Business remains resilient in the face of economic concerns and while MAR won’t be aggressive, investors appear to be discounting significantly lower forward estimates.



Marriott will kick off 3Q earnings season next week.  While estimates have come down by 10% since their last earnings call we are still 3% below consensus for EPS and EBITDA given the continued drag of MAR’s DC exposure and lag effect of the company’s large group and convention business. 


That said, MAR’s stock is also down 25% since their last call, so I think it’s safe to say that investor expectations are not high for the quarter and there is a lot of fear built into future projections.  Like most if not all lodging names, the number one driver for this stock will be driven by the forward macro view.  We believe that most investors are at least partially pricing in a double dip and RevPAR potentially going negative over the next 12 months.  


We certainly wouldn’t want to own anything in lodging into a double dip; however, for the next quarter at least, we do expect RevPAR trends to accelerate as we wrote about in "LODGING: REVPAR REVS UP" (9/9/11).  In fact, September MTD RevPAR numbers have already improved.  If the economy continues to chug along at status quo levels, we think that MAR is a compelling story.  Valuation is at March 2009 trough levels, cash flow is significant and could surprise on the upside, and the timeshare spin off is a strategically value added transaction.



Here are our projections for the quarter:


We estimate that Marriott will report Adjusted EBITDA of $234MM and EPS of $0.26 – about 3% below the Street. 

  • World Wide RevPAR projected at 5.2% (non-comparable) and system-wide room growth of 2.6%
  • Marriott’s outsized exposure to the DC market will continue to be a drag on their RevPAR results in NA.  DC RevPAR from MAR’s 3rd FY quarter tracked down 1.2%, driven by negative ADR and flat YoY occupancy.  Approximately 5% of MAR’s domestic system-wide rooms are located in the Greater Washington, D.C. market and in 2010 the region contributed roughly 6% of MAR’s worldwide fee revenue and 13% of total incentive fees.
  • We estimate owned, leased, corporate housing and other revenue of $243MM – inclusive of $20MM of branding fees and $4MM of termination fees.   We assume a loss of $2MM on the core business compared to a loss of $12MM in 2Q10, and a 100% margin on branding and termination fees for total gross profit of $23MM.  In 2Q10, gross profit margin was only $7MM.
  • We estimate total fee revenue of $283MM – lower than MAR’s guidance of $285-295MM
    • $135MM of base management fees, up 9.4% YoY
    • $123MM of franchise fees, up 12.4% YoY
    • $26MM of incentive fees, up 25% YoY.  Assuming our base management and franchise fees are accurate, incentive fees would need to be up 55% YoY to hit the mid-point of management guidance. 
  • We estimate timeshare contract sales of $167MM, $267MM of sales and service revenue, and segment results of $27MM.
    • Down payments on sales, net of all incentives for financed timeshare sales need to equate to at least 10% of the purchase price according to GAAP before they can reported in current period revenue. In 2Q timeshare segment results were negatively impacted by a higher percentage of sales not meeting the reportability threshold and therefore ending up as deferred revenue. A good part of those sales should be recognized this quarter.
  • $165MM of G&A, which should trend higher QoQ as 2Q results included several one-time items including reversal of a $5MM loan loss provision and lower than expected workout costs which MAR believe will incur later in the year.  2Q also included $3MM of fees associated with the timeshare spinoff – which will likely also be present in 3Q.
  • $34MM of net interest expenses – same as 2Q and below guidance of $40MM




Notable macro data points, news items, and price action pertaining to the restaurant space.




The latest ICSC index fell 0.2%.  We now have been in a downward trend that has been occurring since late July.  Consumers have not stopped spending, but growth remains only modest.


Alcohol not a panacea for all restaurants - NYT.




Sanderson Farms added to Conviction Buy List at Goldman Sachs






MCD - is reprising its popular traffic-driving Monopoly Game promotion beginning Tuesday at its nearly 14,000 U.S. restaurants - stop on by your local arches and purchase any of the following menu items:

  • Medium Fountain Drinks (2 pieces)
  • McCafe Smoothies (2 pieces)
  • Hash Browns (2 pieces)
  • Big Mac® (4 pieces)
  • 10-piece Chicken McNuggets (2 pieces)
  • Egg McMuffin (2 pieces)
  • Oatmeal (2 pieces)
  • Filet-O-Fish (2 pieces)
  • 20-piece Chicken McNuggets (4 pieces)
  • Large Fries (4 pieces)

According to GRUBGRADE this is the best time of year to buy Hash Browns, as they remain the cheapest way to collect game pieces. The contest will run through October 24th.




DPZ and JACK at the Telsey conference today






DRI - Reports EPS tomorrow


PF Chang's announces departure of COO Richard Tasman at the end of FY11




Howard Penney

Managing Director



Rory Green



The Macau Metro Monitor, September 27, 2011




Senior VP of Human Resources, Seah-Khoo Ee Boon, said the tight job market has made it a challenge for RWS to hire, as it looks to fill about 1,000 vacancies for its new facilities, which will include a maritime museum and aquarium and two hotels.  More than 500 of the vacancies are in RWS' Marine Life Park, which is scheduled to open in 2H 2012.  Seah-Khoo added RWS will remain focused on hiring Singaporeans. 



The three judges at the Court of Appeal, led by Robert Tang, ruled unanimously today that the environmental department won the appeal against a suit filed by Chu Yee Wah over air quality concerns on the construction of the Hong Kong- Macau-Zhuhai bridge.  The Environmental Protection Department welcomes the court’s judgment and will continue to implement every possible policy in place to protect the environment.



The unemployment rate for June-August 2011 was 2.6%, down by 0.1% point over the previous period (May-July) and down by 0.3% point YoY.  The employed population increased by about 3,700 over the previous period to 335,000. 



The gaming industry hired 801 imported employees in August, reaching 7,904 foreign employees.  According to the Human Resources Office (GRH), there were 88,740 non-resident workers in Macau at the end of August, 1,613 more than July.  In addition, the construction sector hired a further 591 non-resident workers to reach a total of 9,352, of which 3,392 were hired by casino developers.  The majority of the new non-resident workers hired last month came from mainland China (1,229), taking the total to 51,347. 


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The Only Wall Street Strategy Note Without the Name Of A 1960s Dance In It This Morning

This note was originally published at 8am on September 22, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“We can never be gods, after all--but we can become something less than human with frightening ease.” 

-N.K. Jemisin, “The Hundred Thousand Kingdoms”


I think we can all be thankful for one thing this morning: we no longer have to talk or joke about “The Twist”.  The current Federal Reserve Board once again proved their incompetence as it relates to managing the monetary affairs of the nation.  Not only did the stock market not twist, or torque (as Morgan Stanley so calls it), it tanked. 


Yesterday actually harkens back to the heady days of 2008 when former Secretary of the Treasury, Hank “The Market Tank” Paulson, would get on T.V. to ostensibly calm the markets and inadvertently talk the Dow down a few hundred handles. 


We’ve said it once, and we’ll say it again, the best action that the Federal Reserve can take is to stop what they are doing.  QE 1 was ineffective, QE 2 was ineffective, and QE 2.5 Twistaroo will not work either. 


As The Economist wrote back in March 2011:


“Operation Twist has long been considered a failure. Early studies found little impact on yields, vindicating those who argued that the price of a security depends only on expectations—of inflation, for example, or monetary policy—not its relative supply.”


Not only did QE1 and QE2 not work, but The Twist itself was tried before in 1961 and deemed a failure.


In case you missed the Fed’s announcement yesterday, or have just decided to tune the Fed out, I’ll explain their intention.  The plan is for the Federal Reserve to buy $400 billion of bonds with maturities of six to 30 years, while at the same time selling an equal amount of debt maturing in three years or less.  These actions will occur between now and next June.


Ostensibly, the intention of such an action would be to narrow the yield curve and bring down long term interest rates.  Undoubtedly the Fed Heads are hoping this will lead to a rash of mortgage refinancing, which will free up cash for consumers to spend.  This idea is cool in the theories of macroeconomic textbooks. . . unfortunately real life is not theoretical.  This action actually has very negative implications for an already tenuous global banking sector.


Simply, a narrowing of the yield curve hurts financial stocks.  The cash flow of financial companies is driven by a funny little critter called net interest margin, or NIM.  Banks borrow short and lend long, and thus collect a spread on the transaction.   As the yield curve naturally narrows, or forcefully narrows by Keynesian intervention, the margins for banks compress. 


Our Financials Team, led by Josh Steiner, actually discussed this very topic a few weeks via a 65+ page in-depth study on the topic (ping if you’d like to trial our Financials vertical and receive access to the deck and Steiner’s team for dialogue).  In the Chart(s) of the Day today, we borrowed two charts from Steiner’s presentation.  The first chart shows that asset yields for the major banks, Bank of America, JP Morgan, Citigroup, and Wells Fargo specifically, track the 10-year yield with a very high correlation.  So, as 10-year yields decline, so too do asset yields for major banks.  In the second chart we show the potential impact on margins.  In short, as we think 2012 earnings estimates for the major banks could get cut in half.


The credit default swap markets for the major banks reacted as we expected yesterday and widened dramatically.  Specifically:

  • Bank of America 5-year CDS widened 11.7% to 372 basis points;
  • Wells Fargo 5-year CDS widened by 12.6% to 142 basis points;
  • Citigroup 5-year CDS widened by 12.5% to 260 basis points;
  • Morgan Stanley 5-year CDS widened by 12.0% to 355 basis points;
  • JP Morgan 5-year CDS widened by 10.6% to 146 basis points.

It’s worth mentioning that Moody’s came out and downgraded the long-term credit ratings of Bank of America and Wells Fargo, citing, “an increased likelihood that the federal government allows a large U.S. bank to collapse.” We’re not so sure how much, if at all, impact this had on the credit markets, given that: a) ratings agencies are lagging indicators and b) the results of allowing a “large U.S. bank to collapse” didn’t go so well the last time (Lehman Bros.).


As indicated by the moves in the CDS markets, the irony is that the Fed’s actions yesterday negatively impacted the creditworthiness of major banks and, no doubt, their willingness to more aggressively extend loans and credit. 


For those of you that aren’t applying for Canadian passports after the Fed’s actions yesterday, we are hosting call at 11am eastern today titled, “What’s Next for the Eurozone?”  Akin to the idea of being the tallest dwarf, the intermediate term future looks increasingly negative for Europe, which on a relative basis actually makes the U.S, in particular the U.S. dollar, look good.


On the call today we are going to spend time going through the history of the European Monetary Union, discuss the lead up to the beginning of the sovereign debt crises, as well as potential outcomes.  A key focus on the call will be on the exposures of the European banking sector to PIIGish sovereign debt.  In some instances, these exposures make subprime look like a speed bump.


We will be sending the presentation and dial in materials for the call to our clients later this morning, but if you are not a client and would like to trial our institutional service then please email our head of sales, Jen Kane, at  Jen recently returned from maternity leave and would love to chat with you.


Keep your head up and stick on the ice,


Daryl G. Jones

Director of Research


The Only Wall Street Strategy Note Without the Name Of A 1960s Dance In It This Morning - 1


The Only Wall Street Strategy Note Without the Name Of A 1960s Dance In It This Morning - 2


The Only Wall Street Strategy Note Without the Name Of A 1960s Dance In It This Morning - Virtual Portfolio

CHART OF THE DAY: Perceived and Actual Risk


CHART OF THE DAY: Perceived and Actual Risk - margin debt

Perceived and Actual Risk

“I am a contrarian in the sense of being willing to take on perceived risk as opposed to actual risk, because the market pays you for taking perceived risk. You may or may not get paid for taking actual risk.”
- Wilbur Ross


Wilbur Ross’s quote above gets to the heart of the question facing markets today. Is the risk in the market actual or only perceived? Well, consider some of the following data points.


Bank of America 5-year credit default swaps traded at 402 bps on Thursday of last week, a new all-time high (then dropped slightly to 382 bps yesterday).  Morgan Stanley’s credit default swaps closed Friday at 440 bps.  21 of the 40 largest European banks now have their swaps trading over 300 bps, 13 of which are trading over 400 bps and 10 of which are trading over 700 bps. A default swap at 300 bps implies approximately a 20% probability of default, 400 bps equates to a default probability around 25%, and 700 bps of annual premium works out to around a 40% default probability.


At the end of the second quarter 2011, Bank of America had $74.8 trillion of gross notional derivatives outstanding, second largest among US banks (JPMorgan leads the pack). Of that $74.8 trillion, $4.1 trillion represents OTC credit derivatives. Morgan Stanley has $56.4 trillion in notional derivatives outstanding, $5.7 trillion of which are OTC credit derivatives.  Of course, the vast majority of these notional derivatives are offset positions that should be effectively hedged (assuming no single large counterparty defaults). 


So what does all this mean? Notional derivatives show the size of a bank's counterparty risk, and cds shows the likelihood a bank will default (according to the market). Together, they give us an idea of the problem we have on our hands.  The market is currently saying that BAC – a bank with $76 trillion of gross derivatives exposure – has roughly a 25% chance of default.  Today, the majority of the systemic risk to the system is coming out of Europe and is likely to be addressed head-on on Thursday at the German Bundestag vote.  The market rallied yesterday amid speculation that the EFSF can lever the 440 billion Euro fund up to 2 trillion Euros.  However, the German courts may not allow the facility to use leverage without first getting additional approvals from the Bundestag.  Stay tuned.


Looking beyond the systemic risk posed by Europe and large bank counterparty exposure, fundamentally, the problems of the US Financials have been on three fronts thus far this year:


-  First, there’s been the ongoing issue of mortgage putbacks and great uncertainty on the part of investors around what the true liabilities are for companies with large mortgage exposures like Bank of America. This explains why tangible book value offers no support to the stock. BAC is currently trading at approximately 50% of tangible book value.


 - Second, systemically important financial institutions (SIFIs) were hit this summer with an aggressively punitive capital surcharge under Basel 3 of 2.5%. This is in addition to existing Tier 1 common requirements of 7.0%. The largest US banks (JPM, BAC, C, WFC) will all be hit by this. This is one of the factors calling into question whether Bank of America needs to raise common equity. For reference, BAC has approximately $115 billion in tier 1 common capital under Basel 3 but needs $171 billion to be fully compliant (a shortfall of roughly $56 billion), though, importantly, they are not required to reach this level of capital until January 1, 2019, which is obviously a long time from now.


 - Third, falling revenues and deteriorating fundamentals are putting the squeeze on the banks’ ability to navigate through these challenges. The newest problem facing the sector is that of declining margins (revenue) hitting simultaneously with rising credit and operating costs. Take Bank of America as an example. In 2Q, the company reported roughly $2 billion in non-cash pre-tax earnings from releasing credit card loan loss reserves through the income statement. For several quarters now, these non-cash pre-tax earnings have been used to offset cash expenses associated with higher mortgage servicing related costs and mortgage putback expenses. The catch is that those credit card reserve release non-cash earnings are about to come to an end for all six of the largest US card issuers (BAC, JPM, C, COF, DFS & AXP). This will occur at the same time that the Fed’s Operation Twist will really start putting the squeeze on bank net interest margins. Earth to the Fed: flattening the long end when banks have no more room to take down funding costs is not going to help bank margins.


None of these issues are going away – or are they?  On Friday there was an interesting story out of Bloomberg talking about the upcoming Basel meeting this week (Tuesday & Wednesday). The Basel Committee on Banking Supervision – the same folks who gave us the 250 bps SIFI surcharge this summer – is now considering the need for changes to those surcharges. Not surprisingly, large lenders in the crosshairs of these new rules feel they’re unfair and would like to see them changed. This is a matter of politics, and we have no real edge on the outcome, but we would point out that a substantial chunk of the 34% downside in the XLF since February 21 of this year can be traced back to SIFI surcharge pronouncements this summer. While it’s hard to precisely deconvolve how much of the selloff is attributable to each of the three factors we itemized earlier, an announcement of capital relief by Basel would trigger a material rally in the Financials. Keep your antennae tuned to this potentially important development.


Finally, on a completely unrelated note, take a look at NYSE margin debt. Margin debt hit its post-2007 peak in April of this year at $320.7 billion. Let’s put things in context. The chart below shows the S&P 500 overlaid against NYSE margin debt going back to 1997. In this chart both the S&P 500 and margin debt have been inflation adjusted (back to 1990 dollar levels), and we’re showing margin debt levels in standard deviations relative to the mean covering the period 1. While this may sound complicated, the message is really quite simple. There are two important takeaways. First, when margin debt gets to 1.5 standard deviations or greater, as it did this past April, that has historically been a signal of extreme risk in the equity market - the last two times it did this the equity market lost half its value in the ensuing period). We flagged this for the first time back in May of this year.


The second point is that margin debt trends tend to exhibit high degrees of autocorrelation. For those unfamiliar, autocorrelation is simply a statistical term that means that trends tend to continue. In other words, the last few month’s change in margin debt is the best predictor of the change we’ll see in the next few months. This is important because it means that margin debt, which has retraced back to +0.64 standard deviations as of August, still has a long way to go. We would need to see it approach -0.5 to -1.0 standard deviations before the trend reversed. We’ve dropped 230 S&P handles in getting from +1.5 standard deviations to +0.64 standard deviations. Bear in mind there’s plenty of room for short/intermediate term reversals within this broader secular move.  That said, this setup represents a material headwind for the market. 


Josh Steiner, CFA
Managing Director


Perceived and Actual Risk - margin debt


Perceived and Actual Risk - porto

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