MCD will announce sales numbers for April on Monday, May 9th, before the market open. On the 1Q11 conference call, management indicated April comps were healthy, running at or above the +4.2% rate seen in 1Q11.  Therefore, how the different regions of the world performed will be the focus on Monday.


There was a slight calendar shift between the number of weekdays and weekend days in April 2011 versus April 2010.  April 2011 had one additional Saturday, and one less Thursday, than April 2010.  Easter 2010 and Easter 2011 both fell in April.  I would expect a slight, positive calendar shift in April 2011’s result due to the extra Saturday.


For the U.S., March comparable restaurant sales came in above my expectations, and those of the Street, at 3%.  I have b I have been bearish on the stock since December and released a Black Book to that effect in January.  While March was certainly a blow to my thesis, it by no means has led me to capitulate in my view that 2011 is proving to be a difficult year for the U.S. business overall.  I believe that comps will slow during the year due to a declining core business.  In addition, a complicated menu borne of management’s aim to offset the decline in the core menu with new menu items, it proving a hindrance for operators seeking to operate efficiently at this time with commodity costs so elevated. 


Below I go through my take on what numbers will be received by investors as GOOD, BAD, and NEUTRAL, for MCD comps by region.  For comparison purposes, I have adjusted for calendar and trading day impacts. 


U.S. - Facing a +3.15% compare (including a calendar shift which impacted results by +0.4% to +0.9%, varying by area of the world):


GOOD: A print above 4% would be received as a good result, implying two-year average trends that were roughly level with those in March.  The comparable restaurant sales growth in March, on a calendar-adjusted basis, implied a sequential acceleration in two-year trends of roughly 200 basis points.  While I remain bearish on the prospects of MCD “comping the comps” through the summer months when the compares significantly step up in difficulty, I think that April will likely be a stable month for MCD given the easier compare versus March and the strong performance management spoke to during the earnings call.  The Bloomberg Consumer Comfort Index trended positive overall during April, albeit peaking mid month and declining thereafter.  The decline has continued in May but it is likely, in my view, that April will be a solid month for MCD.


NEUTRAL: A print between 3% and 4% would imply two-year average trends slightly below those seen in March. However, I think it is unlikely that the two-year trend remains quite as robust as it did in the final month of 1Q.  While the mid-point of this range is below consensus, it would still be a healthy result for MCD and imply a two-year trend far in excess of the level seen during the malaise of December/January/February. 


BAD: A print below 3% would not be received well by the Street as it would imply a sequential deceleration in two-year average trends.  In addition, it would likely dampen investor sentiment given that concerns are arising around the pricing strategy that will be required to overcome inflation.  If the core business is not robust, it could be perceived that a price increase will adversely impact traffic, which of course is the lifeblood of MCD’s comps.




Europe:- Facing a difficult +5.30% compare (including a calendar shift which impacted results by +0.4% to +0.9%, varying by area of the world):


GOOD: A comparable restaurant sales number of 6% or higher would be received well by the Street as it would represent a sequential acceleration in two-year trends.  While this acceleration would be meager, I believe that with the austerity measures being implemented in Europe, MCD maintaining the ~5%+ two-year average trends that have been the norm in 2011 would be a positive.  In spite of the austerity measures and cloud uncertainty that remains over Europe’s political/fiscal future, MCD has been performing well in Europe this year and the recent Euro strength may also support confidence somewhat.


NEUTRAL:  Between 5% and 6% would imply two-year average trends slightly below those seen in March.  While a deceleration is never what investors are hoping for, I think a slight slowdown (~20 basis points) in this case would not raise too many concerns and two-year trends would remain above 5% and well above the trends seen in November and December in Europe.


BAD:  Below 5% would imply a significant sequential slowdown in two-year average trends.


APMEA:- Facing a difficult +10.1% compare (including a calendar shift which impacted results by +0.4% to +0.9%, varying by area of the world):


GOOD: Above 2.5% would imply a sequential acceleration in two-year average trends.  Inflation has been a concern for consumers in many Asian countries, and countries around the globe for that matter, and I believe an improvement in two-year trends would be received positively. 


NEUTRAL: Between 1.5% and 2.5% would imply two-year average trends slightly higher than those seen in March but still well below the average two-year comp over the last 6, 12, or 24 months. 


BAD: Below 1.5% would imply two-year average trends roughly in line with, or below, those seen in March which would raise concerns that last month’s poor result could be the start of a longer trend.



Howard Penney

Managing Director

Elections in SE Asia: Consternation’s on the Ballot

Conclusion: Below we flag the potential for a drastic change in the direction of fiscal policy within Singapore. Further, expect the confluence of political consternation, social unrest, and accelerating inflation to weigh on Thai equities over the intermediate-term TREND.


Historic Change on the Way for Singapore?


On April 21, we published a report titled, “Read-Throughs From Singapore’s Upcoming Election”, which outlined the stakes for Singapore’s parliamentary election, currently taking place now through 8:00pm SGT tomorrow night. The largest takeaway was that Singapore is potentially looking at a major inflection point with regard to the direction of fiscal policy, and as such, we expected the ruling People’s Action  Party to continue to give in to more populist demands as they try to protect their party’s 52-year stranglehold on the Singaporean government.


Such measures have included spending $6.6B on cash handouts to citizens as a “growth dividend”, upgrading residential real estate, and increasing federal mandates for corporate pension fund contributions. Prime Minister Lee Hsien Loong has even gone as far as to officially apologize for Singapore’s exorbitant and often unavailable housing, promising additional attention to this issue if re-elected.


Judging by the tone on the streets of Singapore and the recent move in the equity market (suddenly broken from a TRADE & TREND perspective), re-election for Loong and his PAP counterparts is as questionable as it has seemingly been in decades. While that is not to say they won’t win with a majority of the ballots once again, we could see a measured reduction in their party’s current 87 parliamentary seats (out of 94 total) due to a record 82 challenges being mounted by opposing lawmakers including members of the growing Worker’s Party and the Singapore Democratic Party.


Elections in SE Asia: Consternation’s on the Ballot - 1


The strength in the opposition is being driven by a growing discontent among the Singaporean electorate stemming from rising consumer inflation, overcrowding, a general perception that jobs are increasingly harder to come by as a result of the government’s lax immigration policies, as well as a general distaste for what many describe as a “sense of complacency” out of the current government – well deserved complacency we might add.


Singapore’s GDP has grown 41x and its GDP per Capita has growth 45.7x since the PAP took over five-plus decades ago. Even still, there’s a growing sense among Singapore’s youth that the current party in office is out of tune with their interests. To their credit, Singapore’s GINI Coefficient, a measure of income inequality has actually risen over the last decade from 0.44 to 0.48, meaning that Singapore’s world-beating growth rates have yet to fully filter down though the social ranks. Unfortunately for the incumbent party, Singapore’s “rising tide” hasn’t lifted all boats; instead it’s buoyed the yachts of the world’s highest per capita share of millionaires.  As such, it doesn’t come as a conceptual surprise to see quotes like these from the Singaporean voters (Source: 

  • “They keep telling us how they built Singapore… They are really very complacent.” - Alvin Lee, a 25-year-old economics and finance student at Singapore Institute of Management who plans to vote for the opposition.
  • “It’s very pressurizing living in Singapore... Everything is so expensive. The government says the economy is doing well but why am I not feeling it?” - housewife Low Bee Kian, 39, who has three children aged 10 to 16.
  • “The PAP has served us well over the many years but it’s gotten too high and mighty… I think it’s about time we had more opposition voices.” - Yeo Pei Ming, 56, a vegetable merchant and resident of Aljunied. 

With a record number of opposition candidates and a record number of eligible voters (2.21M) – many of whom have grown tired of the status quo – we could potentially see the a major political change take place this weekend in Singapore. Though it is unlikely the PAP will lose their majority in parliament, we could see electoral support for their party erode meaningfully enough to have a measured impact on the direction of fiscal policy in Singapore. Should this outcome occur, we would expect an acceleration in populist legislation (likely bullish for Singaporean consumer names and bearish for Singaporean property developers). We will continue to monitor for such changes, if any, real-time.


Social Unrest on the Horizon in Thailand?


Today, Thai Prime Minister Abhisit Vejjajiva dissolved parliament with the intention of paving the way for an election that may take place anytime within 45-60 days from now (July 26 – June 3). Vejjajiva and his ruling Democrat Party counterparts are looking to win their first popular mandate since 1992, after having been swept into power during the 2007 elections after the former prime minister Thaksin Shinawatra was overthrown in a military coup in 2006 and remains outside of the country avoiding a 2008 prison sentence for the abuse of power.


Now, Shinawatra’s Puea Thai party is “back with a vengeance” and they fully intend to use their widespread popularity – particularly among Thai’s poorer voters – to regain control of the Thai parliament by winning the popular vote as they have done in the previous four elections. If the upcoming election is as emotionally charged and politically polarizing as the 2007 election (which we fully expect), we should continue to see major consternation hang over Thai assets. Since peaking on April 21, Thailand’s SET Index is down in a straight line and is now quantitatively broken from a TRADE perspective. A breakdown through the TREND line would be an ominous leading indicator for the short-term stability of the Thai political economy.


Elections in SE Asia: Consternation’s on the Ballot - 2


The bear case here would be a return to the style of violent and deadly protests we saw grip the streets of Bangkok roughly one year ago. Careful analysis of the situation reveals that protests of this magnitude (nearly 100 deaths) are actually a probable scenario and that they could potentially exceed last year’s riots in both scope and breadth of violence. The results of recent polls conducted by both of the main opposition parties have each expecting to win a majority of the 500 open seats in the Thai House of Representatives. Even Vejjajiva’s own campaign coordinator concludes that “it’s a very tight race”, saying recently, “One time we are down; one time we are up. We can’t tell.”


The largest takeaway from this polling gridlock is twofold: 1) the Thai electorate is torn and supporters of the Puea Thai (red-shirts) are indeed mobilized; and 2) supporters of either party will be both heartbroken and outraged by what is likely to be a close defeat. Should the Democrats (yellow-shirts) manage to win, we expect the red-shirts to once again take to the streets in protest. On the flip side, should the red-shirts win, we are likely to see a second coup – either military or judicial – as both the armed forces and political elite of Thailand continue to strongly back the current ruling coalition. Such an occurrence is highly likely to result in a second round of protests as red-shirts take to the streets in outrage.


The net result of it all is that we fully expect social instability to increase dramatically within Thailand in the coming months as a result of this election. As a result, we do expect the politicized consternation to hang over the Thai equity market, which augments our current bearish thesis on Thai equities – a thesis supported by slowing economic growth and accelerating inflation.


Perhaps the most tell-tale sign that we’re right on both accounts is the fact that Vejjajiva dissolved parliament a full seven months ahead of schedule, citing a desire to “move the country forward”. On the contrary, we think this is a “CYA” move in an attempt to get ahead of higher rates of inflation on the horizon, which may incrementally sway Thailand’s pooer voters into the arms of the populist Puea Thai party. He’s repeatedly affirmed his official policy priority, which is to “help put money in people’s pockets so that they can cope with rising prices”.


Vejjajiva has certainly put his money where his mouth his and has taken to “buying votes” in the process, recently increasing the minimum wage and pledging a further +25% increase over two years, increasing civil-servant salaries, implementing price controls, extending food and fuel subsidies, offering low-interest loans to taxi drivers, offering low-income energy cost exemptions, and extending social-security coverage for undocumented workers.


While these populist measures are likely to help buy him a number of votes in the upcoming election, we believe the net result of these measures is higher rates of inflation through an increase in aggregate demand by adding cash to the economy. In addition, the anticipated removal of State subsidies on diesel is predicted by the Bank of Thailand to add +100bps to the YoY growth rate of Headline CPI and +50bps to the YoY growth rate of Core CPI (currently at 15 and 30-month highs, respectively). It’ll be interesting to see whether or not the government chooses to continue to subsidize fuel and energy costs by allowing the oil fund to swing into deficit come July. Regardless of whether or not the subsidy is removed, we still foresee Thai inflation up and to the right, and remain positively disposed to the baht on expectations of tighter monetary policy. The direction of fiscal policy (populist), keeps us from being outright bullish on the currency.


Elections in SE Asia: Consternation’s on the Ballot - 3


All told, we continue to flag the potential for a drastic change in the direction of fiscal policy within Singapore. Further, expect the confluence of political consternation, social unrest, and accelerating inflation to weigh on Thai equities over the intermediate-term TREND.


Darius Dale


The Week Ahead

The Economic Data calendar for the week of the 9th of May through the 13th 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 - call111

The Week Ahead - call222

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Greece Leaving the EURO? Not so Fast

The German publication Spiegel Online broke a story this afternoon that Greece is considering withdrawing from the euro and returning to the drachma, without revealing the source of the information. Allegedly a secret crisis meeting is being held in Luxembourg late tonight to discuss the restructuring of Greek public debt, with attendance limited to the Eurozone finance ministers and senior staff members.


Assuming the information is reliable concerning a meeting tonight to discuss restructuring Greek debt, we’d like to offer a few reasons why  the prospect of Greece leaving the euro over the immediate to medium term is utterly unreasonable, that therefore unlikely:


1.   The EU has battled over the last 18 months to contain sovereign debt across the region, earmarking  a total of €273 Billion to bailout Greece, Ireland and Portugal, and established both temporary (EFSF) and permanent (ESM) bailout funds to the tune of €500-750 Billion (including IMF support) to aid countries in fiscal “need”. While there has certainly been push back across member states on the guarantees for the funds, the bottom line remains that they’ve come together to “economically” support the currency union.


2.   To further underline the point of support, commitment to the union is more than just a monetary sum, but the belief that the union as a principle is sound, which is to say that the union provides mutual benefit, or that the whole is stronger than the individual parts. This commitment comes from the very top, including President of the European Council Herman Van Rompuy, President of the European Commission Jose Manuel Barroso, ECB President Jean-Claude Trichet, and European Commissioner For Economic and Monetary Affair Olli Rehn (to name a few) on down to all the foot soldiers in Brussels fighting for their constituents.


There’s no chance these Eurocrats are going to let one country at this stage of the game (the infancy of the union) threaten the union, neither in principle nor in the name of their job. And should Greece leave, there’s obviously contagion risk that other members, particularly the peripheral countries, would follow suit. While we’ve argued that from a competitive standpoint it could be far more effective for certain Eurozone members to have their own monetary policy (and therefore currency), it’s not politically expedient, and therefore won’t happen over the medium term. (Note we’re not limiting this outcome over the longer term).


3.   Greece is “sufficiently” capitalized with the bailout moneys received from the EU/IMF until 2013 so a departure from the euro, and therefore a default on its euro-denominated debt doesn’t make sense at this point (also ~ one quarter of EUR-denominated Greek debt is held domestically, making hardships at home unnecessary at this juncture)


4.  Counter liabilities across countries are huge, with Germany and France having the most skin in the game. The impacts from Greece and possibly others leaving the union, suddenly, would have such severe impacts on the government balance sheets, and the banks across Europe, that it would cripple the entire continent.



It seems far more likely that these meetings are being called to discuss the back and forth over recent days about the prospect of Greece restructuring its debt, a position Greeks deny the need for, while select European voices continue to press.  Greece’s equity market (Athex) had a tough week, closing down 4.5% w/w as sovereign cds and government yields remain elevated, with the Greek 10yr yield at 15.5%. That said, we’re not seeing a freak-out in risk intraday that would confirm the validity of the likelihood that Greece leaves the union.


If anything, a serious talk about Greece’s public debt and the prospect for restructuring was probably in order, and the weekend will help shield some of the downside risk to the meeting’s announcement. 


As we continue to highlight in our research, Europe’s sovereign debt contagion is far from over—this has a long term TAIL. Regardless of the monies secured by states, the pain of overcoming years of fiscal imbalances is not an overnight event. We expect headline risks for the EUR and European countries to persist as the region works through its fiscal imbalances and investor fears shift within the process.


Matthew Hedrick


WRC: Why?


Do you get those times when you analyze a company and the numbers simply don’t add up and you get that queasy feeling in your gut? That’s Warnaco.



We emerged from WRC’s 1Q with more questions than answers. Specifically, it relates to FX. This is a company that generates ~60% of its EBIT outside of the US.  When FX moves, WRC is always first on our list as it relates tweaking our model when the Dollar changes. With what we consider a ‘crash in process’ in the Dollar (-8% yy) we should have seen a blowout at WRC.  We saw the opposite.


In fact, incremental FX revenue was up $9.8mm vs. last year, marking a quarter where FX should have been a positive contributor. But at the same time, we saw incremental EBIT go the other way. This is the greatest deviation in this spread we’ve seen in at least 10 quarters.


WRC: Why? - WRC FxEbit


What does this mean?  There’s many possibilities…

  1. The company is doing the right things and investing in sales, marketing and infrastructure to support growth in its CK One launch this year. There’s probably some of this. But not enough to make up for the whole delta – or even half.
  2. WRC is building reserves for what will be heavy discounting in 2H to clear its 36% rise in inventory.
  3. WRC is feeling the operational pain of growing its store base by 80% over two years – remembering that it guided to 120k incremental square feet last year, but ended up adding closer to 200k. This year they threw out the same guidance, but have brought on the Taiwan retail stores since. We’ll likely see the accelerated growth continue. Store level SG&A is around $800k-$1mm per store. Initial productivity is around 60-70% of a more mature store – which run at about $2.5mm. That’s some pretty tough math to result in profitable growth. If we estimate a 3-year maturation curve, we’re looking at 2012 when we should start to see more meaningful leverage. Until then, we’ve got some tough expense numbers to overcome; such as more retail as a percent of the mix, disproportionately high SG&A relative to revenue due to International slant, and higher FX translation of both store-level SG&A as well as inventories needed to support the retail sales ramp.
  4. Gross margins were down 86bps – though the 2-year was a more upbeat +121bps. But what is odd is that Asia GM was up, and Europe was down – despite the FX tailwind. Product costs were only a minor part of the gross margin erosion – and were isolated to the sportswear group.
  5. New store productivity is a question mark. The imputed rate based on numbers given (stores, square footage, and comp) comes in at around 82%. This is great – but it is also a catch-all line item that includes sales, which are growing strong double digit. In the end, it does not have a huge incremental impact on profitability as it cannibalizes a degree of sales from wholesale and company-operated stores – but it can overstate the productivity of new stores.
  6. Speedo had a monster quarter and its WRC’s highest margin business in 1Q from a seasonal perspective. This alone contributed almost 100bp to consolidated margins (which ended up being down 222bp).
  7. Sportswear operating revenue was up by 10.8% -- but it certainly did not get any help from CK Jeans, which was down -3.7%. 19% growth at Chaps more than made up the difference, but there’s no way the single largest line item on the P&L should be down year/year.

All that said, WRC took up guidance for the year – both revenue and EPS. The revenue, we’ll give ‘em. The EPS, not quite. Our estimates are shaking out at $3.90 and $4.38 for this year and next, respectively. We’re ahead on revenue, and are meaningfully behind on margin.


The reality is that inventory is up 36%. They’ve got a lot of ‘stuff’ and it’s gonna sell. The question for us is the degree to which it sells at full price. We’re starting to see cracks in consumer accepting pricing increases, and we won’t be relying on the ‘trust me’ factor here. With some companies we will, but not WRC.


This thing is trading at about 7.4x EBITDA and 14.4x earnings. By no means is it expensive. But given how squirrely some of these items are on the P&L, we think it definitely deserves a risk premium relative to peers. When we can buy names like Nike, RL, GES, and other higher quality names within 1-2 multiple points, we simply think that the risk/reward here is unattractive.




Oil Price Volatility Isn’t Transitory

For those that are long of commodities, in particular oil, the last 5 trading days have been unpleasant.   Unfortunately, we are in that camp as we are long of oil in the Virtual Portfolio via the etf OIL, and are currently down -3.7% in the position.  As we noted on our morning call today, we will stick with our long oil position to a price and that price is our TREND line of support on WTI of $98.63 per barrel.  Our current levels for oil are highlighted in the chart below.


Oil Price Volatility Isn’t Transitory - 1


While price has obviously corrected, which is an important factor in our models, there has only been a marginal shift in our other key factors of geopolitics, supply / demand, and monetary policy.


As it relates to geopolitics, the significant event over the last week was the killing of al-Qaeda leader Osama bin Laden.   While the longer term implications of this event are still being analyzed, broadly across the Middle East social unrest continues to percolate and with it the intermediate future of stability in the Middle East remains largely uncertain. A few points to highlight:

  • Protests continue across Syria, which are being aggressively cracked down on by the government. U.S. Secretary of State Clinton also gave her support for EU Sanctions against Syria this week;
  • Foreign Ministers are meeting in Rome to discuss continued plans to fund Libyan rebels.  In addition, both Britain and France have expelled Libyan diplomats.  The International Criminal Court is also reputed to be in the process of issuing warrants for the arrest of Gaddafi;
  • Hundreds of thousands took to the streets in Yemen to protest against Yemeni president Saleh, who called the protesters “outlaws”; and
  • In Bahrain, four anti-government protestors were sentenced to death.

From a supply and demand perspective, the deluge of negative economic data points (employment, ISM and housing prices) from the United States continues to support what our models had already indicated, which is that growth is slowing domestically.  The United States is the largest consumer of oil globally, so as domestic growth in the United States slows, so too does its consumption of oil.  By way of a proxy, in 2009 U.S. oil consumption declined 4.9% year-over-year, while global consumption was down 1.7% year-over-year.  This highlights the potential impact of a slowing global economy on oil demand.


In terms of the direction of global growth, we continue to get mixed signals.  The market-oriented proxy of growth is the Baltic Dry Index, which implies that we are setting up for a sequential slowdown in global growth on the back of tightening global monetary policy due to inflation concerns.  In the chart below, we’ve highlighted the 1-year plot of the Baltic Dry Index, which is down 64% year-over-year and 26% year-to-date.  This is not a reassuring picture as it relates to future economic growth.


Oil Price Volatility Isn’t Transitory - 2


That said, based on our modeling, the key driver of the price of oil continues to be the price of the U.S. dollar.   Over the past three months, the correlation of the U.S. dollar to WTI is -0.89.  Dollar down equals oil up, or, as we saw this week, just the opposite with the dollar rallying against global currencies and commodities correcting sharply.  On the back of the ECB not raising rates this week and appearing incrementally dovish, the U.S. dollar rallied +2.9% versus the Euro this week from trough to peak.  Over roughly the same time frame, WTI declined -8.4%.


Oil Price Volatility Isn’t Transitory - 3


Currently, based on slowing growth and the rally in the U.S. Dollar, we are seeing a Deflation of the Inflation, but interestingly the tepid economic news could actually lead to every inflation investor’s dream . . . Quantitative Easing 3.   With continued printing of money via debt monetization, the inflation trade should continue . . . until it doesn’t.


Daryl G. Jones

Managing Director

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