“Historically, the claim of consensus has been the first refuge of scoundrels; it is a way to avoid debate by claiming that the matter is already settled.”
In financial markets, consensus is typically what astute stock market operators invest against. That is, if the crowd has a similar view of an asset or asset class, that asset or asset class will typically be priced to perfection. Therefore, savvy analysts and portfolio managers strive to find the nugget of non-insider information that will prove that consensus is wrong, which inevitably leads to a re-pricing of the asset and profits for those that appropriately determined where consensus views were wrong.
Obviously, the key variant macroeconomic view that Hedgeye held coming into 2011 versus consensus was that growth was slowing and would continue to slow. We won’t rehash the thesis, but our view was for sub 1.5% growth in the first two quarters of 2011, while sell side consensus GDP estimates were, based on Bloomberg data, at +3.4% as of early February.
As always, though, the job is to play the game in front of us and while rehashing old victories can be fun, we’ll save those opportunities after the inevitable victories of Yale over Harvard at the Yale / Harvard hockey and football games this year. So two questions to ask into the remainder of the trading year are:
1) What is consensus?
2) What are your best variant views versus consensus?
Yesterday, I noticed a nugget of information that at first suggested to me that market consensus was leaning too far to the negative. Specifically, negative bets on the SP500, as measured by a net outstanding 107,913 futures contract in the week August 30th, were at their highest level since September 2007. My knee jerk reaction, as it relates to determining consensus, was to look at this statistic as a contrarian indicator. History, of course, suggests a different byline.
In fact, as noted above, the last time negative options bets were at this level was September 2007. The next month, October 2007, marked the all time high in the SP500. There are number of studies that provide an explanation as to why this seemingly contrarian indicator is actually not one, but the primary reason is that short sellers, in aggregate, typically invest with better information than market participants broadly. One recent study by Morningstar CMPS on Canadian stocks from 2003 to 2011 showed the following:
“CPMS looked back to 2003 (when it started to record short interest data) and found that a portfolio of the most heavily shorted stocks indeed did poorly and underperformed the S&P/TSX composite total return index by about six percentage points annually, assuming an equal weighting of each of the 15 names and reselecting new names each month.”
Thus, while consensus views are important to determine when contemplating the risk / reward of positions, always be aware of The Scoundrels of Consensus. These critters come in many forms, such as in the form of those who practice the dark art of short selling or even, gasp, in the form of statements from senior executives or government officials.
Typically, of course, I would give little credence to the idea that either government officials or senior company executives have much insight into the global macro environment, or that they would truthfully share their views. At times, though, I do recommend taking the words of The Scoundrels of Consensus at fair value. Some recent statements from European “leaders”, which I’ve outlined below, exemplify this point. To wit:
1. “Under the current structure and with the current membership, the euro does not work. Either the current structure will have to change, or the current membership will have to change.”
- Stephanie Deo, Paul Donovan, and Jacek Rostowski of UBS Bank
2. “The Euro has never had the infrastructure it requires.”
- Herman Van Rompuy, EU President
3. “I regard the huge buy-up of bonds of individual states of the ECB as legally and politically questionable.”
- Christian Wulff, German President
4. “All this reminds one of the autumn of 2008.”
- Josef Ackerman, Deutsche Bank CEO
5. “Dealing with a banking crisis was difficult enough, but at least there were public sector balance sheets on to which the problems could be moved. Once you move into sovereign debt, there is no answer; there’s no backstop.”
- Mervyn King, Governor of the Bank of England
6. “The euro is in danger . . . if we can’t deal with this danger, then the consequences for us in Europe are incalculable.”
- Angela Merkel, Chancellor of Germany
The intention this morning is not to fear monger our subscribers into getting overly negative in the short term. In fact, our most recent moves in the Virtual Portfolio yesterday morning were to cover two shorts : United Kingdom Equities (EWU) and Capital One Financial (COF).
Instead the advice this morning is simply this: be aware and wary of The Scoundrels of Consensus.
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research
This note was originally published at 8am on September 02, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.
“Old age is a shipwreck.”
-Charles de Gaulle
In life, there are certain inevitabilities, with aging at the top of the list. No amount of money, fame, or religion prevents the reality that we will all grow old, at least physically, one day. While in his quote above de Gaulle could easily have been talking about the fiscal discipline of Greece, he was, in fact, appropriately describing the reality of our bodies naturally aging and eventually deteriorating.
Now that I’ve started your morning off on a completely somber note, I’ll offer another reality, which is that aging and longevity research suggests that all of our life spans will be extended versus prior generations. Not only that, we will age more gracefully and comfortably as well. In her new book, “100+ : How The Coming Age of Longevity Will Change Everything, From Careers And Relationships To Family and Faith”, Sonia Arrison, a fellow Canadian and senior researcher at the Pacific Research Institute, provides an insightful overview of the technology of longevity.
In fact, as Arrison notes, human life has generally been extending since human life began. During the Cro-Magnon era, humans could have expected to live just long enough to graduate from high school, or to the ripe old age of eighteen. By the time of the European Renaissance life expectancy had almost doubled to thirty. By 1850, just as the U.S. population hit 23.1 million, the average age reached forty-three. Today, with the acceleration of medical breakthroughs, the average person in the Western world can expect to celebrate his, or her, eightieth birthday. In the future, according to Arrison:
“The first person to live to 150 years has probably already been born.”
The pursuit of longevity has been ongoing since the beginning of recorded history. One of the first contemplations of death actually occurs in Genesis, the first book of the bible. After willfully disobeying God by eating the forbidden from the Tree of Knowledge of good and evil, Adam and Eve were kicked out of the Garden of Eden, a place of immortality, into the real world where they faced sickness, death, and the threat of crazy New York taxi cab drivers.
I don’t need to restate the entire history of human aging to assure you that it is a topic that has been and likely always will be front and center for mankind. As a result, a vibrant growth industry has risen around areas of extending lives and more gracefully aging. In her book, Arrison discuss some of the key areas of development and investment, which we’ve borrowed and outlined in the table below:
The key question that arises of any discussion of the extension of human life is whether the earth has the physical resources to support a growing population. Obviously, an important question given that human population has grown from 900 million in 1800 to just under 7 billion people today. The most famous critic of the earth’s ability to sustain population growth is Thomas Malthus, who in 1798 wrote in his “Essay on the Principle of Population”:
“Population, when unchecked, goes on doubling itself every 25 years, or increases in a geometrical ratio.”
Interestingly, Malthus’ thesis ended up being spot on for the growth of the earth’s population. Where Malthus ultimately failed was in his belief that subsistence could only grow arithmetically, which, according to his theories, would create a major issue in the future as there wouldn’t be enough resources to support the population.
Long term commodities bulls are obviously major advocates of Malthusian theories, as they describe a natural tightening of supply and demand for food, energy, and building materials. Ultimately this supply and demand will lead, according to commodity bulls, to long term favorable real price performance for commodities and impending disaster for those humans who can’t afford the accelerating price of commodities.
This is an interesting theory, but it hasn’t really played out in practice. The most prominent modern advocate of Malthusian theories is Stanford professor Paul Ehrlich, author of “The Population Bomb”. In the 1970s, he predicted that the world would run out of food (it didn’t) and in 1980 bet Julian Simon that over the next ten years, five specific metals would increase in price. So, what was the outcome? As Arrrison writes:
“During the decade from 1980 to 1990, world population grew more than 800 million – a huge increase that, according to Ehrlich, should have spelled disaster . . . Without fail, every single metal decreased in price, and Ehrlich was forced to admit defeat.”
The moral of the story is that even as the population has grown geometrically, humans have continued to innovate, live longer and healthier, and decreased their dependence on finite resources. (Incidentally, as shown in the Chart of the Day, the decade from 1980 to 1990 was also a period in which the U.S. dollar was flat (albeit with huge strengthening in between), versus trending down thereafter, which likely served to keep commodity inflation in check.)
So, as you head into the long weekend contemplating your longevity, I’ll offer a few tips. To start with, there does appear to be some credence to the health benefits of red wine, especially for those who are a little overweight, but the single and simplest tip to living a long and healthy life . . . . caloric restriction. Not sexy, but eating less works.
Enjoy the long weekend with your friends and families.
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research
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The story that MCD is currently conveying to the investment community is one of BIGGER, BETTER and FASTER; this is a very different tale from the story just a few years ago.
It’s nice to get away from the office, especially given the pain being felt in the financial markets. The opportunity that MCD and YUM have in China is a far cry from the euro zone debt crisis that appears to be spiraling out of control. Given the issues that the Financial sector faces (and maybe Energy too) three stocks that look like “safe havens” over the longer term in the restaurant space are YUM, MCD and SBUX.
I would note that the leading story in the Shanghai Daily today was “China’s Local Lending Under Scrutiny.” While China’s debt/GDP is only 50% as compared to 100% for the US and 200% for Japan, the factors most likely to derail the growth story in China are primarily outside of the country's control. Also in today’s paper was a story that according to the chief economist at the State Administration of Foreign Exchange, China’s GDP growth could be below 9% in 2012 for the first time in 10 years. The article stated that “the weakening global demand for Chinese exports will be a challenge”.
Forgetting the negative MACRO environment, the MCD presentation to the investment community today in Shanghai was about as bullish a presentation as any company could give. Importantly, the numbers they are posting support the bullish story. Clearly, the future is bright for MCD in China and throughout the rest of APMEA.
One of the stores we visited was in a more upscale neighborhood and right next to a Starbucks. The McDonald’s was recently upgraded to a look that has a “European edge” to it. McDonald’s term for the store is LIM - less is more. The remodeled store has a McCafé in it selling its coffee/pastry products that are priced at roughly half of what Starbucks is charging for equivalent food and beverage items right next door. The sales of McCafé products currently represent about 8% of sales. It was pointed out to me that over the next three years that MCD will have 500 McCafé stores as compared to the current 470 Starbucks in China.
I guess it comes as no surprise that SBUX announced yesterday that over the next four years the company plans to step up its expansion plans to triple the number of units in China. SBUX now plans to operate 1,500 stores in China by 2015. It would have been nice to hear from the Starbucks team on this trip to China. Maybe over the next year or two the company will be in a better position to address the investment community in a more formal fashion.
BIGGER - ACCELERATING UNIT GROWTH
MCD is well down the road of accelerating unit growth in China and hitting the target of having 2,000 units in the country by 2013. As of June 30th, 2011, there were 1,349 units in China. The unit growth strategy is based on the following principles:
- Accelerate the opening base - open more stores in the core markets (esp. the 5 most important cities) and helping to further make the core TV markets more efficient.
- Portfolio mix - MCD will be looking to open 40% of the stores with a drive-thru and increase the number of stores in transportation hubs. The increase in drive thru stores will help the company continue to drive same-store sales growth given the how the Chinese take to using drive-thru.
- Customer experiences - modernize the store base and build more McCafe’s.
BETTER - IMPROVING SALES TREANDS
McDonald’s average unit volumes in China have improved from $1.3 million in 2005 to $2.0 million over the last 12 months. On an annual basis, the average store in China will serve 470,000 customers, and produce $200,000 in cash flow. The average check right now is about $3 versus a little over $5 for the USA.
So far this year, same-store sales in China have been 10.5%, while traffic is up 8.7%. The growth is being driven by (1) value, (2) breakfast and (3) opening more drive-thru stores. I also learned that SSS in Shanghai have softened quarter-to-date, as they are now lapping strong sales from last year’s World Expo.
Over the next 2-3 years, MCD will be able to generate positive same-store sales as they open more drive-thru’s and they begin to gain scale on their remodel program. A current store remodel is seeing a 6-10% lift in sales and when they include a McCafe in the remodel the sales lift approaches the low teens.
FASTER - HAVING THE RIGHT INFRASTRUCTURE TO GROW
The tough lessons of the past have taught the McDonald’s management to have in place a disciplined and efficient operating structure in China. Over the last few years, MCD has optimized its asset base that now allows the company to accelerate unit growth in the coming years. Importantly, the significant increase in average unit volumes now puts the concept on par with KFC when developers are looking to add one concept or the other to any given site.
On the margin, as MCD takes its real estate professionals from about 120 individuals today to 300 over the next few years, it will create a little more competition for YUM.
Darden Restaurants provided preliminary 1QFY12 EPS from continuing operations of $0.78 versus consensus of $0.87. The company also reported that 1QFY12 combined same-restaurant sales for Red Lobster, Olive Garden, and LongHorn Steakhouse are expected to increase 2.8%. This preannouncement is negative for the group but it is important to point out that some of the drivers are specific to Darden.
Preliminary 1Q U.S. same-restaurant sales results at Red Lobster, LongHorn Steakhouse and Olive Garden are 10.7%, 4.8%, and -2.9%, respectively. On a combined basis, the same-restaurant sales performance for 1Q was not terrible, but there are two important caveats to keep in mind. Olive Garden appears to have structural problems that will take some time to address and Red Lobster’s strong comp is impressive at first glance but comes almost entirely from promotion-driven traffic. An increase in price in August brought a steep decline in traffic.
Red Lobster posted strong comp for the quarter but, with seafood inflation as high as it is, the question most investors will be posing is “are they making money?” The chart below shows the acceleration in two-year trends the preliminary 1QFY12 number implies and the table, below the chart, shows the monthly numbers for traffic, pricing, and menu-mix at Red Lobster.
Olive Garden is clearly suffering from structural problems and we believe that roughly half of the unit base needs to be remodeled. As discussed on the most recent earnings call, management plans to remodel 430 non-Tuscan Farmhouse restaurants in the Olive Garden system with completion by the end of fiscal 2014. On July 1st, management said that 60 restaurants had been remodeled for the purposes of a test and 75 are due to be remodeled this fiscal year. The schedule described by management would suggest that any issues being posed by restaurants in need of remodels are here to stay for some time!
LongHorn Steakhouse has been a strong concept for Darden over the past several quarters but this preliminary number suggests that the chain’s performance has come closer to the Street’s expectations. Same-restaurant sales were certainly strong, but a second consecutive decline – albeit marginal – in two-year average trends is not what investors were looking for. Intra-quarter, LongHorn comps slowed from 6.5% in June to 4.0% and 3.5% in July and August, respectively.
Darden has long been considered the safe haven of the casual dining space and this label has been earned by a competent management team that runs an impressive organization. Over the last few months, however, the difficult macro environment has been taking its toll on the casual dining industry. Gas prices, specifically called out by DRI CEO Clarence Otis this year, and – more recently – plummeting consumer confidence amid a confluence of headwinds have worried management and investors alike.
Today’s preannouncement of 1QFY11 EPS and same-restaurant sales will disappoint investors and likely cause many on the sell-side to realign their expectations with the change in tone from management.
It may be too early to say definitively but Wynn Macau has been losing share recently in both Mass and VIP.
Let’s face it: the Cotai Strip is gathering momentum. Well, it’s not like most of Macau is not doing extremely well. However, Cotai is gaining share – and was gaining share even before Galaxy Macau (GM) opened on May 15th of this year. The following chart depicts Cotai’s share surge beginning in February 2011 for VIP and April 2011 for Mass.
Obviously, Wynn Macau is not situated on Cotai and the company will not have a presence on Cotai until at least 2015. We don’t want to make too big a deal of a few months of share shift but it is curious to see Wynn lose share for more than an isolated month here and there. Wynn has lost share in both Mass and VIP the last two months from June as can be seen in the following chart.
GM seems to be having an effect, albeit delayed. We know GM has been very aggressive on the junket commission front, in terms of levels and commission advancement. City of Dreams was already aggressive. The two recent losers in this segment offer the least attractive commission structures: Wynn and Sands China. Sands China’s junket issues have been well documented – at least by us. Could it be that Wynn’s cherished junket business is showing some chinks? They have been by the far the most productive and profitable despite offering the junkets less. Maybe a slight increase in the amount of commissions advanced could stem the tide.
The drop off in Mass hasn’t been as severe and its sustainability remains to be seen. However, the drop off is possibly even more perplexing. GM opened on May 15th and Wynn’s Mass share barely moved in May or June before dropping in July and August. Wynn certainly doesn’t dominate Mass like it does VIP so it has less to lose. However, given the profitability of Mass in general and Wynn specifically, this is a trend that the company needs to reverse.
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