2006 Restaurant Year in Review and The Menu for 2007

This article was originally published including charts courtesy of CTS Trend on The Street.com’s Street Insight Long/Short Trader on Dec. 26, 2006.

So what's on your menu this week? Some left over latkes from Hanukkah? Perhaps some smoked ham cold cuts from Christmas? Looking into 2007, there are several themes in the restaurant sector that will continue to create investment and trade opportunities. So, without further ado, here is my restaurant year in review and outlook for the year ahead.

IPOs

There were several high-profile restaurant IPOs that took place in 2006. First came Chipotle Mexican Grill (CMG), which soared from the get-go and remained a Wall Street favorite for the balance of the year. The stock even caught on Friday.

The other restaurant spinoff IPO was Tim Hortons (THI). While THI had some success out of the starting gate, the stock has pretty much leveled off and has not found a strong following from analysts or investors.

Finally, Burger King (BKC) came public to join the quick-service ranks along McDonald's (MCD) and Wendy's (WEN), both of which were the source of the two above mentioned spinoffs. BKC stumbled out of the gate, but management appears to be making operational headway and also benefited from the substitution effect.

Look for continued activist shareholder activity in 2007. Don't be surprised if you see a private equity or leveraged buyout deal. CKE Restaurants (CKR) is a good trading stock that rises and falls with such speculation.

Casual Dining

It was a real up and down year for the casual dining segment. A strong start to the year was thwarted in the spring by a market correction, spiking energy prices and the fear of inflation. These companies were hit hard as traffic migrated down the food chain to the quick-service restaurants as the substitution effect took hold. Not until energy prices peaked, the market correction ended and the Fed finally pushed pause in the middle of the summer did the casual dining chains begin to rebound. OSI Restaurant Partners (OSI), which operates the Outback Steakhouse chain among others, managed to get a recent private equity buyout offer. All of the popular casual dining chains had similar chart patterns during the year. Here are some of the favorites: Applebee's (APPB), Darden Restaurants (DRI), Brinker International (EAT) and Ruby Tuesday (RI) all charted together.

Casual dining will struggle in 2007 as the concepts out there are just too homogenous. There are no new offerings that I see on the horizon. Rather, you will have to play this sub-sector as trades, looking to take a lead from economic signals. Commodity costs -- namely, energy and food -- should be watched most closely. There are some potential turnaround stories as well that could provide opportunities. One name that comes to mind is Red Robin Gourmet Burgers (RRGB), which is a great concept that has long suffered from managerial mismanagement and misdeeds. We need to watch RRGB but not rush to act.

Substitution Effect Bolsters Quick-Service Names

The quick-service restaurants were the beneficiary of the substitution effect. The stock that not only weathered the spring squall but managed to be one of the best performers of the year was McDonald's (MCD). Not far behind was Yum! Brands (YUM). I continue to like both of these stocks, especially as they both continue to expand overseas, specifically in China. YUM took a little bit of a hit in December because of an E. coli outbreak at some Taco Bell restaurants, but I believe that to be a short-term issue, and this has presented a good entry point or level at which to add to positions.

The year ahead will be all about international expansion - China, to be exact -- for quick-service names. I continue to like MCD and YUM, which are positioned for this theme. Starbucks (SBUX) is also a China play, but I am not convinced that Howard Schultz can deliver the same level of tremendous growth in 2007 as SBUX has exhibited in the past. Headwinds to SBUX include rising coffee prices and the lingering question, How long can SBUX continue to push up prices to consumers before they revolt?

Steakhouses

The steakhouses were problematic this year. The reason for this was the same woes that hurt the casual dining stocks in the spring and early summer (as I mentioned above). Adding insult to injury, these stocks could not rebound because they were hit with the double whammy of higher beef prices. I traded out of and then back into Ruth's Chris Steak House (RUTH) during the year, managing to sell just at the top and then reentering back in the fall at dramatically lower levels. I am still holding my new positions today. Here is a combined chart of RUTH and its closest high-end steakhouse rival Morton's Restaurant Group (MRT).

I really like the premium steakhouses in 2007. My favorite name remains RUTH. RUTH continues to expand not only from coast to coast but internationally in major financial center cities and high-end resort destinations. The spike in beef prices from last summer has subsided, and prices have now abated for several months. The impact of the spiked prices will have worked through the system by the first quarter of 2007. I think that estimates for 2007 are still low and that the company will grow by at least 20% in 2007 and over the next few years.

Who Wants Pizza?

The one group I played wrong this year was the quick-service pizza sector. I was long Domino's Pizza (DPZ) coming into the year and sold too early. On the other hand, I do have pizza exposure through my YUM holding, so I did not totally blow it.

When it comes to pizza, I think that this is a crowded and competitive market, and it will continue to be throughout the new year. Look for cheese prices and the economy as a gauge for trading opportunities. If you want the best of both worlds, own YUM, which has both Pizza Hut and the China growth story all wrapped up in one.

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At the time of this Blog entry and the Street.com article, Scott Rothbort, his family and or clients of LakeView Asset Management, LLC were long shares of McDonald's (MCD), Yum Brands (YUM) and Ruth's Chris Steakhouse (RUTH) although spositions can change at any time.

The 2007 Seton Hall Stillman School of Business Jim and Judy O'Brien Financial Markets and Economic Colloquium

Scott Rothbort w/Wall Street Guests (below)

Scott Rothbort w/SHU Students (above)

How much would you pay to attend a conference where you had the opportunity to listen to James Altucher, Jeff Bagley, Tony Dwyer, Doug Kass, Brian Reynolds, Cody Willard, and yours truly, Scott Rothbort, in person?

$999?

$599?

$199?

How about nothing? (Although donations to the Stillman School of Business Trading Room are greatly appreciated.)

And how far would you have to travel for that event?

South Orange, N.J.

That's right. On January 31, 2007, this collection of savvy market professionals will descend upon Seton Hall University for the Jim and Judy O'Brien 2007 Financial Markets and Economic Colloquium. Had you attended last year's event, you would have been properly positioned in 2006. Find out what everyone will be forecasting for 2007. It all starts at 3 p.m. I hope you can make it.

The Year in Derivatives: Amaranth 'Highlights' Tumultous Year

This column was originally published on theStreet.com’s Street Insight.

As we close out this year, I wanted to review some of the highlights in derivatives this year.

1. The story with the most pervasive impact on the financial markets was that of hedge fund Amaranth. However, while the headlines were concerned with Amaranth's failure, the real story was what the hedge fund did to the energy markets. The rise and fall of crude and natural gas prices can be linked to Amaranth. The fund participated in and perhaps exacerbated the massive speculation and volatility that took place in the energy futures and options markets. However, once the marginal speculator would no longer enter the market, the music stopped.

Energy volatility and prices collapsed, and Amaranth lost billions of dollars. Comparisons were made to Long Term Capital Management (LTCM). Once again, we saw that the collapse of a large derivative speculator, whether it was the Hunt Brothers, LTCM or Amaranth, did not create a systemic financial depression. The lesson was that the system works.

2. Implied volatilities in the equity spiked when the spring correction took place but returned to lower levels as the year progressed. The VXO stands at low levels on a historical basis. This reinforces my research which indicates that high levels of volatility are predictive of market bottoms and impending rallies but low levels of volatility are just low levels of volatility and have no predictive value. It is likely that the low levels of implied volatility are the result of hedge funds seeking to generate alpha as they constantly sell both put and call options.

Unfortunately this has been a losing formula as we have seen, with options selling on the S&P 500 and individual stocks like Google (GOOG) , Sears Holdings (SHLD) and Goldman Sachs (GS) . Nevertheless, as long as there are levered players out there who need to outperform but have no other edge, it is likely that volatility will be an easy target.

3. Derivatives exchanges were all the rage. Cross-town rivals the Chicago Mercantile Exchange (CME) and the Board of Trade (BOT) agreed to merge after both stocks climbed to new highs. Futures, commodity and options volumes have soared, making these highly valuable properties big moneymakers. Following in the wake of that mammoth derivative exchange merger was the IPO of the New York Mercantile Exchange (NMX) in one of the hottest debuts for a stock in many years. Looking to the future, I expect that after the NYSE (NYX) completes its acquisition of Euronext NV it will next set its sights on a derivatives/commodities exchange as well as opportunities in the Far East. Perhaps it will try to kill two birds with one stone, if possible. My advice is to stay out of Thailand except for a vacation.

4. Options backdating was the scourge for many companies, including one of my favorites, Apple Computer (AAPL), and a company that I divorced from my portfolio, United Health (UNH) . While I am upset that many companies have been embroiled in these scandals, what really irritates me is the inability of these companies to resolve the issues on a timely basis.

The U.S. has some of the finest finance, accounting and legal minds that the world has to offer. Why does it take so long to figure out the impact of the backdated options? This can easily be done with a spreadsheet and some junior accountants. It is a shame that a company needs more than one week to figure out the accounting impact of backdated options.

5. The credit derivative market continues to grow in magnitude and importance for a wide variety of users. These users include the natural hedgers like lenders, speculators (like hedge funds) and the vendors (such as the investments banks). Expect the bears to rally around credit derivatives as the next market to achieve "bubble" status in the next year or two.

At the time of this Blog entry, Scott Rothbort, his family and or clients of LakeView Asset Management, LLC were long shares of Apple Computer (AAPL), Google (GOOG), Goldman Sachs (GS), NYSE (NYX) and Sears Holdings (SHLD).

When 'Buy What You Know' Doesn't Pay

As I penned my list of the Five Worst Managed Companies in the U.S. in October, I had several other companies in mind that were being considered for the article. However, upon closer inspection, these companies had a different theme that I would now like to discuss. Today's list of five inauspicious companies has one thing in common: They are companies with great products that are bad investments. As before, my list could be longer and you may have your own favorites. Also note, that these are bad investments but could be a decent trade from time to time. Without further ado, and in no particular order, here is Scott Rothbort's list of Companies With Great Products That Are Bad Investments:

1. TiVo (TIVO): The quintessential great product bad investment company. I told my wife six years ago that we had to buy a TiVo. She had no idea what a TiVo or DVR was at the time. Six years later, we can't live without it. In fact, we still have the original box and lifetime subscription that we originally purchased. You would think that TIVO had a great concept and would be printing money. No so. By far, TIVO is the best example of how to screw up the concept of giving away razors and making customers pay for the razor blade. Since going public and now for 31 consecutive quarters, TIVO has posted a loss. The most recent quarter was the same old story for TIVO: more losses; litigation issues; fiddling with subscription packages; and, delays in collaborative agreement. Buy a TiVo but not TIVO.

2. Six Flags (SIX): What can be more fun than a day with the family at the amusement park? Well maybe a day at the ballpark, but you get my point. You have to be a real misanthrope to hate amusement parks. Disney (DIS) knows how to build and manage an amusement park. SIX, on the other hand, has managed to deliver declining returns to shareholders. In fact, a weekly chart of SIX looks like a roller coaster ride: a big climb, a rapid fall, some ups and down and then return to terra firma. SIX has been under new management for several quarters now and, frankly, they have just continued the failures of their predecessors. As an example, they managed to bungle the Great Escape in the Lake George region. The geniuses at SIX repaved the Great Escape parking lot this year (it does look good), but in doing so initiated a $10 per car parking fee for the first time ever. There is a Yiddish terms to describe this decision: chutzpah (gall, audacity, nerve). So they spent lots of cash (heavily borrowed), charged to park, and attendance declined. Spend your hard-earned cash for a day at Six Flags but not for a single share of stock.

3. Vonage (VG): Get rid of land lines, give your local telephone company the Bronx cheer and use the Internet for telephone calls. Voice Over Internet Protocol (VoIP). Sounds great. Go ahead and use it. Many people are switching. We have not switched to VoIP but would consider it some day. My sister-in-law has gone VoIP. She is satisfied. I have heard pros and cons in the VoIP debate but nevertheless, I have to say, that as a product and technology it is a great concept. VG seemed to be promoting itself for years. I call it the longest road show ever. It was also the most bungled IPO since the Wilt Chamberlain debacle back in the 1990s. If you have or plan to use VoIP be careful and don't swap your old AT&T (T) stock for VG in the process.

4. Krispy Kreme Doughnuts (KKD): If you read Jim Cramer's Confessions of A Street Addict, then you would probably know Jim as someone who lived for a Krispy Kreme and a great stock idea. Unfortunately, KKD could only deliver the former and not the latter. Those delectable delights are irresistible. Even though the "Under New Management" sign is hanging in the Krispy Kreme window, you have to wonder whether the KKD business model is or ever was viable. Sales continue to decline. The baking business has always been tough. Dunkin Donuts has been handed from owner to owner for years with relatively little success. Just look at the history of Interstate Bakeries or Tasty Baking (TSTY). Bring a dozen Krispy Kremes to your next client meeting, but don't sell them on the stock. Nothing beats McDonald's (MCD) when it comes to a food service investment.

5. Alternative Energy Stocks: Let's reduce our dependence on fossil fuels and tell OPEC to stick it where the sun doesn't shine. It's like a bad gift: It's the thought that counts. This entire asset class gets the great product bad investment nod. We can use light, water, wind, steam or bovine excrement to generate energy for all I care. But even if Earth, Wind and Fire were to sing for us, it is highly unlikely that a stand-alone company is going to make you a dime in the alternative energy sector. Maybe some big-cap companies like Archer Daniels Midland (ADP) or a utility like FPL Group (FPL) can hide their alternative energy losses under the rest of their profitable portfolios. Occasionally, a Johnny-Come-Lately alternative energy stock will go IPO and get investors all lathered up in the first few months of life only to eventually succumb to traditional valuation techniques. The pink sheets and OTC bulletin boards are littered with the carcasses of alternative energy stocks.

Here is a Web site devoted to alternative energy stocks. Go ahead, knock yourself out, and try to find a stand-alone alternative energy investment. Over the long run, these are bad investments. In the meantime, think green, and invest in Exxon Mobil (XOM).

At the time of this Blog entry, Scott Rothbort, his family and or clients of LakeView Asset Management, LLC were long shares of McDonald's (MCD) and Exxon Mobil (XOM).

The Worst-Run Companies in the U.S.

The following article was originally published on The Street.com's Street Insight website (see links to the right) on October 18, 2006. In addition, I followed up with an interview on Street.com TV the following week (the link to the video also appears on the right).

As we are now deeply entrenched in the 2006 third-quarter earnings season, the question that always pops up in my mind when we are at this juncture is, what are the worst-run companies in the U.S.?

Without further ado, and in no particular order, here is my list:

1. Industrials: Alcoa (AA) Year to year, quarter to quarter, this is The Gang that Couldn't Shoot Straight (by the way, also the name of a great book by Jimmy Breslin). When commodity prices work against it, it delivers disappointments. When commodity prices work in its favor, never fear! It will botch it up and disappoint. Competition is never a problem for Alcoa; it does a fairly good job of competing against itself.

2. Technology: Lucent (LU)). How do you destroy Bell Laboratories, once the leading edge of telecommunications innovation in the world? Answer: Spin it off from AT&T (T)), load it up with debt, put lousy management in charge and lose the creative talent to the competition. At least it will soon be Alcatel's (ALA) problem. Au revoir.

3. Media/entertainment: Cablevision (CVC). Or should I say Dolanvison? The Dolan family has managed to destroy shareholder value while increasing their own wealth for many years. In the process, they have destroyed a New York icon, the Knicks, mismanaged another, the Rangers, sabotaged an Olympic bid, delivered lousy service to customers, made a bad investment in The Wiz, failed to grab up the old Adelphia properties on the cheap, piled on debt and then tried to rip off shareholders in last year's failed privatization offer.

After a special cash payment of $10 to shareholders in April, the Dolans were finally able to grab CVC back from shareholders just this past month. Finally, shareholders will be rid of the Dolans and, if they are smart, will invest the proceeds of their sale into a better-managed company.

4. Financial services: Janus Capital (JNS). We are in the middle of the biggest asset-management boom of all time, and this company has managed to move in reverse. Assets have flowed with the accompanying management fees to the competition, and this is likely to be a unidirectional movement. Don't be fooled by the recent stock performance.

5. Retail: It's a tie. Too close to call. Sharper Image (SHRP) and Pier 1 Imports (PIR). I actually ran a five-year comparative chart of the two companies. The relative returns were as close as a pennant race between the Tampa Bay Devil Rays and the Kansas City Royals. Relatively competitive, but absolute losers.

Sharper Image reminds me of the Scotch Tape Store sketch from Saturday Night Live in the 1970s. All that the store sold was Scotch tape. All that Sharper Image seems to sell are ionic breeze air purifier machines. Have you ever gone to one of its stores? It's where the men hang out while the women spend money at the other retailers -- you know, those retailers who know how to manage a business.

As for Pier 1, that store has more junk in it than any women I know would be caught dead living in the same house with.

I am sure you have your own nominees, especially those that have cost you performance in the past. The lesson is, when you invest in a stock, you are also investing in management.

Note: Subsequent to the publication of the article above, Alcatel's acquisition of Lucent was completed. The new company is aptly named Alcatel Lucent (ALU).