in will begin surprise to the upside.

Sizing Up China - HCMI


Chinese real estate prices were up 12.4% Y/Y in May – the first sequential deceleration in a year. It appears the peak has been established, which has been priced into the Chinese equity market for quite some time. With peak property price growth perhaps in the rear view, the next question logical question will be where will the current cycle bottom out?

Sizing Up China - Property Prices


To a large extent, the answer to that question will be to watch the Chinese equity markets and the price of copper. With a positive 0.78 correlation (0.61 r-squared) to property price growth for the last three years, our Hedgeye China Market Index should prove to be a reasonably reliable concurrent indicator for the growth of one of China’s main industries. If Chinese property price growth continues to sequentially decline, we expect those declines to bottom out alongside, or shortly after we’ve put in a bottom in Chinese stocks.

Sizing Up China - Property HCMI


Much to-do has been made about the Chinese trade numbers released overnight (Trade surplus – $19.5B in May vs. $1.7B in April; Exports up sequentially – 48.5% Y/Y in May vs. 30.5% Y/Y in April; Imports down sequentially – 48.3% Y/Y in May vs. 49.7% Y/Y in April). Members of the Manic Media appear puzzled that May could produce such large gains in exports – especially with a significantly weaker Euro. Analysis shows, however, that the May 2009’s export growth compare (-26.4% Y/Y) was the easiest “comp” on record. It appears basic math and probability analysis trumps even European sovereign debt scares, or the analytical skills of the Manic Media.

Sizing Up China - Imports Exports


Lastly, a sequential deceleration in import growth is just what the Chinese wanted to see. With what is widely considered an “undervalued” currency, the Chinese are prone to importing inflation. To gauge real-time, we’ve created rolled out our Hedgeye China Growth Commodities Index, which indexes the price of copper, crude oil, and aluminum to the start of the year. The chart below suggests that China indeed imported deflationary commodity prices in May and is continuing to do so in June. No surprise that China’s copper and aluminum imports were down Y/Y in May (-6.1% and -71.5% respectively).

Sizing Up China - Growth Commodities Index


So what does this all mean? You have a government that put the screws to its economy in order to cool growth and it appears the peaks have been established, making it less likely we’ll see more tightening in the near term and likely that perhaps equities have already discounted future slowing growth.


Darius Dale


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Crash or Correction? SP500 Risk Management Levels, Refreshed...

The only way to have another stock market crash is for there to be a suspension of belief that we can’t crash again. Markets don’t trade on valuation – they trade on expectations. With fleeting low volume rallies to lower-highs in the past few days, the probability of this correction becoming a crash is going up.


Hedgeye defines a crash as a -20% move from a measurable peak-to-trough. Since the 2008 crash, we have not had one. From the April 23rd, 2010 cycle-peak of 1217 to the June 7th closing-low of 1050, we had an expedited -13.7% correction. The crash zone from 1217 is well below the 1000 line at 974, so keep that reference point in mind. That’s the Pain Trade point for the bulls.


If we hadn’t seen 2010 crashes already in major global equity markets like China, Spain, and Italy, the probability for mean reversion would be lower. If our forecast for another breakdown in the US Dollar based on US sovereign deficit and debt risks weren’t concerning us, the probability for lower-lows versus 1050 would also be lower.


If there weren’t so many ifs in our risk management process, we are not quite sure what we would keep us busy throughout the day. If consensus was Bearish Enough, the SP500 wouldn’t be up 2% today either. From a risk management perspective, nothing of consequence has really changed here today, so we’re still a net seller on strength.


Our long term TAIL line of resistance is now at 1081 and has proven to be a formidable wall today. We see no downside support from here to 1037. From 1081 to 1037 = -4.1%. If that were to happen tomorrow, I think it will definitely get people’s attention and put the crash scenario in play. Lots of ifs…


The monthly US budget deficit for May was released at $136 BILLION DOLLARS. Add that to April’s $83 BILLION DOLLARS and I have $219 BILLION reasons to not trust that the US Government should be entrusted with my hard earned capital being put at risk. Our asset allocation to US Equities remains zero percent as a result.



Keith R. McCullough
Chief Executive Officer


Crash or Correction? SP500 Risk Management Levels, Refreshed... - S P

FL: Hedgeye's Process Unleashed

Despite Keith’s selling of FL in the firm’s virtual portfolio, we remain confident in the intermediate-term opportunities for Foot Locker shares. 



By now, many of our subscribers are aware of our unique process at Hedgeye that marries Keith’s macro and quantitative views with our company-focused fundamental perspective.  Often times our best ideas are born out of the intersection of the two processes.  At other times, there can be a disconnect between us, resulting in opposing opinions.  While Keith’s move here is primarily predicated on his broader view of the market, we want to reiterate that our fundamental view on Foot Locker shares and the company’s turnaround efforts remain unchanged.  We still believe this represents one of the better stories in retail, driven by both strong athletic footwear and apparel tailwinds as well as strategic initiatives put in place by CEO, Ken Hicks and his team.


A second pillar of our process is transparency, which means we’re more than happy and in fact, proud to share our thought process with you in real time.  As such, here’s Keith’s perspective on why he sold his position in FL this morning:


“Stock between a rock and a hard place plus I am bearish on the market… market call with a stock that just broke its TREND line of 14.49 and hasn’t been able to recover it … long term TAIL of support all the way down to $11.81, so I have time to buy it back on any market weakness” - KM


Importantly, Keith’s selling of the FL position in the firm’s virtual portfolio does not change our key view on the opportunity for the shares, which we highlight below:


We continue to believe the COMBINATION of Foot Locker specific drivers such as improved apparel assortments, distinct banner segmentation, and inventory management will ultimately lead to a continued string of upside over the next several quarters.  Importantly, the company’s recent 1Q results were the first reported since Ken Hicks unveiled the company’s strategic plan on March 9th.  We remain confident that management is conservative with its forecast on both the top and bottom lines, preferring to use a still “uncertain economic” backdrop as a reason for which to be reserved. 


While management may be conservative, we remain aggressive both on the opportunity to see meaningful earnings upside over the next couple of years as well as the commensurate opportunity for share price appreciation.  Our estimates remain comfortably ahead of the Street for this year at $1.05 vs. $0.87.  We’d continue to use the market weakness and jitters to revisit the intermediate term opportunity.  As stated above, we suspect Keith will also be revisiting at some point as well.  


Eric Levine



The Macau Metro Monitor, June 10th, 2010


Wynn Macau COO Linda Chen said that she believes GGR will exceed the forecast of 30% growth but still sees a slowdown in the 2nd half of the year.  Chen said she expects the VIP market to grow at a faster rate than the mass market segment, contrary to comments from SJM (see note below).  She does not think the weak stock market and tight monetary policies could affect VIP gambling revenues in the second half.


Meanwhile, Steve Wynn said its mega resort on Cotai could break ground next year.  He added that the project could have 1,200 to 1,300 slot machines and be ready by 2014.  Wynn said he will be "splitting the headquarters" of Wynn Resorts between Las Vegas and Macau.



Frank McFadden, president of SJM's joint venture and business development division, said gaming revenue growth will slow in the 2nd half as wealthy Chinese take a hit from a weak stock market and tight monetary policies.  "We see a softening in the VIP market and continued growth in the mass market. The VIP gaming market has been driven by a rising asset base in China and a rising stock market in China."  McFadden believes if VIP slows down, even though mass continues to accelerate, overall gaming revenues in June will decline sequentially.  McFadden said the 2nd half could see 60% of SJM's revenues come from the VIP segment, down from 65% in the first quarter. 


SJM continues to take a 'wait-and-see' approach on Cotai.  McFadden expects SJM to have around HK15 billion in cash by the end of 2010.  He stressed that the strong cash position would help the company secure a prime location on Cotai if the government takes back some of that land.  "We're a bit cautious because the level of equity that you'll need to invest will be high in order to compete," he said.  If SJM does build a property on the Cotai Strip, it could predominantly be geared towards gaming.  McFadden said that "95% of spend here is gaming when the visitors come.  It would be arrogant to think that by building what they call an integrated resort, you can change the consumer behaviour of 1.4 billion people." He added that he wasn't aware of any talks between SJM and Sands or Studio City about a land deal.


The Cotai integrated resorts will create “15,000 to 17,000 job opportunities in the next 18 months,” said CoD president Greg Hawkins. Hawkins said that City of Dreams currently has around 8,000 employees, while The Venetian has more than 10,000.  The vacancies could be good news for the 9,600 residents unemployed in Macau.


Hawkins said the SAR Government “has always been very open” to the demand for non-resident workers. The key will be getting the balance right."


Meanwhile, Galaxy IR, Peter Caveny, is optimistic on the Guangzhou–Zhuhai Intercity Mass Rapid Transit (MRT).  He predicts the rail will bring 400,000 people a day to Macau when it opens this November.



Bally Technologies is targeting to supply 20% of the total slot machines to Sands China’s parcels 5 and 6 and Galaxy Resort.  “If they open with 1,500, we would expect to get 20% of the order,” Cath Burns, vice president for Bally Technologies’ Asia-Pacific operations, told Reuters, referring to Sands China´s projects. “Same with Galaxy — that’s what we are targeting with both groups now.” 



The ban on smoking inside casinos could lead to a 20% drop in gaming revenues, the president of American Gaming Association (AGA) Frank Fahrenkopf told reporters during G2E Asia.


Meanwhile, Taiwan will conclude legislation on gaming by 2012. However, lawyer Benjamin Li told Lusa, that just like Singapore, Taiwan should not issue more than two licenses.


Universal Entertainment Corp, a Japanese pachinko game maker and the biggest shareholder in Wynn Resorts, plans a HK IPO  within three years for a unit that is building a $2.7 billion, 99-acre Manila casino resort.  "Universal Entertainment aims to lure VIP players from China to the Manila resort," said Kazuo Okada, Universal Entertainment's Chairman.  The first phase of the resort will include a casino, a hotel and an aquarium. The completed project will include two casinos, two hotels and a residential building and may be finished within five years, he said.


Companies are attracted by the Philippines' lower tax rates.  “Our gaming tax is lower than Macau and slightly higher than Las Vegas,” said Rafael Francisco, President of Philippine Amusement and Gaming Corp. Licensed casinos pay 25% gaming taxes, along with a corporate income tax for entertainment and other non-gaming income, he said.



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