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Austerity’s Bite in Spain

We’ve written a lot of research over recent weeks and months regarding the impact of austerity measures across Europe. Turning to Spain, we continue to identify three main fundamental drivers that should drag down growth prospects over the intermediate to longer term: 1.) one of the highest rates of unemployment across Europe-27, 2.) continued real-estate depreciation and supply overhang, and 3.) eroding consumer confidence and spending alongside austerity’s consumer squeeze. 


As a reminder, Spain’s €15 billion austerity package includes:

  • 5% average pay cut for all civil servants and a 15% cut on ministers’ salaries
  • €6 billion reduction in public works projects

Spain’s PM Jose Zapatero gained some credibility at home in sacking two wasteful ministries for housing and equality earlier this month, yet the government is still running against the lofty goal of cutting the deficit from 11.2% in 2009 to 6% in 2011, and to 3% by the end of 2013.


Notwithstanding this lofty deficit reduction plan, austerity’s squeeze on wages and jobs should further erode consumer confidence and spending, which is already depressed given the country’s 20.5% unemployment rate and uncertain growth direction following the bust in the country’s real-estate bubble.   


While we applaud countries that are working to reform years of fiscal imbalances for longer term health, we expect Spanish growth to feel “pain” from Austerity’s Bite.   


Matthew Hedrick



Austerity’s Bite in Spain - sp1


Austerity’s Bite in Spain - sp2


Conclusion: Margins improved during the quarter, but sales continue to lag the industry.  We will have to wait and see what happens at Chili’s, but management appears to be doing all of the right things and given its upcoming initiatives and quarterly sales comparisons, there is visibility of a turnaround in top-line come fiscal 3Q11.


My original thesis around wanting to own this name has not changed; the company is working to fix its business model, which will result in significant margin expansion.  What has changed is the timing around when sales growth will start to materialize, and following the company’s fiscal 4Q10 earnings, I said we were possibly 9 months away from seeing a real turn in the fundamentals.  I think that timing continues to hold true as comps should begin to improve come fiscal 3Q11 when the company is no longer lapping last year’s “3 Courses for $20” promotion.



Margin growth already started to materialize during the first quarter with restaurant-level margins improving nearly 190 bps and EBIT margins up about 240 bps.  Improved cost of sales was the primary driver of margin growth in the quarter, down about 200 bps YOY as a percentage of sales.  Management attributed the decline in cost of sales to its more profitable value offerings (2 for $20 this year versus 3 for $20 last year), menu pricing and lower YOY commodity costs, which drove 70 bps of the 200 bp decline. 


The company guided to a similar level of COGS as a percentage of sales for the balance of the year, which would imply a nearly 200 bp full-year decline.  During the second quarter, this YOY benefit should continue to be driven by favorable commodity costs, which are 90% contracted.  Going forward, the company expects food costs to put increased pressure on margins as a result of higher beef costs (only 52% contracted on food costs in 2H11).  These increased food costs, however, should be offset by improvements in the company’s inventory control and actual versus theoretical costs as the company expects to fully implement its POS and back-of-the-house technology in 3Q11.

First quarter margins were also supported by the company’s team service initiative, which was already in place during the quarter.  Labor costs were relatively flat YOY as a percentage of sales as result of sales deleverage and increased manager bonuses, which offset the labor costs savings associated with team service.  Management expects the P&L to continue to benefit from team service savings, in addition to sales leverage in the back half of the year; though the company will continue to invest in manager bonuses if sales trends continue to improve YOY.


The company has already completed five kitchen retrofits domestically and two internationally, which have resulted in increased speed and consistency of food with better labor utilization.  For reference, the completed kitchen retrofits are expected to drive 300 bps of the 500 bp margin increase.  The test results have been so successful that the company has decided to accelerate the rollout of its changes to the prep process.  These changes are expected to optimize the labor component of prep and maximize food prep yield, which will benefit both the labor and COGS expense lines once fully implemented in January (beginning of fiscal 3Q11). 


The company expects to begin the rollout of its reimage program during the fourth quarter as long as test results prove favorable.  The priority of the reimages will be to further drive sales and will follow the implementation of team service, POS and the total kitchen transformation.



Brinker is fixing its business model and transforming its cost structure at Chili’s while working to improve its guest experience and yet, the stock is trading down over 7.0% today.  The company needs to see a turn in sales performance at Chili’s before investors will be convinced that the stated initiatives are working.  Margins are improving already, but in this environment, investors need to see solid top-line trends and unlike most of its casual dining peers that have reported before it, Brinker reported a comp miss relative to street expectations.  And, trends at Chili’s continue to lag the casual dining industry.


Same-store sales at Chili’s declined 5.0% relative to the street’s -4.1% estimate.  That being said, trends improved nearly 130 bps on a two-year average basis from the prior quarter and got better sequentially throughout the quarter.  Adjusting for the one week calendar shift that resulted from the fact that fiscal 2010 was a 53-week year relative to 52 weeks in fiscal 2011, blended comparable sales were -5.8% in July, -5.2% in August and -0.8% in September.  This compares to -8.8% in July of last year, -3.1% in August 2009 and -5.4% in September 2009, which implies a 420 bp acceleration in two-year average trends from July to September.  It is important to remember that the company first introduced its “3 Courses for $20” at Chili's in mid-July of last year after starting out the month with a double-digit decline in comps, continued the promotion into August and then was off of it in September.  To that end, the company saw its best comp growth during September when it was no longer lapping “3C”. 


Chili’s ran its “3C” promotion for six weeks in fiscal 1Q10 and about 10 weeks in fiscal 2Q10 (I included the chart of Chili’s comp performance from 4Q09 through 1Q11 as a reference of the concept’s comparisons for the remainder of the year).   With Chili’s continuing to lap last year’s strong promotional calendar during fiscal 2Q11, trends should remain sluggish, but like we saw in September, trends should see an uptick come 3Q11 when the company is lapping more comparable promotional offerings.  Trends should also improve as guest service continues to improve once the increased speed and consistency initiatives (resulting from the improved prep process) are fully implemented in January.




Howard Penney

Managing Director

FL/UA: Get ‘Em While They’re Hot

FL/UA: Get ‘Em While They’re Hot


Online sales of UA basketball shoes are going strong, and core sizes are out at FL.com. But don’t mistake that for a bullish call on UA. FL is the play here.


If you want to get your UA Basketball shoes through Foot Locker, you’d better hurry up unless you’re a size ‘Sasquatch.’  Core sizes in the flagship product are scarcely available online since the launch on Saturday, October 23rd. This plays into our view that the retailers – espec FL – will benefit from a better capitalized R&D cycle as well as greater capital deployment by the brands into sports marketing assets. Did anyone see the line up of commercials during last night’s NBA opener?


We’re very bullish on UA’s footwear business, but as noted yesterday, we do not like the stock near-term as two new risks (endorsement spending and cotton procurement) led us to take down our 2011 estimate by $0.14 to $1.56 at the same time the Street came up to near $1.50. That’s a far cry from the $0.60 gap that existed when we liked the stock $30 ago.


FL is the play here.


FL/UA: Get ‘Em While They’re Hot - UA2


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Marriott Timeshare Commentary + Q&A



Steve Weisz:  President Marriott Vacation Club International

  • Marriott has 53 timeshare properties
    • Hilton is the second largest competitor with 38 properties, HOT has 24
  • Have 88.5% owner satisfaction this year
  • 2009 contract sales ($543MM):
    • 45% from existing owners
    • Higher than normal driven by steep discounts to incent sales
    • 21% from owner referrals
    • 34% from new customers
      • Normally closer to 50%
  • Have 350,000 timeshare owners
  • What’s the incremental benefit of the new point program?
    • Can check in on day of the week for any amount of time at any resort at any size unit
    • Can use points towards the “explorer collection” – adventure travel (safaris/ cruises)
    • Can use points towards the “world collection” – international travel
  • Benefits to MAR:
    • Will have just in time inventory development
    • Will only sell completed inventory and therefore less deferred revenues
    • Lower unsold maintenance fees
    • Less capex spend
  • 29,000 owners have enrolled 58,000 weeks over the last 4 months
    • Enrolling highly demanded weeks (52% platinum, 26% gold)
    • 51% of owners who tour have converted
    • Purchased $13,600 of points on average
  • Projecting $995MM of contract sales by 2013 (12% CAGR)
    • $192-202MM timeshare segment results
      • $55-60MM of base management fees
      • $255-265MM of timeshare sales and services revenue, net
      • $76-79MM of G&A
      • $42-44MM of interest expense
  • In 2011, they may sell some bulk land that was previously earmarked for fractional and residential
  • Roughly 42% of purchasers used financing in 2010, expect 45% financing through 2013
  • Cumulative Timeshare EBITDA from 2011-2013: $655-690MM
    • Development profit: $330-350MM
    • Financing profit: $265-275MM
    • Services profit: $60-65MM
    • G&A: $220-230MM
    • Timeshare segment results: $435-460MM
    • D&A: $85-90MM
    • Interest expense: $135-140 MM
  • FCF of $625-675MM:
    • EBITDA +
    • Inventory: $85-105MM
    • Less financing activity: $150-160MM
    • Other: $35-40MM
  • Have $1.5BN of timeshare inventory projected at YE 2010 and expect $1.26 BN of inventory by 2013


  • They aren’t many qualified franchisers in China – so they will continue to manage the Courtyard. In India, they will also mostly go managed but would consider franchising with the right owners.
  • Bulk fractional inventory sales in 2011? What’s currently on the books?
    • Ritz’s inventory is about $300MM
  • Target of mid teens return over time – but aren’t there yet
  • Believe that the synergy btw timeshare and hotel business is that timeshare owners are better MAR customers and a lot of their timeshare resorts are co-located
  • Sales and marketing costs as a % of sales has gotten a lot higher over the last few years for timeshare – i.e. lower closing rates (around 10%) and under the new program, it's 14% but albeit at a lower dollar amount since people can buy in smaller intervals
  • Have 35 development people internationally, will ramp that up fairly significantly over the next few years
  • Economics of AC deal - no comment (no real estate ownership- will be a JV company that will manage and franchise hotels)

JNY: Ruined Everything By Being Itself

JNY: Ruined Everything By Being Itself


Earlier this week we noted that this story would break down within 2-quarters. We did not expect it to be within 2-days.  In this note we focus on what’s changed.  Bottom line = If 2011 estimates don’t shake out close to a buck, this puppy needs to see more downward revisions.


  1. First off, the top line grew at 20%, while GAAP EPS was down 7%, and the triangulation of sales/inventories and margins is as bearish as we’ve seen for JNY in 2 years (see Exhibit 1).
  2. This might be nit picking. But don’t you love how this company prints a GAAP number of $0.34, but they say that all these impairment charges and realignment costs (due to underinvestment and mismanagement) are not a part of ongoing business. Why do they also have such costs in the year-ago period? Translation = yes, impairing assets and continuous realignment IS a part of JNY’s business. Note to management: Stop highlighting it as a non-recurring item.
  3. 20% top line was a full 6% better than our estimate. This included the layering on the Stewart Weitzman acquisition – as expected, as well as better than expected retail comps of 2.5%. But the bulk was driven by a greater push (and we mean Push) in Better Apparel and Jeanswear. Net/net, this should have resulted in a BIG gross margin number. Right?
  4. Nope. Gross margins were down 205 bps - which was entirely driven by the Wholesale Better Apparel and Jeanswear businesses. Management was not clear about the drivers, but continually highlighted input costs and freight costs. Here’s what we don’t get… These sales occurred during the third quarter based on product that was built/assembled in 2Q and composed of materials procured in 1Q. Translation = you can’t look at the $1.27 cotton price we see today and possibly imagine that this is showing up in JNY’s margins yet. That will hit in 1Q11.  So what gives?

    The reality is that we don’t know. That is super scary.

    1. Our sense is that Retailers, Manufacturers and other supply chain partners that actually have a risk management process are already jockeying for margin dollars from their weaker partners. Yes, that’s JNY. Think about it. If sales are weak in department stores, can Macy’s turn to Ralph Lauren and demand margin dollars? Not a chance. Historically, the weak brands have funded the stronger brands.  But one major change of late is that LIZ has been pulled out of the equation given that it is exclusive with JC Penney and QVC. The department stores have a big set of crosshairs on JNY.
    2. Another reality is that there’s simply more ‘stuff’ to sell. Inventories were so lean over the past 2 years that orders finally ticked up eight months ago, increased product across most of retail, and has been hitting our shores since August. Yes, it means that top line numbers will be there. But in no way, shape or form does it mean that the margins will be there. 
    3. In fact, when putting b) and c) together, we’d argue that the GM erosion hardly came from cotton over a buck – but more likely due to more units in the marketplace. This, on the margin is probably good for the TJX’s and ROST’s of the world.
    4. Retail sales were up 6%, including a respectable 2.5% comp. But then I ask… How come margins are still flat versus last year at NEGATIVE 6.2%? What would they look like if comps went negative? For a story where the bull case is so focused on a recovery in Retail margins – this print raised some serious questions. Sometimes margins are bad because it’s simply a bad business – not because profitability is ‘artificially depressed.’ Maybe a few years back it was artificially high.

In the end, our core thesis with JNY remains simple and unchanged. Without a major reinvestment in the company – JNY is locked into earning $1-$1.50 in perpetuity. When people start to believe $2 EPS numbers (which the Street did last week, and no longer does today with a 25% melt-down), then the short case becomes more powerful. When the cash flow stream inevitably blows up because the company can’t kick the can down the alley anymore, then we can put on our bull hats. Here, unless the Street ends up at about a buck in FY11, there’s more downward earnings revisions to come.


JNY: Ruined Everything By Being Itself - JNY SIGMA



Marriott International Division Commentary + Q&A



Amy McPherson: President and Managing Director, Europe

  • Have 179 hotels in Europe:
    • 49% Marriott
    • 23% Courtyards
    • 18% Renaissance
    • 5% Ritz
  • Over the last few years, new openings in Europe have shifted towards branded from independent brands
    • As of 2009, only 30% of hotels were branded
    • 2005-2007 openings: 52% branded
    • 2008-2010E opening: 61% branded
  • European travel spend was $1.34BN in 09 vs. $1.15BN for NA
  • 70% of MAR guests in Europe are European (mostly from UK, Germany and France)
  • European contribution to other regions:
    • NA: 2%
    • Caribbean & LATAM: 5%
    • ME&A: 34%
    • Asia Pacific: 10%
  • Marriott is the 10th largest hotel company in Europe with 40,258 rooms – Accor is #1 with 247,603 rooms as of June 2010.
    • 6% of branded supply
  • Just renovated 32 hotels in Europe
  • UK, Germany, and France generate 65% of their revenues in Europe
  • House profit margins in Europe are expected to be 35% higher than peak levels in 2007
  • Have centralized service centers across Europe to drive efficiencies
  • Expect to double their portfolio in Europe by 2015:
    • Autograph
    • Courtyard and FS expansion
    • Using MAR capital to acquire strategically located hotels or chain acquisitions
    • AC hotels
  • AC hotels:
    • 3rd largest brand in Spain
    • 92 hotels (9,500 rooms) located primarily in Spain (10 in Italy and 2 in Portugal)
    • At closing will bump them to #5 in Europe
  • Expect 60-61,000 rooms by 2013 with 48,000-49,000 organic additions from the 41,000 rooms at YE 2010E

Simon Cooper: President and Managing Director, Asia Pacific

  • Have 2.4MM rooms in Asia Pacific, 65% of which are independent, 27% are chain managed and 8% are franchised
    • Of the 647,000 rooms that are chain managed
      • Marriott has 6% share
  • Source of Asia Pacific room nights:
    • 58% Asia Pacific
    • 29% NA
    • 10% Europe
  • China is the fastest growing market with 58MM inbound travelers
  • China is spending $117/per capita on infrastructure spend vs. $17 in India
    • Rail and low cost carriers are creating a new market of leisure travelers
  • Courtyard is full service in Asia
  • Signed a new agreement with Ctrip (China’s largest online travel agency with over 60% market share) to partner with Marriott Rewards this morning

Paul Foskey: Executive VP International Development, Asia Pacific

  • Grew from 35,110 rooms in 2007 to 47,000 at 2010E YE
    • All managed
  • 47,000 room distribution:
    •  46%: China
    • 15%: SE Asia
    • 12%: Indochina
    • 12%: Japan & S. Korea
    • 7% Pacific
  • 47,000 room distribution:
    • 30%: Marriott
    • 24%: Renaissance
    • 15%: Courtyard
    • 14%: JW Marriott
    • 13%: Ritz
  • Signed pipeline: 17,000 rooms
    • 43%: China
    • 5%: SE Asia
    • 39%: Indian subcontinent
    • 13% Indochina
  • 17,000 room distribution:
    • 30%: Marriott
    • 14%: Renaissance
    • 25%: Courtyard
    • 20%: JW Marriott
    • 8%: Ritz
  • Marriott is ranked 4th in open rooms in China and really focus on the gateway and primary cities (18.5k rooms)
    • Projecting that their rooms will generate $1BN in 2010, the same as IHG’s 45k rooms in China – since non gateway cities have very little pricing power
    • So Marriott captures 20% of the revenues with only 15% of the supply vs (AC, HLT, H, IHT, HOT, and Shangri-la)
  • In India, wealth is much more geographically distributed
    • Only 107k rooms
    • Mostly new
    • Less rate disparity between primary and secondary cities
    • Marriott has 2,737 rooms in India – all managed (2nd largest western brand)
  • Goal to launch 75 Fairfield units in 10 years. Also potential for Autograph.
  • Expect to have 72-74,000 rooms in Asia Pacific by 2013, of which 62,000-64,000 are included in their 3 year plan
  • 50% of MAR’s fee revenue in the region comes from outside of India and China

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