An excellent article I came across “The Street” that we truly believe and have to agree on.
Over the past few days, we have seen some discussion on RealMoney about the creeping presence of food inflation. You can drag out all the government figures, statistics and reports about inflation and I can refute them with a trip to the grocery store. Food prices are rising on a year-over-year basis. Even the U.S. Department of Agriculture (USDA) agrees with me on this one. They project food inflation to continue well into 2011. It is not just here in the U.S. either. A news search for “food inflation” shows reports of the same problem in India, China, Australia and other nations. Doug Kass has written a thought provoking column about the potential for water and agriculture conflicts between India and China making the problem even worse in the year ahead. He predicts that restaurant and food stocks will suffer mightily next year as a result.
If he is right, then I may finally move ahead on shorting casual dining stocks. I have attacked this group on the short side using my “chicken shorting” methods. I have traded puts and put spreads on the group several times in the past two years. I would have to go back and add it all up, but I am pretty close to even on the series of trades with a few winners and a few losing efforts. Cracker Barrel has been my biggest nemesis. The stock has support from fellow RealMoney contributor Jon Heller but it has been a loser for me three out of four times. Jon is a very smart guy and I was not very happy to see him long the stock I was short!
However, I think the stars may be lining up for me this time. The consumer is still relatively weak. I love it when people will tell me that they were in XYZ Dining last Friday in such and such a town and they had a decent crowd. Of course, they did. About 80% of us still have jobs, and people on the upper end of the income scale, especially, are a little more willing to spend after two years of belt tightening. Plus, people like to go out on the weekends. But if you stop back in to most these places on Sunday through Wednesday, you will see that traffic is down. In the restaurant business, you cover costs on the weekends, and make a profit the other nights.
As I am no longer the quintessential bachelor who eats in restaurants five or six nights a week — and the ballpark the rest of the time — I had to rely on more traditional research methods to measure traffic at sit-down dining establishments. Fortunately, I have many friends in the business and they report that business is still tough. Weekday dining is still slow and holiday party bookings are less than stellar was the consensus view of the people in the business who I called. Food costs are an issue for most of them. So are wage and benefit costs and they are universally concerned about the prospect for new business regulations and taxes in the next year or two. They are surviving but that’s about all.
Another reason I think this trip to the short side may pay off for me is that the Market Volatility Index (VIX) is at low levels and interest rates are also fairly low, so options are relatively inexpensive. I am a chicken short, I admit it. I never take non-arbitrage related shorts — I use puts and put spreads to short stocks. The group has momentum right now, but I am going to look to establish some shorts as they work higher into the end of the year. I am going to use the longest-dated options I can find and try to buy puts and bearish put spreads. I will only use a small percentage of my total portfolio for these trades. If they work, I will get a fairly big payoff that will add to my overall return. If I am wrong, I will lose a small percentage of my cash flow from dividends and arbitrage activities. That’s the type of asymmetrical risk/reward I love to find when I have established more speculative positions than my usual deep value purchases.
I will use the usual suspects. I will establish short bets in dineeEquity . The company is losing money this year and its revenues continue to fall. No one I talk to is excited about taking the wife and kids out to Applebee’s or IHOP (dineeEquity is their parent company) and the family business both chains depend on is more likely to head to McDonald’s or another fast-food establishment. Buffalo Wild Wings is also a good short candidate. It’s a wing and beer joint at the end of the day to the fact that it’s trading at 22x earnings with an EV/EBITDA ratio over 8 just seems too high. Out of a sense of nostalgia and pure stubbornness, I will include Cracker Barrel. With gas nearing $3 and food costs rising, the chain could see profit growth begin to slow next year. I will add Panera Bread to my list of overvalued dining issues I hope to short going into 2011. Soup and a sandwich is not worth 30x earnings.
I suspect these stocks will move higher along with the market going into the end of the year. I will use strength to open my positions, but New Year ‘s Day should find me mildly hung over, watching football and shorting all of them. I will use a 100% stop-loss on the positions and hold them until they work or expire.
SOURCE: WSJ
