We expect QSR to continue to reap the benefits of strong employment trends among young people. Older cohorts also showed strength in January employment data.
While the 10-24 and 24-34 years of age cohorts saw sequential deceleration in year-over-year employment growth, the employment report was generally positive for restaurant companies. Specifically, the 35-44 and 45-54 years of age cohorts saw employment levels rise year-over-year for the first time since before the recession. 55-64 year olds’ employment level gained 5.1% year-over-year. The sequential deceleration in the younger cohorts is not a huge concern to us at this point, and we expect QSR to continue to gain from the positive employment news. Casual dining is also likely to benefit from the improvement in older cohorts, in particular, as well as from overall employment gains. Casual dining is trading well today: DIN, EAT, BWLD, DRI and others all up.
Hiring trends in the restaurant industry remain strong as of December. See the chart below to view the longer term trend.
Conclusion: Anything but conclusive.
Virtual Portfolio Positioning: Long Chinese equities.
On Wednesday, we had the great pleasure of joining well over a hundred distinguished investment professionals at the New York Academy of Sciences for the Bloomberg China Conference. All told, there were 13 unique discussions on various topics ranging from China’s economic outlook to its real estate market to the opportunities/challenges facing China’s growing consumer sector.
Before we share with you the “best of” version of our notes, we just wanted to briefly reflect upon something that struck me us quite odd: with the exception of NYU professor Ann Lee, none of the 28 panelists were: a) from China or b) Chinese-Americans with valuable connections to the mainland. In fact, the vast majority of the seven-plus hours of discussion centered on the opinions and beliefs of American PMs, professors, and policymakers. Not that this is an issue prima facie – as each of presenters was highly accomplished, well-deserving, and thoughtful – but the general lack of Chinese voices on issues pertaining specifically to China is particularly bizarre in our opinion.
That speaks volumes to what we thought were my two greatest learning points from yesterday’s conference:
- While the general tone is grounded in apprehension, there is no discernable consensus on China. In fact, China appears to be a very difficult economy to reach consensus on because so much of what takes place there is just fundamentally misaligned with the patterns we've been trained to recognize through studying other economies; and
- It's clear that U.S. based investors analyze China from a far too Western point of view, imposing potential avenues for reform and structural economic changes that would ultimately serve China to become more like us. But does China want to be more like the U.S.? There was a sense that perhaps the speakers knew all too well what was best for China – perhaps even more so than the Chinese…
Below is a collection of paraphrased notes that we found helpful to expanding the scope of our own internal debates regarding the world’s second-largest economy (sorted by topic of discussion):
- Francisco Blanch: There aren’t enough natural resources or additional scope for productivity gains to keep China growing at +8-10% per annum. The law of large numbers would tend to support this conclusion as well.
- Daniel Rosen: There’s trillions of dollars in low-hanging fruit the Chinese government can spend to support near-to-intermediate term growth: building schools and hospitals, social safety net expansion, etc.
- PROPERTY MARKET
- Axel Merk: High net worth individuals in China own 3.3 residential real estate properties on average. Most go unrented, as maintenance costs dramatically outpace any potential rental yields.
- Michael Shaoul: The utility of real estate in China has changed from “shelter” to “speculation”.
- Sonny Kalsi/Bhaskar Chakravorti: The median home price in China is 20x the median income – more than double the U.S. ratio. That said, however, there is very little in the direction of low-income, commodity housing in China; as such, a great deal of the homes that are being quoted for prices aren’t exactly being marketed to the median consumer. Thus, household affordability isn’t quite as poor as the headline metrics suggest.
- Bhaskar Chakravorti: Commercial real estate – particularly high-end retail and hotels – is in oversupply across many municipalities in China, due to the incentive of mayors to seek rent-paying tenants. Thus, a nationwide residential property tax might actually return the supply side of the market towards equilibrium as those distortions are mitigated.
- Axel Merk: The PBOC’s regulation of the cost of credit throughout the economy limits the supply of credit that is available to less creditworthy borrowers, such as small-to-medium-sized enterprises (SMEs).
- Axel Merk: Cheap credit isn’t necessary to get/keep an economy going. What economies need, rather, is a market-based system for pricing of risk. Financial repression actually slows growth in the velocity of money, as certain borrowers are crowded out of the credit markets.
- Michael Shaoul: The demand for real estate investment leads the demand for credit in China.
- BANKING SYSTEM
- Michael Shaoul: Since 2007, the Hang Seng Financial Index overlays quite well with the equity prices of Japanese banks in the four years post 1989.
- Joseph Taylor: The deposit rate ceiling acts as a subsidy to the state banks. Thus, the #1 problem with removing the floor is that [largely] unprofitable state-owned-enterprises (SOEs) will see their weighted average cost of capital increase as bank funding costs rise.
- Daniel Rosen: The Chinese consumer is stronger than meets the eye. Since 2003, nominal household consumption has doubled; there’s $500B-$1T in “grey consumption” (i.e. large propensity to spend abroad, unrecorded cash transactions, etc.); and Chinese consumption has grown faster, in real terms, than any other economy over the previous decade.
- Daniel Rosen: China desperately needs to further develop consumer vs. producer rights and establish intellectual property guidelines to reach a higher plateau of value-added consumption.
- Daniel Rosen: China must embrace regulatory reform in order to expand the market for higher-wage, white collar labor.
- CHINESE YUAN
- Robert Kapp: The RMB can’t ever become a free-floating currency without first liberalizing interest rates – which are ultimately a function of the liberalization of cross-border capital flows.
- CAPITAL FLOWS
- David Rubenstein: The U.S. invests about 5x as much money in China as the Chinese do in the U.S.
- Robert Kapp: Many Chinese investors are cynical towards their investment opportunities in the U.S. due to political resistance at the federal level, thus limiting the two-way flow of both foreign and portfolio direct investment. On the State and municipal level, however, many U.S. governors and mayors are welcoming of Chinese capital with open arms.
- DOING BUSINESS IN CHINA
- Robert Hormats: Intellectual property is an enormous problem in China. For example, to establish a joint venture in China – which is key form of FDI – a multi-national corporation essentially has to give away any/all its R&D and intellectual property, which ultimately gets pirated by “competitors”.
- CHINA vs. U.S.
- Robert Kapp: As China grows larger in economic and military might, it will seek to impose its own set of rules upon multinational organizations and international best practices. That said, Chinese international agents are very well aware of how certain systems benefit them and will no doubt seek to uphold those structures.
- Robert Kapp: Chinese policymakers are aware that it is in their best interest to keep the peace on the geopolitical risk front. Furthermore, there are certain stances that they are likely to ultimately choose to not defend – such as sanctions on Iran – if the alternative was to engage in international military conflict.
- POLITICAL LEADERSHIP TRANSITION
- Consensus among panelists: 2012 will be the “year of the status quo”, as China will seek to avoid any major changes ahead of or shortly after “handing off the baton” to the new leadership.
- Tim Adams: It would be surprising to see aggressive monetary easing in 2012. In fact, as Beijing has alluded to the entire way down, the State Council’s goal is to take the air out of the real estate industry. Further, they wouldn’t mind seeing consolidation in the over-supplied property development sector.
- Robert Kapp: The economic/market liberalizing reforms of the last 20-30yrs have essentially ground to a halt. It’s unlikely that China reaccelerates the pace towards Western-style capitalism in the near-term after witnessing the near collapse of the Western economic system in 2008/09.
- SOCIAL UNREST
- Robert Kapp: It appears that Beijing’s strategy in regards to dealing with social unrest is equivalent to “stomping out small fires” rather than enacting sweeping reforms to prevent such conflicts in the first place.
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POSITION: Long Energy (XLE), Short SP500 (SPY)
Am I a day, week, or month early? I don’t know. Being early is called being wrong. Been there, done that.
If you’re not right and the fundamental framework of your position changes, you should change. Today’s lagging indicator (US Employment Report) is a January number that reflects a lot of why I was bullish for the 6 weeks running into last week’s US Dollar Debauchery.
From here, I think inflation expectations continue to rise and growth expectations continue to slow. If that changes, I will. But like February of last year when I made this call, you don’t get the February slowdown data in the January numbers.
Across all 3 risk management durations, here are the lines that matter to me most right now:
- Immediate-term TRADE overbought = 1343 (that’s where I shorted SPY again this morning)
- Immediate-term TRADE support = 1321
- Long-term TAIL support = 1267
With the long-term TAIL intact, you should naturally be asking me why Newt and the SP500 can’t fly from here to the moon from here. I tend to get these questions after rallies, not before them. It’s just human nature.
Provided that the US Dollar’s immediate-term TRADE remains bearish and we keep making lower long-term highs on lower and lower volume studies in the SP500, I’ll stay with this call.
Long inflation, short growth.
Keith R. McCullough
Chief Executive Officer
Buffalo Wild Wings is reporting next week and the CEO, Sally Smith, just appeared on CNBC sounding bullish about Superbowl weekend. We think 4Q numbers will be strong but we are looking for the forward looking guidance and earnings call commentary.
Keith shorted BWLD in the Hedgeye Virtual Portfolio. We know 4Q is likely going to be a strong quarter. We are concerned about FY12 and believe estimates need to come down. This is not a consensus call; zero analysts have sell ratings on this stock.
Buffalo Wild Wings, along with the rest of the space, is trading higher today as jobs data for January indicated that the employment situation continues to improve in the U.S. The CEO of BWLD also appeared on CNBC this morning and her commentary on Super Bowl Sunday was bullish. Smith saying that the company “has dealt” with chicken wing prices does not convince us that expectations for FY12 are appropriately aligned.
Traditional wings make up ~20% of sales for BWLD and wing prices are at extremely elevated levels. This morning, Smith said that the company has “dealt with” wing prices in the past. This may be true but our view is that the Street’s expectations have not dealt with the impact of wing prices on BWLD’s earnings very well in the past. Our view is that FY12 EPS remains high and the growth story is not as secure as the stock’s high multiple suggests.
Second time's a charm?
CZR's IPO INVESTOR CALL
- Ticker: CZR
- Range: $8-$10
- Offering: 1.8M Shares (100% primary)
- Deal Size: $16MM
- Over-allotment: 15% all primary
- Pro-forma Market Cap: $1.125BN
- Pricing: February 6th
- Apollo/TPG not selling any shares in IPO/ subject to a 270-day lockup
- Selling primary shares equal to 1.4% of the total will facilitate the listing of 29% of the shares
- The 1.4% of the shares issued in the IPO and 18.8% of the shares will be immediately tradeable post IPO
- 8.9% of the share will be subject to a 180-day lockup (Company & 50% of Co-investor shares)
- All of Paulson's shares (9.9%) will be listed concurrently with the IPO and not subject to lock up
INVESTOR CALL NOTES
- Going public will allow them to deliver
- Investment in CZR's will give investors exposure to:
- Recovery of CZR's existing facilities
- New CZR's development
- Expect to get Baltimore license and a casino there in 2013/2014
- Option on online poker
- Option on Asia development (If and when new markets get approved and if CZR wins a license in those markets)
- Launched an amend and extend proposition yesterday, which will extend maturities from 2015 from 2018. Listing of equity itself would help them deliver as well.
- Core business recovery:
- What has changed since 2007?
- Total of $2BN of investments
- Added CZR's Palace expansion
- New Horsheshoe Hammond
- Planet Hollywood
- Competitive changes (increases)
- New projects/ developments
- Bottom line they think that they can get to $3BN
- Las Vegas recovery is well underway with positive momentum across all the key metrics
- CZR's cash room rates troughed at $85/night and was $92 in 2011 and still improving
- Occupancy troughed at 90% and improved to 96% in 2011
- Atlantic City has been a very tough market and just reversed 39 months of declines in December. They are continuing to work on efficiencies there. Believe that they can get their $1.5BN business to a 20% margin
- Regional market results have been generally stable to slightly improving.
- The Back To Peak slide...yes if you only they had a 40% increase in ADR they could get $200MM of EBITDA in Vegas... IF....
- Anticipate adding $250MM of EBITDA from their pipeline efforts opening from 2012-2014 with little balance sheet impact
- WSOP & US Online Poker opportunity
- Have taken advantage of markets where gaming is legal in UK and France. When Poker Stars and Full Tilt were shut down, it benefited them
- They also acquired a social gaming platform to distribute their brands - Playtika, developer of social gaming applications on Facebook
- Slotomania is on Facebook, 4 Russian social networks, iphone and ipad. IGT payed $500MM for Double Down. They have 2x as many users and monitize their users just as well as Double Down. They are launching their platforms on ipad and iphone. Slotomania is one of the top grossing apps across all mobile platforms and Facebook.
- Launching CZR's casino application within a week (currently in beta testing) and it will linked to CZR's rewards
- Party.BWIN's stock pop based on the their MGM/BYD announcement boosted their market cap by $600MM and they think that they deserve a similar option value that Party is getting.
- While they are confident of the prospect of federally legalized online poker, it is already happening at the state level
- Real difference between this IPO and last one is that there are two real comps for the value of their options
- IGT/Double Down for their mobile gaming business
- Party.BWIN stock move based on their option to enter US
- Amend and extend underway
- Did an amend and extend for $1,2BN last year on their term loan
- This current deal is seeking to extend at least [$2.4BN] of their term loans through 2018 from current 2015 maturities
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