“Say, my love, I came to you with best intentions,
You laid down and gave to me just what I'm seeking.”
- Dave Matthews, “Two Step”
Conclusion: The Boehner and Reid plans are very different structurally. We expect the Boehner plan to pass this afternoon, which will provide strategic advantage for the Republicans heading into August 2nd.
As Keith noted in the Early Look, the top three stories on Bloomberg this morning related to the debt ceiling. Admittedly, this story is being over-analyzed and over-studied, but we did want to spend a few minutes highlighting the two most recent plans from Senator Reid and Speaker Boehner and the details therein.
As we highlighted in a note earlier this week, the primary outstanding issue relates to timing. The Republicans, led by Boehner, are recommending a two-step process. The first step of the process would involve extending the debt ceiling by $900BN or so, which would be matched by comparable discretionary spending cuts over ten years (duration mismatch, anyone?). The next tranche of a debt ceiling increase of $1.6 trillion would be tied to Congress passing an additional deficit reduction bill that attempts to remove an incremental $1.8 trillion in expenditures related to cuts in mandatory spending programs. These mandatory spending cuts are to be determined by a 12-member joint leadership committee.
The plan from Reid has a number of noteworthy differences from the Boehner plan. First, the Reid plan is not two-step in nature. Second, while the Reid plan proposes $2.2 trillion in deficit cuts, the bulk of the cuts in this plan actually come from an assumed winding down of the Iraq and Afghanistan military adventures. In fact, of the total proposed cuts by the Reid plan, more than $1 trillion come from a wind down of Iraq and Afghanistan.
In the table below, we compare the revised Boehner plan versus the Reid plan as scored by the CBO and based on our interpretation:
While the primary issue between the Democrats and Republicans remains one of timing, the underlying issue, as outlined in the table above, is the exact source of cuts. The Republicans don’t count the natural winding down of wars as a cut in spending, a stance which is consistent with CBO scoring standards. On the other hand, Democrats are using the wind down of military spending as the primary component of the deficit reduction plan. This debate over source of spending cuts is the primary reason that Republicans are pushing for a two-step process. If the Republicans agreed to the Democratic plan, they would in fact be ceding away much of their long term budget cuts proposals.
This is not a political statement per se, but we think Speaker Boehner characterized the current political impasse best with the following quote from yesterday:
“There are only three possible outcomes in this battle: President Obama gets his blank check; America defaults; or we call the president’s bluff by coming together and passing a bill that cuts spending and can pass in the United States Senate. There is no other option.”
The vote on the Boehner plan is scheduled for 5:45pm today, after the markets close. The House Republicans, led by the Tea Party Caucus, are adamantly opposed to giving the President any sort of blank check, and so will certainly call the White House hand on the veto threat and pass this bill. In fact, there is risk that Boehner can’t get the votes he needs this afternoon, though the most recent information we’ve received suggests that he will.
If the Boehner plan does indeed pass this afternoon, the bill then goes onto the Democratic controlled Senate and then, if passed, onto the President to sign, or veto. From a strategic perspective, the Republicans have positioned themselves well as the proverbial budget ball will be in the hands of the Democrats in the five days leading up to August 2nd.
The political theater is about to get very interesting in Washington and, despite his veto threat, President Obama may be out on the dance floor doing the two-step in the next couple of days.
Daryl G. Jones
Director of Research
Improving Strip trends and MGM’s earnings release could make BYD the derivative play
Keith added BYD to the Hedgeye virtual portfolio as a LONG this morning at $8.93. While there were some encouraging signs from its latest quarterly report (i.e. margin improvement, strong regional results, and stabilization of the LV Locals market), the stock has traded off.
We believe there are a couple of catalysts ahead for BYD. First up is MGM’s earnings call on August 8th, where we think management will praise the robust LV Strip results in Q2. BYD could be bid higher as investors look for other ways to play gaming – the thesis being that LV locals improvement should follow the Strip. July-to-date, BYD’s stock is down -2% while MGM is up 14%. The second catalyst should be a Q3 beat. BYD’s decision to resume issuing guidance, its first since it guided for Q3 2008, is a good sign. We think its 3Q 2011 guidance is conservative and results may come in at the high end of the range.
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Positions in Europe: Short EUR-USD (FXE); Italy (EWI); UK (EWU)
As Keith noted in today’s Early Look, alarm bells sounded yesterday on a confluence of factors:
- EUROPE – both European stocks and bonds are turning into a proactively predictable train wrecks. Our research catalysts remain crystal clear (accelerating debt maturities for the majors through September) but, more importantly, now all of our TRADE and TREND lines across every major European stock and bond market (ex-Russia) have been broken and confirmed by volume and volatility studies.
- USA – stocks broke their intermediate-term TREND line of support (1320 in the SP500) and short-term bond yields finally busted a move above my 2-year yield TRADE line of resistance (0.41%). Credit risk derived by market morons in Congress will be priced on the short-end of the curve (where Bernanke has tried to mark it to model for 2 years), so watch that 0.41% line like a hawk.
- GLOBALLY – China’s Shanghai COMP TREND line = 2831 (broken); India’s BSE Sensex TREND line = 18,578 (broken); German DAX TREND line = 7251 (broken); FTSE TREND line = 5985 (broken); SP500 TREND line = 1320 (broken); Russell2000 TREND line = 827 (broken); WTIC Oil TREND line = 103 (broken); EURUSD TREND line = $1.43 (whipping around the line)
European indices have been down for the last four days and hit lower today on declining Eurozone confidence readings and a slew of bellwethers missing earnings. We continue to think that European sovereign debt contagion will erode confidence and slow growth across the region, with no country insulated. To this point, Germany’s high frequency data has slowed in recent months with inflation bumping up marginally.
Eurozone Business Climate Indicator 0.45 JUL vs 0.95 JUN (down for 4 straight mths)
Eurozone Consumer Confidence -11.2 JUL vs -9.7 JUN
Eurozone Economic Confidence 103.2 JUL (vs expected 104.0) vs 105.4 JUN (down 5 straight mths)
Eurozone Industrial Confidence 1.1 JUL (vs expected 1.6) vs 3.5 JUN (down 4 straight mths)
Eurozone Services Confidence 7.9 JUL (vs expected 9.2) vs 10.1 JUN
European risk, as indicated by sovereign bond yields and cds prices, has ticked up in recent days following a massive plunge after the announcement of Greece’s second bailout package on 7/21. Critically, the 10YR Spanish government bond yield is above 6%, as Italy’s flirts just below it, and CDS spreads are above the 300bp line for Spain and Italy, two critical (historic) break-out levels (see charts below). Confirming the trend of higher yields, Italy sold €2.7 billion of 10-year government bonds today at an average yield of 5.77% vs 4.94% on June 28.
Below we show our price level charts for the EUR-USD, DAX, and FTSE. The EUR-USD has held in a band between $1.40 – $1.45 since mid March, and we think has largely been supported by implicit guarantees from European officials to fund fiscally imbalanced countries with favorable short-term bailout packages, and in some cases refuse that possibility of default/exit of any Eurozone member country (Trichet and ECB).
We think Spain (IBEX) and Italy (MIB) have more room to run on the downside, despite being down -13.5% and -20.4% since intermediate term highs on 2/17, respectively. We’re currently short Italy via the etf EWI in the Hedgeye Virtual Portfolio. We covered our position in Spain (EWP) on 7/26. Germany has now broken its TREND line of support, an additional ominous sign in our models, as is the UK (FTSE) on sticky stagflation.
HOT 2Q CONF CALL NOTES
“We continue to see strong demand across both business and leisure travelers. This demand fueled growth across each of our nine distinct and compelling brands. Our efforts to hold the line on costs enabled us to beat EBITDA and EPS expectations in the quarter."
- Frits van Paasschen, CEO
HIGHLIGHTS FROM THE RELEASE
- Adjusted EBITDA $262MM and EPS of $0.50 (excluding special items) vs. guidance of $245-255MM and $0.42-$0.46 and consensus of $256MM and $0.46
- WW Systemwide SS RevPAR: 11.8% (8.2% in constant $) and SS NA RevPAR: 9.5% (8.7% in constant $)
- In line with constant dollar guidance
- "Excluding special items, the effective income tax rate in the second quarter of 2011 was 25.4%"
- "International gross operating profit margins for Same-Store company-operated properties were flat, negatively impacted by political unrest in the Middle East and North Africa, as well as the earthquake in Japan. North American Same-Store company-operated gross operating profit margins increased approximately 170 basis points, driven by REVPAR increases and cost controls."
- "Management fees, franchise fees and other income were $201 million, up $24 million, or 13.6%... Management fees increased 11.0% ...and franchise fees increased 19.5%... Excluding North Africa and Japan, management fees increased 16.1%."
- "At June 30, 2011, the Company had over 350 hotels in the active pipeline representing almost 90,000 rooms."
- During the second quarter of 2011, 13 new hotels and resorts (representing approximately 2,900 rooms) entered the system. Six properties (representing approximately 1,700 rooms) were removed from the system during the quarter"
- [Owned, leased, consolidated JV]: "Second quarter results were impacted by the effect of the earthquake at the new leased St. Regis Osaka, five renovations and three asset sales."
- "Originated contract sales of vacation ownership intervals increased 8.1% primarily due to improved sales performance from existing owner channels and increased tour flow from new buyer preview packages. The number of contracts signed increased 5.3% when compared to 2010 and the average price per vacation ownership unit sold increased 2.0% to approximately $14,800, driven by inventory mix."
- "Selling, general, administrative and other expenses decreased 4.3%...due to lower accruals for incentive compensation and lower legal expenses, offset by a weaker dollar."
- Capex: $51MM of maintenance and $32MM of development capital. Net investment spending on VOI & residential was $31MM
- During 2Q, HOT "completed the sales of... Westin Gaslamp (San Diego) and W City Center (Chicago), for cash proceeds of approximately $237 million. These hotels were sold subject to long-term management contracts. Additionally ... the Company sold a consolidated joint venture hotel, the Boston Park Plaza, for cash proceeds of approximately $44 million and the buyer assumed $57 million of debt...The Company recognized an after-tax loss in discontinued operations of $18 million as a result of the sale."
- 3Q Outlook:
- Adjusted EBITDA $225 - $235MM (includes impact of asset sales which reduced EBITDA by 8MM)
- Guidance is below consensus of $240MM - The Westin Gaslamp and W Chicago were previously announced but the Boston Park Plaza announcement is new
- SS Company Operated WW RevPAR: 7-9% in constant $ (500bps higher at current FX rates)
- Branded SS Owned WW RevPAR: 8-10% in constant $ (700bps higher at current FX rates)
- Fee growth of 13-15%
- VOI and residential earnings: Flat
- D&A: $76MMM
- Interest expense: $55MM
- Income from continuing ops: $70-78MM
- Tax rate: 25%
- EPS: $0.36-$0.40 (consensus $0.37)
- 3Q Outlook
- Adjusted EBITDA $975MM - $1BN
- Unchanged from prior guidance. 4Q consensus is $293MM vs. implied guidance of $280-295MM
- SS Company Operated WW RevPAR: 7-9% in constant $ (300bps higher at current FX rates)
- Branded SS Owned WW RevPAR: 8-10% in constant $ (400bps higher at current FX rates)
- 1% higher than prior guidance
- EBITDA impact of asset sales: $20MM
- Branded SS WW Owned Margins: 150-200bps
- Fee growth of 11-13% (1% higher)
- VOI and residential earnings: $130-140MM (Unchanged)
- SG&A growth: 4-5% (unchanged)
- D&A: $310MMM (vs. prior guidance of $320MM)
- Interest expense: $230MM (prior guidance of $240MM)
- Cash taxes: $80MM
- Tax rate: 25%
- EPS: $1.67-$1.77 ($0.07 raise)
- Capex: $300MM for maintenance; $150MM for investment projects & JVs. VOI ex Bal Harbour: $165MM of positive cash flow
- Closing of Bal Harbour units to commence in late 4Q11. Capex of $150MM
CONF CALL NOTES
- Many developers around the world are interested in investing in hotel development. Their corporate clients and affluent leisure customers are healthy.
- Rate and occupancy are now equally contributing to RevPAR growth and expect that going forward, ADR will be more of a driver
- Latin America was their fastest growing region. Europe performed well despite soveriegn debt issues. Mexico is recovering. Asia Pacific grew 16% outside of Japan and Shanghai.
- 8th quarter in a row of RevPAR index growth
- Rates on newly booked business for 2012 are up 9% and 12% for beyond 2012
- Business transient revenue is up 9%
- Forsee strong rate increases for corporate rate negotiations next year and the balance of this year
- Leisure business - 7% price increase this quarter
- VOI: For the first time in 4 years realized price increases.
- Expect solid group and transient pace for the balance of 2011
- SPG drives 50% of their occupancy in China
- Exceeded the high end of their guidance despite the sale of 3 large assets which cost them $5MM in the quarter
- Gaslamp was already announced and factored into their guidance
- Core business is performing better than they expected at the beginning of the year
- So far in July, the momentum of the second quarter is continuing. They see no change in trends so far and therefore assume that the normal RevPAR recovery will continue.
- No change in US momentum headed into 3Q
- No improvement in sight for the Middle East. The Gulf continues to work through oversupply issues as well. Most significant impact on their business is on incentive fees.
- Asia is now their 2nd largest region which should double in 5 years. Demand continues to outpace supply in Asia. China ex Shanghai was up 12%.
- Vacation ownership - default rates are back to 2007 levels. Remain focused on cash flow generation with a securitization planned for 4Q.
- More comfortable for the midpoint of their guidance range than the high end reflected by the Street. Their guidance for FY11 has remained unchanged despite the events in Japan and the sale of 3 assets.
- North Africa and Japan are projected to negatively impacted management fees by $18MM for FY11. 4Q growth will be lower than in the first 3 Q's of the year.
- 40% of their fees are earned in the US
- Remain on track to open 70-80 hotels in 2011
- Bal Harbour: Plan to start closing in November. Sales pace is good - especially from Latin American buyers
- Usually 1/3 of their group business in 2011 was booked in 2011, 1/3 was likely booked in 2010 and 1/3 was booked in the year for the year...which is typical
- Their leverage ratios are approaching investment grade, but rating agencies are more conservative in calculating leverage. They include leases and don't give credit for cash on the balance sheet. They have $650MM of maturities next year.
- Have no philosophical issues with returning excess cash to shareholders, it's really an issue of timing for them
- They are signing most of their new deals in Asia and Latin America for fresh construction. North American signings have more conversions.
- Their NA hotels will have margin improvements above 200bps, but international will be below 150bps - given the margin pressures in Latin America. L.A. had 75bps of negative impact on the quarter's margins.
- As time passes they do believe that there will be good ROI investment opportunities for timeshare, but the business will not get back to its prior scale
- The group pace for 2012 continues to improve, but today it's mostly volume driven rather than rate for what's on the books. However, new business being booked is at much higher rates.
- Approaching 60% of the value of the condos at Bal Harbour under contract ($1BN in total). Indications are that closing rates will be high. Prices are still at pre-crisis levels.
- M&A environment - not deep enough for a large portfolio sale. See pricing improving substantially, but it's a one's and two's market
Keith re-shorted JCP after an analyst upgrade offered the opportunity for more downside. Hedgeye Retail remains negative on all durations (TRADE, TREND and TAIL). Too much storytelling around Ackminism obfuscating poor positioning in the face of major industry risks, and what is likely to be a very sloppy management transition – both of which should take estimates (and the stock) down before they can ultimately go up.
This afternoon, the Hedgeye Retail team will be releasing our RETAIL Black Book, JCPENNEY - WHAT ACKMANISTS ARE MISSING, following up with a conference call on Tuesday August 2.
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