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Shorting Hong Kong Equities – Trade Update

Conclusion: We are sticking to our guns on the short side of Hong Kong equities.


Late last Friday, we shorted Hong Kong equities in our Virtual Portfolio; this is consistent with the research view we’ve held since 2Q. On May 24th, we formalized our bearish research view of Hong Kong equities in a lengthy note titled, “Hong Kong Is Not Mainland China” (email us if you’d like a copy of the report). The conclusion of the note was as follows:


“The combination of slowing growth, accelerating inflation, and a property bubble that will either pop or continue to be addressed from a policy perspective has us bearish on Hong Kong equities over the intermediate-term TREND.”


That thesis is largely still intact, with the exception that we believe Hong Kong inflation has already peaked for the current cycle – largely due to a +7.9% YoY pop experienced in July as a result of a property subsidy in July ’10. Without such on-off factors, inflation in Hong Kong would have accelerated to +6.3% YoY in July and has since slowed to +5.7% YoY in August. While slowing inflation might prove bullish for most economies in the sense that they can cut interest rates, Hong Kong is in “the box”, with rates already near ZERO percent due to the currency peg with the USD:


Shorting Hong Kong Equities – Trade Update - 1


Even though we expect Hong Kong CPI to continue trending down over the intermediate term, we expect it to remain as sticky as any CPI readings globally form an absolute perspective, given that inflation in Hong Kong is largely being perpetuated by a property price bubble. Hong Kong property prices, up +71% since the start of ’09 and +2.1% above the prior leverage cycle peak just before the Asian Financial crisis (per Centaline Property Agency data), have been driven higher largely by an influx of mainland Chinese buyers looking for healthy inflation adjusted returns amid a crackdown on domestic property speculation. Additionally, the yuan’s +7.2% increase vs. the Hong Kong dollar over time period has indeed made Hong Kong property cheap on an FX-adjusted basis. Burgeoning retail rents (up +27% since the start of ’09, per Collier International) are contributing to supply-side price pressures that we don’t see easing absent a bursting of the world’s most expensive property market – per a recent study by Demographia International that ranks Hong Kong dead last among 325 global property markets with a median house price at 11.4x gross annual median income (nearly double that of New York City’s 6.1x ratio!).


Shorting Hong Kong Equities – Trade Update - 2


Now Hong Kong is in a catch-22 scenario, whereby a property bust could spell disaster for the Hong Kong banking system or allowing the “fun” to continue and put pressure on consumer price inflation – risking an acceleration of this year’s well-attended protests as consumers become increasingly disgruntled with prices as wage growth slows due to waning economic growth. It’s worth highlighting that Hong Kong is among the world’s most sensitive economies to the global economic cycle (exports > 200% of GDP) – a cycle we’ve been appropriately bearish on YTD and continue to be bearish on for the intermediate-term TREND. Manufacturing growth is slowing; export growth is slowing; and the trade balance is compressing at an accelerating rate on a YoY basis:


Shorting Hong Kong Equities – Trade Update - 3


Shorting Hong Kong Equities – Trade Update - 4


A 13yr-low in unemployment (3.2% in Aug) will keep the wheels from completely falling off of the economy, but this story isn’t about consumer demand. No, it’s more about a government that is in “the box” from a policy perspective and must sit idly by as the global economy dictates its growth rate. As such, we anticipate that lower-lows are more than likely on the horizon for Hong Kong economic growth over the intermediate term.


Darius Dale



Shorting Hong Kong Equities – Trade Update - 5


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. 


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 sales@hedgeye.com 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 sales@hedgeye.com.  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

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