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Thailand’s Lady Luck?

Conclusion: The Pheu Thai’s victory in the recent parliamentary elections paves the way for aggressive populism in Thailand over the long-term TAIL. To the extent such policies are implemented successfully, we can see a strong argument for being long-term holders of Thai equities. On the contrary, any slip-ups by the young prime minister and her party will likely result in a long-term bull market for Thai inflation and interest rates.

 

On Sunday, Yingluck Shinawatra watched her Pheu Thai party win 265 seats in Thailand’s 500-seat parliamentary election, giving her the title of Prime Minister – the first such honor for a female in Thai history. What’s in store for Thailand under her rule may not be so heartwarming; rather, it may be downright inflationary – particularly if she lives up to her billing as her brother’s “clone” (Thaksin Shinawatra, May 20, 2011).

 

Indirectly led by her older brother and exiled former leader Thaksin Shinawatra, the Pheu Thai party has made its populist intentions very clear from day one. Using promises of aggressive crop-price fixing, tablet PC giveaways, high-speed rail initiatives, and a new city, Yingluck and Co. were able to mobilize the support of Thailand’s lower class, which mostly resided in the country’s less urbanized north and northeast regions (~52% of Thailand’s 67M people). Also included in the Pheu Thai’s populist promises was a +36-89% increase (depending on province) in the minimum wage to 300 baht ($9.84) per day. That dwarfs the +2.4% average YoY gain since 1998, with the largest increase (+9.1%) coming in 2007-08, according to the Thailand Development Research Institute.

 

We can’t say for sure how quickly such policies will be implemented; only that rushing to complete them in short order is very likely to provide a substantial amount of upward pressure on Thailand’s consumer price inflation. In a perfect world, Yingluck and her fellow lawmakers will have time to gradually implement such populist initiatives. Unfortunately, the Thai political scene is far from perfect, with routine insurrections and oft-violent demonstrations a norm within the streets of Bangkok. We are of the view that the ruling coalition (299 seats split between the Pheu Thai and four other small parties loyal to Thaksin) will be under increasing pressure to deliver on its lofty campaign promises from the start. As such, we remain bullish on Thailand’s CPI and expect that series to make higher-highs over the long-term TAIL.

 

Such a case is not without precedent in Thailand. In fact, under Thaksin’s former rule (premier from Feb. 9, 2001 through Sep. 19, 2006), populist fiscal policies ranging from a debt moratorium for farmers (~35% of population) to fuel and electricity subsidies supported a +570bps increase in Thailand’s YoY CPI rate during the Thaksin regime from February ’01 to its May ’06 peak. Easy monetary policy out of the Bank of Thailand also contributed to the pickup in Thai inflation rates during Thaksin’s stint as prime minister.

 

Thailand’s Lady Luck? - 1

 

Perhaps learning from the policy blunders of previous Bank of Thailand boards, current central bank members have openly expressed concern about the potential for expansionary fiscal policy to supply upward pressure on Thai CPI growth rates and downward pressure on Thai GDP growth rates. In the speech accompanying its latest rate hike, assistant governor Paiboon Kittsrikangwan plainly stated, “the central bank is concerned that populist polices in the election will affect inflation and economic growth.” We share their concern, and, as such, we remain bullish on Thailand’s short-term interest rates over the long-term TAIL.

 

Digging deeper into the Thaksin’s administration, we see that his expansionary fiscal policies were indeed able to reduce poverty on both an absolute and a relative basis. According to World Bank statistics, from 2000-2004,Thailand’s national poverty headcount ratio fell from 20.7% to 11.5%, while the share of income earned by the bottom 20% of earners increased from 5.85% to 6.1%. That was supportive of a -0.7pt decrease in Thailand’s GINI Coefficient (a measure of income equality) from 2000-2004 to 42.5 (World Bank).

 

Such gains were not without costs, as growth in both government expenditures and tax receipts far outpaced previous and subsequent administrations. Still, “Thaksinomics” (as his policies have been popularly dubbed) were able to grow the Thai economy enough to reduce the country’s gross sovereign debt burden -1,583bps to 42% of GDP by his forced removal from office in late 2006.

 

Thailand’s Lady Luck? - 2

 

For now, it looks as if Thailand’s political elite and military will let the Pheu Thai have its way. A recent shift to a more neutral stance out of the military and former Prime Minister Abhisit Vejiajiva’s late Sunday night resignation after conceding defeat in the election paves the way for a peaceful transition of power – an outcome we’d argue the market is anticipating based upon our proprietary quantitative analysis of the benchmark SET Index.

 

Thailand’s Lady Luck? - 3

 

As always, political instability remains a near-to-intermediate term risk in Thailand, though certainly not at the level we once perceived it to be. The real risks to the Thai economy lie over the long-term TAIL and they are generally regarding the implementation of a second round of “Thaksinomics”. For now, we’d be predisposed to wait and watch for more color on the new regime’s strategies, but we can certainly see a case whereby the successful implementation of such pro-growth policies proves bullish for Thai equities over the long-term TAIL.

 

By “successful implementation”, we mean in a way that encourages sustainable consumption growth and job creation with limited impact on inflation. It remains to be seen whether or not the young Yingluck can pull that off. At the bare minimum, we would not want to be short-and-holders of Thai equities (or any equities for that matter) due to the likelihood that the market bids up Thai economic growth. If we’ve learned anything over the last few years, it’s that investors are generally much less willing to distinguish between sustainable, organic growth and short-to-intermediate term, stimulus-driven growth en route to price discovery.

 

Darius Dale

Analyst


QSR - THE INDUSTRY IS BEING REVALUED...WHY?

I have never seen so many restaurant companies trading at 10x EV/EBITDA or better.

 

Every day I open my industry valuation models and, of late, I have been amazed to see the number of companies trading at double digit EV/EBITDA multiples.  As of today, there are ten companies with that distinction.  In the past, a double digit cash flow multiple was reserved for those companies that demonstrated 15-20% unit growth or had an international presence that made it look more like a consumer multi-national. 

 

Coming out of the Great Recession, the industry is being revalued despite some serious headwinds.  The double digit valuations are being achieved despite rampant food inflation, which has traditionally has caused investors to flee from the space (especially the more mature names). 

 

QSR - THE INDUSTRY IS BEING REVALUED...WHY? - QSR VALUATIONS

 

 

This is also inconsistent with traditional measures of future demand like consumer confidence, which has flat-lined since 2009.  More importantly the small improvement in consumer confidence since bottoming in late 2008 has been driven by the expectations component which is now rolling over.  Not surprisingly, we are now starting to see personal income and spending roll over too.

 

QSR - THE INDUSTRY IS BEING REVALUED...WHY? - personal income expectations

 

 

While overall demand for eating out is holding up, all of the restaurant companies that are valued by the street with double-digit cash flow multiples have seen same-restaurant sales slow on a one-year basis.  Looking at two-year trends, however, paints a more positive picture.  Two-year average trends are improving and much of the decline in one-year comps may be due to difficult compares.

 

QSR - THE INDUSTRY IS BEING REVALUED...WHY? - QSR Domestic SSS

 

QSR - THE INDUSTRY IS BEING REVALUED...WHY? - QSR Domestic SSS 2 year

 

 

On the positive side, restaurant companies have not been raising prices as aggressively as supermarkets and reduced spending on other more “durable” categories is helping maintain the consumer’s frequency of eating out.  The industry is not overly levered and the cash flow generation, dividend yields and high margin franchises business models of some of the more mature companies are very attractive.

 

With this being said, when trying to justify a revaluation of a business or an industry, there is an acute risk of stretching the facts.  The rolling over of consumer expectations is a concern for me, as are the peak multiples being awarded to restaurant companies at the present time.

 

 

Howard Penney

Managing Director

 

Rory Green

Analyst

 

 



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DID BAC'S SERVICING LIABILITY JUST TRIPLE TO $18 BILLION?

Make That $60B?

The New York Post is out this morning saying that the servicing settlement will be much larger than previously reported.  The settlement will be $55-60B, not the $20B previously rumored, according to "sources close to the discussion" cited by the Post.  The money would be applied to restitution for harmed borrowers, civil penalties, and 51 funds - one for each state plus a national fund - for regulators to use at their discretion.  These discretionary funds could be used to do principal reductions, although the banks and some AGs worry that principal reductions for delinquent borrowers will create a moral hazard for borrowers who are still current.

 

We have used the top five servicers' market share to determine their possible liability. The chart below shows the mortgage servicing market share of the top five banks, which collectively control 60% of the market, as of 2009.  BAC is the largest servicer, with Wells Fargo in second place.  For purposes of this calculation, we are assuming that the settlement amount is $55B and is split on a pro rata basis according to market share among the top five servicers.  

 

DID BAC'S SERVICING LIABILITY JUST TRIPLE TO $18 BILLION? - servicing exposure

 

To put these levels in context, a $18.5B settlement from BAC is equal to 14% of their tangible book value, while WFC's penalty would be 17% of tangible book.  That said, it's likely that any penalty would be due over a period of time, rather than in a lump sum.  It's also likely that national regulators would be partially motivated by safety and soundness of the financial system, and would be averse to a settlement so punitive that banks would require recapitalization.  

 

DID BAC'S SERVICING LIABILITY JUST TRIPLE TO $18 BILLION? - servicing TBV

 

Joshua Steiner, CFA

 

Allison Kaptur


WEEKLY COMMODITY MONITOR: PEET, GMCR, SBUX, MCD, PNRA, DPZ, BWLD

Our weekly roundup of key commodity price action and company-specific food cost commentary.

 

There was an interesting divergence over the past week between milk and cheese prices.  Cheese prices have flat-lined since early June while milk prices have continued on an upward trajectory.  Whether or not dairy prices are set to continue higher or flat-line, the current, historically high, level of dairy prices is sure to weigh on margins for CAKE, DPZ, and PZZA.  Grain prices, while still at elevated prices, and up significantly year-over-year, declined last week as warmer weather in Canada and the U.S. may help the development of the spring crop.  Despite declining on two of the past three days, coffee costs are up over 4% week-over-week.

 

WEEKLY COMMODITY MONITOR: PEET, GMCR, SBUX, MCD, PNRA, DPZ, BWLD - commod 75

 

 

Coffee


Coffee prices have been pressuring the coffee retailers into raising prices over the past couple of quarters and, as the chart below indicates, it will likely be some time before year-over-year inflation in coffee markets subsides.  On two of the past three days, prices have come down thanks to reduced concern that frost may damage crops in Brazil – the top coffee producing country.  Below is a selection of comments from management teams pertaining to coffee prices from recent earnings calls:

 

WEEKLY COMMODITY MONITOR: PEET, GMCR, SBUX, MCD, PNRA, DPZ, BWLD - coffee 75

 

 

  • PEET (5/3/2011): We believe we're better off lowering our earnings guidance by $0.10 this year and continuing with the plans we have in place than we would be curtailing spending activity or taking extraordinary pricing action that would be inconsistent with our long-term business interests, and the more sustainable long term cost of coffee we foresee.  As a result, you will see throughout our call today that we have a very strong performing fundamental business, but we have to buy some unusually high priced coffee in the short term, then we're not going to do unnatural things in reaction to an unnatural market environment short term.
  • Hedgeye: prices were sliding as the dollar caught a bid but, over the last couple of weeks prices have swung higher again.  While it seems that prices may have been “unusual”, this elevated level of pricing may persist for longer than expected.
  • GMCR: (5/3/11): Before closing, I also want to touch on rising coffee costs and the effect of our business. Like others in the industry, we are closely watching coffee prices. When we announced our last price increase in September of 2010, coffee prices had increased roughly 30% from $1.45 to $1.90 per pound over the course of roughly three months. Since then, costs have continued to escalate, recently hitting historic highs of more than $3 a pound, a nearly 60% increase since September.  In attempt to offset rising green coffee costs, as well as increases in other input costs, we are currently in the process of raising prices for all packaged types. We expect that consumers will see an increase of approximately 10% at the point-of-purchase as the result of this price increase. We expect to see the full benefit of this price increase during our fiscal fourth quarter of 2011.  We generally fix the price of our coffee contracts three to nine months prior to delivery so that we can adjust our sales prices to the marketplace.  
  • Hedgeye: Coffee has backed off the “historic” high of more than $3 per pound but is still at $2.60 plus and up over the last couple of weeks.  Demand remains strong; without a rising dollar, expect price to continue to pressure retailers.
  • SBUX (4/27/11): Regarding coffee costs, as I have indicated previously, we have fully locked our coffee costs for 2011 and are price-protected for a couple months into fiscal 2012.  As we progress through the balance of 2011, we will progressively take actions to secure our coffee needs and lock coffee costs for additional months into 2012. While we expect that the costs we pay for coffee may be higher in '12 than they are in '11, we remain confident that we can offset those increased costs and preserve our long-term earnings growth targets. 
  • Hedgeye: SBUX is confident that it can pass on price and offset coffee inflation with other efficiencies.  It is interesting that it expects higher coffee prices in 2012 than in 2011, which would somewhat contradict PEET’s assertion that in May that prices at the time had been unusual.  SBUX expects worse prices to come.

 

Wheat


Wheat costs declined 4.1% week-over-week, bouncing over the past couple of days as buyers (China is said to be one) took advantage of the dip in price.  The initial decline was widely attributed to easing concerns surrounding supply given signs that the global economy may slow.  In addition, Russia, once the world’s second-largest shipper, will lift an export ban on July 1, adding to speculation that global supplies will be ample. Below is a selection of comments from management teams pertaining to wheat prices from recent earnings calls:

 

WEEKLY COMMODITY MONITOR: PEET, GMCR, SBUX, MCD, PNRA, DPZ, BWLD - wheat 75

 

  • MCD (4/21/11): And so if the commodity markets move significantly from here and the main ones obviously looking at beef, looking at corn, wheat, coffee, et cetera, our guidance reflects where the markets are today. If they stay around these levels, the 4% to 4.5% [commodity guidance for 2011] should be locked in. If they move dramatically up or down, then we'll have to reflect that as we move forward. 
  • Hedgeye: inflation guidance may have to be adjusted higher.
  • PNRA (4/27/11): In this expense line, we expect margin unfavorability to continue to grow on increased all-in cost inflation throughout the year -- and because we haven't taken and we don't currently plan to take pricing in our dough sales for franchisees this year.  
  • Hedgeye: wheat inflation could possibly subside in the back half of the year as comparisons become less unfavorable for buyers.  This will be more likely, of course, if the dollar strengthens.
  • DPZ (3/1/11): We’ve got wheat locked down for the year.

 

 

Chicken Wings


Chicken wing prices are continuing to tick higher, rising 2.5% last week.  BWLD is a name we are cooling on (not based on COGS!) but the next quarter, we expect, will still be strong.  Below is a selection of comments from management teams pertaining to coffee prices from recent earnings calls:

 

WEEKLY COMMODITY MONITOR: PEET, GMCR, SBUX, MCD, PNRA, DPZ, BWLD - chicken wings 75

 

  • BWLD (4/26/11): For cost of sales, the traditional wing market continues to be favorable and the price of chicken wings for the first two months of the second quarter is averaging about a $1.02 per pound, which is lower than any quarterly price since 2003. It compares to last year’s average price for the second quarter of $1.51. Our Boneless Wings contract is extended through March of 2012 at flat pricing to 2010. 
  • Hedgeye: Traditional wings count for 20% of restaurant sales and boneless wings count for 19%.

 

 

Howard Penney

Managing Director

 

Rory Green

Analyst


TALES OF THE TAPE: CMG, SONC, PZZA, CBOU, PEET, SBUX, DRI, RUTH, BJRI, BWLD

Notable news items and price action from the restaurant space as well as our fundamental view on select names.

 

MACRO

 

The main commodity data points this morning are wheat and coffee prices declining.  Warmer weather may aid wheat spring prospects and easing fears about frost damage in Brazil is causing coffee prices to decline.

French newspaper Le Figaro is claiming that French lawmaker Bernard Reynes is proposing an increase in the value-added tax on soft drinks from 5.5% to 19.6% to help finance assistance to agriculture.

 

QUICK SERVICE

  • CMG, it emerged yesterday, invested $2.5m in Soul Daddy, the winner of the America’s Next Great Restaurant television show.  $2.5m is equivalent to $0.08 per share for CMG.
  • SONC has introduced a line of sundae shakes and a new spicy hot dog option.
  • PZZA was cut to “Neutral” at SunTrust Robinson.  The stock closed down -4.7% on accelerating volume yesterday.
  • CBOU, PEET and SBUX all gained on accelerating volume as coffee prices came down.

 

CASUAL DINING

  • DRI was raised to “Strong Buy” at Raymond James.  The PT is $62.
  • RUTH, BJRI, and BWLD gained on accelerating volume.

TALES OF THE TAPE: CMG, SONC, PZZA, CBOU, PEET, SBUX, DRI, RUTH, BJRI, BWLD - STOCKS 76

 

 

Howard Penney

Managing Director

 

Rory Green

Analyst


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