CHART OF THE DAY: A Known Assumption --- Geopolitical Risk is Over After Egypt



CHART OF THE DAY: A Known Assumption --- Geopolitical Risk is Over After Egypt -  Chart of the Day

Men of Conformity

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:

  1. Immediate-term TRADE (3 weeks or less): down, literally, almost every day since the President’s State of the Union Address and the Fed’s January FOMC statement.
  2. Intermediate-term TREND (3 months or more): up for 7 out of 8 weeks post US Midterm election promises, but down for 5 out of the last 6 weeks on the probability increasing that those promises are broken.
  3. Long-term TAIL (3 years or less): lower-highs and lower-lows -a national embarrassment.

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:

  1. Chapter 10 – Banking Crises (America has been there, done that)
  2. Chapter 11 – Default Through Debasement (America bailed some of these currencies (stock prices) out, but the national story is far from over)
  3. Chapter 12 -  Inflation and Modern Currency Crashes (America is in motion on this front – and in some cases, cheering it on)

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:

  1. The CRB Commodities Index (19 commodity basket) was up another +1.8% yesterday closing at its highest levels since October of 2008.
  2. Inflation, as measured by the CRB basket, is up +29% since Ben Bernanke opted for Quantitative Guessing II in Jackson Hole, WY.
  3. Dr. Copper is hitting a record high this morning at $4.48/lb (all-time records aren’t deflationary are they Mr. Ber-nank?)
  4. Oil prices are breaking out again to new intermediate-term highs with WTI Oil breaking out above our immediate term TRADE line of $90.21
  5. Food prices, measured by the UN’s basket, continue to hit all-time highs – from corn to rice, yes, this is a crisis for the world’s poor.
  6. South Korea’s inflation rate shot up to +4.1% in JAN versus 3.5% in DEC
  7. Indonesia’s inflation rate continues to rise with CPI for JAN 7.02% versus 6.96% for DEC
  8. Brazil’s CPI is now tracking up +11.5% y/y in JAN versus 11.3% in DEC
  9. Ivory Coast, which is seeing massive inflation in Cocoa prices, became the 1st country to default on their debt overnight ($2.3B in Eurobonds)

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:

  1. Cocoa = -0.91
  2. Wheat = -0.90
  3. Rice = -0.88

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


Men of Conformity - obama


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.



  • 8:30 a.m.: Non-Farm payrolls, Jan., est. 146k, prior 103k
  • 8:30 a.m.: Private payrolls, Jan., est. 145k, prior 113k
  • 8:30 a.m.: Manuf. payrolls, Jan., est. 10k, prior 10k
  • 8:30 a.m.: Unemployment rate, Jan., est. 9.5%, prior 9.4%
  • 10 a.m.: Fed’s Patrick Parkinson testifies to Congress on CRE
  • 1 p.m.: Baker Hughes rig count, Feb. 4  


  • Egyptians poured into Cairo’s Tahrir Square before Friday prayers, raising the prospect of more violence. Mubarak tells ABC News late yesterday he fears “there will be chaos” if he abruptly quits, warns the Muslim Brotherhood will come to power. 
  • FDA staff report due before Feb. 8 advisory panel on data gathered on drugs given marketing clearance before 2009 under accelerated approval program: Includes LLY’s Erbitux for colorectal cancer, GSK’s Bexxar for non-Hodgkin’s lymphoma and Arranon for T-cell leukemia and lymphoma, GENZ’s Clolar for pediatric leukemia
  • UBS says employees will find out about their bonuses on Feb. 16, rather than planned Feb. 9, receive them in early March, because of regulatory reviews 
  • Daimler Says Its View on EADS Stake Is Unchanged: WSJ
  • EADS Golden Share Considered as Daimler Seeks Exit: Tribune
  • China’s AVIC May Seek U.S. Defense Contracts: WSJ
  • U.S. Companies Increase Contract Hiring: Detroit Free Press
  • Consumers Turn to Plasma TVs as Prices Fall: L.A. Times
  • U.S. Aviation Bill Won’t Give Carriers Equipment: WSJ
  • Rosneft May Buy Out Russian Holders of TNK-BP: Vedomosti
  • Ralphs Grocery Faces Fine for Overcharging: L.A. Times



Only the XLP remains broken on TRADE - 8 of 9 sectors positive on TRADE and 9 of 9 sectors positive on TREND. 

  • One day: Dow +0.17%, S&P +0.24%, Nasdaq +0.16%, Russell 2000 +0.31%
  • Month-to-date: Dow +1.43%, S&P +1.63%, Nasdaq +1.99%, Russell +2.22%
  • Quarter/Year-to-date: Dow +4.19%, S&P +3.93%, Nasdaq +3.81%, Russell +1.91%
  • Sector Performance - (All 9 sectors  traded higher): - Consumer Disc +1.17%,Materials +0.42%, Consumer Spls +0.52%, Utilities +0.41%, Healthcare +0.13%, Tech +16%, Financials +0.03%, Energy +0.05%, Industrials +0.04%  


  • ADVANCE/DECLINE LINE: 268 (+465)  
  • VOLUME: NYSE 999.87 (+7.11%)
  • VIX:  16.69 -3.53% YTD PERFORMANCE: -5.97%
  • SPX PUT/CALL RATIO: 1.67 from 2.35 (-29.12%)



Treasuries were weaker for a fourth straight session.

  • TED SPREAD: 17.26 0.406 (2.409%)
  • 3-MONTH T-BILL YIELD: 0.14% -0.01%      
  • YIELD CURVE: 2.87 from 2.85


  • CRB: 341.00 -0.81%  
  • Oil: 90.54 -0.35% - trading +0.22% in the AM
  • COPPER: 454.45 +0.01% - trading +0.17% in the AM
  • GOLD: 1,354.22 +1.82% - trading -0.41% in the AM


  • World food prices rose to a record in January on higher dairy, sugar and cereal costs and probably will remain elevated, the United Nations said.  An index of 55 food commodities climbed 3.4% from December to 231 points, the seventh straight increase.
  • London is set to overtake New York as the biggest center of crude and oil product futures trade this year, signaling a shift in power as the British capital benefits from soaring demand in Asia and mounting concerns over the usefulness of key U.S. contracts. 
  • Newmont Mining Corp., the largest U.S. gold producer, agreed to buy Fronteer Gold Inc. for C$2.3 billion ($2.3 billion) to gain exploration and development projects in Nevada.  Newmont is paying a 41 percent premium based on Fronteer’s average share price over the 20 days prior to the deal, according to Bloomberg data.
  • Argentine corn farmers will harvest 19.5 million metric tons of corn this season as a drought in the world's second-largest exporter trims output to below estimates, the Buenos Aires Cereals Exchange said. Corn gained in Chicago. 
  • U.S. wheat futures fell on Thursday, retreating from 2-1/2 year highs amid profit-taking, disappointing exports and a stronger dollar, but worries that extremely cold weather in the U.S. Plains might hurt the winter wheat crop underpinned prices. 
  • A drought may slow economic growth in Kenya for the first time in three years as farmers in the world’s biggest black-tea exporting nation scale back production and millions face food shortages. 


  • EURO: 1.3649 -1.01% - trading -0.15% in the AM
  • DOLLAR: 77.748 +0.76% - trading +0.06% in the AM


  • FTSE 100: +0.40%; DAX: +0.27%; CAC 40: +0.33%; IBEX: +0.17 (as of 6:30 ET)
  • European markets trade higher helped by a late rally on Wall Street and firmer markets in Asia.
  • Corporate results were mixed and there is limited European economic data scheduled.
  • The focus is on the European leader’s summit where German and French leaders will present their proposals for EuroZone economic reform and there are hopes that discussion may lead to a stronger bailout fund.
  • Advancing sectors lead decliners 14-4 led by insurers and construction both up +1.4%; food & beverage (0.8%) and personal & household (0.3%) lead laggards.
  • Spain 4Q GDP probably advanced 0.2% from the 3Q and 0.6% Y/Y, the Madrid-based Bank of Spain said today in its monthly bulletin.  Banks higher on the news
  • UK SMMT January new car registrations (11.5%) y/y
  • UK Jan house prices up 0.8% M/M but down (2.4%) y/y vs consensus (3.0%) - Halifax


  • Nikkei +1.1%; Hang Seng (closed); Shanghai Composite (closed)
  • Asian markets that were open rose solidly today, though trade was thin since so many markets around the region are closed.
  • Japan rose, as the announcement that Sumitomo Metal and Nippon Steel plan to merge had investors gambling a round of industry reorganization is pending. The stocks soared 16% and 9%, respectively, leading the steel sector to a significant gain.
  • Indian stocks fall after PM Manmohan Singh says inflation poses “serious threat” to growth.
  • Australia rallied 0.87%. QBE Insurance Group jumped 7% after agreeing to buy Balboa Insurance from Bank of America. Miners rose on higher commodities prices.
  • Indonesia rose 0.44% despite a 25-basis point interest rate increase.   Indonesia’s central bank unexpectedly raised its benchmark interest rate for the first time in more than two years after inflation climbed to a 21-month high.
  • Thailand up 0.43% - PTT Exploration & Production jumped 6% after Australia said the company would not lose its oil licenses there.
  • Hong Kong and South Korea are closed until 7-Feb, Taiwan is closed until 8-Feb, and China is closed until 9-Feb for Lunar New Year.



Howard Penney

Managing Director

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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




  • Confident that their EBITDA growth will continue into 2011 - as validated by their January results
  • 806MM shares is their fully diluted share count in the quarter
  • Singapore - 1Q2011 - most of the remaining elements of the property will be launched: Lion King, Museum, and Water Show on the Bay
    • Mice business continues to grow
    • Visitor arrivals to Singapore have increased over 20%
    • LVS now owns the 2 top MICE hotels in Asia
    • The Singapore market is still growing, and the subway stop at their property opening in 2012 will help them
    • They are in the process of adding 300 more slot units
    • Think that CNY will be a big growth catalyst for them
  • Macau
    • EBITDA should be the true metric on which performance is judged, not GGR. Their market share of EBITDA was more than 2x that of SJM.
    • "Remember you can't put GGR in the bank"
  • Sands Bethlehem: 300 room hotel will open in May
  • Development pipeline:
    • Visited with government and tourism officials all over the world at their request to discuss the development of a MBS-like resort
    • Talking to Korea, Taiwan and Japan
    • Also to Florida and Texas


  • Margin pressure in Macau due to wage pressures and competitive pressures?
    • Wage pressures are under control for now
  • Lot 3- will they get an extension?
    • Feel confident that they will get an extension if they want it. But they can monetize.
  • Still waiting to hear from the government on the FS condos.  Feels very confident that they will get something approved in the quarter.  Just received some pages commenting on issues at FS condos
  • FS Plaza had a hold issue - only 1.55%.  That was reversed over the last few weeks. They have made more than $20MM of EBITDA in just Jan 2011. The limited # of junket reps there make it more volatile - they are looking to bring in more junkets to make it less so.
  • Seasonality in MBS - saw some softness in November and saw strength during Christmas and New Year's.  CNY should be great ... they are still learning.
  • EBITDA is over $110MM in January at MBS. Wouldn't let one month's drop in RC determine what the future of Singapore will be.
  • In Vegas, experienced over 90,000 room nights during January and lowered their comps considerably to get a better customer in. Rates are somewhat under pressure but are seeing some improvement in January.  There is a lot more competition now at the high end.  Have high expectations on their Intercontinental alliance.  They have cut out almost all of their comps except to their best customers - which is resulting in a substantial increase in cash income
  •  Labor expectation for Sites 5 & 6.  Expect to get 3,000 workers from Galaxy's site at the end of February. Still plan on opening a portion of Ph1 - 1000 rooms, one of the mass casinos and a VIP casino. Have 3,500 employees now.
    • May 2012 is the scheduled completion of PH1 of Sites 5 & 6. What happens afterwards depends on the labor situation.
  • Singapore ramp of non-gaming amenities - running in the mid-to- high 80's for occupancy - close to their 90% target. Their MICE business in the first quarter of 11' is good.  The rate is good. Think that they are at 80-85% of their potential in their life cycle for non-gaming revenues.  Have about 40 more retail stores to open. Probably 55-60% of the way there for retail EBITDA - which will get a nice boost when the subway opens.  Sales are $982/psft now. Mid 80's EBITDA run rate on the Mall - think that eventually they can do $170MM of EBITDA there in a few years
  • Concentrating on improving the junket business.  Think that there is huge upside there for them.  
  • 16-24% is the range of their direct business at their properties in Macau. At Venetian its 18.6%. 
  • They are in the process of looking for a CEO of MBS and they will take their time. Looking for a broad based business person.
  • Any commentary of 2012 business in Vegas?
    • Have 781,000 rooms nights - and the forecasted ADR is closer to $200 vs. this year's $180
  • Singapore - slot win per unit per day is great- what is their capacity to add more aside from the 300 they are adding?
    • Not sure - the market is very deep for Mass and Slot drop/ handle - thinks $1-1.5BN
    • Will add 300 games by end of Q1
  • Mark Juliano is moving over to the casino side in Singapore this weekend. Also hired a SVP marketing executive formerly from Starwood.
  • Dividends?
    • Haven't really spoken about it
    • But are talking about paying down $2BN of debt in Macau
    • Aren't paying down debt in Singapore yet
  • Has no reason to think that they won't earn $3BN of EBITDA this year including a $1BN in Singapore
  • CNY should be huge all across their regions this year
  • Demand in Las Vegas for CNY is huge- they are completely sold out
  • They are talking about getting grants and incentives in Europe as well. Will take an approach of bidding out construction going forward.
  • Their 270 moving day average is 2.93% in Singapore... so according to Sheldon you don't need to adjust the hold % for the high hold this quarter
  • In another location where Intercontinental is partnered - they brought in 44% of hotel revenue
  • Relationship with their junket reps is improving - they will have 40 private gaming rooms that are junket operated in the VIP casino at sites 5 & 6

January Schmanuary

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. 


January Schmanuary - TotalSSS


Callouts from today’s reports:

  • While e-commerce sales remained robust for most, sales were actually down 6% at and only up 2.6% for  Sites with strong growth included Kohl’s (+60%) and Macy’s (+27.2%).
  • ROST continues to take advantage of the environment to secure closeouts at favorable (current) prices ahead of cost increases.  The company ended January with pack-away up 900 bps y/y  to 47%.  Inventories did increase slightly since December as well going from up 19% in total to up 25%.
  • Consumer electronics remained weak for the month as measured by performance at COST and TGT.  COST noted that TV unit sales were flat while overall dollars were down in the mid single digit range.  Target noted that overall hardlines declined by mid single digits, driven by weakness in electronics, music, movies, and books.
  • Comparisons are still overrated- for Nordstrom.  The company reported its 17th consecutive month of traffic increases.
  • Men’s apparel was cited as a leading category for the month by: JWN, KSS, and TGT.
  • COST noted that while inflation is tracking about 1% for food and sundries, the levels of increases have subsided a bit relative to recent months.  Meat and deli showed the highest levels of inflation, up mid single digits.
  • KSS noted that clearance levels were down 9% year over year.  Clearly a help to margins and a potential headwind for sales.
  • Aeropostale noted that average unit retail decreased in the low double-digits, primarily due to increased promotional activity vs. last year.
  • American Eagle noted that less promotional activity and a higher mix of accessory sales resulted in a flat average unit retail price for the month.
  • Big Lots noted that the later timing of income tax refunds and the reduced availability of income tax refund anticipation loans, impacted a portion of their customer base and certain discretionary categories, particularly furniture.  
  • Next month’s sales day will be even less hectic, with all three teen retailers (ARO, AEO, & ANF) ceasing to report monthly sales. Let the speculating begin!          

Eric Levine



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:


  • Commodity inflation – guided to +5% in China, +4% in the U.S. and +3% for YRI.  Management is hedged for about 6-9 months, but still has about $40 million of commodity exposure in China and the U.S. if prices don’t improve from current levels.


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. 


  • Continued labor inflation in China – guided to a mid-teen increase in wages.  Labor increases are not a new phenomenon in China but there were two wage rate increases in 2010, which had a sizeable impact on the labor expense line in 4Q10 and should continue to impact it, particularly in the first half of 2011.


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. 


  • China: Lapping 2010’s one-time $16 million benefit from participating in the World Expo in Shanghai and facing $25 million in incremental tax expenses in 2011 from a new business tax – Combined, these two items are expected to have a 5% negative impact on China’s 2011 profits.


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.


YUM – HIGH HOPES FOR 2011 - yum china 4q10


YUM – HIGH HOPES FOR 2011 - yum us 4q10


YUM – HIGH HOPES FOR 2011 - yum yri 4q10


Howard Penney

Managing Director

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