“I don’t have to be careful, I’ve got a gun.”
It’s only a matter of time before the likes of Jon Stewart and Matt Groening (creator of The Simpsons) start mocking this European Gong Show for what it has become – a gong show.
Groening made his debut in Wet Magazine in 1978 with a cartoon called “Life in Hell.” That might be a better way to describe how a money manager feels about dealing with La Bernank et Le Trichet’s concepts of Keynesian “price stability.” Today’s game of Globally Interconnected Risk is being driven by rumors of Barroso’s Bazooka.
Does Jose Manuel Barroso (President of the European Commission) have a bazooka? What’s the timing on its deployment? Who supports it? Oh the drama…
What we do know is that the IMF, ECB, EU, and Timmy Geithner are working on it, feverishly. These are the said leaders of our lives who are going to centrally plan our way to long-term prosperity. What would we do without them?
On the topic of the bazooka, this is what Geithner had to say yesterday:
“Europe needs a more powerful financial backstop.”
This, of course, comes on the heels of Christine Madeleine Odette Lagarde saying she (or the 187 countries she now represents on behalf of France and The DSK at the IMF) has ze “infinite resources” to print ze ammo for Le Bazooka.
Or is it La Bazooka?
Maman, pardon mon francais, but this is what a Yale education has reduced me to. I’m now just a man with a keyboard and a tweet machine fighting the Socialists of the world who are putting another bailout gun to capitalism’s head.
Back to the Global Macro Grind…
With the SP500 up +4.1% from its Monday closing low of 1099, the pain being felt in the hedge fund community is much greater than that.
You see, if you shorted the immediate-term TRADE oversold bottom (Tuesday morning) of 1078, and you’re staring down the crosshairs of the S&P Futures indicated up another 10 handles this morning, you are feeling the bazooka of the Pain Trade yourself.
Obviously whoever shorted the low instead of seeing it for what it was – a Short Covering Opportunity – does not Occupy Hedgeye as part of their risk management process. Shorting low and covering high isn’t cool.
So what do we do now?
The thing about this Barroso Bazooka is that it’s real. Weeks ago we did a 52-slide presentation outlining what the size of the bazooka could be and we’ll go over this again for clients on our Q4 Macro Themes Call next Friday (email sales@hedgeye if you want in), but here’s our headline math (slide 42):
- 1.25-1.75 TRILLION Euros to Recapitalize European Banks
- 0.75-1.25 TRILLION Euros to Fund Future Deficits
- = 2-3 TRILLION Euro-TARP Bazooka
Now, to be clear, as our Director of Research, Big Alberta, often reminds me – size matters. But there are still some other things about this bazooka to consider:
- Timing – there is no timing. That’s a problem.
- Coordination – to deploy a bazooka that big, herding politicians of the world will be like herding cats.
- Markets – remain real-time. Tick tock.
So… on with our risk management day.
Instead of sending our Senior European analyst, Matt Hedrick, back to France to pose as one of two-eggs-side-by-each on Lagarde’s breakfast meeting plate, the best we can do is let Mr. Macro Market tell us what to do.
The German DAX is breaking out above our immediate-term TRADE line of resistance (5439) again this morning. So the 1stthing we do is don’t short European Equities. Wait and watch.
The 2ndthing we do is watch the Euro/USD currency pair. If the Euro can close above $1.34, then the short squeeze in almost everything inversely-correlated to the US Dollar can continue (EUR/USD drives USD Index). If the Dutch come out intraday and vote down the size of Barosso’s Bazooka (and the Euro fails again at $1.34), there is no support all the way back down to its 2011 lows of $1.29-1.30.
In the end, like you are seeing with US money-center banks post the 2008 Geithner/Paulson TARP1 Bazooka, there will be an end … and piling more short-term debt-upon-debt on insolvent banks and their incompetent political advisors will end badly. Very badly.
But, back to the immediate-term, if you’re not the one with the gun – things can end badly for the pig-headed short seller too.
My immediate-term support and resistance ranged for Gold, Oil, the German DAX, and the SP500 are now $1, $75.86-84.59, 5, and 1099-1172, respectively. On Tuesday morning, I cut our Cash position from 73% down to 67%, taking our asset allocation to US Equities up to 6% (versus 0% at this time last week).
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
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.
- 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)
- $13MM of the increase was attributed to
- 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
- G&A was $5MM higher than we estimated
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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.
- 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.
- 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.
- 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.
- 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.
- 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.
- 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.
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.”
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.
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.
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.”
Daryl G. Jones
Director of Research
(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
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.
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.
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