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MAR THESIS PLAYING OUT

Can’t control the macro but a strong Q3, solid forward guidance, and aggressive share repurchase keep the thesis intact

 

 

Marriott reported revenue and EBITDA that was 3% above our estimate but slightly below the Street.  EPS exceeded our estimate by 11% and Street estimates by 8% due to their aggressive share buyback in the quarter.  MAR bought back $550 million worth of stock in the quarter.  Given the free cash profile and low valuation, we expect the company will continue to be aggressive on this front.  The macro remains uncertain but long term, MAR remains in the enviable position of a growth company with little capital needs and a management team willing to deploy that cash flow in the most shareholder friendly way.

 

 

Detail:

  • System-wide room growth was in-line with our estimate
  • RevPAR came in better than we expected - partly due to a favorable FX impact
  • Owned, leased, corporate housing and other revenue was $11MM better than we estimated driven by higher branding and termination fees, which also drove higher gross margins of $35MM vs. our estimate of $23MM.  Higher recurring branding fees deserve a high multiple.
    • Branding fees were $12MM better than we estimated or $32MM
    • Termination fees of $8MM were $4MM above our estimate
    • F&B and other revenues were $8MM lower than our estimate but partly offset by better RevPAR ($3MM)
    • CostPAR looks like it increased 3.9% YoY
  • Fee income of $289MM was in-line with their guidance and $6MM better than we estimated
    • 50% of the better fee performance was due to higher incentive fees, while the balance was due to better RevPAR performance
  • Despite contract sales beating the high end of MAR’s guidance, timeshare segment profits came in $5MM below our estimate
    • Contract sales were 7% above our estimate, entirely due to a spike in JV sales
    • Sales and service revenue net of direct expenses came in at $36MM vs. guidance of $40-45MM
  • Other stuff:
    • G&A was $5MM higher than we estimated
      • $13MM of the increase was attributed to
        • $8MM of spin-off related expenses
        • $5MM related to the increase of a guarantee reserve for one hotel and the write-off of deferred contract acquisition costs.
      • Offset by $6MM of lower legal expenses (should be sustainable)
    • Net interest expense was $2MM higher than we estimated but $3MM below company guidance
    • Equity earnings were $3MM higher than our estimate and guidance
    • Tax rate came in at 32% vs our estimate of 34%
    • Diluted share count was 9MM lower than we estimated to a much more aggressive buyback

WEN LOOKS GOOD BUT WILL TAKE TIME

Wendy’s hosted a lunch in New York yesterday with the new president and Chief Executive Officer Emil Brolick.

 

Yesterday's lunch with Emil Brolick focused on the plan for Wendy’s going forward and Mr. Brolick’s general vision for the brand at this early stage in his second phase at the company.  We are impressed with Mr. Brolick’s knowledge of the broader industry and Wendy’s in particular, especially given the role he played in Wendy’s during the 1990’s, often working directly with founder Dave Thomas.  Below are some takeaways from the meeting that we think are valuable.

  1. ASSET BASE IS AN ISSUE - The asset base being reimaged is a key focus that franchisees and management agree needs to be addressed.  However, it seems that we are still two years from this becoming a reality and MCD and other competitors opening new/reimaged stores is a negative for Wendy’s.   Brolick noted the importance of improving the line-of-sight that customers have in the renovated restaurants as one of the many features of reimaging that is additive to the customer experience and, therefore, sales growth.
  2. BREAKFAST IS STILL NOT WORKING - Breakfast remains a key component of the company’s plan to achieve its long-term goal of 10-15% EBITDA growth.  Management is aiming to roll out breakfast to 1,000 stores by the end of 2011 (currently in roughly 300) and Brolick emphasized that feedback on the breakfast menu has been positive.  The goal for breakfast is to drive it to a level where incremental average weekly sales are between $150,000 to $160,000 and, Brolick says, “we’re close”.  San Antonio remains disappointing.  
  3. FOOD INFLATION - Food inflation remains a concern for the company.  Beef is the largest component of WEN’s commodity basket and, because of Wendy’s commitment to using fresh beef rather than frozen, the inflation currently in the price of beef is impacting margins.  Brolick also highlighted a new pricing model the company has been using that focuses on sales, traffic and profits to enable management to make prudent decisions on pricing that do not hamper profit growth. 
  4. A NEW MARKETING MESSAGE IS NEEDED - While Brolick has not been on board long, we got the impression that there is a desire to step up the marketing focus at the firm.  This is not a new thought; in January at the Analyst/Investor Day, new commercials were shown emphasizing a return to the roots of the chain.  However, Brolick said that the company was searching for a Chief Marketing Officer currently.  Brolick’s time as CEO is just getting started, but this statement, as well as his repeated highlighting of the importance of people, implies that he is looking at every level of the company for possible areas of improvement.  For instance, he noted that service in the restaurant at off-peak times was not as strong as it needed to be.
  5. CAPITAL - The company continues to commit capital to new unit growth as well as the other sales driving initiatives and stock buybacks.  We believe that fixing the restaurant and core products remains the key ingredients to the WEN turnaround; the more time that slips by, the further behind competitors the company falls. 
  6. SUMMARY - Lastly, we continue to like WEN on the long side but believe that the process of turning the company around will take time.  Having Emil Brolick at the helm is, in our view, good for the company and we are bullish on the stock on a TAIL duration (3 years or less) but despite the “cheap” valuation, would not be a buyer of the stock until the reimaging program looks more secure.  However, the short-term TRADE (3 weeks or less) remains negative.

 

Howard Penney

Managing Director

 

Rory Green

Analyst


This Isn’t Herman Cain’s First Rodeo (Though It Could Be Rick Perry’s Last)

Conclusion: Increasingly, even despite a last minute flurry by Herman Cain, it is looking like Mitt Romney will be the Republican nominee for President. 

 

“My father gave me pride.  He was the best damn chauffeur. He knew it and everybody else knew it.”

-Herman Cain

 

As we noted a few weeks ago, the Republican primary debates would be critical for Texas Governor Rick Perry.  Unfortunately for Perry and his supporters, the debates were critical and Perry soundly disappointed expectations.  In discussions with certain conservative operatives, we were advised that the Governor’s performance was, by their view, so dismal that calls for New Jersey Governor Christie to enter the race have been renewed with some vigor.

 

According to InTrade, former Massachusetts Governor Mitt Romney’s odds of gaining the Republican nomination have reached an all-time high of 56%.  At the same time, Perry’s odds have declined to below 20% on InTrade.  Recall just a few weeks ago, Perry was leading Romney with a close to 40% probability of winning the nomination. 

 

This Isn’t Herman Cain’s First Rodeo (Though It Could Be Rick Perry’s Last) - 1

 

In more traditional polls, Romney has also now gained the lead as outlined in the chart below from the Real Clear Politics aggregate. The trend is not Perry’s friend, though it does appear to be Herman Cain’s friend as he has gained substantial ground in the last couple of weeks.

 

This Isn’t Herman Cain’s First Rodeo (Though It Could Be Rick Perry’s Last) - 2

 

In the recent debates, Perry not only disappointed, but his performance has also initiated serious questions amongst pundits and Republican faithful as to whether he has the appropriate qualities to be President.  As William Kristol wrote shortly after the third debate:

 

“But no front-runner in a presidential field has ever, we imagine, had as weak a showing as Rick Perry. It was close to a disqualifying two hours for him.”

 

Amongst conservatives, the core of the concern following the debates was Perry’s comments regarding illegal immigration.  At one point, Perry indicated that critics of a Texas policy that allowed children of illegal immigrants to pay in-state tuition at state universities did not “have a heart”.  A stance that is, of course, juxtaposed versus the strong immigration stance of much of the Republican base.

 

In terms of his more broad Presidential appeal the concern has been related to Perry’s foreign policy views, or lack thereof.  When asked in the last debate how he would respond to a 3am phone call that Pakistani nuclear weapons had fallen into the hands of the Taliban, he gave the following meandering response:

 

“Well, obviously before you ever get to that point, you have to build a relationship in that region.  That’s one of the things that this administration has not done.  Just yesterday, we found out through Admiral Millen that Haqqani has been involved with, and that’s a terrorist group, directly associated with the Pakistani country.  To have a relationship with India, to make sure that India knows it is an ally of the United States.  For instance, when we had the opportunity to sell India the upgrade F-16s, we chose not to do that.”

 

As mentioned, Perry’s mistakes have opened the door for Herman Cain to establish himself as a legitimate contender versus Mitt Romney.  Despite his late emergence in this race, on paper Cain has some Presidential worthy characteristics.  His life story, as outlined by the quote at the outset, is a heart grabbing “made in America” narrative.  Cain had a very humble upbringing and rose above any disadvantages of either race or poverty to become highly successful in the business world.

 

The bulk of Cain’s business career was in the restaurant industry in which, over the course of two decades, he turned around the struggling Philadelphia region for Burger King and then was appointed the CEO of Godfather’s Pizza by parent company Pillsbury.  Cain went on to lead a management buyout of Godfather’s in 1988 and remained CEO for 8 years before leaving to become CEO of the National Restaurant Association.

 

In 1992, he was appointed to the Board of Directors of the Federal Reserve Bank of Kansas City, so is a rare Presidential candidate that has experience within the Federal Reserve system.  Cain has also been actively involved in politics for the last 15 years or so as an advisor to a number of campaigns and as a candidate himself.  First, Cain briefly ran for President in 2000 and eventually endorsed Steve Forbes.  Second, Cain ran for the U.S. Senate in Georgia in 2004, but lost in a landslide in the primary to Congressman Isakson.

 

In the current race for the Republican nomination, Cain has quickly gone from being a long shot candidate to being considered a serious candidate.  This has occurred on the back of a number of straw poll victories, including Illinois, Florida, and at the National Federation of Republican Women.  The Florida poll, in particular, has led to an increased status for Cain as he finished with 37 percent of the vote, while Perry trailed with 15 percent and Mitt Romney followed with 14 percent.

 

Realistically, though, it is going to be almost impossible for Cain to catch Romney at this juncture.  Romney has a massive campaign finance advantage, a massive organizational advantage, and has hit his stride in terms of executing on the campaign strategy.  The question as always is whether Romney is developing an emotional bond with potential primary voters and even if the answer is “no” to that, voters may be looking beyond Romney’s likability factor finally as the InTrade contracts appear to be pricing in.

 

David Brooks of the New York Times wrote the following early yesterday:

 

“It’s exciting to have charismatic leaders. But often the best leaders in business, in government and in life are not glittering saviors. They are professionals you hire to get a job done. The strongest case for Romney is that he’s nobody’s idea of a savior.”

 

Indeed.

 

Daryl G. Jones

Director of Research


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Retail: Shifting Into The Danger Zone

 

(Note: This post includes the industry SIGMA, which was not included previously - otherwise unchanged)

 

With the Q2 Retail earnings season now in the books, let’s revisit the industry’s financial health. Following our mid-earnings update, the 2H shaped up considerably different than the first. Results started off good overall and remained that way through the quarter. The notable change however, was the positive turn in sales/inventory trajectory.

 

After starting the quarter down -25% reflecting continued deterioration, the industry finished with a sales/inventory spread down only -11% marking the first quarter in the last five to show sequential improvement. The delta was driven primarily by footwear and sporting goods retailers (FL, FINL, DKS, HIBB, DSW, GCO) as well as a few notable apparel companies (GES, LTD, and ANF) that posted a positive sales/inventory spread reflecting cleaner inventory levels in the athletic channel relative to the industry more so than stronger top-line growth.

 

This doesn’t change the fact that the consolidated SIGMA for the apparel/footwear supply chain remains squarely in the lower left quadrant with inventory growth outpacing sales growth and margins contracting. To some extent, it’s needed for the industry to catch up on 3+ years of unsustainably low inventory levels. But the fact remains that Gross Margins are near peak for the space. Also, we’re facing a dynamic where the better companies ordered 10% fewer units and have realized close to 10% higher prices. Coupled with a sharp decline in cotton prices, we think there’s a high likelihood of a false sense of security across the industry that will compel companies to order up for next season – not good.

 

Shorts: JCP, UA, HBI, SHLD

Longs: LIZ, NKE, RL, TGT

 

Retail: Shifting Into The Danger Zone - Ind SIGMA Q2 9 11

 

The sales trajectory setup for the space is unchanged, Q1 through Q3 of last year grew steadily between 8-10%, but then in the three quarters since, we have seen a definite step-up. While the yy change has only been by roughly 200bps, the underlying 2-Yr trend has increased from sub 2% to 4% in Q3 last year before jumping up to 9-11% over each of the last three quarters. This would be less concerning if inventories were tight and margin compares easy, but that’s not the case.

 

Retail: Shifting Into The Danger Zone - Ind SIGMA PODs 9 11

 

Not surprisingly, with sales slowing and margins tightening, we’ve seen the industry shift from the top-left quadrant where 52% of the industry was this time last year (sales/inv spread positive margins expanding), to the lower left quadrant otherwise referred to as the “Danger Zone” where 37% of the industry players we track are now (negative sales/inv spread margins contracting). This move has still not been fully reflected in the stocks leaving an notable overhang on the industry. In addition, with Q3 earning season setting up to be the worst in worst in 2-years, we see further downside near-term for retail stocks. We’ll get the latest read on this reality when retailers report September sales tomorrow.

 

Retail: Shifting Into The Danger Zone - Ind Sig Quads Q2 9 11

 

 


Occupy Hedgeye: SP500 Levels, Refreshed

POSITION: Long Utilities (XLU)

 

Keith is on the road today in beautiful Kansas City, but, as always, the global macro grind goes on back at Hedgeye Headquarters in New Haven, CT.  The short covering opportunity we called for yesterday is further manifesting itself today with the SP500 up +0.8% to 1,129.  Our “Trade the Range” mantra continues, as we are seeing higher-lows of immediate-term TRADE support and lower-highs of intermediate-term TREND resistance. The current TRADE range is 1,093 to 1,139.

 

In the last couple of days, the global macro news has been better than bad, but we should be clear, our fundamental concerns have not changed. In that vein, an interesting new negative catalyst that is emerging is the “Occupy Wall Street” protests.  The most recent rumor suggests that group may attempt to erase the NYSE from the internet on October 10th.  We aren’t exactly sure what that means, but it is potentially a leading indicator for this group to disrupt financial markets, or at least attempt to do so.

 

Aside from the opportunity to cover shorts, make no mistake about it though, the SP500 remains broken on both a TREND and TAIL basis with those resistance lines up at 1,237 and 1,266, respectively.  In fact, according to some recent analysis from Ned Davis:

 

“The average bear since 1900 has lasted 410 days and seen a decline in the major averages of -31.5%. So far, the 2011 version has lasted 158 days and the decline just under -20%. To reach the average, the DJIA would have to fall to 8,775.”

 

It is unlikely this bear is done growling.  Trade the range.

 

Daryl G. Jones

Director of Research

 

Occupy Hedgeye: SP500 Levels, Refreshed - SPX


MAR YOUTUBE

In preparation for MAR's 3Q earnings release tonight, we’ve put together pertinent forward looking company commentary from its 2Q earnings call.

 

 

2Q YOUTUBE

  • “Transient business is back in a big way. The 2011 transient occupancy rate for the Marriott brand increased 3.5% points, reaching 2007 peak transient occupancy levels this quarter"
  • [Internationally] “We opened over 32,000 rooms in the last 12 months, roughly a 4.5% net unit growth rate”
  • “Our development pipeline increased to more than 100,000 rooms with nearly 40% of our rooms in the full-service pipeline in China and India”
  • “YTD, we have returned over $700mm in share repurchases and dividends to shareholders, and we remain committed to do more”
  • Timeshare sales and services net was about $0.02 lower than expected, largely due to reportability. We expect about half of this shortfall will turn around later this year and the remainder next year.”
  • “G&A was about $0.02 better than expected due to several non-routine items including reversal of an earlier loan loss provision… largely due to $5mm reversal of a loan loss provision and lower than expected workout costs which we now believe will occur later in the year"
  • “Approximately 5% of our domestic system-wide rooms are located in the Greater Washington, D.C. market, considerably higher than the industry’s concentration. In 2010, approximately 6% of our worldwide fee revenue came from this market and 13% of our incentive fee.”
  • “Across North America, second quarter Group REVPAR at the Marriott brand increased 2% YoY”
  • “Group bookings made in Q2 for later in 2011 increased 18% and long-term group bookings are returning. In Q2, we booked business for 2012 that was 19% higher than the prior year and booked business for 2013 that was 13% higher… Nearly a quarter of the group business booked in our second quarter were for the years 2014 and beyond”
  • “With good cost controls, we expect domestic house profit margins to increase 100 to 125bps and international margins to increase roughly 150BPS for the full year and that’s excluding the impact of the Middle East and Japan”
  • “Incentive fee growth YoY was constrained by modestly lower incentive fees in the DC market and declines in incentive fees at hotels in the Middle East.”
  • “Our owned and leased profits declined $2mm due to lower hotel termination fees YoY and lower results at our leased hotels in Tokyo”
  • “Timeshare sales and services net declined due to lower interest income and to a lesser extent, higher product costs.  Compared to our expectations, lower timeshare sales and services net reflected higher sales and marketing costs as well as delays in revenue recognition associated with certain special promotions”
  • “Our international REVPAR growth, even excluding the Middle East, is likely to slow a bit in Q3 from Q2 pace. The 2010 World Expo will be a tough comp for our Shanghai hotels later this year.  REVPAR growth in Europe is expected to moderate in H2 due to the timing of this year’s fairs in Germany as well as tougher comparables.”
  • Guidance:
    • Q3 International system-wide REVPAR: 6% to 8% (ex Middle East and Japan)
    • FY11 International system-wide REVPAR: 7% to 9% (ex Middle East and Japan)
    • Q3 NA system-wide REVPAR: 5% to 7% due to a higher leisure mix
    • FY11 NA system-wide REVPAR: 6% to 8%
    • 3Q Timeshare contract sales: slightly up YoY
    • 3Q Timeshare segment results: $25-30MM
    • FY11 Timeshare contract sales: slightly down YoY
    • FY11 Timeshare segment results: $140-150MM
    • FY11 Timeshare sales and services revenue, net: $205-$215MM
    • FY11 G&A expense: +6% to 8% over adjusted levels in the prior year (which includes $5MM in transaction costs) 
    • FY11 EPS: +17% to 24%
    • FY11: EBITDA will climb 9% to 13% compared to last year’s adjusted amount
    • FY11: $500-$700MM of investment spend; including $50-100MM of maintenance spend
  • “We expect to remain aggressive given our recent stock price and substantial investment capacity”
  • [Timeshare Spinoff] “We also believe we can generate cash flow over time from the sale of excess assets including some very attractive beachfront real estate.  We expect to generate meaningful amounts of FCF for the foreseeable future. As our inventory declines over time, we intend to pursue asset light expansion opportunities. We also expect to be able to develop new resorts, buy distressed inventory, or enter into turnkey projects with third-party developers”
  • “Cash tax benefits to be several hundred million dollars; and just to clarify, that’s cash taxes. We’ve benefited those over the years. But this is inherently triggering those taxes as part of the spin. And a good portion of those will be recognized currently or be benefited currently at the date of the spin with the rest carried forward over the next several years”
  • [Japan]:”We’re seeing occupancy build, but we expect that even in Q4, we will be on average 20% to 30% REVPAR down from Q4 2010.”
  • “That wholesale business is not likely to come back with significance until there has been sustained stability in that market. We haven’t seen that yet and so we would both expect in the guidance that we’ve given and as a predictive matter that Egypt is probably a 12 to 18 month recovery story.”
  • “Jordan is not as bad as Egypt and in many respects is more stable. But generally, I think implicit in our guidance is a pretty slow recovery for the region as a whole”
  • “If anything, we’ve been very heartened by the strength of leisure business. Now, let’s back up and state the obvious: leisure travel is more price-sensitive than business travel. Notwithstanding that, I think most of the leisure business which is driven in our hotels is probably coming out of the higher wealth demographic. As a consequence, the persistent high unemployment, the weakness in the construction trades and the like is probably less relevant currently to what we’re seeing in leisure demand. But leisure demand is going to be more influenced by pricing and by consumer sentiment and those sorts of things. And as a consequence, we see it to be a little bit weaker but still pretty healthy on a y-over-y basis and are quite gratified by what we’ve seen so far.”
  • [Group bookings in] “Q2 were up anywhere from roughly 15% to roughly 20% depending on whether you’re looking at bookings for Q3 or Q4 or 2012 or 2013”
  • “Our incentive fee…increased without the DC, Middle East or Japan.  Incentive fees would have been up almost 22% in Q2. So you could see the effect that that had on percentage that we ended up reporting at 9%.”
  • “$30mm to $35mm is the total fees out of the Middle East last year.”
  • “Marriott brand is bigger than most of the full service brands. So we tend to have more suburban hotels; we’re probably going to tend to have more secondary market hotels. I know among our markets where we have disproportionate market share, we’ve got Detroit, we’ve got Atlanta, and we’ve got Washington DC.”

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