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SUN RISING IN THE EAST FOR YUM

"Hide your brightness; bide your time"

-Deng Xiaoping

 

On the second day of my trip to Shanghai, I turned to a person sitting next to me and remarked that one can easily lose sight of the fact that China is a communist country.  At that point, I was told about Richard McGregor’s book, The Party: the Secret World of China’s Communist Rulers.  As Richard McGregor says in his book, China’s economy is one that appears on the surface to be a “uniquely unbridled form of capitalism.”  Travel in China with two global restaurant companies and that comment becomes very clear.

 

There are few companies better positioned than YUM to capture the “unbridled form of capitalism” which is growing rapidly alongside the megatrend of the urbanization of China.  This is not new, but it’s also not going to slow down any time soon.  Driving away from China’s east coast, as I did last week, presents the chance to witness firsthand the phenomenon of urbanization in the country.  YUM and MCD are pointing to the significant number of retail spaces and transportation centers that are going to be built to accommodate the concentrated consumer demand that will partly define this trend. 

 

The “megatrend of urbanization” is a critical aspect of the China story for YUM.  YUM’s operations are accordingly focused on the opportunity; the company has roughly 700 people on the development team focused on, among other things, any possible changes that “The Party” may make as they continue to spend on new infrastructure projects.  For the time being, 35% of KFC and 25% of Pizza Hut new unit development is coming from the central and west provinces which represents about 50% of the population.

 

Suffice to say, my first “YUM China” experience was truly eye opening.  In a small part, I also feel better about Hedgeye’s macro call to be bullish on China.  My view of China is somewhat impacted by two of the biggest restaurant companies there anticipating significant unit growth potential over the next 10 years.   In addition to this, the companies will also benefit from a doubling of the minimum wage over the next 5 years.  This is a challenge from a P&L perspective, but will certainly help to further efforts of “The Party” to stimulate and diversify the Chinese economy.    

 

The YUM presentation on China was very different from MCD’s, stemming from the face that YUM gives detailed financials every quarter about the trends in the business in China.  This point does not make one better than the other, it's just a function of the level of commitment to the country.  Looking at the whole, YUM needs China to work now more than MCD does.  China is an important part of the MCD story, just less so given the strength of the overall business in nearly every region of the world. 

 

The read on current YUM China trends:

  • The company previously stated, “we are experiencing double-digit comps in 3Q11." I believe that commentary still stands today!
  • 1H 11 Chinese businesses was strong across all brands and across all tiers; the business is stronger in smaller cities.
  • 50% of KFCs units and 73% of Pizza Hut delivery units are being built in T1/T2 cities.
  • In 2Q SSS grew 18%, driven by an 21% increase in transactions.  KFC was up 17% and Pizza Hut up 22%.  System-wide sales growth was 28% with operating profit growth of 25%
  • SSS were driven by transaction growth through strategic initiatives like breakfast (13% of transactions), delivery (1,600 units) and 24-hr operations (1,300 restaurants)
  • Average guest check in 2Q was RMB 26 ($4) at KFC and RMB 122 ($19) at PH
  • Inflation is a net positive for YUM in China as stronger brands flourish in an inflationary environment.  For YUM, the ownership of the supply chain gives the company increased flexibility
  • YUM experienced inflation of 5% and 6% in Q1 and Q2, respectively.  Over Q3 and Q4, the company expects to see inflation of 9% and 12%, respectively, in China.  The company has chicken locked for the next three months and expects priced to decline from current levels. 

Two decades ago Deng Xiaoping set the tone for how China should enter the world of capitalism - hide your brightness; bide your time.  Today, the trends in China are very bright and YUM is extremely well positions to capitalize on the current trends.    

 

SUN RISING IN THE EAST FOR YUM - yum china sss

 

 

Howard Penney

Managing Director

 

Rory Green

Analyst


NOTES ON ASIA

Here are some tidbits we've been hearing:

 

  • Singapore: MBS could be tracking for a 30% increase QoQ on RC volume. Through July and August, they may have already made up 2Q volumes and Formula One could provide an extra boost for September.
  • Sun City is fairly committed to opening at Venetian.
  • Neptune may be getting spread too thin as it struggles to find good room managers and hosts.  The junket operator could be overcommitted and may not contribute that much to Venetian.
  • Starworld seems to be having some luck issues.  Also, some players came across from Galaxy Macau to play at MPEL this past week.
  • Wynn had better hold this week but they will have a tough time catching up.  September likely to be disappointing
  • Moon Festival holiday starts tonight – family time – but tomorrow will be a bit busier than usual on a typical Tuesday
  • October Golden Week: starting October 1, we may get a 10BN week
  • Wynn Cotai got their land approval.  They can start piling work late this year/early next year. They should be open in 3.5 years, at the latest.
  • SJM Cotai approval may not come until year end.
  • Macau Studio City:  The guys at MPEL have gone really quiet due to their potential listing on the exchange.
  • A MPEL project in the Philippines looks dead.  MPEL may be requiring PAGCOR to maket an MPEL license the last.  Also, MPEL would likely require PAGCOR to step down as an operator. 

Long Oil?

This note was published by Lou Gagliardi, Managing Director of Energy, on Friday afternoon; we think it is pertinent to all Macro clients.

 

Is it safe to buy oil here? The short answer is NO! Global growth (and demand) continues to slow.


Product demand – globally and in the U.S. – continues to deteriorate; this coupled with the return of Libyan supplies near the end of 4Q11 will dampen crude prices over the intermediate-term TREND duration.

 

Over the immediate-term TRADE duration, weak demand will be the single major suppressant to crude price, as the summer driving season winds to a close and U.S. liquids production continues unabated.  In short, absent any additional monetary stimulus that weakens the U.S. dollar, we don’t see much crude price support.

 

Crude supplies from Cushing have been declining over the last several weeks due less from demand and more from refiners being opportunistic to run throughputs to capture higher margins driven by the wide WTI/Brent spread that is roughly $26/bbl, though that tailwind is abating as refiners will soon transition to produce more middle distillates before winter.  Refiners will begin to shut down for winter maintenance to prepare for the winter heating oil season. Greater refining downtime/maintenance will mean less crude drawdowns, which will be interpreted as even greater demand weakness. But that weakness in demand is real – gasoline demand remains weak into the end of August and early September, down ~3% YoY. 

 

Reports out today, that resumption in Libyan crude exports/production may reach 1 MM b/d within 6 months, with full production of 1.6 MM b/d of production within 15 months. We believe this is slightly on optimistic side, however, directionally correct. We can expect Libyan light/sweet bbl to gather momentum by end of 4Q11 into 1Q12 of several hundred thousand b/d of production and picking up steam from there.

 

Following close behind is the IEA having recently reduced its forecast for global energy demand; in fact, it has been ratcheting downward since the beginning of the year – no surprise here as they are late movers, and often error on the high side, so conditions may be worse than theirs forecast indicates.

 

One last data point, when I go through my GDP/global wellhead production model, the gap between the growth in each metric for 2011 and 2012 is well below the marker of 200 bps that has historically indicated tightening upward pressure on crude prices. Simply put, the slope of global GDP growth and wellhead production is decelerating, and the tailwind of monetary stimulus appears to have run out of steam. Indeed, if global GDP is under a 3% per annum clip for 2011 and 2012, which right now it appears to be, demand pressure on price will remain weak into 2012.

 

From the Oil and Gas Patch,

 

Lou Gagliardi

 

Kevin Kaiser

 


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SOLID WEEK IN MACAU

No change to our September forecast of HK$20-22BN.

 

 

A solid week in Macau this past week keeps our full month September forecast at HK$20-22 BN, up 35-48% YoY.  We are hearing that volumes are strong as well so no major market wide hold impact.  Hold is likely impacting the operators individually, however.  Wynn Macau’s market share was only 8.4% and while that is much improved from last week’s 5.4%, it is way down from its post Galaxy Macau (GM) opening of 13.6%.  MPEL continues to outperform with a huge 19.3% share, up from its post GM share of 15.0%.  While hold likely played a role, we are hearing that a lot of play moved over from Galaxy Macau this month.  Not sure why yet.  LVS is lagging once again, well below its recent share.  On a positive note, we are hearing that junket operators Sun City and Neptune are getting close to ramping up at The Venetian.

 

SOLID WEEK IN MACAU - macau sept


MONDAY MORNING RISK MONITOR: EU SWAPS BLOWOUT REMAINS THE PRIMARY INDICATOR

The European crisis dominates the Risk Monitor changes this week.  Sovereign CDS put in one of their worst weeks ever, and bank CDS on both sides of the Atlantic reflected the deterioration.  The TED spread hit a new high for the YTD and the 2-10 spread continued to tighten.  In all, there is little good news in today's risk monitor.  


Financial Risk Monitor Summary (Across 3 Durations):

  • Short-term (WoW): Positive / 1 of 11 improved / 7 out of 11 worsened / 3 of 11 unchanged
  • Intermediate-term (MoM): Negative / 3 of 11 improved / 7 of 11 worsened / 1 of 11 unchanged
  • Long-term (150 DMA): Negative / 2 of 11 improved / 7 of 11 worsened / 2 of 11 unchanged

 

MONDAY MORNING RISK MONITOR: EU SWAPS BLOWOUT REMAINS THE PRIMARY INDICATOR - Summary

 

1. US Financials CDS Monitor – Swaps widened in 27 out of 28 major domestic financials in our table last week. 

Widened the most vs last week: C, GS, AGO

Tightened the most vs last week: PMI, AON, MMC

Widened the most vs last month: PRU, LNC, HIG

Tightened the most/widened the least vs last month: XL, GNW, MMC

 

MONDAY MORNING RISK MONITOR: EU SWAPS BLOWOUT REMAINS THE PRIMARY INDICATOR - CDS  US

 

2. European Financials CDS Monitor – Banks swaps also widened in Europe last week.  35 of the 39 swaps were wider and 4 tightened.   The average widening was 5.9%, or 25 bps, and the median widening was 21.3%.  Tightening was concentrated in the Greek banks, where swaps are already trading well over 1,000 bps. 

 

MONDAY MORNING RISK MONITOR: EU SWAPS BLOWOUT REMAINS THE PRIMARY INDICATOR - CDS  Europe

 

3. European Sovereign CDS – European sovereign swaps went parabolic last week.  All the countries we track, with the exception of Ireland, hit a new high as of this morning.  Greek swaps are up 56% WoW as of this morning, rocketing to 3500 bps.  French CDS rose 23% WoW to a new high of 191 bps. 

 

MONDAY MORNING RISK MONITOR: EU SWAPS BLOWOUT REMAINS THE PRIMARY INDICATOR - sov

 

MONDAY MORNING RISK MONITOR: EU SWAPS BLOWOUT REMAINS THE PRIMARY INDICATOR - Sovereign CDS 2

 

4. High Yield (YTM) Monitor – High Yield rates rose 13 bps last week, ending at 7.82 versus 7.69 the prior week.

 

MONDAY MORNING RISK MONITOR: EU SWAPS BLOWOUT REMAINS THE PRIMARY INDICATOR - High Yield LT

 

5. Leveraged Loan Index Monitor – The Leveraged Loan Index rose 2 points last week, ending at 1538. 

 

MONDAY MORNING RISK MONITOR: EU SWAPS BLOWOUT REMAINS THE PRIMARY INDICATOR - Leveraged Loan Index

 

6. TED Spread Monitor – The TED spread made a new YTD high, ending the week at 33.3 versus 31.5 the prior week.

 

MONDAY MORNING RISK MONITOR: EU SWAPS BLOWOUT REMAINS THE PRIMARY INDICATOR - TED spread

 

7. Journal of Commerce Commodity Price Index – Last week, the JOC index fell very slightly to -2.1.

 

MONDAY MORNING RISK MONITOR: EU SWAPS BLOWOUT REMAINS THE PRIMARY INDICATOR - JOC LT

 

8. Greek Bond Yields Monitor – We chart the 10-year yield on Greek bonds.  Last week yields hit another new all-time high, ending Friday at 2056.

 

MONDAY MORNING RISK MONITOR: EU SWAPS BLOWOUT REMAINS THE PRIMARY INDICATOR - Gr Bond LT

 

9. Markit MCDX Index Monitor – The Markit MCDX is a measure of municipal credit default swaps.  We believe this index is a useful indicator of pressure in state and local governments.  Markit publishes index values daily on six 5-year tenor baskets including 50 reference entities each. Each basket includes a diversified pool of revenue and GO bonds from a broad array of states. We track the 14-V1.  After bottoming in April, the index has been moving higher.  Last Friday, spreads rose 12 bps and closed at 162 bps.

 

MONDAY MORNING RISK MONITOR: EU SWAPS BLOWOUT REMAINS THE PRIMARY INDICATOR - MDDX spread

 

10. Baltic Dry Index – The Baltic Dry Index measures international shipping rates of dry bulk cargo, mostly commodities used for industrial production.  Higher demand for such goods, as manifested in higher shipping rates, indicates economic expansion.  Last week the index rose sharply off a low level, climbing 98 points to 1838.

 

MONDAY MORNING RISK MONITOR: EU SWAPS BLOWOUT REMAINS THE PRIMARY INDICATOR - Baltic Dry

 

11. 2-10 Spread – We track the 2-10 spread as an indicator of bank margin pressure.  Last week the 10-year yield fell 7 bps, pushing the 2-10 spread to 174 bps.   

 

MONDAY MORNING RISK MONITOR: EU SWAPS BLOWOUT REMAINS THE PRIMARY INDICATOR - 2 10 spread

 

Margin Debt Flat in July

We publish NYSE Margin Debt every month when it’s released.  This chart shows the S&P 500, inflation adjusted back to 1997, along with the inflation-adjusted level of margin debt (expressed as standard deviations from the long-run mean).  As the chart demonstrates, higher levels of margin debt are associated with increased risk in the equity market.  Our analysis shows that more than 1.5 standard deviations above the average level is the point where things start to get dangerous.  In July, margin debt held close to flat at $306B.  On a standard deviation basis, margin debt fell to 1.21 standard deviations above the long-run average.

 

One limitation of this series is that it is reported on a lag.  The chart shows data through July.

 

MONDAY MORNING RISK MONITOR: EU SWAPS BLOWOUT REMAINS THE PRIMARY INDICATOR - margin debt

 

Joshua Steiner, CFA

 

Allison Kaptur


THE M3: WYNN COTAI; CHINA AUG LOANS

The Macau Metro Monitor, September 12, 2011

 

 

ACCEPTANCE OF LAND CONCESSION CONTRACT FROM THE MACAU GOVERNMENT IN RESPECT OF THE COTAI LAND Wynn Macau Limited

Palo Real Estate Company (owned by Wynn) and Wynn Macau have accepted the terms laid out by the Macau government regarding developing the ~51 acres of land on Cotai.  Palo will pay a land premium of MOP1.55 BN and rental fees of MOP6.17MM to the government.   The first payment towards the land premium will occur in the form a down payments of MOP500,000,000 (approximately HK$500,000,000 or US$62,500,000) and the balance will be paid 8 additional semi- annual payments beginning six months from the date the Land Concession Contract is published in the official gazette of Macau.

 

and Wynn Macau to develop a resort containing a five-star hotel, gaming areas, retail, entertainment, food and beverage, spa and convention offerings on Cotai.  Palo will lease the Cotai Land from the Macau Government for an initial term of 25 years from the date the Land Concession Contract is published in the official gazette of Macau with the right to successively renew the Land Concession Contract for additional periods, subject to applicable legislation.

 

NEW LOANS HIT 548.5 BILLION YUAN IN AUGUST People's Daily

China's commercial banks were more aggressive in lending in August than in July due to a temporary ease in inflation in August.  New loans reached 548.5 BN Yuan.  New lending in August, up 1.7% YoY and 11.3% MoM.  


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