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Buck Breakout: US Dollar Levels, Refreshed...



Higher-highs and higher-lows. That’s what the US Dollar Index is accomplishing all of a sudden. It looks like it’s going to close up for the 5th of the last 6 weeks, confirming both a bullish immediate-term TRADE and a higher probability of a continued bullish intermediate-term TREND.


In the chart below we show the newfound bullish intermediate term TREND line of support at $79.07. The corollary to this is that what was intermediate-term TREND support for the Euro is now resistance at $1.34. We’re short the Euro and long the USD and we’re likely to stay with both positions until they are either immediate-term oversold or overbought, respectively.


The immediate-term overbought TRADE line of resistance for the US Dollar Index is now $81.35. In terms of catalysts, we’re looking forward to Ron Paul’s subpoena of Ben Bernanke and/or a concurrent reduction in the size/pace of the Fed’s Quantitative Guessing program. Additionally,  inflation accelerating should continue to provide a bid to US Treasury yields, which augers bullishly for the US Dollar Index.




Keith R. McCullough
Chief Executive Officer


Buck Breakout: US Dollar Levels, Refreshed... - buck


Below are some highlights from our Macau trip.  




Overall Macau Trends

  • Market is off to strong start in December
  • No impact from China tightening
  • PWC’s forecast of a doubling of gaming revenues in 4 years is doable
  • Mass:  20% visitation growth, 10% GDP growth = 30% revenue growth, this is probably sustainable
  • VIP:  same as above except for credit multiplier so growth has been higher – there is a lot more credit in the market but consensus is that it is manageable

Mass Market Promotional Activity

  • CoD reinvesting the most –some say 30% - which means they will have the lowest margin
  • MGM only 23%
  • Venetian only in high teens

Asian expansion

  • Japan, Thailand, Taiwan, South Korea, Vietnam are all on the radar screens of the big Macau operators
  • MPEL wants to get involved, possible on a smaller scale somewhere in Asia to prove they can do it outside of Macau.  Very bullish about Asian gaming expansion prospects.


  • May be delivering on top and bottom line – not buying as much business as people think; just doing a good job
  • We're more bullish on the property’s prospects now than before the trip.  Recent revenue and EBITDA spike looks sustainable.

LVS November market share loss

  • Low hold impacted them
  • They also had a terrible first week because Beijing government officials were staying at Four Seasons/Venetian so the junkets stayed away.  Impacted 2nd week as well but weeks 3 and 4 were very strong.

Galaxy Cotai

  • Even the competition thinks it will be a nice product
  • Trial won’t be a problem, getting repeat business might be
  • Concern over management team since they’ve never operated a Mass property before
  • CoD could get blasted and is most at risk
  • Peninsula could give up 10-20% of its business to Cotai when Galaxy opens


  • Studio city ruling in March – MPEL wants it and thinks they can get it
  • Lots 7/8 could persuade the Studio City antagonists to settle their differences – would be a positive for MPEL


  • Cannibalization of Wynn Macau is inevitable when Wynn Cotai opens
  • Wynn Macau will need some material investment before Cotai opens (room renovation, some new restaurants, etc.) to limit cannibalization
  • Wynn Macau rebound is being sustained in December
  • Two new VIP rooms could juice market share


For now, if the stock market is your gauge, Bernanke is seeing some success.  There are many other real time markets (commodities, global growth) that show a disconnect from U.S. equities.  The most recent consumer data point indicates that the consumer is feeling better.  I’m less-than-convinced that this will be sustainable or that Ben Bernanke has discovered any lasting solution to the problems facing the U.S. economy. 


The following are some current positives in consumerland:


1.       Income growth is getting better

2.       Job growth is still stagnating but trends are better that they were in January

3.       Retail sales are hanging in

4.       Consumer sentiment improved 5.7% and 3.6% sequentially in November and December, respectively. 

5.       The Consumer discretionary index (XLY) is up 25% YTD

6.       The S&P 500 up 8.76% and 3.69% September and October, respectively and is up 4.4% so far in December.


The University of Michigan consumer confidence reading rose to the highest level in six months, but is still registering a lower high; index of consumer sentiment rose to 74.2 from 71.6 at the end of November.  The Bloomberg consensus was for a reading of 72.5. 


The bullish consumer sentiment is not being conferment by the more weekly ABC consumer comfort index which is at a -45, up from the low of -54 set on 12/01/08.  Year-to-date the consumer sentiment index is only up 2.3%, with the expectations component down 3%, while the current conditions is up 10%. 


The consumer is clearly responding to diminishing levels of uncertainty as corporate profits have improved to the best level since 2007.  We are reminded that not every this is turning up roses and part of the improvement increased profits is due to better efficiencies thru lower labor costs.  Just today TJX closing down the A.J. Wright division and cutting 4,400 jobs; other notable companies recently announcing layoffs in the past 30 days are the Washington Post, Express Scripts, State Street VF Corp and Apollo Group Inc.


The current trends in consumer sentiment as measured by the University Michigan are critical and continued improvements are needed to sustain the bullish sentiment running thru the market. 


1.       The Bullish to Bearish spread for the AAII sentiment index is approaching the danger zone again at 30.5.

2.       The VIX is down 48.9% over the past six months and is now down 20.99% year-to-date; another shoe dropping could see the VIX busting a serious move to the upside.


If the politicians in Washington come to some sort of compromise from the expiring Bush income tax cuts, it’s net neutral for the economy and will not likely benefit consumption.  At some time austerity will need to become a part of the conversation and a cursory glance at the television and how that is going down in Europe shows you what the consumer is going to think about that.  The continuation of the unemployment benefits helps buttress consumption.  I have described this before in the context of extended and emergency benefits.  Allowing them to expire would essentially sweep the legs from under a large portion of consumers and, whether or not one believes that this is good policy, it would initially be a negative for consumer spending and the broader U.S. economy.


On the plus-side for consumers, the one year's elimination of two percentage points in the Social Security withholding tax will directly boost disposable income of individuals currently paying those taxes.  As a result, there should be some consumption pick-up, but it is “one time” in nature and, just like the stimulus package, the impact will only be short lived.


As the facts change, we can adapt to the new trends.  For now we are sticking to our Consumer Cannonball theme (albeit on a different duration), as some of the major pillars of that thesis have not changed; primarily the outlook for housing and the labor market in 2011.  I will expound upon this point in a post next week.


Howard Penney

Managing Director


CONSUMER CONFIDENCE – BERNANKE IS THE MAN! - univ mich sentiment dec


CONSUMER CONFIDENCE – BERNANKE IS THE MAN! - univ mich expectations dec


CONSUMER CONFIDENCE – BERNANKE IS THE MAN! - univ mich current conditions





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R3: JNY, BEBE, Twitter, Reebok


December 10, 2010





  • Just what every kid needs.  Gucci launched an iPad app that allows users to dress up a virtual kid in the brand’s just launched children’s line.  While the paper doll motif is somewhat clever, we wonder just how many children will be asking their parents to replace their Dora apps with Gucci’s Playground?
  • According to the Pew Research Center, one in ten internet users are Twitter users.  Approximately 74% of Americans use the internet, which implies about 6% of the entire population is now Tweeting.  Interestingly, females outpace males by about 1/3 with their Twitter usage.
  • Just as Bebe introduced its latest resort collection for the company’s Kardashian line, the company’s president also indicated that the collaboration with the pop-culture icons may also be nearing an end.  So much for a long-term partnership – “at Bebe we need to move with fashion and we want to be first in the fashion world with everybody else and not fall behind. We are definitely assessing the situation.”  



Jones Group to License Kids' Brands The Jones Group is taking its children's’ footwear business out of house. The company’s portfolio of kids' brands, which includes Nine West, Sam & Libby and Mootsies Tootsies, has been licensed to Edison, N.J.-based LJP International, the firm founded by children’s market veteran Larry Paparo. The Dockers boys’ line will not continue under the new partnership. Current Nine West kids’ exec Joe Truglio will join LJP as director of sales. Rick Paterno, group president of footwear for Jones, said the move, which will be effective Jan. 1, is a logical one. “While kids’ has always been a good business for us, it’s somewhat outside our core competency. We’re a women’s house and that’s what we’re experts at,” Paterno said. “This licensing arrangement gives the children’s business a dedicated focus from Larry and his team, while still allowing us to control the design and direction of the product.” Paparo, whose company has extensive sourcing networks in China and Brazil, had been working with Jones for some time as a production agent for its kids’ lines. “We think Larry will do a fantastic job running the business,” Paterno said. “He has his ear closer to the children’s market and really understands it, and he has great relationships in the marketplace.” <WWD>  

Hedgeye Retail’s Take: While kids footwear may not be a “core competency” of Jones, it’s also likely that recent top management departures have forced the footwear division to clean house.  


Innovation Out of Reebok - Reebok International Ltd. and Cambridge, MA-based MC10, Inc. announced an R&D collaboration to create a new class of athletic apparel and equipment, combining market leading sport design with advanced electronics. Reebok said the collaboration will use MC10's conformal electronics platform and Reebok's design capability to bring new products to the athletics market. When combined with Reebok's heritage of innovation for the athlete, MC10's proprietary approach to making high performance electronics "skin like" and invisible to the wearer will enable entirely new classes of intelligent sports equipment and apparel. Reebok also noted that it has a strong history of innovation with iconic products in the sporting goods industry like The Pump, and more recently EasyTone, and ZigTech. <SportsOneSource>

Hedgeye Retail’s Take:  We see this collaboration going one of two ways – using innovative technology to enhance performance intelligence in athletic apparel product (positive); or harnessing electromagnetic currents to stimulate muscles in order to encourage weight loss at all times (just bad). Yes, a bit tongue-in-cheek, but pushing the brands as the next great innovator seems a bit of a stretch.


Burberry Expanding in India - The Burberry team hit India this week with much fanfare and for a simple reason — to celebrate its presence in the emerging market, which company executives consider key for the brand’s global retail expansion. Chief executive officer Angela Ahrendts and chief creative officer Christopher Bailey, on his first trip to India, arrived in Mumbai earlier this week, and on Thursday night, descended on the Aer Bar at the city’s Four Seasons Hotel roof terrace for a fete with 200 guests. This being Burberry, there had to be a distinct Brit flavor to the affair, so the brand flew in musician Rory Cottam from English band The Cheek, who appears in Burberry’s fall campaign and did a DJ set that night. Indian musicians and brothers Aman and Ayaan also gave a live acoustic set, and Indian DJ Aqeel spun tunes. There are four Burberry stores in India. The brand has a presence at the Palladium Mall in Mumbai, the Emporio Mall in New Delhi, UB City Mall in Bangalore and the Taj Krishna hotel in Hyderabad. The brand will open a fifth unit at Oberoi Hotel in New Delhi this month. The stores are operated by Burberry India, a joint venture with Genesis Colors that was unveiled late last year. “This was my first visit to India,” said Bailey, who has kept the brand’s Facebook fans abreast of the trip. “It’s a country that we are so excited by. They have a huge appreciation for luxury and Britishness, so being there and meeting everyone and feeling the energy behind the country was incredible and we had a great night in Mumbai.” <WWD>

Hedgeye Retail’s Take: While not nearly the same opportunity as China, the UK/India history is certainly one that should help build the re-emergence of the British luxury brand.  Keep in mind that the luxury biz in India is highly concentrated on a handful of urban centers, which for now makes substantial unit growth a challenge (despite housing the world’s second largest population). 


Mulberry Opens Flagship Amidst Strong Demand - Profits at Mulberry Group PLC more than tripled in the six months to Sept. 30 to 3.3 million pounds, or $4.9 million, from 1 million pounds, or $1.5 million, on the back of strong, full-price sales growth in robust markets including the U.K. and the U.S. And sales show no signs of flagging: In the ten weeks to Dec. 4, Mulberry said global retail sales rose 47 percent, and that full-year performance was likely to exceed market expectations. The spring 2011 wholesale order book is 91 percent higher than last year and orders have not yet closed, the firm said. The group reported the results Thursday, just days after opening a 5,400-square-foot flagship store at 50 Bond Street, an open, environmentally-friendly space that showcases the brand’s accessories and ready to wear together for the first time. “It’s the largest single-floor space on Bond Street – there aren’t even any pillars,” said Godfrey Davis, chairman and chief executive, during a walk-through. “And it was a logical move for us. Finally, we’re all on one floor.” Mulberry’s former shop, at number 42, was smaller, narrow and on various levels. <WWD>

Hedgeye Retail’s Take: While not likely a key influence in the UK, we wonder if the company’s second collaboration with Target has been a key driver of the brand’s growth here in the U.S.  Unfortunately the company’s nine Target SKU’s are now sold out.


Luxury Watch Retail Expansion Continues - Officine Panerai has retail expansion on its timetable. The storied watch brand, which was founded in 1860 and bought by Compagnie Financière Richemont SA in 1997, currently sells its watches in only 500 points of sale around the world, including around 100 locations in the U.S. There are also 24 company-owned boutiques worldwide, with three in the U.S., on Madison Avenue in New York, Beverly Hills and the latest addition, Boca Raton, Fla., which opened in September. Over the next several years, Panerai will add significantly to its retail stable, revealed chief executive officer Angelo Bonati. “In three years, we will grow to 100 stores,” he said. “We’re convinced that opening boutiques is the right [strategy]” to attract Panerai’s customers. London and Paris will be added over the next three months and, within three years, six to seven stores will open in key luxury markets in the U.S., as well as additional units in Europe, the Middle East and Asia. <WWD>

Hedgeye Retail’s Take: The surge in luxury watch demand is driving a notable push for retail expansion of late – recall Omega made an even more aggressive announcement just last month. While demand is certainly present heading into the holidays, one has to question just how sustainable demand will be as brands ramp store growth into the 2H of 2011.  


PPR Primed to Offload Conforama - French retail-to-luxury group PPR said it has entered into exclusive negotiations with South Africa’s Steinhoff International Holding Ltd. for the sale of furniture chain Conforama for 1.2 billion euros, or $1.58 billion at current exchange. Under the terms of the deal, Steinhoff would also take over Conforama’s debt to PPR, an undisclosed sum. “This planned cession to a global furniture sector player is a major strategic opportunity for Conforama,” PPR chairman and chief executive officer François-Henri Pinault stated. “Steinhoff International has an intimate understanding of Conforama’s business and the two companies operate in complementary markets.”PPR has said it wants to sell its retail assets, including music, books and electronics retailer Fnac, in order to fund expansion in the lifestyle segment, which should eventually dwarf its luxury division, Gucci Group. With 41,000 employees, Steinhoff is already one of the largest furniture and household goods suppliers in Europe and had been looking to reinforce its position in France and other territories. Natixis analyst Boris Bourdet estimated Conforama’s debt at roughly 400 million euros, or $529 million, which would bring the total purchase price to around 1.6 billion euros, or $2.12 billion. <WWD>

Hedgeye Retail’s Take: Lots underway going into yearend for CEO Pinault with the pending sale of PPR’s furniture business while at the same time revisiting the acquisition of a skate/lifestyle brand. Recent headlines (and the market) suggest the company is near a deal with Quicksilver, though apparently Billabong is also under consideration. Given the prospect of capital gains tax relief, the urgency to close deals before year end is less pressing, but the reality is that activity is likely to accelerate.


Outdoor Product Sales Rise in November - The outdoor market outperformed the broader markets in November posting an impressive 8.7% retail sales increase versus the same month in 2009.  Footwear category sales were up 9.6% (largely due to late-arriving winter boot sales), apparel category sales were up 11.7% and hardgoods category sales grew 4.1% over the same time period in 2009. Aggressive promotions, pent-up consumer demand and colder weather patterns combined to drive retail chains and outdoor vendors to their best November in four years.  According to retail point-of-sale data compiled by SportScanInfo for OIA VantagePoint™, sales trends in the outdoor market are mirroring the trends at retail overall, with luxury and specialty out-performing lower-end stores and the Internet channel continuing to take market share from traditional brick and mortar business. Despite higher than anticipated unemployment and tax uncertainties, holiday gift-giving and winter weather patterns combined to loosen consumer purse strings.  Sales motivators began shifting in November, with consumers driven both by wants and needs instead of just needs.  For example, Winter Boots made up 36.0 % of total outdoor footwear sales in November 2010, while comprising only 8.8 % of sales for the entirety of third quarter 2010 (retail calendar third quarter is August-October). <SportsOneSource>

Hedgeye Retail’s Take: primarily a function of two factors, the obvious is favorable weather, less obvious is the fact that holiday creep continues to push consumer purchasing earlier and earlier.



Inflation Signals In Europe

Position: Long Germany (EWG); Short Euro (FXE), Short Italy (EWI), Short Spain (EWP)


We continue to point out in our macro research that we see global inflation accelerating. Below we show charts of the German Wholesale Prices Index that registered +7.8% in November year-over-year and the UK Producer Price Index that rose +3.9% in November year-over-year (see charts below).   


Inflation Signals In Europe - a1


Inflation Signals In Europe - a2


Points to consider:

  • We’d expect increases in wholesale and producer prices to be "pushed" to the consumer = bearish for consumer.
  • While UK PPI is sequentially lower, the elevated level will put addition pressure on the BOE to address headline inflation that has stood above its target rate for the last 8 months.
  • The UK Statistical Report noted that the rise in PPI mainly reflected price rises in petroleum products (including duty), food products and computer, electrical and optical products.
  • The German Wholesale Price Index is making higher highs despite more difficult annual comps.
  • The weakness in the EUR-USD  in Q2 of this year should encourage inflationary pressures on the comp beginning in 2Q11 (see chart below).

Inflation Signals In Europe - a3


As Keith pointed out in the Early Look this morning, the price of everyday consumer goods (commodities) have signaled huge inflationary gains over the last three months, despite the highly politicized and manipulated US CPI figure that stands at a mere +1.2% in October year-over-year. In case you missed it, here’s a look at these price moves.

  1.  Crude Oil = +18.2%
  2. Natural Gas = +20.8%
  3. Heating Oil = +18.2%
  4. Gold = +10.1%
  5. Silver = +41.2%
  6. Palladium = +38.3%
  7. Copper = +17.3%
  8. Cocoa = +12.3%
  9. Cotton = +52.4%
  10. Lumber = +19.8%
  11. Orange Juice = +16.5%
  12. Sugar = +35.5%
  13. Corn = +24.2%
  14. Oats = +27.9%
  15. Rice = +20.5%
  16. Soybeans = +23.6%
  17. Wheat = +10.3%

Suffice it to say, inflation is showing up in Europe. For the major economies on the continent, we believe the most current “threat” of inflation, which needs to be addressed, is in the UK. That said, Eurozone countries should begin seeing higher inflation, especially if our bullish intermediate term call on oil is correct, and as comps from a weaker EUR show up beginning in 2Q11.


Matthew Hedrick



YUM continues to pursue an aggressive growth strategy.  Here is a recap of their analyst day that occurred this week in New York.


Chief Executive Officer, David Novak, and his team gave a detailed presentation today in midtown NYC and their overall strategy remains unchanged.  As they presented it, their four-pronged strategy is:


1) Build leading brands in China in every single category

Hedgeye take: An incredibly strong business and much of the future sentiment around the stock will be anchored on the performance of the China division.

2) Drive aggressive, international expansion and build strong brands everywhere

Hedgeye take: Herein is lies a risk for the company’s “aggressive growth” strategy.  Incremental international “growth” related capital is moving toward the lower return western part of Europe

3) Dramatically improve U.S. brand positions, consistency, and returns

Hedgeye take: Apart from the Taco Bell and the franchise revenue stream, the US business is not competitive and is in a continued, long-term, secular decline

4) Drive industry leading long-term shareholder and franchisee value

Hedgeye take: This significant growth profile will limit the amount of cash returned to shareholders relative to the past 5 years.


I have some thoughts to share on the respective segments, as they were discussed today, and then I will conclude with some thoughts on the company’s guidance and overall strategy heading into 2011. 




China’s performance remains impressive and management is as bullish as ever on prospects for that market.  YUM plans to further improve asset utilization in the near future with breakfast being rolled out in all stores, delivery being implemented and also 24-hour service on a limited basis (just over 1,000 stores).  KFC is opening in cities where no competitors exist and are currently in 650 cities in China.  Management was repeatedly citing a Euromonitor source outlining the projected 650m Chinese that will make up the Consuming Class in 2020 versus the 2010 total of 450m. 


Overall, the division is focused on its aim to continue growing aggressively in China.  The company is appropriately focused on cities and transport hubs.  It was interesting to see that the company breaks cities into six tiers.  While I was unable to find a specific definition for these tiers, it follows that Shanghai and other large, developed cities are Tier 1 cities and smaller cities such as Xinghua in the Jiangsu Province are Tier 5 cities.  In 2010, 15% of total builds were Tier 1, 33% were Tier 2, and 52% were Tier 3-6.  It is interesting to note that operating margins have stayed relatively flat versus nine years ago despite growth being more focused on lower tier (higher margin) cities in recent years.  This obviously implies that margins have declined for YUM in Tier 1 markets.  There is a 500-800bps difference between T1 cities and the balance of the country.  This was explained to us as being mainly attributable to higher rent expense in T1 cities.  Given that operating margins are so much higher in other cities the contraction is not overly problematic, but the trends are important to watch.


China accounts for 37% of the company’s operating profit and I think it is now unwise to be negative on YUM unless one is also negative on China.  YUM’s management team is “all in” as it relates to China and this is evident in their guidance for 2011.  The “ongoing” growth target remains 15% on an annual basis and embedded in that number are assumptions of double-digit percent unit growth, at least 4% of comparable restaurant sales growth, and moderate G&A leverage.  The 4% same-store sales imply a significant step up in two-year trends and I believe it may be slightly aggressive but top line trends remain robust.


Their earnings guidance also takes into account expected inflation levels of 5% on the Food & Paper line coming from 6-to-7% inflation in chicken (45% of mix) and 2% inflation for packaging.  Management’s projection of 12% inflation in labor due to ongoing government requirements is a double-edged sword for Yum since consumers have more money but labor costs go up for their China division.  Obviously one edge of that sword is sharper than the other and this will negatively impact earnings.  Management seemed confident that sales leverage and the scale that exists in China would enable them to overcome these headwinds in 2011.



United States


The United States is a relatively difficult market for YUM and the company is investing less and less (as a percentage of total) in the division as a result, preferring to increase their focus on China and emerging markets.  In 1998, 78% of YUM’s operating profit came from U.S. operations.  At present that figure is 35% and the company projects that it will shrink further, to 25%, by 2015. 


For now, though, the U.S. remains an important market and the company is struggling to stimulate the KFC business and readily admits that no silver bullet is forthcoming.   Taco Bell drives 60% of U.S. operating income.  For 2010, 376 (over 2x the 2009 number) remodels will be carried out and management are stepping up the pace of new unit growth for the concept.  The “Bold Goal” is to build 8,000 Taco Bells in the U.S.  The slide management presented to illustrate this point showed the number of Burger King restaurants in the U.S. as a comparison, which is roughly 7,300.  This is not an especially useful comparison given the intrinsically different natures of the two concepts and the fact that Burger King, many could argue, could stand needs to close many of its stores. 


In terms of guidance for 2011, the company is forecasting 6% operating profit for Taco Bell U.S. in 2011 and 3% for “Rest of U.S.”, which, if you take Taco Bell as 60% of operating income, implies overall profit growth of 4.8% for the entire U.S. Division.  Taco Bell’s guidance assumes “modest” unit growth, 3% comparable restaurant sales growth, and “modest” G&A leverage for the year.  Specific guidance for KFC and Pizza Hut within the U.S. Division were conspicuous by their absence.  The lack of disclosure doesn’t bode well for their respective performances in 2011.


Overall, I expect the U.S. business to continue to be a drag for YUM.  Despite best efforts, KFC is struggling and I do not believe any of the initiatives mentioned at the Analyst Day, such as increasing sandwich mix, will yield improved margins.  Again, comparisons of markets (in this case U.S. versus U.K.) may be interesting but do not necessarily offer a winning solution from a strategy standpoint.   The refranchising strategy that the company is pursuing with KFC should insulate the company’s bottom line from the weaknesses in that business somewhat, but alongside the bold (and brave) pronouncements that defined the other segments of the presentation, the management’s tone during commentary on the U.S. market was decidedly cautious.  Goal number 3, of the 4 pronged strategy outlined at the outset of the presentation, to “dramatically improve U.S. brand positions, consistency, and returns”, will definitely be the most difficult of all 2011 goals for Yum Brands.





This was an interesting part of the presentation.  YUM is aggressively pursuing growth opportunities in select emerging markets, such as Indonesia, Malaysia, Thailand, and others.  The thesis is similar to YUM’s China stance; the consuming class population is set to grow at an even faster rate in “YRI Emerging” markets than in China; set to grow to 2 billion by 2020 from 1.1 billion today versus 450 million to 650 million over the same period in China. 


Management was particularly enthusiastic about the prospects for growth via the Asia Franchise Business Unit.  There are 4,500 units in operation within these countries where six franchisees own 75% of the units.  GDP growth in many of these emerging markets in Asia, such as Malaysia, Thailand, Indonesia, and Vietnam is expected to greatly exceed that of the U.S./Euro area over the next 30 years and, as with the China thesis, it is not hard to understand the appeal.   This was truly a presentation of bold statements, from start to finish, and the YRI section held its own in that regard, showing the 7.5 YUM stores per million people in the Asia FBU division versus the 60 YUM stores per million people in the U.S.  Undoubtedly the Asia FBU number will grow, but I don’t understand the significance of the (probably over-saturated) U.S. number in this context.





One of YUM’s goals for 2011 is to “drive aggressive, international expansion and build strong brands everywhere”.  Apparently, they meant it.  Africa, putting the “A” in “BRICA”, is on the “ground floor of growth”, according to YUM.  This is a plan that is in its embryonic stages so it would be wrong of me to be hypercritical at this stage but the thesis certainly did not seem water-tight to me.  The GM of the Africa effort made some statements that alarmed me within an otherwise interesting and well-delivered presentation. 


One of these was that “Africa has good governance”.  I’m not an expert on Africa’s political economy but, merely by following the news, I know that the level of political stability in many African nations is far from good.  This is true for several of the nations cited by management as targets for unit expansion with stories abounding of political unrest regularly.  A simple news search online can illustrate my point. 


I don’t think that this will significantly impact YUM’s earnings power but there are certainly better uses of capital, in my opinion.  While the long term debt schedule included in YUM’s folder of slides that was provided for the presentation shows that the company has access to cheap capital, it may not last forever.  David Novak underlined the company’s commitment to “watch returns manically” but the company could rue investing capital in some of the African markets mentioned should their projections be overly bullish.  


Projections are only as useful as the assumptions implicit in them and I would submit that the estimate of Africa’s GDP hitting $2.6T in 2020 is not very useful given the length of time and the politically and economically volatile nature of African political economies.  Again, the extent to which the company will lever itself to the African markets is as yet unknown and can be assumed, for now, to be small.  Perhaps this new direction is allied with Chinese investment in Africa, given how important China is as a market for YUM, but I hope that they proceed with more caution than was communicated in the presentation yesterday.





At the end of the day, the strategy of “building brands everywhere” and “growing in China till the cows come home” works until it doesn’t.  I’m not suggesting that management won’t stay focused on returns but it will be important to monitor what they do more closely than what they say.  Bold statements have set great expectations and it will be important for the company to retain its discipline – something it purports to do – and not become married to a mantra of growing “everywhere”.  A change in the macro environment, pertaining to individual companies or to the company’s cost of capital, could be a future risk.


Overall, the company remains an impressive organization but the more it stretches itself, developing new brands and new markets, the more investment it will take to maintain current performance.  The 500+ person team employed in almost every province in China is just one example of the infrastructure YUM has built for itself in certain international markets.  All in all, no revelations were revealed during yesterday’s meeting.  Management was extremely positive and as bold as ever in their projections and outlook for the business.    Given the company’s significant growth profile, how the company invests its incremental cash is a vital determinant of the stock price.  By that score, as shown in the charts below, 2010 has been a very strong year for YUM.


YUM – AS BOLD AS EVER - china roiic


YUM – AS BOLD AS EVER - us roiic


YUM – AS BOLD AS EVER - yri roii


Howard Penney

Managing Director

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