The “Flows” Are Reversing For Indian Equities

Conclusion: Slowing growth and accelerating inflation indeed have interconnected risk compounding in India as the “flows” are currently working against its equity market(s).


Position: Short Indian Equities via the etf IFN.


After making the research call loud and clearly back on November 9th, we added a short position in Indian equities to the Hedgeye Virtual Portfolio this morning, largely in conjunction with our position to short the US Dollar yesterday – an implicit sign of our view on the slope of global inflation: up.


Nothing has changed meaningfully in the supply/demand picture for many commodities that would support prices deflating from current elevated levels in the near term absent dollar strength. To the contrary, panic buying and stockpiling of food in developing nations across the globe only exacerbates the current supply/demand imbalances that are being exploited by a weak dollar in the form of higher prices from Fed-sponsored speculation.


In Bernanke's defense, the dollar can blame its current instability on fiscal policy fundamentals (see: Obama’s weak budget), rather than an Arthur Burns/BOJ-esque monetization of US debt.


Irrespective of Washington politics and global central planning out of the Federal Reserve, Indian stocks will continue to get squeezed in all areas where it matters:

  • On the topline: growth will slow from topping out in 4Q10;
  • In the margins: +8.23% YoY inflation at twice the government’s projections (and perhaps 3x corporate expectations) and Brent crude oil prices are up +30% YoY (India imports ~70% of its crude oil needs); and
  • On the bottom line: short-term interest rates will continue to trend higher as the RBI continues its sluggish reaction to fighting inflation; Yields on 2Y gov’t notes have backed up +74bps since the start of 4Q10.

Our daily analysis of news flow reveals a level of buy-side capitulation on Indian equities:


“Nobody expected the inflation issue to hit so hard so fast.” – Harsha Upadhyaya, PM at UTI Asset Management.


While we’d normally try and fade capitulation, the permanently bullish storytelling around India’s demographics and growth potential will always keep a bid under this market, especially in times of low volatility. Given this, we view the lack of capitulation by some investors such as Mark Mobius as a shorting opportunity into the recent 5-day, +4.6% up move.


On Friday, Mobius had this to say regarding the recent trend in broader emerging markets: “The trend of investors pulling money from emerging markets and increasing bets on stocks in the U.S. and Europe is a short-term event and investors will return because of developing nation’s growth prospects… We are seeing a tremendous inflow in our emerging market funds.”


To Mark’s point about the “flows”, international investors have pulled (-$1.7B) from Indian equities this year, a stark reversal from last year’s 2010 inflow of +$29.3B. It’s paramount to keep in mind that the 2008-09 crash in Indian equity markets was aided by a (-$12.9B) outflow of international capital in 2008.


The “Flows” Are Reversing For Indian Equities - 1


Domestically, the “flows” are working against Indian equities as well: rising short-term interest rates have Indian money market funds attracting record inflows (+$16B in Jan; roughly 10x the inflow of full-year 2010) as investors shift out of stocks (-$3.5B) and long term bonds funds (-$4.3B) in the first ten months of the fiscal year ending March 31.


As Keith says on nearly every Morning Macro call for the last few months, when the “flows” start going the wrong way, they go fast and it hurts. India's SENSEX is down (-10.9%) YTD already and we see further downside from here.


Darius Dale



The “Flows” Are Reversing For Indian Equities - 2


I think PEET is one of the best positioned, small-cap growth names in the restaurants/coffee space.  Unfortunately, the surge in coffee prices is an overhang, but not a deal-breaker to the growth story.  We would use any commodity concern-induced dips as an entry point.  PEET is scheduled to report 4Q10 earnings after the close tomorrow.


PEET’s current FY11 EPS guidance range of $1.53 to $1.60 represents an effective doubling of the company’s EPS from 2008.  Guidance includes a price increase already implemented in the retail and home delivery businesses at the start of 4Q10 and an announced price increase to foodservice and office customers, most of which will occur at the start of 2011; they have not taken any pricing in the grocery channel at this point.

  1. The guidance also includes expectations that PEET has locked in 40% of their coffee needs for 2011 and the assumption that they will be buying significantly higher cost coffee over the balance of the year.  As of the company’s 3Q10 earnings call, PEET guided to a 15% increase in total 2011 coffee costs.
  2. Sales are targeted to grow in the 8% to 10% range, driven by a mid single-digit rate growth in retail and a higher growth rate in specialty.
  3. Gross margins are expected to decline by about 100 bps, due to higher coffee costs and an increase in mix of specialty sales as a percent of total sales.  For reference, the Specialty business yields lower gross margins than the retail business, but as a result of relatively lower operating expenses, it generates higher operating margins (estimated 27% operating margin for FY10 relative to 10% for the retail business).
  4. Operating margins are expected to improve about 50 to 100 bps driven by the mix shift towards the Specialty business, the continued optimization of the retail channel and leveraging of fixed costs.

The company is working to offset higher coffee costs and improve retail margins by continuing to focus on initiatives to reduce waste in coffee, milk and based goods.  Secondly, retail margins should continue to benefit from improved efficiencies in all areas of the store, including labor productivity, supplies and maintenance.


What does SBUX see in PEET?


PEET is firmly positioned at the high end of the specialty coffee category and the company’s continued growth within the grocery channel is key to its overall growth rate going forward.  As the specialty category becomes mainstream, there will continue to be new opportunities for the company to grow, geographically, through new channels, and to customers that would not have been possible a decade ago when specialty coffee was still in its infancy. 


Relative to new channels, in early 4Q10, PEET began shipping to 600 Wal-Mart stores using its DSD network.  Although the company only expected the new distribution to contribute modestly to business in 4Q10, it expects the contribution to be more meaningful in 2011.  We are looking forward to getting an update on the Wal-Mart trends on tomorrow’s 4Q10 earnings call.


  1. PEET has posted strong double-digit sales growth in its existing traditional grocery store business for the past eight years. Growth within the grocery channel had been driven by the selling, merchandising and person-to-person marketing approach inherent in a DSD system. PEET is a leader in the specialty coffee segment in its most established markets with 32% share in California (#1) and 20% share in the West (second only to SBUX), according to IRI.  SBUX has witnessed PEET’s success with direct delivery and now wants control of its own distribution system.  SBUX could easily leverage PEET’s DSD experience and infrastructure.
  2. As the specialty coffee category continues to become more mainstream, the Peet's brand would be ideally positioned within the Starbucks portfolio.  Although some would argue that Starbucks would not want to buy a premium brand that would compete with its own brand, it is important to note that the Peet’s brand would add another price point to SBUX’s coffee portfolio as it is priced about 15% higher than the Starbucks brand in the grocery channel, according to IRI.  Peet’s would give SBUX three price points within the grocery channel when you include Seattle’s Best, which is priced about 20% lower than the Starbucks brand.  With Peet’s, SBUX would dominate the growing specialty segment and have complete ownership of the grocery aisle.
  3. PEET’s operating margins have improved nearly 240 bps since 2008 (based on my FY10 estimate), as a result of the company’s decision to slow down retail unit growth and focus on in-store execution and from the growing sales contribution from the specialty segment, which as I highlighted earlier, is a significantly higher margin business.  For reference, the specialty segment accounted for 34% of PEET’s total sales in 2008 and about 39% in 2010.  Most of this growth has been driven by the grocery segment.  Based on my estimates, I expect the specialty segment’s sales mix to increase to about 43% in 2011, which will have a positive impact on margins.  I am sure the recent strength in PEET’s margins has not gone unnoticed by SBUX.
  4. PEET has “built an infrastructure that is delivering increasingly profitable growth without requiring significant new capital investment.”


Howard Penney

Managing Director


The future of the single-serve category is Starbucks’ to shape.  While the company may engage in several philanthropic endeavors, I do not see GMCR as one of their causes. 


The importance of social and digit digital media channels and investments in technology to our overall strategy is increasing and becoming a significant competitive advantage as we create rich, emotional engagement with consumers and enhance their Starbucks experience, while at the same time benefiting from the lower cost of customer acquisition.  -Howard Schultz, 1Q11 Earnings Call, 1/26/2011


I’m not privy to the thought process or grand strategy of Starbucks but I have been covering the company since the day it came public.  A few weeks ago, I spent a weekend reading The New Rules of Retail, by Robin Lewis and Michael Dart, a tour de force that I believe offers a tremendous look-back and look-forward at the past, present, and future of retail.  I highly recommend it. 


Without wanting to spoil the book, the key shifts in the consumer that Lewis and Dart outline pertaining to the new, third “wave” of retail are:

  • From needing “stuff” to wanting experiences
  • From conformity to customization
  • From plutocracy to democracy
  • From wanting new to demanding new and demanding now
  • From self to community

The shift from ubiquitous brands such as GAP and Levi’s to niche brands, from large chains to small brands, and from (perceived-to-be) socially irresponsible firms to (perceived-to-be) socially responsible firms certainly corroborates with The New Rules of Retail thesis.   I see the first bullet as being most crucial here; the chains that offer an experience, and the anticipation of such, are thriving while those standing still in this regard are faltering.  Starbucks offers an addictive product and Schultz has succeeded, for many people, in creating a “third place” between work and home. 





Starbucks has learned some lessons the hard way.  Simply by way of human nature, confidence can grow to outsized proportions and a company’s store base can grow in step with that.  Lewis and Dart, in discussing Starbucks, references an internal memo from Schultz  to then-CEO Jim Donald from 2/14/07 that was highly self-critical, lamenting the concept’s move towards standardized, aroma-less, uniform stores that were seen as “sterile” and “cookie cutter”.   Moving back towards former practices and restoring the experience has yielded positive results for Starbucks.  On new channels of growth, and Via in particular, Lewis and Dart have this to say (page 194), “If Via, it’s new instant coffee brand, is going to have sustained resonance in the supermarkets, it will be because people associate it with the Starbucks experience in the stores.  If that experience remains strong and powerful, Schult’z wholesale strategy for growth will succeed.” 


If Lewis and Dart’s argument is credible, and I believe it is, the idea of Starbucks putting their coffee through the Keurig machine does not make sense.





Starbucks has certainly been taking up a lot of airtime of late, beginning with the dispute with Kraft, then with their most recent strong earnings release, and now with the speculation around the myriad possible avenues they may take towards growth in the single-serve market.  I believe that the quote in the last paragraph is crucial to this whole story; customers have to associate the consumption of Starbucks’ products with the Starbucks in-store experience for it to truly gain traction and serve as a vehicle for earnings growth.


Earlier in The New Rules of Retail, on page 149, Lewis and Dart outline control as a key attribute of successful retailers heading into the next phase, or third wave, of retail.  Having maximum control, if not outright ownership, of their entire supply chains from creation through consumption, is a key characteristic of the winning brands. 


The dissolution of the agreement with Kraft fits neatly into this framework.  Both sides have been outspoken in their public and mutual admonishments.  Starbucks, for its part, has alleged that Kraft failed to meet certain provisions of their arrangement, including keeping Starbucks involved in major marketing initiatives.  Whether or not one agrees with this statement – I have no insight to how true or untrue it is – what is clear is that Starbucks are expressing a frustration at a lack of control over the distribution segment of their value chain.  In extricating itself from the agreement with Kraft, Starbucks will likely take a charge that will ultimately prove to be an investment in that it will allow the company to assume more control of its distribution chain in perpetuity.


Given the healthy nature of Starbucks' balance sheet, I think any incurred cost will be kept firmly in perspective; the company appreciates the importance of control.


The single-serve saga is just another act in this play and I do not believe the overall theme will change.  Starbucks is a company that is forward looking and our view is that the coffee machine will be revolutionized by the entrance of the company into the business.  Here is my prediction of what the new Starbucks machine will be like (if not at first, then version 2.0, 3.0 etc.).  Notice that while some of these attributes seem fanciful, they all have founding in both Starbucks’ quest for control and the overall direction of retail, as described by Lewis and Dart and as confirmed by the trends within the space:

  • The design of the machine will evoke the design and feel of the Starbucks store and experience.  I would think black and green, as well as the Siren logo, will feature. (experiences)
  • The name will also likely evoke the store.  “My Barista”, “The Siren”, or other names along those lines are likely.  (experiences)
  • The experience will be customizable, perhaps a touch screen or another user interface that allows the user to provide the machine with specific instructions as to the composition of the coffee they would like. (customization)
  • A “menu” (like a playlist in iTunes), where one can save a recipe or style of coffee for repetitive use and save it with a name like, “Jim – morning coffee”. (customization)
  • Connection to the internet via home computer system to allow the sharing of “menus” and reception of coffee ideas from Starbucks and fellow machine-owners.  This also allows a direct tap into social networking for the new machine.  (community)

I’m sure this imagining of ours will be received by many with a high degree of skepticism.  I have two questions and a quote for you.  First, the questions:  If not Starbucks, who?  If not now, when?  This machine, or something like it, will happen.  Starbucks has the ambition, financial muscle, and forward-thinking management team to make it happen.  And I believe they will want to be in the driver's seat, they didn’t seem overly content sharing control with Kraft.  Second, the quote, from ex-Hedgeye Technology Sector Head and friend of the firm, Rebecca Runke’s Black Book in November 2009: “Mobile phones won’t get a lot smaller than this.  After all, they have to reach from your ear to your mouth.” – Fortune magazine, 1989, about the Motorola TAC mobile phone.


I believe Starbucks will ignore the naysayers and enter the single serve market by revolutionizing it.  As we have outlined in the prior “parts” of this post, beginning in January, “Starbucks will do to the single serve coffee maker what Apple did to the market for portable mp3 players”.   In The New Rules of Retail, Lewis and Dart write the following on Apple, “Each purchase, be it an iPod, iPhone, iPad or otherwise, is then customized by each customer to reflect their individual tastes.  This is one of the best examples of a co-creation of experiences with Apple as the platform.”  Starbucks will create a co-creation of experiences between the office, the home, and the store in the same fashion. 





To finish, I would like to cite a press release from Starbucks that, at least by our interpretation, further corroborates with our thesis:


“The single-serve coffee category in the U.S., and much of the world for that matter, is in its beginning stages of development.  At this very early stage, there are numerous contenders and no demonstrated, long-term winners related to either format or machines. Following our very successful introduction of Starbucks VIA® Ready Brew in the U.S. and into a growing number of international markets, Starbucks will continue to explore the many single-serve and on-the-go solutions and options available to us, and to participate in those where we can better and more conveniently serve our customers wherever they may be. Look for further announcements from Starbucks as we continue to expand our presence in the premium single-serve category.” - Jeff Hansberry, president, Starbucks Consumer Products Group.


Starbucks wants to control the supply chain from creation to consumption to best serve their customers.  This is clear from the thesis I have laid out, and it is also underlined by Mr. Hansberry’s statement this morning.   At the most recent Annual General Meeting, the global nature of Starbucks’ business was emphasized again and again.  Keurig is, in my view, a more U.S. centric brand than Starbucks would like for a partner in the global single-serve market.  I believe Tassimo, a brand with global penetration, would be a more suitable partner.


Howard Penney

Managing Director

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Lower-Highs: SP500 Levels, Refreshed

POSITION: no position in SPY


The bad kind of risk management uses a 1-factor price momentum model with a fixed duration. The good kind of risk management uses multi-factor and multi-duration models. Chasing trends and/or price momentum tends to end badly if you aren’t liquid and/or hedged.


This, of course, will make absolutely no sense to people when buying all dips within a bullish upward channel of price momentum is working. This is typically when the storytelling gets really good. “The market is cheap on historical valuations” … “US growth is back” … etc…


Now to illustrate the problem with this one-factor/one duration strategy, all you have to do is pull back the curtain to a longer-term TAIL of price data. In the chart below we show the SP500 on a 4-year basis. On this score, not surprisingly for those of us who still remember the storytelling associated with the heights of 2007-2008, the SP500 is simply making another lower-high.


As of yesterday’s new closing high for this intermediate-term cycle at 1332: 

  1. The SP500 down -14.9% from its October 2007 closing high
  2. The SP500 is up +97.0% from its March 2009 closing low 

Now, since I tend to be lopped in with the perma-bears anytime I say anything that isn’t perma-bullish US Equities, as a reminder this is what I wrote on March 4th, 2009:


"Early Look: Obama’s Bottom?": The SP500 was down another -0.64% yesterday so I added to my exposure to US Equities, taking my Asset Allocation Model up to 22% in the USA versus the 9% I had allocated in the US as of Monday morning. Immediate term bottoms are processes, not points... so when prices are lower than my entry point, I buy more. Buy low, you know... like the community organizer said!


And back then I was being called a socialist Obama/FDR lover inasmuch as today I am being called an anti-Obama raging Republican…


Time and price change the storytelling on Wall Street, but the reality is that my risk management process hasn’t changed. I had a 22% allocation to US Equities in the Hedgeye Asset Allocation Model then (my peak for an asset class is 33%) and today I have a 6% allocation.


Then we were making a long-term higher-low. Today we’re making a long-term lower-high.


My immediate term TRADE lines of support and resistance are now 1321 and 1336, respectively. And my draw down line of risk is -7% lower down at 1242 in the SP500.




Keith R. McCullough
Chief Executive Officer


Lower-Highs: SP500 Levels, Refreshed - 2

R3: VFC, SHOO, UA, Avatar


February 15, 2010






  • With Steve Madden stepping up late last year to rescue debt laden Betsey Johnson, it didn’t take long for the two brands launch a new line.  Shown for the first time at Fashion Week, Johnson debuted a lower priced line called “Pink Patch”.  All items will be priced below $100.  Not surprisingly the runway models wore a new line of Madden shoes which are available for a short time only on the company’s website.
  • According to Nielsen, grandparents are growing into a major consumer segment.  There are currently 69.6 million grandparents in the US with the number expected to grow 11% by 2015.  Grandparent households spend 4.4% more per year than all other households, which equates to extra spend of about $300 per year.  Oddly, grandparents with just one grandkid spend two times more than those with two to 10.  Note to parents looking to have their kid(s) spoiled. 
  • In a report out of the Financial Times Deutschland, VF Corp. is said to be vetting German outdoor company Jack Wolfskin along with two other parties. As one of Europe’s largest outdoor wear manufacturers and sales north of $400mm, the company fits several of VF’s stated acquisition criteria. However, with double-digit sales growth in each of the past seven years, we’re not sure it matches the profile of an underperforming/broken brand. 



Under Armour wins MLB Footwear License - Under Armour was named the official performance footwear supplier of Major League Baseball, effective for the upcoming 2011 season. Under Armour replaces Reebok. The multi-year agreement gives Under Armour the worldwide rights to produce and distribute the official "silhouetted batter" MLB logo on its MLB Authentic Collection baseball cleats. As part of this new licensing agreement, Under Armour will have the rights to include the MLB logo and MLB Club marks on the brand's in-store, digital, and print advertising for baseball footwear and will have a feature attraction at MLB All-Star FanFest beginning this summer in Phoenix and throughout the term of the contract. <SportsOneSource>

Hedgeye Retail’s Take: Coming on the heels of the rumored Cam Newton endorsement, UA is clearly focused on gaining more exposure “on field”.  On the other hand, it looks like Reebok remains solely focused on its women’s/toning image having let the NFL and now MLB footwear license fall into new hands.


Converse Invests in London's The 100 Club - Converse has provided a cash injection to The 100 Club, London's legendary live venue that had been facing financial difficulties and threatening to close. In a statement posted by, Converse said, "We at Converse are very excited about our new partnership with the legendary 100 Club in London. Converse's commitment to being a catalyst for creativity is at the heart of the brand and we are dedicated to championing and supporting artists, fans, the music scene, venues and the experience. <SportsOneSource>

Hedgeye Retail’s Take:  Interesting marketing opportunity which immerses Converse into the art/music scene and takes the brand far from any athletic association. 


Apparel Prices Set to Rise -Fashion’s sticker shock has only just begun. If designers think the worst of their problems with spiraling fabric prices is over, they should brace themselves for even higher costs in the next few months — just in time for spring 2012. And while rising raw materials costs are on the verge of bursting through at the retail level, there’s no sign consumers are willing to absorb all the increases that designers have had to bear. Over the last year, cotton prices have jumped 160 percent and wool prices have risen 44 percent. While the pace has slowed, prices continue to climb. The cost pressure on designers and manufacturers comes as there are signs consumers are willing to spend again — creating a delicate balance between how much firms can boost wholesale and retail prices without spooking shoppers who remain focused on value. <WWD>

Hedgeye Retail’s Take: At this point nothing related to cost pressure should be a surprise.  However, the consumer reaction and how long this will last still remains the big unknowns.  


Shoe Execs Discuss Market Drivers - Footwear executives kicked off FN Platform Monday with a discussion highlighting widespread market trends, from boots and sandals to toning and barefoot running. "In terms of fashion right now, there are so many trends colliding," said Scott Prentice, VP of sales at Calvin Klein Footwear, who spoke on the Sterne Agee-sponsored panel moderated by company analyst Sam Poser. Other speakers included Rick Ausick, president of Famous Footwear; Cliff Sifford, EVP of Shoe Carnival; Steve Silver, owner of the Next chain; Isack Fadlon, owner of Sportie LA; and Ilse Metchek, president of the California Fashion Association. Major trends for fall, the panel noted, include the enduring Americana look in the men's category, preppy boat shoes, tall boots and toning and minimal running styles. <WWD>

Hedgeye Retail’s Take: The key to a sustainable footwear trend is stated clearly above in the statement, “there are so many trends colliding”.  This is about the healthiest set up a retailer could envision given that multiple categories are working at the same time. 


NRF Forecast 6% Growth in 1H Container Imports - Import cargo volume at the nation’s major retail container ports is expected to be up 11% in February over the same month last year and the first half of 2011 should be up 6% over the same period in 2010, according to the monthly Global Port Tracker report released today by the National Retail Federation and Hackett Associates. “Strong growth in 2010 has retailers cautiously optimistic that the economic recovery is finally taking hold,” NRF Vice President for Supply Chain and Customs Policy Jonathan Gold said. “While high unemployment and rising commodity prices are cause for concern, retailers are encouraged by six consecutive months of retail sales gains and improved consumer confidence.” U.S. ports handled 1.14 million Twenty-foot Equivalent Units in December, the latest month for which actual numbers are available. That was down 7% from November as the holiday season wound down, but up 5% from December 2009. It was the 13th month in a row to show a year-over-year improvement after December 2009 broke a 28-month streak of year-over-year declines. One TEU is one 20-foot cargo container or its equivalent. January remained steady at 1.14 million TEU, a 6% increase over January 2010. February is forecast at 1.11 million TEU, up 11% over last year, with March at 1.16, up 8%; April at 1.22 million TEU, up 7%; May at 1.3 million TEU, up 3%, and June at 1.37 million TEU, up 4%. <SportsOneSource>

Hedgeye Retail’s Take: Given the volume ramp in the 2H of 2010 as retailers looked to ‘front-run’ escalating costs, 2H growth is likely to decelerate from 6% in the 1H. Interestingly, compared to the 7-8% growth forecast for next year from the Transpacific Stabilization Agreement (TSA) representing Asian-U.S. trade, it would appear that volume through Asia is growing at a modestly faster pace.


Brazil December Retail Sales Slow  -  Brazil’s retail sales stalled in December for the first time since April after the central bank took steps to curb credit growth. Retail sales were flat in December from the previous month, the national statistics agency said in Rio de Janeiro. Analysts had been forecasting sales to grow on a seasonally-adjusted basis by 0.4 percent, according to the median forecast in a Bloomberg survey. Sales increased by 10.1 percent from a year ago and 10.9 percent in 2010, the biggest jump since the series began in 2001. Supermarket, food and beverage sales fell 0.3 percent in the month, while six of the remaining seven categories posted growth. It was the first time since April 2010, when sales declined 3.1 percent, that merchants didn’t sell more items than the previous month. <Bloomberg>

Hedgeye Retail’s Take: With food accounting for close to 20% of household income in Brazil the heightened sensitivity to food inflation relative to domestic trends are evident in December sales results.


Social Network Use in China - Marketers planning to expand into Asia-Pacific cannot ignore China. Its GDP continues to climb at more than 10% year over year, and the number of internet users in the country is increasing every day. “As penetration approaches saturation, users are adopting activities that mirror the West but remain distinctly Chinese,” said Mike Froggatt, eMarketer research analyst and author of the new report “China Social Media Marketing.” They show a particular taste for social networks. eMarketer estimates that 265 million internet users in China will use social networks at least monthly this year, a 28% increase over 2010. By 2015 China will boast 488 million social network users. <emarketer>

Hedgeye Retail’s Take: No comment on the “Pimp up my avatar” interest, but the fact that following brands is the second most common activity by Chinese consumers is worth noting for retailers that are still cutting their teeth on this new channel domestically.


R3: VFC, SHOO, UA, Avatar - R3 2 15 11




MAR 4Q2010 conference call notes 





Timeshare spin-off  

  • "Marriott International expects to spin off its timeshare operations and development business as a new independent company through a special tax-free dividend to Marriott International shareholders in late 2011."
  • "The new company will focus on the timeshare business as the exclusive developer and operator of timeshare, fractional and related products under the Marriott brand and the exclusive developer of fractional and related products under the Ritz-Carlton brand. After the split, Marriott International will concentrate on the lodging management and franchise business. Marriott will also receive franchise fees from the timeshare company’s use of the Marriott and Ritz-Carlton brands."
  • "The new timeshare company will be positioned to expand faster over time while Marriott International will further advance its longstanding strategy of separating real estate from management and franchise operations. With two public companies, shareholders will be able to pursue investment goals in either or both companies rather than one combined organization."
  • "After the special dividend, the Marriott family is expected to hold approximately 21 percent of the outstanding common stock of each company"

4Q results

  • The quarter was littered with numerous one time charges:
    • $84MM impairment charge related to a revenue management software investment
      • "The software is designed to manage and price group rooms and catering business at North American full-service hotels and will be a significant competitive advantage... rollout began in the fourth quarter of 2010 and the company expects it will be implemented at nearly 500 hotels by mid-2013 with more properties to follow. Marriott funded the nearly $270 million total system cost as it was developed, expecting to recover the cost from individual hotel properties over time. However, due to the significant
        impact of the recent recession on hotel owner profitability and the long-term nature of its
        relationships with its owners and franchisees, in the fourth quarter Marriott agreed to absorb a
        portion of the cost. As a result, the company recorded the $84 million impairment charge on the
        investment in the fourth quarter to reflect the expected levels of cost recovery."
    • $27MM of impairment charges related to a golf course land parcel for sale
    • $11MM reversal of a liability recorded as part of the Timeshare impairment charge in 3Q09
    • $85MM non-cash benefit in the provision of income taxes resulting from an IRS settlement related to the treatment of funds received from foreign subsidiaries
  • Comparable systemwide WW RevPAR of 8.1% came in a touch above the high end of company guidance
  • “We were also encouraged by trends in our North American group business. Fourth quarter catering revenue for the Marriott Hotels & Resorts brand increased 4 percent and group room revenue rose 3 percent. Near term group bookings for that brand are also picking up. Revenue for group rooms booked in the 2010 fourth quarter for stays in 2011 increased 21 percent year over-year, including 11 percent higher room rates."
  • 35 new properties (8,571 rooms) were added to MAR's system while 8 properties (1,973) exited the system

2011 outlook

  • “While 2010 was a terrific year for the company, we are even more optimistic and enthusiastic about the future. Demand and pricing continue to strengthen....With continuing room rate momentum, premier service quality, and global expansion, we expect an outstanding 2011.”
    • WW systemwide REVPAR: +6-8%
    • ~35,000 room additions to the system
  • 1Q11:
    • Comparable systemwide RevPAR: 6-8% in NA, 9-11% Internationally, 7-9% WW
    • Fee Revenue: $280-$290MM
    • Owned, leased, corporate housing & other, net of direct expenses: $20-$25MM
    • G&A: $155-$160MM
    • Gains: $5MM
    • Net interest expense: $35MM
    • Equity in earnings (losses): -$5MM
    • EPS: $0.24-$0.28
    • Timeshare contract sales: $140-$150MM
    • Timeshare sales and segment revenues, net of direct expenses: $35-$40MM
    • Interest expense associated with securitized notes: $20-$25MM
  • 2011 (doesn't assume spin-off occurs in 2011):
    • Comparable systemwide RevPAR: 6-8% WW
    • Fee Revenue: $1,310-$1,340MM
    • Owned, leased, corporate housing & other, net of direct expenses: $115-$125MM
    • G&A: $690-$700MM
    • Gains: $10MM
    • Net interest expense: $150MM
    • Equity in earnings (losses): -$10MM
    • EPS: $1.35-$1.45
    • Tax rate: 34%
    • Timeshare contract sales: Flat with 2010
    • Timeshare sales and segment revenues, net of direct expenses: $200-$210MM


  • 2010 was a stellar year for MAR. They resumed share repurchased in the 4th Q
  • The spin-off of the timeshare platform is a way for the business to grow faster. They believe that the two businesses appeal to different investors.
    • Probably because their existing shareholders wouldn't be thrilled for them to grow their timeshare business and less so because there are people that love the timeshare business (at least not public investors)
    • While the business is still rich with inventory, there will be good investment opportunities that they would like to pursue
    • New company will have exclusive rights to the Marriott and Ritz Carlton name - for which they will pay MAR a franchisee fee. However, they will be free to pursue additional brands.
    • Don't expect the timeshare company to be investment grade in the near-term, they do expect to continue to securitize notes as a source of capital and funding
  • Continue to press retail rates higher. Nearly 90% of their hotels have raised rates in the 4Q.
  • They are 2/3rds of the way done with corporate rate negotiations with rates up in the high single digit range and their customers tell them that they will travel more in 2011
  • 35% of their pipeline rooms are under construction and nearly 20% are expecting conversion
  • For timeshare, lower rental income will depress results in the 1Q but should improve going forward
  • Assume $500-$700MM of capex in 2011
    • $50MM of maintenance
    • most of the guided amount is already committed
    • Fairfield rollout in India and Brazil (10's of MM's of dollars)
  • Will return cash to shareholders if opportunities do not present themselves...most likely through share repurchase
  • Form 10 with the new deal details will come out late in the 2Q2011
  • Acquired Seville in Miami and Burners in London which will be converted to Edition - those were the 2 largest investments they made in 2010
  • As they expand more internationally they need to invest more in infrastructure (service centers and overhead)
  • Will need an IRS letter ruling but are confident that they will get it.
  • SG&A split for timeshare is in the schedules.  New company will obviously need additional overhead to run as an independent public company
  • Timeshare throws off about $200MM of FCF and they have a long runway of inventory until they decide to accelerate growth
    • Warehouse facility to fund notes in btw securitizations
    • R/C
    • Securitizations
    • Point program will help them match development spend with cash flow. Expect to be FCF positive for a few years.
  • Marriott International will generate a lot of cash but it is not their goal to become debt free.  They will likely continue to put investment grade leverage on the business
  • Will the finance income be impacted?
    • Don't expect to have a material impact there
    • That can certainly be a risk if the new entity has a higher borrowing cost. However, it shouldn't manifest until growth accelerates.
  • Expect group business to be up about 10% YoY in 2010.  Group vs. transient mix - Marriott brand would be about 40% in 2011.  2/3rds of their group business was on the books already at YE 2010 for 2011.
  • Don't want to give people the impression that they are low-balling with their 2011 guidance.
  • Doesn't necessarily think that limited service will continue to grow faster than full service.
  • They are not restricted to buyback stock prior to the F-10 since they have already announced it
  • is their cheapest distribution channel. Beyond that they are happy to sell rooms in any way that their customers want to buy them
  • Some OTA negotiations will start later this year
  • The health of the new company is a consideration of setting fees for MAR. Plus they want their incentives to be aligned.
  • HPT negotiations are going well but its premature to comment on it yet.  Nothing in the guidance as to how that will get resolved.

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