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The Week Ahead

The Economic Data calendar for the week of the 25th of April through the 29th is full of critical releases and events.  Attached below is a snapshot of some (though far from all) of the headline numbers that we will be focused on.

 

The Week Ahead - weeek


COTTON EYE JOE

“He came to town like a midwinter storm… but all he had come for was having some fun.”

-Rednex

 

Conclusion: While the global cotton situation can be characterized by tight supply relative to demand, we would advise you not to buy this soft commodity at this time. Production is rebounding, consumption is decreasing, and historical analysis lend credence to our view that aggressive forecasts for stockpile rebuilding are actually not that aggressive after all. Thus, we do not see current prices as a buying opportunity.

 

“Stay long of The Bernank’s Inflation,” has been one of our more successful themes over the past 3-6 months, and with the USD setting up for may be an expedited move to the downside over the next 8-10 weeks, we’re been looking to increase our exposure to certain commodity markets. Cotton, in particular, has been one of the commodities we’ve been bullish on for the last couple of quarters, so we put our up-and-coming intern Freddy Masotta to the test with the following question – “should we be buying the dip in the cotton market?”

 

 With cotton futures trading slightly above $166.00, cotton has made a nice run over the past twelve months while riding an inverse correlation of -0.80 to a sinking US Dollar. In total, the numbers are staggering: cotton is up +29.2% YTD and +114.4% over the last twelve months while the US Dollar Index is down -5.9% and -8.3%, respectively.Over the past three weeks, however, the correlations have changed. Cotton is down -11.8% over the past month and currently has a three-week positive correlation of 0.64 with the greenback. Though not what we’d consider statistically significant, we would be remiss not to remind you that the US Dollar remains quantitatively bearish across all three of our key investment durations: TRADE, TREND, and TAIL. As the inverse correlation between the two is firmly broken, we viewed this as a unique opportunity to delve into cotton’s supply and demand fundamentals.

 

COTTON EYE JOE - 1

 

On the supply front, production is expected to pick up for five out of the world’s seven largest cotton producers in the 2010/11 season. India, the United States, Brazil, Central Asia, and Australia should all make significant rebounds and see their cotton production increase by double-digit percentages over their disappointing 2009/10 levels; as a whole, global production is estimated to increase by 13.6% during this season. However, China and India, the world’s largest and fourth largest cotton producer, respectively, are likely to face production declines. This will mark the third time in as many years that China’s cotton production has declined.

 

One concern on the supply front is the -27.8% drop off in the world 2010/11 beginning stock, but production this year seems to be sufficient enough to make up for the majority of this decrease. It is also important for investors to keep in mind that it typically doesn’t take more than a couple of years for ending inventories to refill. And given the severe weather incidents that plagued the last planting season (flooding in Australia, drought in China, freezing in Latin America, etc.), the “comps” for this projected rebound in supply are easy to say the least.

 

The main driver on the demand side has been China. The surging demand in China presents a legitimate concern in regards to the global cotton market and supply and demand fundamentals. China faces restricted supplies from all sources in 2010/11 and will likely be constrained by a lack of foreign exports. Further, declining area and weather problems in China are likely to reduce production to a five year low. This, coupled with tight beginning stocks, probably has bulls everywhere licking their chops. We argue, however, that this is likely priced in at current levels – especially given cotton’s massive run-up YTD. In addition, China’s cotton consumption is forecast to decline by 6% in the 2010/2011 season, while, globally, cotton consumption is expected to decrease between -1% to -2% as global clothing brands delay purchases into the latter half of the calendar year (courtesy of the Hedgeye Retail team).

 

We believe cotton could continue to correct from here, as the aggressive production and consumption numbers presented in the 2011 USDA Cotton Outlook appear quite feasible when analyzed with a historical lens. While total supply is expected to decrease by -0.4% this season, consumption is expected to decrease by a greater amount in the 2010/11 season, falling -1.6%. Needless to say, we urge caution to any investor thinking about buying the dip in the cotton market.

 

Darius Dale

Analyst

 

COTTON EYE JOE - 2

 

COTTON EYE JOE - 3


R3: JNY, Groupon, GPS, Puma, TOY and Luxury

OUR TAKE ON OVERNIGHT NEWS

 

Jones Group one of bidders for Jimmy Choo- report - Clothing maker Jones Group Inc  is one of three potential buyers for upscale shoe and handbag maker Jimmy Choo, Dow Jones reported, citing people familiar with the matter.A spokeswoman for Jones Group, whose brands include Nine West and Jones New York, declined to comment on the report. Jones Chief Executive Wesley Card told Reuters in February that his company was looking to buy brands that would help extend Jones' reach, particularly into overseas markets. "Acquisitions are an important part of our growth strategy," Card said at the time. Last year, Jones bought high-end shoemaker Stuart Weitzman.Bahrain-based Investcorp INVB.BH and German luxury company Labelux Group have made a joint offer for Jimmy Choo, while U.S. private equity firm TPG is also in the process, according to the Dow Jones report <Reuters>

Hedgeye Retail’s Take: Let me get this straight…JNY potentially competing against middle-eastern oil money and deep-pocketed German Lux group for iconic brand Jimmy Choo. JNY does not have the wallet for this. It hasn’t even paid off Stuart Weitzman deal in full yet (deferred purchase price and ownership structure).  The fact that JNY is aggressively going after more deals speaks to the state of its base business. If not for strength in its Jessica Simpson line (sustainable???), JNY would be pre-announcing – again.

 

Groupon gets hyper-local - Groupon has acquired Pelago, creator of location-based check-in service Whrrl. The deal is the latest sign that the daily deal space is converging with geolocation, making it possible for businesses to present offers to consumers based on where they are. The move comes a little more than a month after LivingSocial, Groupon’s primary rival, began testing a mobile app feature that lets consumers search for deals within a half-mile radius of their current locations. In announcing the acquisition, Groupon CEO Andrew Mason praised Whrrl’s platform, which allows users to share recommendations for activities and places to go. When others heed that advice the recommender earns “influence points.” Brands and merchants can encourage consumers to visit the promoted bricks-and-mortar locations by offering contests and prizes to people who check in at those locations. <InternetRetailer>

Hedgeye Retail’s Take: There’s no way Groupon could afford to go on a roadshow looking for a $20bn valuation with the competitive gap narrowing. This move was pure defense – but it will probably work.

 

Michael Kors, Valiram Group Team Up - As part of its plan to expand in Southeast Asia, Michael Kors Inc. has partnered with the Valiram Group to bolster business and open stores in Malaysia and Singapore. The first freestanding Michael Kors store in Malaysia is scheduled to bow in August in the Pavilion Kuala Lumpur. The 3,500-square-foot boutique will showcase ready-to-wear, handbags, small leather goods, footwear, eyewear, watches and fragrances from Michael Kors, Kors Michael Kors and Michael Michael Kors. The debut of the company’s first Singapore boutique is also slated for August. It will be housed in Scotts Square, a luxury shopping center opening later this year in the city’s busy downtown shopping district not far from the Grand Hyatt and Marriott hotels. <WWD>

Hedgeye Retail’s Take: Great example of how easily scalable great brands are into new geographies, and how the brands (content) are ultimately more valuable than the retailers (distribution). One has limited growth, the other is blue sky.

 

 “Luxury triangle" of brands to be landed in Shanghai - The 3,000-sqm Austen Branded Goods City is scheduled to open this year in the Gubei New Area, Shanghai, setting the site up as the city's new shop window on major European branded goods.  The 30-plus brands moving into the mall in Gubei New Area are all showing luxury goods of top quality, including Weill, one of France's oldest fashion brands, Lauren Vidal, a designer label on sale in Paris' Lafayette department store, and Italian brand Tricot Chic is also well-known, for its bright colours and feminine styling. Austen City is not expected to adopt a business model characterised by exclusive buy-outs or distribution. Rather, it will be directly involved in shop design, production, marketing and after-sales services of the brands on offer. Constituting a second leg of the triangle is 180-year-old Takashimaya, one of the largest department store chains in Japan. The group's first store in China is to be in Gubei, on a business area of 40,000 sqm. <FashionNetAsia>

Hedgeye Retail’s Take: Ditto on the Michael Kors comment. When you’ve got the content, you’ve got the growth. Period.

 

Gap Streamlines its International Operations - Now that Gap Inc. is out to conquer the global business-to-consumer e-commerce market and other retail venues, the chain retailer is rolling all of its international operations into a single unit and putting one executive in charge. Gap, No. 23 in the Internet Retailer Top 500 Guide, is consolidating all of its foreign e-commerce and store programs in Europe and China under a new unit to be headed by Gap Europe and strategic alliances president Stephen Sunnucks. Gap’s streamlined international operation will include 530 stores across 30 countries. Gap in the past two years also has launched e-commerce operations for shoppers  in Austria, Estonia, Belgium, China, Denmark, Finland, France, Germany, Ireland, Italy, Luxembourg, Malta, Netherlands, Portugal, Slovakia Slovenia Belgium, Spain, Sweden, the United Kingdom, and elsewhere. <InternetRetailer>

Hedgeye Retail’s Take: This makes perfect sense. While the investment community at large is focused on Gap’s inability to comp – especially in the US – the International chess board is being set, and GPS is accelerating stock repo in the interim. Don’t bet against this one.

 

Nordstrom eyeing Hudson Yard - Nordstrom Inc. is eyeing the massive Hudson Yards project under development on the far west side of Manhattan where it could open its first full-line store in the city. After years of combing Manhattan for a site and considering a number of alternatives, the Seattle-based department store chain is “looking at the potential of Hudson Yards,” said a source. “They’re in discussions with Related Cos.,” developer of Hudson Yards, a 26-acre commercial and residential project to be built over the rail yards near the Hudson River located between 30th and 33rd Streets and 10th Avenue and the West Side Highway.  “It’s fair to say they’re interested and considering it, but nowhere close to any kind of deal or commitment,” the source added.  Nordstrom is also considering other sites in Manhattan, but Hudson Yards seems like its best bet given the enormity of the project and its ability to provide Nordstrom’s space requirements of at least 180,000 to 200,000 square feet, a parcel extremely difficult to find in Manhattan, particularly in an area dense with upscale shoppers. <WWD>

Hedgeye Retail’s Take: Huge potential win, and huge potential waste of capital.

 

Puma Opens Eco-Friendly Concept - As Europe’s activewear giants race to clean up their act on the sustainability front, Puma on Wednesday inaugurated its revamped Boulevard de Sébastopol flagship, combining high-tech interactive features with eco-friendly materials for merchandising and decor. Materials included energy-efficient lighting and FSC-certified sustainable wood, while clothes hangers are made from cornstarch.

The store’s new look is urban and colorful, however, with exposed concrete walls, video screens, loud comic-inspired wallpaper, puma cat-shaped coat pegs in the changing rooms and clusters of green and red poufs. Old-school metal sports-room lockers used as merchandising units come decorated with sports trophies. Local artist collective 9eme Concept collaborated on the store’s design.  A red joypad wall on the first floor carries 32 iPads loaded with interactive content for customers to play with, such as Puma’s new iPad and iPhone Life Scoreboard application, where users can vote on a flow of open questions pitting two subjects — such as Mac versus PC — against one another, and then check the scores. <WWD>

Hedgeye Retail’s Take: Very interesting idea, and great way to stay fresh with a younger audience.

 

Toys ‘R’ Us Expanding e-Commerce  - One way Toys ‘R’ Us Inc. is supporting its burgeoning e-commerce program is by opening its first dedicated distribution center for fulfilling Internet orders. This July, Toys ‘R’ Us, No. 37 in the Internet Retailer Top 500 Guide, will open a new 300,000-square-foot distribution center near Reno, NV. The center, which will eventually employ about 120 workers and another 230 part-time workers during the peak holiday season, will fulfill orders for Toysrus.com and Babiesrus.com. “As more consumers enjoy the simplicity and ease of online shopping, Toys ‘R’ Us continues to invest in e-commerce enhancements to advance customer service and satisfaction across all shopping channels,” says CEO Larry Storch. “We believe the facility will play an important role in further accelerating our company's online business growth and order fulfillment.” <InternetRetailer>

Hedgeye Retail’s Take:  It seems odd that such a seasonal business would require a fully allocated DC that would add to cost structure year-round. This puts pressure on the company to knock their e-commerce strategy out of the park.

 

Underwear Sales Heat Up in Men's Retail - Forget simple white briefs: Men’s underwear has discovered fashion and technology. The sector has been growing rapidly on the back of those two trends, which is part of the overall boom the men’s wear market has seen across all categories following the depths of the recession. A plethora of bold colorblocking and oversize logos and advances in high-tech temperature-regulating applications that keep the wearer cool and comfortable are expected to continue to propel sales this fall. In the three months ending February 2011, the men’s underwear market generated sales of $1.24 billion, up 13 percent from the three months ending February 2010. In the 12 months ending February 2011, men’s underwear sales generated $3.9 billion, up 8.6 percent from the same year-ago period, according to The NPD Group.  <WWD>

Hedgeye Retail’s Take: Great for Warnaco (CK Underwear), and opportunity for Hanesbrands (which competes at the lower end of this market).

 

Shoemakers Urged to Avoid Competition Over Low Prices - Low-priced shoe exports to the EU may cause further trade penalties, warned the Local Shoemaking Association after the recent removal of EU shoe anti-dumping duties.  More shoe orders from the EU were received after the removal of duties which resulted in a drop in export prices. However, industry experts indicate worries over a new round of competition over prices, stressing that this might result in new penalties to be imposed on shoe exports. <FashionNetAsia>

Hedgeye Retail’s Take: Be careful what you wish for.


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HBI: Don’t Bet Against HBI

Top line momentum + transparency on the cost side are factors few companies have in this environment.  The market has figured it out – but in this instance, the market is right.

 

 

Investment Conclusion

It’s tough to bet against HBI at this stage. The company has solid top-line momentum and a high degree of transparency on the cost side – unlike almost every other company in retail (sans GIL). As it relates to revenue, there’s still three quarters of the Gear for Sports acquisition that give the model implied growth, but also continued organic growth due to considerable momentum with several marketing campaigns (ie watch Oprah today). Let’s not forget that this company is not afraid to miss top line targets; its done it plenty of times in the past.  But don’t bank on it in reported numbers until January ’12. On the cost side, this is a company that has the luxury of directly procuring nearly all raw materials instead of relying on another partner in the supply chain to look out for them. Anyone that is beholden to someone else in the chain immediately exposes themselves to risk of the unknown. In this business, ‘the unknown’ is far worse than severe fluctuations in costs. At least the latter can be managed proactively by nearly any management team. In the meantime, you’re looking at a name trading at 8.2x EBTDA, 9.5x earnings,  and that throws off enough cash to pay down its considerable debt burden within a 4-year time period. We’ll keep a sharp eye on the overwhelmingly positive sentiment factors right now (8 out of 9 analysts have Buy ratings, and only 6% of the float is short), but we think that – at least for the time being – that the consensus has this one right.

 

 

Overview of the Quarter and our Model

Solid quarter for HBI with Q1 EPS of $0.49 topping our estimate of $0.34. The beat was broad-based coming in better than expected on every line item. Strong top-line results (+12% vs. our +10%) driven by the Outerwear and International businesses coupled with less significant gross margin contraction and greater SG&A leverage drove 60bps in operating margin expansion in the face of the toughest compare of the year. The Street was also looking for $0.34.

 

On the margin, we’ve adjusted several lines in our model to reflect the traction that’s clearly evident in the business as well as the company’s ability to successfully mitigate higher costs. The bottom-line here is that following Q1 results, increased full-year guidance of $2.70-$2.90 up from $2.60-$2.80 actually looks conservative.

  • First, our consolidated top-line assumptions remain little changed for the year up +12% taking into account stronger growth than we expected in the company’s International business and a modest ramp in Outerwear driven by early success at Gear offsetting more modest growth assumptions in Innerwear due to less meaningful from timing related space gain contribution.
  • GMs contracted -108bps in the quarter 100bps less than expected in the face of the toughest compare of the year +460bps proving the company can mitigate higher commodity costs. With supply chain efficiencies of $8mm-$10mm, or 75-100bps a quarter, offsetting less onerous commodity costs as we look out to the balance of the year, we’ve taken up margins modestly in the 2H to flat and down -25bps in Q3 and Q4 respectively from down -50bps in each quarter.
  • SG&A leveraged better than expected with dollars coming in below our expectations with added distribution costs to handle higher sales volume coming in much lighter than anticipated. Additionally, despite the perception of increased marketing spend given a multitude of new campaigns, the company confirmed that marketing spend will stay in-line with historical spend of $90-$100mm annually.

 

All in, given the $0.15 beat in the quarter and approximately $0.08 of added benefit attributed to both gross margins and SG&A over the balance of the year, we are taking our numbers up to $2.95 and $3.40 for this year and next ahead of what amounts to conservative guidance. While inventory growth of +30% (+26% ex Gear) is higher than we’d like to see at this point in the year, taking inventory early may in hindsight be an opportunistic move with retailers potentially looking to take stock earlier than usual heading into BTS.

 

 

Few Key highlights from the call:

 

Retailers/Inventory:

“what is interesting is that retailers are taking very different approaches to managing inventory as cost increases start to hit them throughout their entire apparel floor. Some are extremely conservative, some are pretty aggressive using as an opportunity to gape share, they will start to normalize later in the year, we clearly did anticipate in our guidance somewhere during the year we would see unit levels drop on in aggregate for retailers.”

Consumer:

“We are seeing a pickup in spending and confidence that help may help mitigate that a little bit. We are seeing consumers actually start to travel back up scale in terms of retailers and show a predisposition to begin spending higher prices per unit, that bodes well for the economy throughout the year.”

 

Re Pricing

“We got the lion's share of pricing secured. We feel fine about it and remember we price on a run rate basis, not to try and make a fiscal year and so we look at what we think the go forward rate is from a inflation stand point, both with cotton, oil and wages, as we put in prices, that should take care of not only 11 but cascading in to 12. We are fine from a pricing perspective”

 

 

HBI 1Q FY11 Earnings Call

 

P&L Notables:

  • Sales Increased 12%Reflecting:
    • o Innerwear: (Flat)
      • Innerwear Operating Margin -400bps
      • Deterioration Reflects:  higher cost cotton and commodity cost throughout the quarter and price increases that were not implemented until mid quarter
        • o Outerwear segment: +37%
        • o Hosiery:  -6.9%
        • o International segment sales: +24%
        • o International Business
        • o Direct to Consumer: -2%
  •  
    •  
      •  The fact that price increases were only in place for two months in the quarter contributed to a 23% decrease in operating profit.
  •  
    •  
      • Across-the-board strength in Gear For Sports, wholesale casual wear (Hanes), retail casual wear (Just MySize andHanes), and retail active wear (Champion).
      • 19% was due to Gear for Sports Acquisition
  •  
    •  
      • Strength in all geographies - Canada, Latin America, Asia and Europe. Operating profit increased 86 percent (75% Constant Currency).
  •  
    •  
      • Sales from Brazil, China and India all saw 40%+ revenue growth

 

  • Gross Margins 34.2% down 108 bps
    • o Spoke to GM in Q&A

 

  • SG&A up 4.5%
    • o Spoke to SG&A in Q&A

 

Balance Sheet:

  • Inventories up 30%
    • o Reflects the normal seasonal build for back-to-school, Gear for Sports acquisition, and higher Cotton and Commodity costs.
  • Continue to have a priority of deleveraging and will continue to pay down debt with free cash.

 

2011 Guidance

  • Expect Sales for FY 2011 to be within the rage of  $4.9 billion to $5 billion
  • Expect free cash flow to be between 100-200 million
    • o Expect to reduce year-end debt levels by the amount of free cash flow
  • EPS  for 2011 at $2.70- $2.90

 

 

Q&A:

 

  • International Business Drivers
    • o Strong positions in Canada, Mexico and brazil. Overall you will see continued strength in the teens in International .
    • o China: All of the major developing markets have a long term growth potential. Our categories are used all around the world. As middle class grows HBI benefits. Focused on developing china, Mexico, brazil and India.
    • o In china focused on building the basics business first. Intimate apparel will be built out later.
    • o International up 17% on constant currency. Believe that international should be able to deliver low teens. All geographies are performing well.
  •  
    •  
      • Only weak region is Japan. It is a 75-80 million dollar business.

 

  • Gear For Sports/ M&A environment/ Gold Toe:
    • o Acquisitions are not a major part of our strategy. Three are a lot of opportunities to grow business. Clearly tuck-in acquisitions are helpful. On the look out for acquisitions but acquisitions are not necessary for success of HBI.
    • o Gold toe has been perennially on sale. They have passed on the acquisition in the past.
    • o Low profit quarter for Gear for Sports when seasonality is taken into account.

 

  • Innerwear /Elasticity
    • o Weakness in Innerwear growth due to tough comp
    • o "From a profit perspective its simple we are starting to see the impact of inflation. Price increases have not hit innerwear yet. Will begin to see rebound in second and third quarters."
    • o Company has embedded a substantial unit fall off in guidance for FY 2011.
    • o 400bps of EBIT margin deterioration
  •  
    •  
      • Last year there were huge space gains and fixture fills (approximately 30 million).
  •  
    •  
      • Higher commodity prices
      • Price increases not passed through yet

 

  • SG&A
  •  
    • Was unplanned. Still in marketing mode (Marketing expected to be 90-100 million for the year). Bulk of SG&A dollars went to G4S. Might see SG&A  dollars go up.
    • Through the remainder of the quarters SG&A will be leveraged. Rate will continue to improve (dollars up but leverage as a % of sales up)
    • SG&A dollars were up about $11 million.  Gear  represented ~$12 million of SG&A in the first quarter (Excluding Gear, SG&A was relatively flat in dollars)

 

  • Elasticity
  •  
    • From retailer perspective, retail  inventories are where they should be. Interestingly however, retailers are taking much different approaches to managing inventories. Some are being conservative, others are using this time period to take share.
  •  
    •  
      • Unit levels have dropped off in the aggregate for retailers.
  •  
    • No consumer elasticity impacts as of yet.
    • Seeing a pickup in consumer spending and confidence. Seeing consumers travel back to upscale merchandise.
  •  
    •  
      • As there is better visibility feel more secure in negotiating with retailers and feel more comfortable with position.
  •  
    •  
      • "It is the end of the deflationary environment in retail"

 

  • Pricing/Cotton
  •  
    • Have the lion share of their costs locked in.
  •  
    •  
      • Use run-rate pricing
  •  
    • Work directly with merchants who become involved in the futures market.

 

  • Gross Margins
  •  
    • Excess service costs spilled over very little but was not material.

 

  • Inventory
  •  
    • Inventory in 11 will be up 50million
  •  
    •  
      • Inflation costs +100
      • Turns will improve by +50

 

  • Competitor Responses to price Increases
  •  
    • Every single company is having to deal with huge inflation. No one is immune. Every company is going about inflation differently. There are a few big global players who have been surprised by the increased.

 

  • Average Interest Rate on all debt?
  •  
    • 7.5%

 

  • Outerwear
  •  
    • Overall increase was driven by G4S.  Even so, everything was up excluding G4S (~18% Excluding g4s)

 

  • Direct -Sales Segment
  •  
    • Down about 2%. Comps were up 2%. Internet business was soft. Attribute softness to a mid quarter change in mailing strategy and timing.  Believe it will turn around later in the year

 

  • Transportation and Energy Prices
  •  
    • Built into guidance is oil at 100

 

 

Brian McGough

Casey Flavin
Robert Belsky


MAR 1Q2011 CONF CALL NOTES

Good enough.  We expect Q2 to come in at low end of guidance. 

 

 

"We are optimistic about the future.  Overall business transient demand is very strong and corporate group demand is building.  Our outstanding brands continue to lead in their respective market segments as reflected by our substantial REVPAR index premiums to competitor hotels.

- J.W. Marriott, Jr., Marriott International chairman and chief executive officer

 

 

HIGHLIGHTS FROM THE RELEASE

  • "We expect to open approximately 35,000 new rooms in 2011 alone, or over one-third of our worldwide development pipeline of 95,000 rooms."
  • "We plan to launch the AC Hotels by Marriott brand on our booking channels next month."  
  • 1Q11: "REVPAR for worldwide comparable systemwide properties increased 6.5 percent (a 6.6 percent increase using actual dollars)."
  • "While our Washington, D.C. hotels reflected weaker demand associated with a shorter Congressional calendar and budget negotiations and New York was impacted by new supply, most North American markets reflected both strong demand increases and modest supply growth."
  • "Calendar quarter REVPAR for North American comparable systemwide properties increased 6.8 percent."
  • "Owned, leased, corporate housing and other revenue, net of direct expenses, increased ... largely due to an increase in branding fee revenue, higher termination fees and improved operating results at owned and leased hotels."
  • "Nearly 25 percent of company-managed hotels earned incentive management fees compared to 23 percent in the year-ago quarter."
  • "North American house profit margins were affected by the non-comparable New Year's holiday, increased state unemployment tax rates, higher marketing and sales costs and the timing of property-level bonus" accruals.
  • "Contract sales to existing owners represented more than 61 percent of sales in the quarter compared to 48 percent in the year-ago quarter.  While sales to existing customers were strong, with fewer sales to new customers year-over-year and a lower average contract price, first quarter adjusted Timeshare segment contract sales declined $27 million."
  • "Timeshare segment results increased from the year-ago quarter largely due to the $5 million decrease in losses for a residential and fractional joint venture and the $2 million decrease in interest expense as a result of lower interest rates and lower outstanding debt obligations related to previously securitized notes receivable."
  • [SG&A] "The increase in expenses reflected $7 million of higher incentive compensation costs, which are largely related to timing, the absence of $8 million in prior year favorable items noted below, as well as higher costs in international markets and increased brand investments."
  • "While all terms of the transaction are not yet complete, post spin-off, the company expects the new timeshare company will pay a franchise fee to Marriott International totaling approximately 2 percent of developer contract sales plus a flat $50 million annually for use of Marriott's brands.  The franchise fee is also expected to include a periodic inflation adjustment."
  • Repurchased 7.8MM shares in 1Q11 for $300MM. YTD MAR repurchased 13.4MM shares for $493MM. There are 10.5MM shares left under MAR's share repurchase authorization as of 4/19/2011
  • Cash: $144MM
  • Debt: $2,857MM, including CP of $42MM
  • FY 2011 Guidance:
    • Largely unchanged from previous guidance; only differentiated commentary/guidance is highlighted below
    • "Compared to full year guidance issued in February 2011, the company expects stronger performance at European owned and leased hotels and higher termination fees, offset by a $10 million decline in results in Japan."
    • Adjusted EBITDA was lowered by $15MM
    • Fee revenue was lowered by $5MM
    • SG&A was increased by $15MM
    • Net interest expense higher by $10MM
  • 2Q2011 Guidance:
    • EPS: $0.34 to $0.38 is below consensus of $0.40
    • Fee revenue: $320-330MM
    • Owned, leased, corporate housing & other, net of direct expenses: $25-30MM
    • Timeshare sale and services, net of direct expenses: $50-55MM
    • G&A: $165-170MM
    • Net interest expense: $35MM

CONF CALL

  • Washington DC - business is already improving with the recent budget settlement
  • Group business was weaker than expected for in the quarter for the quarter booking, however, bookings in the quarter made for the balance of the year was strong, up 10%.
  • Why was MAR's RevPAR lower than Smith travel data?
    • Systemwide, 1 in 20 of their systemwide hotels are in the DC market more than twice that of their comp base. They also have more exposure to group business - 45% more than the average smith travel hotel - 40% more than the average Sheraton.  Group business tends to lag the RevPAR index.  
    • 47 hotels are under renovation this year vs. [30] last year
    • They don't feel like they are overpriced relative to comps
    • They report comparable hotel data rather than same store like their competitors
  • Expect that domestic house profit margins will expand 100 -150bps this year while international will expand 100 bps
  • Last year's G&A included $8MM of unusual benefits
  • Expect to file the timeshare spinoff with the SEC in June 
  • International RevPAR will slow later this year.  Shanghai World Expo is a tough comp and they will be impacted by the events in Japan and the Middle East - although they expect that Japan and ME RevPAR will rebound by YE
  • Special Corporate rate negotiations resulted in rate increases in-line with their expectation
  • Interest income will be lower as one of their loans is expected to be paid back early
  • Expect share count to decrease due to their large share buybacks as they have been taking advantage of the recent share weakness
  • Believe that their actual openings will exceed today's pipeline over the next 3 years
  • Expect to add another 1700 AC hotels rooms next quarter
  • Have not adjusted their guidance for the incremental costs of the Timeshare Spin transaction
  • After adjusting for large renovations - Marriott's brand share was flat in Feb - despite their larger group concentration
  • Their brands are not losing marketing share
  • Over half of the occupancy in their hotels is touched by direct sales - group primarily
  • Recently changed their sales efforts (Sales Force One) for booking group business to a centralized system to be able to sell across all their brands vs. selling taking place at the individual hotels. Expect that their group market share will increase as a result.

Q&A 

  • Have seen good group bookings for 2011. March was the second best month that they've seen in 2 years for group bookings. Think that what they saw in 1Q was an anomaly.
  • $500-$700MM of investment spending update
    • Not a lot has been committed - the last investor day is the best guidance
    • Flat level of investment spending in 2011-2013
  • The Timeshare spinoff fees were set as to not stifle potential growth outside of MAR brands
  • House margin growth is based on incentive comp accrual - they are booking more aggressive comps than last year. They also have some issues with NY's day revenue recognition issues. Expect that RevPAR will be stronger in the balance of the year than in Q1
  •  Timeshare growth strategy out of the box regarding new brands?
    • As they convert to points they can be more efficient in growing the company without building new product
    • Individual projects; also don't need to be as large
    • Right now, the business is generating positive cash flow and given the level of inventory, they expect that that continues in the near term
  • Expectations from their leisure customer base?
    • Fairly optimistic despite the rise in gas prices. So far, there hasn't been an impact from the increase in gas prices and airfares
    • They still expect growing leisure business
  • Philly hotel renovation had 1/2 pt of RevPAR impact on their business. They don't take their under renovation hotels out of the comp set unless a material number of guest rooms are out of commissions. 
  • Haven't included one time costs from the spin transaction into their guidance
  • Ex Japan and ME, their international business is expectations are higher than they were last quarter. Feel like they are losing 3 cents of EPS due to ME & Japan impact.  
  • G&A - they had some one time items in 2010. Core G&A is growing more like 5% vs. earlier guidance of 3-5%
    • Ok i don't understand their response. Marriott clearly was aware of all the one-time 2010 items when they guided last quarter - including under accrual for incentive comp in 1Q2010... so the explanation for the revision doesn't really hold water
  • Claim the ME & Japan will impact their incentive fees by $10MM or so. Plus the DC market was really soft in the Q1 and they expect that to improve
  • How much of their group business in 2011 was booked before 2011
    • Varies by hotel. Bigger hotels could have as much as 75% of their business on the books before the year starts
    • Claim that on average 65% of their group business for the year is on the books at the beginning of the year
  • Not seeing much change in their booking window

PENN 1Q2011 CONF CALL NOTES

First of three strong regional earnings reports. This one was very good.  PNK and ASCA next.

 

 

"With first quarter results exceeding guidance and cautious expectations for continued positive operating momentum throughout 2011, we are raising our full year 2011 revenue and adjusted EBITDA guidance to $2.7 billion and $677.0 million, respectively. We're generally seeing a stabilization of consumer spending across our businesses and markets, though we are hesitant to forecast higher revenues based on February and March trends which benefited from favorable weather versus 2010."

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

 

 

HIGHLIGHTS FROM THE RELEASE

  • Development/Acquisition updates:
    • "Beginning in June 2011, operating results are expected to reflect the acquisition of The M Resort. The property generated adjusted EBITDA of $6.2 million in the first quarter and we believe that our operating discipline, rationalized approach to marketing and active player database can gradually improve the property's financial performance.  Since sending offers to stay at M Resort to some of our highest value players earlier this year, the facility has booked approximately 2,500 incremental room nights and we are now developing other plans to drive profitable revenue at the property."
    • "Based on the current pace of construction, Hollywood Casino at Kansas Speedway and Hollywood Casino Toledo are expected to open in the first and second quarter of 2012, respectively, provided the required regulatory framework and approvals are in place."
    • "In Columbus, we have instituted legal proceedings and requested injunctive relief to protect our rights to continue to receive water and to utilize pre-existing sewer services from the district's sole provider, the City of Columbus, at the former Delphi Automotive site in Franklin Township. In the meantime, we recently named Smoot Construction Company of Ohio as our construction manager for the project and are planning a groundbreaking on April 25... We remain hopeful that the project will open as originally contemplated in the fourth quarter of 2012."
    • "On April 8, Penn National closed on its 50/50 joint venture to own and operate the Sam Houston Race Park in Houston, Texas, the Valley Race Park in Harlingen, Texas and a planned racetrack in Laredo, Texas. Our joint venture ownership also includes significant real estate, including interests in 323 acres at Sam Houston Race Park, 80 acres at Valley Race Park and an option to purchase 135 acres for the planned racetrack in Laredo... we are seeking legislative action to permit the addition of slot machines at existing Texas pari-mutuel facilities in order to maximize the overall value of these businesses. Recent polls indicate that the overwhelming majority of Texans want the right to express their position on slot machines at racetracks through a state-wide referendum"
  • Guidance:
    • Net revenue: Q2: $682.7MM; 2011: $2,707.5MM
    • Adjusted EBITDA: Q2: $179.4MM (Consensus $171MM); 2011: $677MM (Consensus of $662MM)
    • EPS: Q2: $0.47 (Consensus of $0.41); 2011: $1.64 (Consensus of $1.54)
    • Pre-opening expenses:  Q2: $1.1MM ; 2011: $9MM (up from $7MM previously)
    • D&A: Q2: $57.9MM; 2011: $239.5MM
    • Non-cash stock comp: Q2: $6.3MM; 2011: $25.1MM
    • Blended tax rate: 43.2%
    • Diluted Share count: 107MM

 

MGMT COMMENTARY:

  • More optimistic than in the past
  • Columbus going as planned
  • Cost cuts went well
  • Still not seeing robust top line growth except Penn National and Charlestown

Q&A:

  • Gotten off to decent start in April; will watch Easter calendar shift this year.
  • 1Q Corporate expense: high legal expenses (TX, MD)
  • Can't extrapolate margin improvement in 1Q for rest of FY 2011
    • Can't expect 3Q/4Q margins to be as good as 1Q/2Q
    • they might be sandbagging a bit
  • Assuming revenues are basically flat for FY 2011
  • Charles Town: Tables games revs will start to anniversary so YoY growth will come back in-line, in other words, not as strong as 1Q.
  • M Resort - will act as a typical LV Local business
  • Columbus water dispute: considering alternatives
  • Have met with Gov Kasich's staff, but no meaningful dialogue yet; hopes Ohio will follow PA's example
  • Vegas alliance? Do not see any opportunities at this time.
  • 1Q consumer spending: slight strength in VIP and mass non-rated play; generally flat
  • March was generally flat; February higher, driven by weather.
  • Gas price impact: does not see any correlation with spending; most of their consumers reside within 30 miles of the property so high gas prices not significant.
  • Texas: standalone slots at racetrack bill pending, final bill/hearing may come next week. There could be a special session in June/July.
  • Illinois smoking ban bill: pending in Senate
  • Sees JV track losses to be lower going forward
  • Maryland Jockey Club - will be positive in 2Q because of Preakness; also, Maryland state may provide funding to mitigate losses in MJC--waiting on Governor's desk.
  • LV Locals-- not much change in promotional spending in 1Q, it's "moderate";
    • Fairly stagnant; modest growth in group business and Southern Cali business
  • Anne Arundel: nothing in guidance; no smoking facility (Charles Town has smoking)
  • Charles Town: adding 20 more tables games in 2Q; opening $40MM entertainment/sports bar in June/July
  • 1Q total cash: $234 MM; unrestricted sub: $59MM;  $175MM operating cash;
  • Debt: $35MM non-revolver debt; $1.518BN term loan B; $1.53BN total bank debt; $2.135BN total debt
  • 1Q Capex: 54.5MM (14.7MM maintenance, 39.8MM project); FY 2011 Capex: $443MM (85MM maintenance, 287MM project)
  • Promotional spending: very rational at this time across the country
  • Margin trends: cost structure very sustainable; if top-line continues to grow, still room for improvement
  • Online gaming: not interested
  • In 1Q, low-end rated play ($1-$99) declined but non-rated play increased
  • Non-rated retail spending picked up
  • Gulf coast properties: have reduced insurance costs
  • Admission counts flat 
  • Term loan B: L+175bps
  • 10th IL gaming license impact: Elgin takes biggest hit, followed by Aurora and Joliet, and Northwest Indiana
  • Unrated customers in 1Q: low to mid single digit growth benefited by tables games in WV and PA
  • No pre-opening expense in Joliet
  • Joliet: not satisfied with performance; have picked up share from Harrah's Joliet but still need non-gaming business to do better

Hedgeye Statistics

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

  • LONG SIGNALS 80.33%
  • SHORT SIGNALS 78.49%
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