The Canadian Majority

Conclusion:  The Conservatives won a majority in Canada’s election, which is supportive of pro-business tax policies and fiscal conservatism. 


Position:  No position, but we remain bullish on the Loonie for the intermediate term.


Yesterday, we wrote an intraday note analyzing the Canadian federal election.   Our view was that based on the results of recent polls that a Conservative majority was unlikely.  In fact, the Conservatives won a very decisive majority.


Based on preliminary results, the Conservatives gained 39.6% of the popular vote and 167 seats, which give them a solid majority in Canada’s 308 seat parliament.  Interestingly, and this was as predicted by polls, the NDP received 30.6% of the popular vote and 102 seats in parliament.  The most noteworthy loss was that of the Liberal party, who for the first time in Canadian history will not be the governing party or the official majority.  The Liberals are expected to finish a distant third with 18.9% of the popular vote, and 34 seats.


This election also marks, at least for now, the demise of the Bloc Quebecois, who received only 6.0% of the popular vote and only 4 seats.   The Bloc is a Canadian political party that runs only in Quebec and whose mandate is to protect the interests of Quebec in the House of Commons.  Aside from the Liberals finishing third, this was really the watershed moment of the election.   In the prior six elections, the Bloc had won between 38 and 54 seats.  In this election, the province overwhelmingly shifted towards the NDP, who are expected to win 58 seats in Quebec, which is supports a unified Canada.


The Conservatives clearly have a mandate to govern with the results of this election.   While there is some risk that the Conservatives shift too far to the right (at least by some critics), from an economic perspective we have been impressed by the results of the Canadian economy over the last couple years, which has been driven, in part at least, by Conservative policy.  As such, we view the results of this election as positive for Canada’s economic future.


In the table below form, we’ve highlighted the results from the election.


Daryl G. Jones

Managing Director


The Canadian Majority - 1


Another lackluster lodging release.



"Transient demand was very strong in the first quarter with both occupancy and rate improvements across many markets. We are very pleased with the performance of our hotels, particularly the strong continuing increases in RevPAR in our Hyatt Place and Hyatt Summerfield Suites properties."


- Mark S. Hoplamazian, president and chief executive officer of Hyatt Hotels Corporation




  • Hyatt reported $109MM of Adjusted EBITDA  - 4% below street estimates
  • "Comparable owned and leased hotels RevPAR increased 2.0% (1.4% excluding the effect of currency)"
    • "RevPAR for comparable owned and leased hotels is estimated to have been negatively impacted by approximately 400 basis points."
    • "Operating margins decreased 120 basis points"
    • "Adjusted EBITDA is estimated to have been negatively impacted by approximately $10 million due to renovations during the first quarter of 2011."
    • "Excluding expenses related to benefit programs funded through Rabbi Trusts and non-comparable hotel expenses, expenses increased 2.4% in the first quarter of 2011"
  • Comparable North American select-service RevPAR: +11.6%
  • Comparable International RevPAR: +11.0% (6.9% excluding the effect of currency)
    • "Adjusted EBITDA increased by 42.9% a result of increased fee revenue from new hotels and non-recurring items."
  • "Our international hotels continued to perform well and we saw particularly strong performance in China and Brazil. There was some increased volatility in the results in the first quarter due to the devastating earthquake and tsunami and aftermath in Japan, as well as specific events in the Middle East and North Africa, but demand throughout Asia Pacific and Latin America was strong."
  • "Management and franchise fees ...increased approximately 23%, partially as a result of new managed or franchised hotels opened over the last few years in addition to RevPAR growth at existing hotels"
  • "Looking ahead, year-over-year North America group booking activity for future dates continues to be strong. This is encouraging as the booking window remains short and we are keeping a close eye on changes period-over-period. Recent activity gives us confidence in the recovery for the remainder of 2011 and beyond."
  • "As of March 31, 2011, this effort was underscored by executed management or franchise contracts for approximately 145 hotels (or more than 33,000 rooms) across all brands."
    • ~70% outside NA
  • 1Q11 Capex: $46MM ($9MM maintenance, $34MM enhancements to existing properties, $3MM investment in new facilities"
  • During 1Q11, Hyatt contributed the Hyatt Regency Minneapolis " to a newly-formed joint venture... in exchange for an ownership interest in the joint venture.... assigned a $25 million loan to the joint venture."
  • 1Q11 balance sheet items:
    • Debt: $770MM
    • Cash & equivalents: $1.1BN
    • Short term investments: $525MM
    • Undrawn R/C capacity: $1.1BN
  • 2011 guidance:
    • Capex: $380-400MM (includes renovation of 5 properties and expects negative impact on owned & leased segment through 3Q11)
    • D&A: $275-285MM
    • Interest expense: ~$50MM
    • 15 new hotel openings in 2011



  • Group bookings in the Q for the Q were up 15%
  • RevPAR was up 7% in constant dollars in their international hotels
  • Are making progress with 3rd party developers in urban US markets where they don't have a presence currently, despite the difficult development environment
  • Have 12 hotels under contract for development in India
  • Have Hyatt Places opening in Costa Rica, Hawaii and Amsterdam over the next 2 years
  • In NY, they accelerated their renovations and should finish a few weeks ahead of schedule.
  • Expect renovated hotels to have higher revenues vs. the comp set. These hotels are also in markets with limited supply and therefore should outperform over the next few years
  • Last year in 1Q2010 they benefited from an $8MM settlement of a dispute in their timeshare segment
  • Adjusted for the renovation impact, margins at owned hotels would have grown 60bps
  • NA management and franchising - full service
    • Timing of Easter negatively impacted them by 150bps on RevPAR
    • Group revenue was stronger as a result of stronger in the quarter for the quarter bookings.  There was also a 10% increase in in the quarter for the year bookings mainly due to rate increases
    • Shift of business mix continue to benefit rates
  • NA select service management and franchised:
    • Fees increased by 13%
  • International mgmt & franchise business
    • Asia Pacific continued to be strong
    • China RevPAR + 20%
    • 2010 benefited from the World Expo in Shanghai so comps are tough
    • Latin America comps were strong as well
    • Europe, ME & Africa was weaker
    • 1/3 of their increase in international fees (incentive fee line) was due to a $2MM termination fee received in the quarter
    • Expect fees to decline about 30% in 2011 for Japan and ME for the balance of the year
  • Adjusted SG&A would have increased 9% if not for the easy comps of last quarter which included some bad debt charges.  The increase was mainly due to higher compensation.
  • Expect renovations to impact EBITDA by $10-15MM (500bps of RevPAR impact) in 2Q and in 3Q the impact should be less than $5MM (100bps of RevPAR impact). Total impact of renovations will be 400bps to RevPAR and a little over $25MM EBITDA impact in the first 3 Q's of the year


  • The 15 hotel openings in the year is a gross number - they had 3 properties leave the system in this Q
  • Hyatt Minneapolis impact: $3MM EBITDA on an annualized basis
  • Focused on moderating their energy costs in India and also in the Middle East by making alternative and solar energy investments
  • Expect to also manage cost creep through food offerings and productivity gains
  • Have been focused on how they can apply their capital to get more development projects underway in the US. They are seeing a lot more opportunities now then they did a few quarters ago. They have done preferred equity, key money, equity, and loans to get the right opportunities in the US.  The construction lending marketing hasn't really improved.
  • Part of the benefit that they will see once renovations are complete is just a market weight factor - since the markets their hotels are in are performing well. The second part is due to getting higher RevPAR once the renovations are complete.
  • Group business grew 11% in the quarter.  A little over 80% of their business is booked for 2011, and rates being booked on 2012 are higher than rates on business booked for 2011.  They had 70% biz on the books at the end of last quarter. 
  • Expect that rate will be a major contributor to RevPAR growth in the future
  • Weather was a big factor in NY in the quarter, and therefore, RevPAR was weaker than most expected - including Hyatt.  They have had renovation disruption at their property. Their 2 Andaz properties are still ramping up too - so they don't have good comps.
  • Roughly 1/4 of the hotels in their pipeline have some sort of Hyatt capital behind it
  • Filed a shelf registration for 19.4MM shares on behalf of some Pritzer family shares - it's really their decision on what to do with those shares.
  • The reason that impact from renovations increased is because they are taking roughly 20% more rooms out in Q2, which is a seasonally strong quarter for them
  • Next phase of renovations? They do have some other renovations planned for the year - they will begin later this year but they don't expect them to have material disruption. It's about 4-5 properties - they are typical renovations - not as extensive as the 5 they outlined
  • They continue to pursue conversion opportunities but those opportunities are opportunistic - (Tulsa, Hawaii, Maldives)


A common theme for this earnings season is that top line sales trends remain strong, but nearly every management team has underestimated the impact of inflation on margins and earnings.


Here is a look at what DPZ was saying about their most important commodity during the company conference call on 03/01/11.  Keep in mind that cheese prices went up 20.86% during the first quarter of 2011.  DPZ has a contract that effectively eliminates one third of the price volatility of cheese in its commodity basket.


The average cheese block price in the fourth quarter was $1.61 per pound versus $1.48 last year, an 8.8% increase.  DPZ seems to be more in tune with inflation expectations in their guidance of 3-4%.  Compared to other companies maintaining a 2-3% range for inflation, DPZ is far more realistic.



Question: Okay, and then just one more. Just in the 3% to 4% food cost inflation, what are your cheese expectations and how covered are you on your cheese needs for 2011 at this point?


Answer: Yeah, so the forward curve and kind of looking at about three different sources right now have cheese actually easing a little bit through the rest of the year. We're at almost $2 right now. And so, our expectation is that we're going to see a little bit of easing, to give you on cheese. We've talked about this in the past, we've got a contract in place that basically reduces the volatility on cheese moves by about a third. So about two thirds of increases or decreases in cheese are passed through to our system. About one third of that volatility is – does not come to us and does not come to our stores. So that has not changed on the cheese in terms of how that's kind of fixed and locked in. Other commodities we do have more locked in.



Question: Okay, and the assumption for the cheese is that prices ease as we move through the year. And then the meats you said other than chicken that you're not locked on that either or – ?


Answer: That is correct. Meat prices, which are primarily toppings for us, are not locked. But chicken is. 

[Interestingly, management was correct in its statement that prices would ease going forward; ten days later cheese prices fell off a cliff and are currently ~20% off the 03/11/11 peak]



Question:  What spot price are you assuming for cheese in fiscal '11 given the fact there we're at $2 now. I know you said lower, but how much lower is it?


Answer:  I think the consensus forecast out there right now for cheese are in the $1.70 to $1.75 range. And – you know so what you're looking at is kind of a $0.25 to $0.30 move and I think we've said in the past a $0.40 move in cheese is equal to a point at the store level P&L…so what you're looking at is – best guess is about a 0.5 point of easing from where we are today. But obviously there is – it's been a moving picture out there the last 4 to 6 weeks. But order of magnitude, if 3% or 4% up on total commodities is around a point, if cheese stayed right where it is you'd be looking at about another 0.5 point is the way to think about it. So if the consensus is wrong and it stays where it is as opposed to backing off that's about a 0.5 point.


Now just as a reminder though, while that's very important to us, it's very important to our franchisees and to our overall system. Remember we're over 90% franchised domestically, we're 100% franchised internationally. And I would point out I've been assuming that all the questions we're getting are domestically focused. And that's the way we've been answering them. But remember we're quickly approaching being 50-50 on this.






Howard Penney

Managing Director


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A common theme for this earnings season is that top line sales trends remain strong, but nearly every management team has underestimated the impact of inflation on margins and earnings.


Here is a look at what PZZA was saying about their most important commodity during the company conference call on 2/23/11.  Keep in mind that cheese prices went up 20.86% during the first quarter of 2011.



Confirming guidance (but they need to maintain sales trends)- We are reaffirming our 2011 earnings per diluted share guidance range of $2 to $2.12, as we expect the favorable impact of early year sales results to substantially mitigate the unfavorable impact of currently projected commodity cost increases, most notably cheese, throughout the remainder of the year.


Change in accounting this quarter - As Jude will discuss in more detail, we reached an agreement with our domestic system regarding the national marketing fund contribution rate for 2011 through 2013.  In connection with this agreement, we eliminated the year-end BIBP deficit of approximately $14.2 million and substantially all franchisees have executed a cheese purchase agreement.   As a result, future differences in cheese costs and prices paid by franchisees will be reported as changes in a payable to or receivable from franchisees as opposed to income or expense in our financial statements. And accordingly, we intend to eliminate pro forma reporting for the impact of BIBP beginning in Q1 of 2011.



Question - Going back and doing the math, it looks like it's around a three to four basis point change in operating margin for every $0.01 change in the price of cheese.  What I'm wondering is, in this environment is that still relevant to think that a $0.01 increase in cheese prices equates to a certain dollar amount of operating margin? And if so, I was wondering if you could possibly quantify for us the comparable sales level that would be required to make up, say a 40 basis point decrease in margin, operating margin resulting from a $0.10 to $0.12 increase in cheese prices in '11, if that were to be the case?


Answer - John H. Schnatter: Yeah, it correlates exactly, mathematically the way that you described it, if you lived in a linear world. Fortunately we do not live in a vacuum. Fortunately we do not live in a vacuum. So, with inflationary pressures on all the restaurant chain while cheese is going up and we don't like it, so are our other commodities and we see price increases in the restaurant segment that should offset these costs, or at least to your point, mitigate it along with the great top-line sales we're having.  And David, I don't think we'll be any more specific than that relative to how the year has started off since it is the current quarter that we're in.



Question - Can you kind of give us an outlook on where you guys think the competitive environment is going here with cheese costs? Do you see the other guys backing off of these deep, deep discounts and that's a benefit to you, or do you think that you're still going to be competing on very, very discounted pizzas out there for the foreseeable future even with cheese where it's at? 


Answer - John H. Schnatter: I've been doing this for 26 years. We've seen a lot, if not everything. We've learned that if we just run our business the way it's supposed to be run, we do quite well with our brand and our positioning and the quality of our product. With that being said, I think 2010 was unprecedented in that I've never seen two of the bigger competitors change their whole product and spend the kind of marketing dollars they spent and run the kind of discounting they run and us still have positive traffic. So 2010 in our eyes was a litmus test, for the brand is very solid.





Howard Penney

Managing Director

Brazil: All Bark & Little Bite

Conclusion: Our proprietary Global Macro research process continues to point to more Stagflation in Brazil.


Position: Bearish on Brazilian equities for the intermediate-term TREND; Bearish on Brazilian real-denominated debt for the intermediate-term TREND.


“Guaranteeing purchasing power means playing tough on inflation. This is one of the fundamentals of our political economy, and one we’ll never let up on.”

-Brazilian President Dilma Rousseff, May 1, 2011


Judging by the quote above, one would expect Brazilian policymakers to be more proactive in combating inflation, rather than reactively waiting and watching for more surprises to the upside. Alas, we continue to see more “bark” than “bite” with regard to Brazil’s inflation-fighting efforts. For instance, just as Rousseff was uttering these vigilant words, it was reported that her administration intends to launch a new program to reduce extreme poverty. The initiative – which will initially expand upon Brazil’s Bolsa Familia program – will emphasize cash transfers, a general expansion of public services and Brazil’s social safety net, and specialized job training.


It appears that as Rousseff & Co. lean hawkish with their political rhetoric, their actions tell an entirely different tale of dovishness, populism, and fiscal laxity. While we certainly applaud the overwhelming success of Bolsa Familia in delivering millions of Brazilians from the clutches of poverty, we do question the timing of the decision to expand upon it here and now – particularly with regard to inflation, which is running at a 28-month high on an official basis. Simply put, the last thing the Brazilian economy needs at this juncture is increased government spending for socialist projects.


Brazil: All Bark & Little Bite - 1


In an earlier report titled: “Brazil: One Step Forward; Three Steps Back”, we’ve shown that Rouseff’s R$50B in proposed spending cuts for this fiscal year are little more than smoke and  mirrors when analyzed with a careful lens (email us if you’d like a copy of the report). Importantly, it means that the increase in government spending via this latest initiative is not likely to be funded with savings from other areas of the budget. As we outlined in a recent post titled: “Oh, Brazil…”, Rousseff is likely to miss her central government budget target of a primary surplus of R$117.9B reis and initiatives like the one introduced this weekend certainly do not help her cause.


Be it Greece in March or the US in January, it’s important to remember that sovereigns can and do miss numbers. Net-net, we remain bearish on Brazilian real-denominated debt over the intermediate-term TREND as Brazil’s deficit and debt burden is likely to surprise to the upside alongside Brazilian inflation in the coming quarters.


Shifting gears, we remain bearish on the slope of Brazilian growth through 2Q11 and on a full year basis, we think Real GDP could surprise to the downside of consensus expectations of +4.05% YoY – expectations that have dropped like a rock in recent weeks as the sell-side once again proves how useless after-the-fact estimate revisions are. Economists now find conviction in their bearish forecasts on recent weak economic data – something we contend they should have saw coming in early November. 


Brazil: All Bark & Little Bite - 2


Brazil: All Bark & Little Bite - 3


Brazil: All Bark & Little Bite - 4


In the meantime where risk is managed on a proactive basis, we’ll stick to our process which continues to point to the conclusion that Growth Slows as Inflation Accelerates in Brazil. As inflation ramps up in the coming months, we expect Brazil’s consumption growth to deflate, Brazil’s GDP Deflator to inflate, and the central bank to resume hiking interest rates in an aggressive manner. These primary factors continue to have us bearish on Brazil’s equity market and we will look to short Brazilian equities on strength up to the Bovepa’s TREND line of resistance of 68,333.


Darius Dale



Brazil: All Bark & Little Bite - 5

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