Dissecting Manufacturing PMI Further

Conclusion:  The Prices Paid component of the ISM Manufacturing Survey suggests that margin compression cometh, as this component accelerated from a December reading of 72.5 to a January reading of 81.5 and is likely heading higher. 


The Institute of Supply Managers came out with their Purchasing Managers Index (PMI) Tuesday and it came in at a solid reading of 60.8 for January 2011.  This was a sequential increase from the December 2010 reading of 58.5.  Further, this was the highest reading since May 2004.  There is no doubt that at face value this report was a bullish indicator for economic activity in the U.S. manufacturing sector. 


As a refresher, this survey is given to more than 400 purchasing managers around the country, who are chosen based on industry and geographic diversification.  The supply managers answer questions based on five subsectors: production level, new orders, supplier deliveries, inventories, and employment levels.  The supply managers are asked to answer “better,” “same,” or “worse” for each category, which the ISM then diffuses into an overall reading.  A reading over 50 typically implies an economic expansion. 


In conjunction with the reporting the PMI, the ISM reports a number of other surveys in its index with a key one being Prices Paid.  While Keith highlighted this immediately after the report, we wanted to take a deeper dive into this number. 


We show this below, but Prices Paid accelerated from 72.5 in December 2010 to 81.5 in January 2011.  This is up 353% since December 2008 and back to levels last seen in the summer of 2008 when oil was testing $150 per barrel.  While we won’t debate that the headline PMI number is, on the margin, positive as an indicator of economic activity, the Prices Paid component is worrying as it pertains to future corporate margins. 


Interestingly, the ISM also included five comments in their report from various survey respondents.  We’ve You Tubed these comments below as they are very indicative and supportive of what we are seeing in the economy. The comments are quoted below: 

  • "Continued weakness in the dollar is having a negative effect on the components we purchase overseas and increasing our material costs." (Transportation Equipment)
  • "Lead times are increasing significantly, and commodity pricing is starting to increase." (Chemical Products)
  • "January/February sales will be decent, and we see a strong March. We're cautiously optimistic but reluctant to hire." (Fabricated Metal Products)
  • "Business is still slow with no pick-up in sight." (Furniture & Related Products)
  • "We continue to see unexpected strength in many non-U.S. markets." (Fabricated Metal Products) 

While this is anecdotal, these were the only five comments in the release and they are quite telling – “negative impacts from the U.S. dollar” . . . “commodity prices increasing” . . . “reluctance to hire” . . . “business is slow.”  It seems the headline number may not accurately reflect the underlying business conditions.


The key issue with supply managers reporting higher prices paid is the potential impact on future corporate margins.  Historically, studies have shown a four quarter lag in margin compression after the Prices Paid component of PMI accelerates to current levels. In the second chart below, we’ve outlined broad corporate margins in the U.S. currently.  The takeaway is that they are currently near all-time high levels.


With an acceleration in commodity costs that is now being reflected in the Prices Paid component of the Purchasing Managers Index, it seems unlikely that near-peak corporate margins can be sustained.  A corollary to this point is, of course, that the forecasted 15% growth in 2011 for SP500 earnings is also increasingly unlikely as margins come in.


Perhaps the CEO of Whirlpool said it most succinctly yesterday on his firm’s earnings call:  “And finally, we expect raw material inflation to drive higher costs and therefore have an unfavorable impact on operating results.”




Daryl G. Jones 

Managing Director


Dissecting Manufacturing PMI Further - 1


Dissecting Manufacturing PMI Further - 2


Stronger incentive and other fees and lower below the line items lead to a "blowout" this quarter.  1Q guidance is at the low end of Street while 2011 is raised.


“We ended 2010 with a strong fourth quarter, and momentum has continued into 2011. Our robust REVPAR growth is fueled by strong global brands along with sales and marketing initiatives. By containing costs we are translating these higher revenues into higher profits.”

- Frits van Paasschen, CEO



  • "Worldwide System-wide REVPAR for Same-Store Hotels increased 10.1% (10.3% in constant dollars)" vs. guidance of 6.5% to 8.5%
  • "Management fees, franchise fees and other income increased 13.0%" vs. guidance of 4-6%
  • "Worldwide REVPAR for Starwood branded Same-Store Owned Hotels increased 10.1% (10.9% in constant dollars)" vs. guidance of 6.5% to 8.5%
  • "During the quarter, the Company received a refund from the IRS of approximately $245 million primarily for previously paid taxes and related interest relating to the settlement of a dispute regarding the 1998 disposition of World Directories, Inc."
  • "During the fourth quarter of 2010, the Company signed 37 hotel management and franchise contracts, representing approximately 8,000 rooms, of which 29 are new builds and eight are conversions from other brands. At December 31, 2010, the Company had approximately 350 hotels in the active pipeline representing approximately 85,000 rooms."
  • "During the fourth quarter of 2010, 23 new hotels and resorts (representing approximately 5,700 rooms) entered the system...Seven properties (representing approximately 1,400 rooms) were removed from the system during the quarter."
  • "Originated contract sales of vacation ownership intervals decreased 1.2% primarily due to lower average prices. The number of contracts signed increased 7.6% when compared to 2009 and the average price per vacation ownership unit sold decreased 7.0% to approximately $14,000, driven by price reductions and inventory mix."
  • "In December 2010, the Company received $75 million in connection with a favorable settlement of a lawsuit. The cash payment to the Company included the reimbursement of legal fees in connection with the matter."
  • 2011 Guidance:
    • Adjusted EBITDA: $975MM - $1BN (raised by $20-25MM; consensus $980MM)
    • WW SS Company Operated RevPAR (constant $): 7-9% (same as prior guidance)
    • WW Branded SS Owned RevPAR (constant $): 7-9%  (same as prior guidance)
      • margins: +150-200bps
    • Management, franchise and other income: +10-12% (raised by 1%)
    • Operating income from VOI & residential: $125-135MM (high end raised by $10MM)
    • SG&A: +2-3% (raised by 1%)
    • D&A: $325MM (decreased by $5MM)
    • Interest expense: $245MM (decreased by $5MM)
    • Tax rate: 25% (same as prior guidance)
    • EPS: $1.55 to $1.65 (raised by $0.10 to $0.11; consensus $1.57)
    • Capex:
      • (Maintenance, renovation, tech ex. VOI and Residential): $300MM
      • Investment projections and JV commitments: $150MM
      • VOI (ex Bal Harbor): Positive CF of $165MM
      • Bal Harbor: $150MM
    • Bal Harbor: Closings to commence in late 4Q11 but current outlook doesn't include any CF from potential closings but does expect revenue recognition in 4Q11. 
  • 1Q 2011 Guidance:
    • Adjusted EBITDA: $195MM - $205MM (consensus $206MM)
    • WW SS Company Operated RevPAR (constant $): 8-10%
    • WW Branded SS Owned RevPAR (constant $): 8-10% Management, franchise and other income: +12-14%  
    • Operating income from VOI & residential: $30-35MM
    • D&A: $78MM  
    • Interest expense: $60MM
    • Income from continuing operations: $43-51MM and an effective tax rate of 25%
    • EPS: $0.22 to $0.26 (consensus $0.24)



  • Results suggest that the lodging recovery has held steady in an uncertain world. Remain cautiously optimistic about the near term prospects and bullish on their long term prospects.
  • Continue to work hard to drive their hotels past former peak levels
  • Rising consumer confidence is reflected in their VOI business in higher tour and close rates
  • Feel like the Aloft is doing the same for limited service that W did for tiered upscale hotels
  • 90% of Westin's pipeline is outside the US
  • St. Regis has doubled its footprint in just 2 years
  • Business travel remains strong with 90% occupancy rates in most major markets.  This is a travel intensive recovery.
  • Group business is also strong; they are beginning 2011 with pace up double digits. Booking windows are slowly starting to lengthen. December crushed the all time record for group business.
  • Business travelers account for 75% of their business
  • Leisure travel has also been robust, affording them the option to cut out some expensive distribution channels - like the opaque ones
  • What will make or break 2011 is rate.  Expect rate to drive 50% of RevPAR gains. 
  • New corporate rates will be up high single digits
  • RevPAR is tracking double digits in January across the US
  • Expect some slowdown after the World Expo in Shanghai but haven't seen any slowdown as RevPAR was up 24%.  Australia is very strong. Japan is the only soft spot.
  • Starwood branded rooms in Asia are up 80% since 2005
  • Despite the concerns about Spain, their business was very strong, helped by the W Barcelona
  • Hedged 50% of their Euro exposure
  • Middle East was the only region that was down. Have 16 hotels in N Africa which are likely to be impacted in 2011 - account for about $10-12MM of fees
  • Local inflation is hurting their owned hotel margins in Latin America. Their US$ based hotel rates aren't going up as fast as hotel costs.
  • VOI business is stable. Delinquency and default rates are stable and improving.
  • Hope that Bal Harbor will be 65-70% sold by the time closing starts
  • 1 pt of RevPAR = $15MM of EBITDA
  • Expect to open 70-80 hotels in 2011 with 50% outside the US
  • Why aren't margins higher?
    • High inflation in emerging markets
    • Pre-opening costs at owned W London
    • Revenues lag RevPAR
  • Several significant renovations in 2011
    • Westin Gaslamp
    • Grandin Florence
    • Sheraton Kaui
  • $245MM from refund, $75MM from legal settlement + proceeds from JV sale
  • Moving rapidly towards achieving an investment grade rating - hopefully by end of the 2011


  • Group pace at this point is driven more by volume than by rate but as the new business comes in, they will benefit more from rate
  • US incentive fees are not a large number - relatively a small % of their hotels are paying fees. Only in the Middle East and Africa, incentive fees haven't grown.
  • Latin America is the only international place where they price in US dollars
  • Why did incentive fees grow 39%?
    • Powered by Asia, it was good in the US from a very low base. There are a few things that impacted the quarter but won't elaborate.
    • Lean ops helped them
    • Don't expect to continue at a 40% clip
  • Headcount - they are continuing the approach of flat headcount aside from large growth opportunities like in China
  • Real estate market has only partially recovered. Real buyers are from well capitalized REITs and high net worth buyers. You aren't seeing the PE funds back yet though. REITs are looking for stable assets in gateway cities. 
  • There isn't a whole lot of seasonality
  • Thinks that about 1/3 of hotels are paying incentive fees in NA and in international are 70%
  • 10 of their 16 hotels in N. Africa are in Egypt
  • For the full year, fees in ME & A was 12% of their total fees
  • Over 60% of their hotel base was either opened or recently renovated over the last 3 years
  • Not a large % of their business comes from expensive online channels - total OTA bookings are only 5%
  • General thoughts on the timeshare?
    • Starting to believe that it's starting to improve. Delinquencies are going down. So the business is in a rebound although perhaps not a rapid one

TGT: Trend Brewing?

Despite January expectations that were gradually ratcheted down, Target’s results were once again disappointing.  This marks the second month in a row where internal projections called for a low to mid single digit increase and results failed to materialize. 


Interestingly, there remains a major divergence between the growing, P-Fresh driven performance in the food and consumables category and the rest of the store.  Unfortunately, grocery induced traffic does not appear to be leading to an acceleration in discretionary spending at this point.  While two months doesn’t make a trend, scrutiny surrounding the company’s topline initiatives centered on 5% rewards and P-Fresh is on the rise. Over time, these strategies should work.  However, sales expectations need to be taken down in the near term.  Management’s guidance for low single digit increases in February is a start, but this is clearly not the 4+% comp trend we were originally expecting to see for most of 2011. 


TGT: Trend Brewing? - TGT matrix


Eric Levine



Enter your email address to receive our newsletter of 5 trending market topics. VIEW SAMPLE

By joining our email marketing list you agree to receive marketing emails from Hedgeye. You may unsubscribe at any time by clicking the unsubscribe link in one of the emails.


Hard to bet against this management team. We were above the Street and they beat us. 



"We are very pleased with fourth quarter casino operating results which compare favorably to the prior year. Ten of Penn National's fifteen gaming properties grew net revenue, twelve of fifteen properties generated year-over-year improvements in Adjusted EBITDA and eleven properties successfully increased Adjusted EBITDA margins... While we are encouraged by our fourth quarter performance and early indications for an overall improvement in the economy, our current outlook and guidance for 2011 contemplates a continuation of the trends we saw in 2010 until we gain more visibility of a meaningful recovery."

- Peter M. Carlino, Chairman and Chief Executive Officer of Penn National Gaming



  • "$14.4 million impairment charge and lobbying costs incurred in the fourth quarter at Maryland Jockey Club which are not expected to recur."
  • "The fourth quarter and full year GAAP net loss reflects fourth quarter pre-tax impairment charges of $193.2 million, as a portion of the goodwill and other intangible assets associated with the Company's original purchase of the Aurora and Joliet facilities was deemed to be impaired based on the planned 2011 opening of Illinois' tenth gaming facility and the continued challenging operating environment in the state."
  • "During the quarter we repaid $85 million of the $145 million that was drawn on our revolving credit facility to partially fund the October 2010 acquisition of all of the outstanding debt of The M Resort LLC."
  • Development updates:
    • M Resort: "In early January, we began sending offers to stay at The M to some of our highest value players and while it is still early, the response has been encouraging. We believe we are close to completing negotiations with the property's equity holders regarding ownership and future operations and are simultaneously working with Nevada gaming regulators to secure necessary approvals for the transaction."
    • Hollywood Casino Harvey: "We are currently seeking Louisiana's fifteenth gaming license and in December provided details of our proposal to bring a first class gaming vessel to the Harvey Canal in Jefferson Parish. The project's nearly $150 million first phase investment would bring capacity for up to 1,500 slots machines, 44 table games, a parking facility and an upscale buffet and steakhouse, as well as other food and beverage offerings and a multipurpose room. As part of the proposed $155 million second phase investment, Penn National would add a 250-room hotel, an additional parking garage, a dedicated entertainment showroom and a pedestrian skywalk that would connect these amenities to the riverboat...We are prepared to fund a significant escrow account to demonstrate our unmatched financial liquidity and our genuine commitment to the project, Jefferson Parish and the State of Louisiana...The Jefferson Parish Council recently passed a resolution allowing Parish citizens to vote on whether they support the development of the proposed riverboat gaming facility if Penn National Gaming is awarded the provisional gaming license, which is expected to be granted by the Louisiana Gaming Control Board this spring."
    • Laurel Park and Pimlico: "Late in the fourth quarter, The Maryland Jockey Club reached an agreement with local horsemen to run 146 live racing days at Laurel Park and Pimlico and preserve the Preakness Stakes... Pursuant to the agreement, these tracks, which have recently generated significant losses, are expected to receive financial subsidies from the state and horsemen, saving jobs and significantly reducing future operating losses. Longer-term, we continue to believe that bringing a video lottery terminal (VLT) operation to Laurel Park would guarantee the preservation of Maryland's rich racing heritage and the existing jobs and other economic benefits associated with the racing industry."
  • Guidance:
    • Net revenues: $2,688.3MM in 2011 and $657.1MM in 1Q
    • Adjusted EBITDA: $662.9MM in 2011 and $169.6MM in 1Q11
    • EPS: $1.48 in 2011 and $0.40 in 1Q11
    • Assumes M Resort purchase closes in early 3Q2011
    • "Excludes the impact of the announced fourth quarter opening of the Anne Arundel, Maryland slots facility pending additional clarity of the exact opening date"
    • "September opening of the tenth gaming facility in Illinois"
    • "December opening for a competing facility in the Baton Rouge, Louisiana market"
    • "Expiration of the Casino Rama Management agreement and related amortization in July of 2011, although we are in negotiations for an extension"
    • "Full year of results for Beulah Park"
    • "$7.0 million of pre-opening expenses"
    • "Excludes any additional gain from insurance proceeds related to Empress Casino Hotel fire"
    • D&A: $242.2MM in 2011 and $55MM in 1Q11
    • Non cash stock comp: $25.2MM in 2011 and $6.3MM in 1Q11
    • Tax rate: 45%
    • Diluted share count: 108MM


  • January 2011 is off to a rocky start due to weather
  • Seeing a stabilization in their business.  Seeing flat spending behaviors still. Forecast for 2011 is more of the same of what they saw in 2010.


  • Why is EBITDA above consensus and EPS below for 2011 guidance?
    • Not sure.  103.2MM of interest expense and stock comp is in-line with last year.
  • M Resort - need to sign a purchase agreement with the current owners and get through regulatory approvals;
  • Moving their tracks in Ohio? Governor is new and they aren't sure what he's thinking. Given the budget issues they have PENN believes that they may be inclined to generating more revenues from their tracks by relocating to more optimal locations. Already expect competition for Lawrenceburg in late 2012 and 2013.  Land-based casino in Cincinnati will be more a competitive threat than River Downs.
  • Perryville - Feel like they are running within expectations. They are working on building their database. Expect to see continued growth in 1Q unless weather continues to impact them.
  • Promotional and marketing environment? Seems very stable and rational.
  • Weather impact? They have factored the impact into the guidance but they aren't going to elaborate in the exact impact. When weather is good, the business has been good.
  • Cash: $246.4MM ($78MM in unrestricted sub)
  • Debt: $71Mm on R/C; $1,589MM of total bank debt. Total debt $2,171MM
  • Cap interest: $1.1MM
  • Capex timing: $77.7mm (18.2MM of maintenance) in the Q. 1Q: 70.2MM of new and 26.9MM in 1Q
  • Capex 2011: $289MMM in new  and $88.5MM in maintenance, plus Kansas Speedway capex for a total of 449.2MM
  • $7MM of pre-opening is for Toledo and Columbus mostly Toledo. There are also some $2MM of Kansas speedway pre-opening but its in JVs.
  • Expenses: still room for improvement
  • Maryland status quo not sustainable for long-term
  • 2011 corp expense is roughly 78MM
  • Slot spending: 60% of maintenance capital; still refreshing 1/7th of the floor annually; nothing changed in outlook
  • Feb 9: LA gaming board meets; Feb 17: final decision on 15th license
  • In general, states are considering gaming expansion plans more than raising taxes as a solution to the budget deficits
  • Doesn't see Harrisburg winning in Category 3 license but Foxwoods license may go there. No time frame for Cat 3 license.
  • Vegas outlook: Vegas has a future but way too much capacity. Waiting for another opportunity
  • Atlantic City outlook: gloomy; Revel will cannibalize the market; couple of more years of contraction
  • More racino acquisitions? More focused on location rather than the property itself
  • M Resorts: has positive operating income


Initial Claims Fall 39k 

The headline initial claims number fell 39k WoW to 415k (42k after a 3k upward revision to last week’s data).  Rolling claims rose 1.25k to 429k. On a non-seasonally-adjusted basis, reported claims fell 23k WoW.  As the third chart below shows, NSA claims have risen in this week of the year for the last three years.  It's possible that this discrepancy reflects weather-related reported delays, which could reverse next week.  


We continue to remind investors that based on our analysis of past cycles, the unemployment rate won't improve until we see claims move into the 375-400k range. That said, it is worth highlighting an important caveat. This recession has been different in that it has pushed the labor force participation rate down by ~200 bps, which has had a correspondingly positive improvement on the unemployment rate. In other words, the unemployment rate isn't really 9.4%, it's 11.4%. So when we say that claims of 375-400k will start to bring down the unemployment rate, we are actually referring to the 11.4% actual rate as opposed to the 9.4% reported rate.








One of our astute clients recently pointed out the relationship between the S&P and initial claims shown below, suggesting that claims is one of the strongest drivers of the market. Based on the chart below, we are hard-pressed to disagree.  We show the two series in the following chart, with initial claims inverted on the left axis.





In the table below, we chart US equity correlations with Initial Claims, the Dollar Index, and US 10Y Treasury yields on a weekly basis going back 3 months, 1 year, and 3 years.






Joshua Steiner, CFA


Allison Kaptur


The HOT Q4 was better than we predicted but not quite a blowout. Guidance was good – slightly lower than consensus for Q1 but higher for 2011 due to timeshare.  Q2 remains our concern.



Contrary to our prediction, HOT did beat the quarter and modestly raised guidance for FY11.  However, below the surface of a “blowout” quarter, things aren’t as exuberant as they appear. Likewise, the raise for FY2011 was driven by higher timeshare (partly timing of Bal Harbor revenue recognition), higher incentive fees, and lower below the belt items.


If we deconstruct the $29MM Adjusted EBITDA beat vs. consensus, 74% of the beat came from low quality items; namely, 45% came from higher incentive fees, 17% from “other fees”, and 12% from VOI.   These items account for $0.11 of the $0.13 EPS beat, with lower interest and D&A expense making up the balance.  That said, HOT still would have beat our number due to better control expenses with SG&A and CostPAR growing less than we projected as well as $4MM of better base management and franchise fees.  




Starwood reported strong 4Q2010 results with total revenues exceeding our estimate by $13MM (2%) and unadjusted EBITDA beating our estimate by $20MM (9%).  The EBITDA beat was driven by a higher mix of high margin fees revenue, which was largely driven by higher incentive fees, better VOI margins and lower SG&A expense.

  • ­Owned room revenue of $459MM missed our estimate by $12MM ( 3%) but the revenue miss  was somewhat offset by expenses being $6MM lower as well.
    • Owned comparable RevPAR of $151 was almost $7 below our estimate, growing 8.6% vs our estimate of 12.5% (however our number isn’t same store)
    • Room revenue was the culprit of the miss while F&B and other revenues look like they grew 10% YoY
    • CostPAR only increased 2% to vs. our estimate of 6.7%.
  • Managed, franchised and other revenues of $209MM beat our number by $22MM
    • 813 (.3%) more managed and franchised rooms were added to the systems than we projected – with all of the upside coming from Luxury segment additions
    • $13MM of the beat was higher incentive fees (which the company explicitly guided to only being up single digits and ended up growing 39% YoY)
    • Other “revenues” termination / etc was $5MM higher than our number
    • Franchise and Base mgmt fees beat our number by $2MM each, respectively.
  • Timeshare sales and service revenue beat by $2MM and operating expenses were also a little better for a total operating profit beat of $3MM
    • Originated sales revenue was $1MM better and other sales and service revenue was $6MM better than our estimate. However, deferred revenues were $4MM higher.
    • Originated sales margins reached 41%, much higher than the 35% YTD margin and 30% margin in 2009
    • Other expense margin was 23.4%
  • Other stuff:
    • SG&A: $4MM lower
    • D&A: $8MMlower
    • Interest expense: $5MM lower

get free cartoon of the day!

Start receiving Hedgeye's Cartoon of the Day, an exclusive and humourous take on the market and the economy, delivered every morning to your inbox

By joining our email marketing list you agree to receive marketing emails from Hedgeye. You may unsubscribe at any time by clicking the unsubscribe link in one of the emails.