McDonald’s is a great company but, alas, it is still a company – subject to the same factors as other restaurant companies.

I did not learn anything on the earnings call that alters my bearish thesis on MCD.  There was some noise in the quarter, but EPS was reported at $1.16 versus consensus of $1.16.  Global comparable restaurant sales came in at +5.0% versus consensus +5.1%.

MCD reported global comparable restaurant sales growth of 5% for the fourth quarter.  A more detailed breakout of the comparable restaurant sales results is shown in the table below.  The December numbers posed some as Global +3.7% vs. consensus of +3.9%.  US +2.6% vs. consensus of +3.8%, Europe (0.5%) vs. consensus of +3.0% and APMEA +8.9% vs. consensus of 5.6%.




Europe trends were adversely affected by weather in the month of December, as were trends in the U.S.  Management estimates that the impact of weather was 5% and 2% on the Europe and U.S. markets, respectively.  While restaurant level margins increased year-over-year, the trend is certainly not favorable heading into 2011 and what I believe will be a difficult inflationary environment for MCD.  From a sales perspective, comp compares will become progressively more difficult in 1Q, 2Q, and 3Q10.  Margin comparisons also step up next quarter, and remain difficult for the first three quarters of the year.  The quadrant chart below shows where we expect the company to trend operationally over the next four quarters. 


MCD: A CULTURE OF NO BAD NEWS? - mcd quadrant


Management is acutely aware of the current trend in input costs that several Hedgeye teams have been highlighting for months.  As such, they have raised their commodity inflation outlook.   For the full year 2011, the total basket of goods cost is expected to increase 2-2.5% in the U.S. and to increase 3.5-4.5% in Europe.  Prior guidance was for inflation of 2% in the U.S. and 3% in Europe.   On the earnings call, management expressed their capacity to raise prices as commodity and other cost pressures become more pronounced throughout the year.   Given how important value has been for MCD traffic growth, raising prices enough to significantly offset increases in input costs may be detrimental to comps.  MCD has obsessed over driving guest counts and maintaining 2010’s momentum while passing on inflation may be difficult.


Another measure that management presented to help buttress margins was 24 hour openings.  While the rolling out of 24 hour operations in some markets may have coincided with increase in margin previously, I am unconvinced that this initiative is fail-safe given the disparate results quick service restaurant operators have experienced through 24/7 opening hours. 


The beverage business can be a high margin business and much of MCD’s margin success in 2010 was due to the sales of frappes and smoothies in 2Q and 3Q along with commodity cost favorability.   Lapping these benefits in 2011 will prove difficult, in my view.  While management underlined the growth in coffee sales as a percentage of total sales, from 2% “a few years ago” to 6% today, it is important to remember, as I illustrated in the Hedgeye MCD Black Book earlier this month, that beverage marketing as a percentage of total marketing spend has increased to 43% in 2010 from 3% in 2008.   That is an unsustainable trend.


Variable labor costs increased in the fourth quarter and I believe that the company’s ever-expanding menu and focus on beverages and other small check items (dollar menu) are significant parts of the problem. 


Much of the sentiment around this stock continues to purport that MCD can defy gravity.  I would argue that the year-over-year margin compares, compounded by last year’s leverage to beverage sales and parabolic commodity price increases, together with slowing sales in the U.S. will eventually convince the investment community that a culture of “no bad news” is generally misleading!


MCD: A CULTURE OF NO BAD NEWS? - MCD ratings chart


Howard Penney

Managing Director

Supply Constraints in Commodity Land

Conclusion:  While we will continue to pick our spots across the commodity complex, broadly speaking supply data points continue to support elevated prices, which in turn drives higher inflationary readings globally. 


There is a well know adage when it comes to advice in the stock brokerage industry, which is:


“Advice is the only commodity on the market where the supply always exceeds the demand.”


While this adage no doubt is true, we believe that the commodity markets themselves may be an area where supply continues to be constrained, which is supporting higher commodity prices.


As we wrote on January 4th, 2011:


“Interestingly, despite our view of slowing growth into 2011, it seems that we are seeing evidence of supply constraints across the commodity complex that are poised to drive commodity prices higher in the face of a sequential slowdown in growth.  Higher commodity prices and slower growth mean one thing: stagflation.”


Since that note, the agricultural commodities have continued to increase in price.  In fact, the commodities we highlighted in that note specifically are up as follows since January 4th, 2011:


-          Sugar +0.9%;

-          Soybeans +1.8%;

-          Cotton +14.1%; and

-          Rice +4.6%


In the meantime, we continue to collect global data points that highlight supply constraints in the commodity complex, specifically:

  • Australian authorities expect coal production to be down 10% in the coming year due to the flooding in Queensland;
  • Corn inventories in the United States are the lowest levels since 2007;
  • Ivory Coast is limiting exports of cocoa;
  • Based on the latest reports, US cow and bull (non-fed) slaughter for the past seven days (Jan 13 - Jan 19) was 131,000 head, about 13,000 head or 9% lower than the same  period a week ago and also 10.9% lower than the previous year;
  • A looming shortage of milk stares Kenya in the eye. The North Rift region, which produces 80 per cent of the country’s milk for sale, has registered a 40 per cent drop in supply;
  • Indonesian exports of coffee are down year-over-year and Brazilian production fell sequentially from November (3.5MM tons) to December (3.15MM tons). As well, Colombia’s largest growing province is expected to post lower production this year due to less sunlight;
  • The Uzebekistanian cotton crop is expected to be down 5% year-over-year; and
  • Natural gas inventories in the U.S. continue to decline and are now only 1.9% above the 5-year average.

The last point on natural gas is an important one to highlight.  The bear case for natural gas is well known and, in the long term, we support it.  In fact, in the longer term we believe investors may not be bearish enough on natural gas supply growth (which is driven by an acceleration of horizontal drilling and shale projects) in the United States.  In the short term, price is driven by fundamental changes on the margin.


As it relates to natural gas, the primary change on the margin is rapid declines in the way of U.S. inventories, which we’ve highlighted in the chart below.  In the last month, natural gas is up almost 10%, which is the third best performing commodity we track.  (Only orange juice and milk are ahead of natural gas.)  The drive is colder than expected weather in the U.S. and as a result natural gas has gone from being well oversupplied to being marginally oversupplied.  Two weeks ago natural gas inventories were 5.8% above their 5-year average, which declined to just 1.9% last week.  Still oversupplied, but less so.


As always, what happens on the margin drives prices.


Daryl G. Jones

Managing Director


Supply Constraints in Commodity Land - natty 2

Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.46%
  • SHORT SIGNALS 78.35%


In preparation for WMS's FY Q2 2011 earnings release tomorrow, we've put together some forward-looking commentary from the company's FY Q1 2011 conference call and subsequent conferences.




  • “While standing at the threshold of entirely new revenue streams from our suite of Networked Game Enablement Portal applications and online gaming, we still see meaningful opportunities to grow our revenues, earnings and cash flow.”
  • “Our full-year guidance for fiscal 2011… underscores our expectation that we will continue to achieve top and bottom line growth throughout our fiscal year in the face of the continued impact from the slow replacement cycle, consumer uncertainly leading to no real increase in discretionary spending and our current expectation for the delay in the opening of the Illinois VLT market until fiscal ‘12.”
  • “I sense an improving sentiment among gaming operators. We’re seeing continuing willingness by the large multi-site operators to invest in the future and freshen their floors by increasing the size and breadth of their orders with WMS, large orders that would have been fulfilled over several quarters and that cover both new unit sales and recurring revenues in gaming operations.”
  • “In total, Bluebird xD and Bluebird2 cabinets accounted for 90% of our total global unit shipments, with Bluebird xD cabinets totaling almost 1,900 units or a healthy 35% of total global shipments.”
  • “Penn’s new Maryland casino are not in our September quarter shipments, but should be in the December 2010 quarter”
  • “Overall, higher shipments into the international markets we entered in fiscal 2010, Mexico and New South Wales, Australia, more than offset ongoing weakness in Europe.”
  • “We also experienced the meaningful increase in other product sales revenues, up 7 million or 47% from the prior year. The increase was led by significantly higher used gaming machine revenue and higher hardware and software conversion revenues.”
  • “Our daily average revenue per gaming machine was down slightly, both on a year-over-year and quarterly sequential basis, mostly reflecting the impact of lower consumer discretionary spending and the launch of new web products focused primarily at refreshing our footprint not expanding during the September 2010 quarter.”
  • “Our initial Bluebird xD gross margins were lower than the targeted launch goal. We have identified significant opportunities to improve the xD gross margin through cost reductions and supply chain efficiencies and we have a plan in place to accomplish this throughout the balance of fiscal 2011. We expect to reach margin parity between the Bluebird xD and Bluebird2 cabinets in the June 2011 quarter, even as we anticipate raising the bar by improving the margin on the Bluebird2 cabinet during the same period” 
  • “We expect depreciation to increase in total dollar expense over each of the remaining quarters in fiscal 2011, as we invest capital to continue to transition our gaming operations base from Bluebird to Bluebird2 units, place our first units into the new Italian VLT market and selectively invest in other high-return lease opportunities.”
  • Guidance:
    • “Annual… revenues of 830 million to 850 million.”
    • “For the December 2010 quarter, we expect to generate revenues of 198 million to 205 million, which would represent 5% to 9% increase over the prior-year quarter and approximately 23% to 25% of our total expected annual revenues.”
    • “We expect revenues for the first half to be 45% to 47% of our annual revenues, which is consistent with the initial overall revenue guidance that we provided of 44% to 48% of the fiscal year’s revenues being generated in the first half.”
    • “We sold approximately 1,250 gaming machines for new casino openings and expansions in the December quarter last year. In the December quarter this year, there are far fewer expansions and new openings.”
    • “We continue to see an acceleration of revenues in the second half as a result of the commercial launch of our WAGE-NET networked game enablement portal applications and online gaming business in the U.K.; ongoing penetration in the Mexico, New South Wales and Class II markets; market share growth in both domestic and international markets; and our entry into the Italy VLT market.”
    • “We expect to see operating margin improve on a quarterly sequential basis throughout fiscal 2011 and for the December quarter, we expect operating margin to improve over the September quarter to a range of 19% to 19.5%.”
    • “For the year, we are maintaining our operating margin guidance of 22.5% to 23%.”
  • “Upon receiving final regulatory approval by GLI, projected to be later this quarter, we expect to begin earning revenues from this product at the beginning of next quarter. The momentum will continue with the launch of PiggyBankin’, the second theme in the Ultra Hit Progressive portal family, followed by PENG-WINS, the first theme in the second portal family called Winners Share.”
  • “Our fiscal 2011 revenue guidance assumes only very modest revenues from our new online business. And consistent with our prior comments, our margin guidance anticipates running at a small loss”
  • “Recently launched in July, we already have nearly 500 of THE LORD OF THE RINGS games installed in more than 150 casinos”
  • “Near-term, as a result of the already identified cost reductions from proving the Bluebird xD cabinet, we expect to achieve our targeted run rate of a 55% product sales margin beyond the next few quarters, even without the benefit of an improving replacement cycle.”
  • “We’ve got four WAPs coming out in the Q2 and Q3, which will really drive second half revenues for the year.”
  • “The order size is still in the, call it, 15 to 18, Joe; it’s in that ballpark, so the order size hasn’t really by market or by quarter or year-over-year has not changed a whole lot. We’re having to work harder for the same results … Class II is maybe a little bit bigger because it’s a new market for us and we’re entering the floors for the first time, but not significantly bigger than those numbers.”

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