“How soon ‘not now’ becomes never.”
Don’t worry, I’m not going to go off on the Protestant Reformation of 16thcentury Europe this morning. I’m going to give some much simpler advice re: chasing any asset price higher today – Not Now. Most things will get marked-up into month-end.
That’s not to say I didn’t think yesterday at 9:51 AM wasn’t a good time to buy. With the SP500 testing 1301 (down 32 points, or -2.4% from last Thursday morning’s 1333 high), that’s where I bought Energy (XLE), taking my Cash position down from 91% to 85% and taking up my US Equity position in the Hedgeye Asset Allocation Model from 0% to 6%.
Some people get all fired-up about this whole TimeStamping thing we do. It’s really nothing to get emotional about. It’s just what we do. We like to make calls and be held accountable to the timing of those calls. We call it the score.
Back to the Global Macro Grind…
These German dudes and dudettes have to be right fired-up this morning. In the face of the entire world begging them to bail out the dysfunctional; and after watching the American media chastise them for not being able to do the “right thing” – they just kept saying Not Now to just about everyone who no longer needs Luther’s Latin translation for the word never.
How is the economic model of German fiscal conservatism scoring? Here it is, head-to-head, versus Italy:
- Germany Unemployment = 6.7% JAN vs 6.8% DEC = 20-year low
- Italy Unemployment = 8.9% JAN vs 8.8% DEC = 8-year high
What’s in your wallet?
Again and again and again, we’ve tried to remind our audience that the strength of a country is not explicitly reflected by the daily moves of her stock market. Ask the Germans who lived through a 1920s stock market hyper-inflation about that.
If you don’t have a policy to fear-monger your citizenry into believing that saving is evil, you might just build a national confidence and pride that reflexively equates to more stable employment and consumption.
In the US, we’re getting closer to figuring this out. Or are we? Romney’s monetarily conservative message seems to be picking up some momentum in Florida and, at the same time, it still looks like President Obama can change fiscally.
Yes We Can. But will he?
Instead of being politically polarized by the debate, I think the world’s vote on this will continue to be on the tape each and every day, ticking, via the sequential momentum in the US Dollar Index.
If you haven’t noticed, in the last few weeks, the US Dollar has lost a statistically significant amount of momentum:
- US Dollar Index = down -3.1% since its intermediate-term top of $81.53 in mid-January 2012
- US Dollar Index = up +8.2% since testing a 40-year low during the thralls of Qe2’s policy to inflate (April 2011)
To be crystal clear on this, the correlation to asset prices between the US Dollar Index and everything else in Global Macro right now is unclear.
In sharp contrast to April 2011, when the inverse correlation between US stocks and the USD was tracking in the -0.8-0.9 range, today’s 120-day correlation is actually a positive +0.44 and US Equity Volatility (VIX) has an inverse correlation to USD of -0.59.
In other words, before The Bernank Tax last week, the Fed was out of the way and we saw a stabilization/strengthening of the US Dollar over the course of the last 3-6 months that:
A) firmed up US Confidence, Employment, and Consumption (71% of GDP)
B) started to tone down one of the biggest risks to returns in any business – expected price volatility
American Progress by simply having Bernanke and Geithner out of the way – fancy that. Americans were/are getting it done without the heavy hand of government help. No matter what your politics, that’s just good.
What would not be good for the US economy or stock market (again, two very different things) would be a breakdown in the US Dollar Index of $78.03 intermediate-term TREND support and a breakout in US Equity Volatility (VIX) above TRADE line resistance of 20.86. That would really fire up the price of oil. Copper is already up +12.5% YTD!
Not Good. Not Now.
As you can see in the long-term chart of US Stocks (SPX) vs Equity Volatility (VIX):
- The SP500 is making a series of lower long-term highs
- The VIX is making a series of higher long-term lows
The charts look Japanese because the long-term Bush/Obama Keynesian Policies have been. That chart also summarizes the societal American Zeitgeist about markets and the central planners infecting them.
Is President Obama prepared to tell Ben Bernanke to get out of the way and let American Savers earn a rate of return on their fixed incomes? Not Now. While hope is not a risk management process, I can only pray that doesn’t mean never.
My immediate-term support and resistance ranges for Gold, Oil (Brent), EUR/USD, US Dollar Index, German DAX, and the SP500 are now $1, $110.61-111.89, $1.30-1.32, $78.70-79.75, 6, and 1, respectively.
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
Wendy’s’ stock has flat-lined for over three years and, after today’s presentation, we have become less positive on the next three years. Its going to be an uphill battle for WEN to hit its long-term target of high-single- or double-digit EBITDA growth over that period.
TRADE: While the new burgers continue to help lift same-store sales trends, the combination of beef inflation and lower long-term guidance limits the current upside.
TREND: We are cautious on this duration as rival brands continue to execute on their own remodel strategy. CEO Emil Brolick has admitted that, while menu innovation is important, the full benefit won’t come through until the asset base is upgraded.
TAIL: More than $3.7 billion is required to the Wendy's asset base, according to management. That's the figure needed to carry out an "Image Activation" at the 70% of the Wendy's system that is earmarked for extensive remodeling. The company's market cap is $1.99 billion. Its 2011 revenue came in at $2.43 billion. We do not have a view on the TAIL because there is a lot of uncertainty as to how the remodels will test. The math does not inspire much confidence.
The first question anyone need to ask is where is that money going to come from and when will the capital start to flow?
Coming into today’s presentation, we were of the opinion that WEN was facing a difficult environment over the TRADE (three weeks or less) and TREND (three months or more) durations. Over the longer-term TAIL, we expressed a positive view on WEN, giving the company the benefit of the doubt pending lessons to be learned as remodel testing initiative is undertaken over the next six months or so.
Currently, as we wrote above, we don’t have a view on Wendy’s over the TAIL duration, but remain bearish on the TRADE and TREND. Wendy’s is behind the curve in the QSR space and requires a staggering amount capital investment to right itself.
Our thoughts on the Wendy’s presentation today can be boiled down to three key points. 1) In order to fix the asset base and make the concept competitive with category leaders, more than $3.7 billion will have to be spent. 2) The company effectively admitted that its older stores are substandard and are hindering any improvement in consumers’ perception of the Wendy’s brand. 3) Even if they current strategy that the company is testing is the correct one – and it may not be – it will be difficult to persuade franchisees to go along with the level of investment required to turn the brand around.
The table below shows the $3.7 billion and our calculation of that number. It should be noted that the total remodeling program will cost much more as that calculation only includes the 70% of Wendy’s restaurants that require “Image Activation”. Some additional stores require less extensive refreshing.
The question of where $3.7 billion is going to come from is especially bearish for WEN on the TAIL duration. We would not be a buyer of this stock today. While WEN endures this prolonged period of high capital spending, competitors will continue to proceed with already-well-underway remodeling programs that should, in our view, make the competitive environment for Wendy’s difficult.
The company’s “Recipe to Win” is based on four reimaging the restaurants, people, experience, and the food. Our main issue with this presentation is that the cost of this recipe, $3.7 billion, is going to significantly limit the earnings power of the company for a number of years.
ASSET BASE: The company has just over 6,200 restaurants in North America. The substandard condition of the units, relative to the competition, is hampering progress. The company estimates that a sales life of 25% will result from remodels. We would wait for that to be proven out and highly doubt, given the level of spending that the turnaround is going to require, that any upside will be missed from waiting on the sidelines. At this point, the anecdote of customers saying “this can’t be Wendy’s” in the remodeled stores is not a positive.
EBITDA: Management did lower the bar on guidance, as we had suspected it would, bringing long-term EBITDA growth expectations down to high-single-digits from the prior 10-15% range. We do not believe that high-single-digit EBITDA growth will happen for Wendy’s for at least three years.
SSS: The company is guiding to comps of 2-3% for this year. This almost doesn’t matter given the massive capital that the company is now if need of to turn the brand around. Over the longer term, management believes that an enhanced pricing strategy and marketing approach will help drive the top line.
BREAKFAST: No timeline was attached to the comments on breakfast. This has been a difficult ask for Wendy’s operators given the real estate challenges and the dominance of McDonald’s in this daypart. McDonald’s buying up billboards in test markets doesn’t help either.
COGS: Guiding to 4-5% basket inflation for ’12. Beef makes up ~20% of food and paper spend. The company is planning to offset by menu mix.
TAX RATE: The tax rate is expected to be between 40% and 42% this year.
The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.
LONG SIGNALS 80.52%
SHORT SIGNALS 78.68%
He Won’t Be Retiring In Florida
Conclusion: Romney is going to win Florida, but it is increasingly looking like Gingrich will battle Romney all the way to the Republican convention. We believe this puts a Democrat sweep very much on the table.
In the second half of October and early November last year, the Republican nominating process looked like all but a coronation for former Massachusetts Governor Mitt Romney. The contract on InTrade that calculated whether he would become the next nominee was trading at over a 70% probability after never trading above 40% prior to October 2011. By mid-November both Rick Perry and Herman Cain, who for short period of times led national polls, had completely flamed out. Then, of course, along came Newt Gingrich with his benefactor Sheldon Adelson.
The chart below from Real Clear Politics highlights the poll averages over the last year from the Republican field. Specific to Gingrich, the chart shows that for much of the race he was a non-factor, running as far back as sixth place. Slowly on the back of solid debate performances and the failures of Cain and Perry, Gingrich gained momentum as the right wing of the Republican Party coalesced around him. On December 13, 2011, Gingrich had the most commanding lead of the race with 35.0% of those polled supporting him versus only 22.3% for Romney. Since then, Gingrich’s polling has fluctuated dramatically. In the course of six weeks since December 13th, Gingrich’s polls have been characterized by volatility, reaching as low as 16.2% on January 16th and as high as 31.3% on January 27th.
Romney, on the other hand, has been the embodiment of controlled stability in the polls. Although he peaked at 31.2% in early January, his poll numbers have largely ranged between 20% and 25% since late July. It seems the Republican Party likes him, but not enough to enable him to land the knock-out blow and clinch the nomination, despite his superior organization and fundraising. The fundraising point has been critical to Romney turning the tide in Florida. As of Friday, Romney and his super PAC had spent $15.3 million in Florida buying media spots versus $3.4 million for Gingrich.
This spending, most of which has come in the last couple of weeks, has had a meaningful impact. In the chart below, we show the last seven days of the InTrade contract on whether Romney will win Florida. It has gone from ~40% to just under 95% in that period. This is also reflected in Florida-specific polls, as Romney has won in the last 14 Florida polls going back to January 22nd and currently holds an 11.5 point lead over Gingrich on the Real Clear Politics poll aggregate. Given the Florida primary is tomorrow, it is unlikely that anything will shake Romney’s sizeable lead.
Despite a likely loss by a wide margin in Florida, Gingrich has made one point very clear: he won’t be retiring his candidacy in Florida. In fact he stated to Politico this weekend, “I will go all the way to the convention. I expect to win the nomination.”
On some level, Gingrich appears to be adopting the Reagan strategy of 1976 when Reagan lost a number of early primaries, but won North Carolina, which shifted the momentum. In the end, Reagan lost by a handful of votes at the convention to Gerald Ford despite limited cash and a lack of establishment support. Following this tight loss, Reagan was lauded by conservatives for his efforts to push the Republican Party to the right.
The Gingrich camp is clearly trying to establish themselves as the conservative and right wing alternative to, as they call Romney, the “Massachusetts Moderate.” On some level, this position is working as Gingrich has repeatedly associated himself with Reagan and has seen his standing in national polls increase as more conservative candidates, like Cain and Perry, have exited the race. In fact, this weekend Gingrich actually received the tacit endorsement of conservative and Tea Party standard bearer Sarah Palin who said the following on Fox this weekend:
“We need somebody who is engaged in sudden and relentless reform and is not afraid to shake up the establishment. So, if for no other reason, rage against the machine, vote for Newt, annoy a liberal, vote Newt, keep this vetting process going, keep the debate going.”
In South Carolina, the exit polls showed very clearly that Gingrich is attracting the more conservative vote in the Republican primaries. In the ideology category of the South Carolina exit polls, Gingrich received 48% of the very conservative vote (which was 36% of the entire vote) versus 19% for Romney. In the same category, Santorum received 23% of the vote. Assuming that Santorum’s very conservative voters were split between Gingrich and Romney based on the 48% to 19% split it would have widened Gingrich’s victory by roughly 3.6%.
In the more broadly defined ideology breakdown of conservative versus liberal, which is represented by 68% and 32%, respectively, of those exit polled in Florida, Gingrich received 45% of the vote versus 23% for Romney and 19% for Santorum. Doing the same math as above, assuming a Gingrich and Romney split of Santorum’s votes, equates to an additional 2.7% margin for Gingrich based on those that define themselves as conservative.
Clearly, the combination of support from the Tea Party right and the actually internals from recent exit polls support Gingrich staying in this race, even if he loses by a wide margin in Florida. As well, a key strategic distinction that Gingrich has versus Reagan in 1976 may be money. Or at least the money of casino mogul Sheldon Adelson, who has an estimated net worth north of $20 billion and has already donated $10 million to Gingrich’s Super Pac. To the extent he wants to do so, Adelson certainly has the ability to keep Gingrich in the race.
So, what does the likelihood of an extended and bloody battle for the Republican nomination for the Presidency mean for the Republicans? Well, it seems to be conventional wisdom that it is not a good thing, and we tend to agree. Assuming Gingrich stays in the race to the bitter end, this could be an epic battle between the right wing and the moderate wing of the Republican Party, with the two candidates both likely to suffer ongoing and negative attacks from the other. This constant and negative barrage won’t be good for the candidates, or the Republican Party itself.
On the first point, President Obama has started to poll better compared to both Gingrich and Romney than he has in the last six months. In the most recent Rasmussen poll, Obama is up on Romney by +6 points and up on Gingrich by an astounding +17 points. Moreover, in the generic congressional polls, the Democrats for the first time in over a year are widening the gap from the Republicans, which we’ve highlighted in the chart below. Currently, the Democrats have an advantage of 44.0 to 42.2 versus the Republicans, for an advantage of +1.8. This is a stark contrast to their shellacking in the 2010 mid-terms.
The one election alternative that few pundits are considering currently is a Democratic sweep of the Presidency and both Houses of Congress. In an extended war between Gingrich and Romney, this scenario could be squarely on the table.
Daryl G. Jones
Director of Research
Positions in Europe: Short EUR-USD (FXE)
As a follow-on to our note today titled “European Banking Monitor and EUR/USD Update”, here we include that the ECB's secondary sovereign bond purchasing program (SMP) bought a mere €63 Million in the week ended 1/27 versus €2.243 Billion in the week ended 1/20 to take the total program to €219.0 Billion. This light figure comes as a surprise, especially given the relatively strong bond auctions last week, particularly from the periphery.
Q4 lukewarm but 2012 should be HOT.
HOT’s headline number should beat consensus when they report Q4 on Thursday. The benefit from the sale of the Bal Harbour units will boost Q4 EBITDA as Starwood should have started booking in the quarter. Excluding the Bal Harbour units, the ‘clean EBITDA’ number could be on the lower end of company guidance and a little below consensus of $279MM. However, any slight miss would be due to USD strength, offset by stronger North American RevPAR trends.
International exposure which has been a tailwind for Starwood these last 2 years turned into a headwind this last quarter. Since HOT reported 3Q results on October 27th the Euro has depreciated by 7.4% vs. the dollar and the dollar index has strengthened 4.4%. While HOT hedges roughly 50% of the Euro exposure, it still maintains plenty of exposure to other currencies. Every 1% move in FX impacts EBITDA by $4MM.
Given the healthy trends in NA RevPAR, we’ve been positive on the lodging space since late August (see “IT’S NOT THE ECONOMY, STUPID” 08/25/2011). However, given HOT’s heavy international and European exposure, we have preferred to express our positive thesis on lodging through MAR, which now derives almost all of its EBITDA from higher multiple fees.
We estimate $285MM of EBITDA and EPS of $0.61, inclusive of Bal Harbour sales.
We model owned, leased and consolidated JV revenues of $440MM and margins of 19.2%
- $281MM of room revenue, up 0.5% YoY
- Room count should be down 8% YoY as a result of asset sales
- We estimate non-same store RevPAR of $157.62
- $159MM of F&B revenue, down 11%
- CostPAR of $279.70 – up 2.2% YoY compared to up 8% in 3Q – benefiting from the strong dollar
$227MM of revenues from management & franchise fees, and other income
- $85MM of base management fees, up 15% YoY
- $56MM of incentive fees, up 3% YoY. 4Q10 is a tough comp as incentive fees were up 38.5% YoY
- An 8% YoY increase in franchise fees to $35MM
- $30MM of amortization of deferred gains and termination fees & other
- $11MM of miscellaneous income
$175MM of VOI and residential sales and $44MM of operating profit, including Bal Harbour
- $90MM of SG&A
- $78MM of D&A (including $11MM of unconsolidated JV)
- $47MM of net interest expense plus $6MM pro-rata unconsolidated interest
- 24% tax rate and 195MM shares
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