This note was originally published at 8am on February 01, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.
“I would rather be a man of conviction than a man of conformity.”
-Martin Luther King, Jr.
When I read, I flag pages and write in them. It’s my way of taking some time to get lost in thought and scribble about what lessons history might provide me in preparation for today. Last night, as I was finishing "The Autobiography of Martin Luther King, Jr.", I found that timeless leadership quote.
It’s certainly not a quote for modern day American politicians. As King goes on to say on page 342, “… there comes a time when one must take a position that is neither safe, nor politic, nor popular, but he must do it because Conscience tells him it is right.”
While I can’t imagine that Presidents George Bush or Barack Obama have a conscience that would lead them to believe that burning America’s currency at the stake is right, there are certainly many Men of Conformity who have been advising them by example of cowardice.
Whether you think Henry VIII clipping his citizenry’s coins caught up to him in the end, or whether you think that modern day American Presidents backing fiscal and monetary policies that debauch America’s dollars will equate to many globally interconnected consequences, no man, woman, or child will ultimately make the call on either. History will. And in this case, I’d rather be the man who sides with history’s lessons.
Before I dig in on the unintended consequences associated with a debasement of the world’s reserve currency, let’s look at what the US Dollar has done across multiple durations:
Now if you can show me one man in an American position of fiscal or monetary policy setting power who shows any conviction in backing a strong US Dollar – just one man – I’ll readily accept this claim and consider why he has had no impact on the US Dollar where it matters – on the tape.
If you’ve studied economic history across long-dated cycles (yes, beyond The Ber-nank’s preferred point-in-time academic dogma of the great depression), you’ll already have learned that currency crashes and inflation are globally interconnected risks.
In fact, most modern day risk managers who have read Reinhart & Rogoff’s "This Time Is Different" have learned that there is a pattern that has repeated across 8 centuries of economic data. A simple way to consider this would be to re-read, rethink, and re-learn the lessons Reinhart & Rogoff outline in Part IV – Banking Crises, Inflation, and Currency Crashes where the sequence of chapters are as follows:
So rather than reacting to the next country that erupts into social chaos against governments who are lying to them about real-world inflation, my advice would be for both the President of the United States and his Keynesian advisors to do the required historical reading. Remember gentlemen, conviction or not, a successful national currency landing will depend on whether your preparations meet this opportunity.
All is not yet lost. With some conviction and focus, America can arrest the social unrest associated with Global Inflation Accelerating – but this can no longer be willfully neglected. Again, for the 44 million Americans on food stamps, it’s time.
If you don’t think it’s time, take a gander at this morning’s Global Macro grind:
And again, for those fans of the Fiat Fools who say this has nothing to do with a humble looking bald man with a beard, that’s just a charlatan’s way of ignoring the math. Here are the refreshed inverse correlations between the US Dollar Index and major global food prices:
Notwithstanding that US farmers are planning to plant the fewest acres of rice since 1989 (they make more money planting things like corn), and the global supply shortages we are seeing associated with flooding and/or countries engaging in revolutions, the simple reality here is that mostly every major food staple in the world is keying off of what the US Dollar does every day – and yes, Mssrs Obama and Bernanke, that Burning Buck stops with you.
My immediate term TRADE lines of support and resistance for the SP500 are now 1276 and 1297, respectively. I remain long of inflation and bought my Sugar (SGG) back in the Hedgeye Portfolio yesterday. Being long inflation also means being short bonds and emerging markets.
Being long inflation is an explicit conviction that the Ben Ber-nank will remain a Man of Washington Conformity.
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
TODAY’S S&P 500 SET-UP – February 4, 2011
Equity futures are trading near fair value following Thursday's late rally which erased earlier losses and ahead of today's January jobs report.
Also, focus will fall on the EU leader's summit in Brussels which will address the thorny issue of whether to strengthen the Financial Stability Mechanism. According to the latest press releases, Germany and France remain split on the issue of bond buybacks and on how best to co-ordinate a response to the crisis.
As we look at today’s set up for the S&P 500, the range is 20 points or -0.93% downside to 1295 and +0.60% upside to 1315.
MACRO DATA POINTS:
TODAY’S WHAT TO WATCH:
Only the XLP remains broken on TRADE - 8 of 9 sectors positive on TRADE and 9 of 9 sectors positive on TREND.
CREDIT/ECONOMIC MARKET LOOK:
Treasuries were weaker for a fourth straight session.
OTHER COMMODITY NEWS:
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Big benefit from high hold, particularly at MBS, drives a small beat over consensus. Despite higher whisper numbers, 2011 estimates continue to look reasonable. We will have a detailed analysis later but here are our conf call notes.
"We are pleased to report record financial results for the fourth quarter of 2010. We set quarterly records for net revenue, adjusted property EBITDA, and adjusted property EBITDA margin during the quarter. Strong revenue growth and margin expansion in Macau, together with outstanding results at Marina Bay Sands in Singapore and improving results in Las Vegas and Bethlehem, contributed to an industry-leading financial performance."
- Sheldon G. Adelson, chairman and CEO
CONF CALL NOTES
January sales results provided a surprisingly solid end to the retail fiscal year, with about two-thirds of today’s sales reports surpassing (tempered) expectations. With January sales volumes amongst the lowest of the year, the relevance of such results can be debated. However, the reality of the sequential uptick has two important takeaways. First, most retailers end the year with clean inventories and less clearance on a year over year basis. This sets up well for the Spring transition. This is also the reason why we saw some companies raise their EPS guidance, even in some cases with lower than planned sales results (JCP, KSS). Second, the weather was barely mentioned as an excuse. Only a handful of retailers including Costco, BJ’s, JCP, and HOTT cited the impact of stormy weather on the month and actually quantified it. Despite this, COST and BJ still exceeded expectations. Others with winter apparel and footwear exposure likely benefited, leaving little reason to mention record snowfalls and deep freezes as an excuse.
We do not expect this strength to continue, especially as first quarter compares are challenging and prices at retail are beginning to creep higher. With that said, the facts are the facts and the two-year same store sales run-rate for the broad index reached its highest level since 2007. Time to focus on 2011 with full attention and unfortunately less clarity than we’ve seen surrounding the retail environment in well over a year.
Callouts from today’s reports:
YUM finished 2010 strong with 4Q10 results that came in better than expectations on both the top and bottom line. Earnings of $0.63 per share easily beat the street’s $0.60 per share estimate and the reported 8% comp growth in China and 5% comp growth in the U.S. came in much better than the street’s 6.0% and 2.8% estimates in China and the U.S., respectively. YUM’s YRI segment was the only division to fall short of same-store sales expectations with the company reporting 1% comp growth versus the nearly 3% consensus estimate. That being said, the company’s restaurant margins during the quarter were stronger than street estimates across the board.
YUM’s CEO David Novak opened his remarks on the earnings call by saying, “I'm especially pleased to announce that 2010 was one of our best years as a company. We reported 17% full-year EPS growth excluding special items, marking the ninth straight year that we exceeded our annual target of at least 10%. In fact, 17% EPS growth is our best ever and what makes us even more impressive is that it was driven by a 15% increase in operating profit including gains across all three of our business divisions.” These comments, alone, set the stage for a more difficult 2011 on a relative basis as the company will be lapping these strong results.
Although the company maintained its confidence in its ability to grow EPS by at least 10% in 2011, management did highlight expected headwinds, which will hurt operating profit growth and margins in 2011:
Hedgeye thought: These incremental costs will definitely have a negative impact on margins in 2011, but this is not a problem that is unique to YUM.
Hedgeye thought: Again, this higher wage inflation is not unique to YUM. That being said, YUM investors have become accustomed to restaurant-level margin growth after seven quarters of growth prior to the slight decline reported in 4Q10. The company already implemented a price increase in China in early 1Q11, which management said should cover about three-quarters of the expected inflation impact, but margins are expected to decline YOY. Specifically, in 1Q11, the company is lapping 1Q10’s 26% margin, which management said is not a sustainable level.
Hedgeye thought: These one-time items only exasperate the already difficult operating profit and margin comparisons the company faces in 2011. Although management has tried to set reasonable margin expectations, investors may not react positively to reported margin declines in what is now YUM’s most important segment from a profit contribution standpoint.
These headwinds will take a toll on YOY growth in 2011, but again, most of these issues are beyond management’s control. Going beyond the expected $20 million foreign currency benefit in both China and YRI, margins should be supported in FY11 and beyond by the company’s current refranchising strategy in the U.S. and YRI and growth in emerging markets.
U.S.: I typically have a hard time finding anything positive to say about YUM’s U.S. business, but the company’s significant progress on refranchising company units in the fourth quarter, combined with the recent announcement that YUM intends to sell its entire Long John Silver’s and A&W restaurant business, is a definite step in the right direction. The company does not expect the eventual sale of this business to have a material impact on its ongoing earnings, but it signals that management wants to better align its focus in the U.S. on what matters to profitability and that is Taco Bell.
To that end, the company sold 306 company-owned units to franchisees during the fourth quarter and 404 for the full year. The bulk of those units (330) were Pizza Hut and KFC restaurants, which again lessens YUM’s profit exposure to those concepts in the U.S. The company plans to refranchise another 500 units in 2011, with KFC expected to drive the majority of those sales. With KFC same-store sales down about 4% in 2010, following on the heels of the prior three years of declines, this decreased company ownership will be welcomed by investors. Given the current state of business, these KFC sales may not yield the highest of proceeds for YUM, but at least it will allow the company to shed some of the restaurants which have been a drag on margins.
Management attributed the 60 bps of U.S. restaurant-level margin improvement in 4Q10 and 30 bps for the full year to refranchising. With most of the refranchising occurring during the fourth quarter, in addition to the continued refranchising initiatives planned for 2011, YUM should see an even greater benefit to margins going forward.
YRI: Restaurant margins increased 80 bps in 2010 and 190 bps in 4Q10, driven primarily by YUM’s equity business in Thailand and the refranchising of the company’s Taiwan business in the first quarter. 2011 margins will be helped even further by the fact that the company completed the refranchising of its Mexico business during 4Q10. Specifically, management stated that the Mexico refranchising should have a positive impact on 2011 operating profit of about $10 million. YUM will focus on the U.K. market in 2011 to further execute its refranchising efforts.
Sales were sluggish overall for YRI during 2010. System sales grew 9% in the company’s emerging markets, however, far outpacing the 4% growth in its developed markets in 4Q10. YUM opened 548 of its total 884 new YRI units in 2010 in emerging markets so sales growth should improve as the company further accelerates its development in these higher growth markets.
In conclusion, on top of the expected outlined headwinds and the fact that the company is facing difficult comparisons in 2011, I am somewhat concerned about the company’s current same-store sales guidance, which seems quite aggressive across the board given reported trends during the fourth quarter. Despite the same-store sales growth upside reported in China and U.S. during the fourth quarter, two-year average trends actually decelerated slightly from the third quarter for China, YRI and Taco Bell in the U.S. The 2011 comp guidance for China (up at least 4%), YRI (up at least 2-3%) and U.S.’s Taco Bell (+3%) all assume a significant acceleration in two-year average trends from 4Q10 reported levels.
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