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What’s Next in Europe?

---There are a lot of moving parts in the coming days and weeks in Europe.  Below we show a calendar of the more notable events.  As we’ve stated on numerous occasions, there will be no Bazooka to magically cure the sovereign and banking imbalances across Europe.  Managing risk will include factoring in the uncertainty around decisions Eurocrats agree upon as they direct the Eurozone project forward.

 

15 February: European Finance Ministers will meet again and potentially sign off on the Greek bailout deal, although Eurogroup Jean-Claude Juncker says there are no guarantees a final decision will be made then. 

 

27 February:  The German Bundestag plans to vote on the issue of Greece’s second bailout, including the embedded terms of the PSI.

 

25-26 February:  G20 Finance Ministers Meeting in Mexico City. Decision on IMF loan of €500B is expected.

 

29 February:  2nd 36-Month LTRO Allotment.

 

29 February:  Eurogroup Meeting to sign the previously endorsed agreement between the 17 members on the Treaty for the European Stability Mechanism.

 

1-2 March:  Signing of the Fiscal Compact by 17 Eurozone leaders together with the non-euro area leaders of countries willing to join. Further, the group will reassess the adequacy of resources under the EFSF and ESM rescue funds.

 

20 March: Greece’s €14.5 billion Bond Redemption due.

 

April:  French Elections (Round 1) begins to conclude in May.

 

30 June:  Deadline for EU Banks to meet €106 billion capital target/the 9% Tier 1 capital ratio.

 

1 July:  ESM to come into force.

 

 

 

Matthew Hedrick

Senior Analyst


PFCB: A LOOK AHEAD TO 2/16 EARNINGS

The bottom line is that the raw math suggests that there is no way the company is going to provide guidance in line with current consensus.  Right now the current consensus is for 4Q11 EPS of $0.45, down 30% y/y and bringing the full year to $1.61, down 20% y/y.  We think $0.43-$0.44 is more realistic and therefore so is $1.50 to $1.55 for 2012 EPS guidance. 

 

Right out of the box, management needs to offset $0.26 to $0.30 of incremental EPS pressure in 2012 coming from share based compensation expense and incremental pre-openings costs.  There are some offsets to those costs, but improving same-store sales trends in 2H12 will be one of the biggest contributors as the company begins to leverage the incremental labor costs implemented in 2Q11.  Therefore, if the company can pull off a flat year in 2012, that will imply a strong year operationally and should go some way towards convincing investors that the turnaround is in motion.    

 

As we said in our PFCB note two weeks ago, the “the road to recovery” for PFCB is 18 months in the making and the plan should come together in 2012, with management’s messaging taking a more distinctly positive tone in 2H12.  In our aforementioned post of 2/6, “PFCB – The Queen Mary”, we summarized the evolution of the turnaround and the reason why we are close to the bottom that the top: 

  • DISCOVERY AND EVOLUTION: 2010 was the year of admitting to the real problems and 2011 was the year of planning for the future.
  • IMPLEMENTATION AND EXECUTION: Now 2012 becomes the year of executing - new menu items, new look and new price points.  The Irvine store will play a key role in this process.
  • GETTING THE SYSTEM MOTIVATED: The onus in on management to get the employee base geared up for the changes, manage costs and driving consumer awareness of the changes taking place at PF Chang’s.
  • CONTINUE TO EVOLVE: As a company, PFCB is not going to play defense, rather it is going on to be offensive in its strategy.

Here are some incremental thoughts around the messaging from the most recent earnings transcript and our view on those topics as we approach earnings this week:

 

THE PLAN: The challenge is converting that PF Chang’s brand equity into top-line momentum. The path to increasing traffic includes improving entry level pricing, enhancing our overall price-value equations, providing more differentiated options at lunch, and increasing menu diversity.

 

HEDGEYE: To-date, the details of how the plan will unfold and the implication for margins is still an unknown to the Street.  See our note from 2/6, “The Queen Mary” for details.

 

REMODEL SPENDING: Management has discussed plans to invest in a Bistro remodel program, with the expectation of spending around $25 million 2012.

 

HEDGEYE: Management is still working through some of the design elements from the “Irvine Project” so we do not see this number being revised significantly higher. 

 

IMPAIRMENT CHARGES: Last quarter there was a charge of $4.8 million or $0.16 per share related to one Bistro location in Corte Madera, California and two Pei Wei locations (one in Farmington Hills, Michigan and one in Chino Hills, California).  We’re assuming that their 4Q11 quarterly analysis will identify more locations that need to be closed or written down.

 

HEDGEYE:  This needs to happen sooner rather than later and will, in our view, help grow EBITDA in 2012.

 

LOWER GUIDANCE: The last full-year EPS range offered as guidance for 2011 was $1.60 to $1.70, assuming comp trends “will improve slightly from where they were in Q3” since, the company claimed, there were “easier comparisons coming up at the Bistro in the fourth quarter”.  The company still expects full year comps to be down 2% to 3% at both concepts.

 

HEDGEYE:  This is a difficult call to make, but given the risk/reward setup, we are a buyer on weakness after the earnings event.  We think consensus FY12 EPS is likely to come down due to outlier estimates but we are a buyer on weakness once this quarter is behind us.  This quarter should mark the bottom in negative revisions and the upside in the stock, in our view, far outstrips the downside.  We believe that sales could be choppy for a couple of quarters, but – as we maintained with EAT in May 2010 – we believe that management is doing the correct things and that earnings revisions should turn, albeit slowly (like the Queen Mary).

 

SALES

 

We suspect that the current trends have improved at the Bistro, along with the rest of the industry.  Here is a recap of 3Q11 performance for the Bistro.

  • Bistro revenues were down 3.5% in the third quarter with comp sales coming at a negative 3.7%
  • The impact of Hurricane Irene, which resulted in 75 closed store days and cost about 40 basis points of comp sales during 3Q11
  • Bistro sales softness was widespread across all day-parts but weekdays continue to perform slightly better than a weekend, that’s like a reflection of the ongoing strength of our business guests
  • From a geographic perspective, the Bistro saw negative comps in most states.  Some of the weakness in the northeast was due to the hurricane
  • The good news is that we are seeing some sequential trends flatten out a bit in large states like California, Arizona and Nevada
  • Comp trends in Florida actually improved sequentially in 3Q11
  • As the quarter progressed and year-over-year comparisons got a little bit easier, we saw overall comps get stronger
  • Two-year trends have shown some improvements in recent months

 

The messaging from Pei We last quarter was not good and I don’t hold out much hope for Pei Wei in its current form.

  • Pei Wei 3Q11 quarter comp sales were down 3.6%
  • Pei Wei sales softness was also widespread as Texas, Arizona, Florida and California which collectively represent two-thirds of our business remain negative

HEDGEYE: This quarter is less important than the forward commentary which we think will be more positive than the Street expects.  The Bistro has a strong January and some of the current initiatives are showing favorable trends in the test markets – any incremental positive or less-bad messaging around Pei Wei is an added bonus.

 

EXPENSES

 

While much of the focus is around top line trends and deducing whether or not the company is turning its concepts around, commodity inflation and other factors are pressuring margins.  Here is a recap of commentary on these items from the 3Q earnings call.

  • Commodity costs were higher for most of their product basket, with cost of sales increasing about 50 basis points - Beef, wok oil, and Asian import prices all climbed, but with the benefit of contractual price rebate on poultry
  • Without the poultry rebate, cost of sales would have been up more than a 100 basis points, consistent with expectations of 4% to 5% commodities cost pressure.
  • Consolidated labor expense increased about 110 basis points. This includes the cost of targeted investments in staffing to support the Bistro guest experience and some pressure from new staff labor and efficiencies at Pei Wei. 
  • Operating expenses increased 120 bps in 2Q11 on sales deleverage as well as a number of cost pressures that were unique to 3Q11 (including additional supplies and printing costs related to the re-launch of Happy Hour, and the write-off of Bistro card printing expenses.)
  • Overall, the top line and cost pressures added up to 340bps decrease in Bistro restaurant operating margins down to 16% and a 200 basis point decline in Pei Wei margins to 13.9%.
  • Projecting commodities inflation of 4% to 5% in 4Q.  Inflation pressure should moderate in 2012
  • Continued pressure on the labor line, but some of the operating expense increases should moderate in 4Q11. In total, restaurant operating margins are expected to decline about 150 basis points for a full year (excluding asset impairment charges).

HEDGEYE:  Without an improvement in top line trends, the expense side of the equation is going to be a drag on EPS in 2012.  

 

PFCB: A LOOK AHEAD TO 2/16 EARNINGS - bistro pod1

 

PFCB: A LOOK AHEAD TO 2/16 EARNINGS - pei wei pod1

 

 

Howard Penney

Managing Director

 

Rory Green

Analyst

 


HST YOUTUBE

In preparation for HST's Q4 earnings release tomorrow, we’ve put together the recent pertinent forward looking company commentary.



YOUTUBE FROM Q3 2011 CONFERENCE CALL

  • “Despite the upheaval in the equity markets created by headlines about legislative gridlock and slow employment growth in the U.S. and sovereign debt risks in the EU, our outlook for the remainder of the year remains quite positive.  Our fourth quarter group booking pace is quite solid compared with last year with bookings up over 2% and revenues ahead by almost 5%. In addition, our transient bookings are up over 6% with very strong rate growth. While a realistic appraisal of the impact of weaker economic data suggests that we will not experience significant outperformance in the fourth quarter, we do expect that fourth quarter RevPAR growth will generally be in-line or slightly better than what we experienced in the last two quarters, leading to full-year RevPAR growth of between 6.25% and 6.75%.”
  • “Assuming that adjusted profit margins expand between 80 and 90 basis points, we would project that adjusted EBITDA will range between $1,015 million and $1,025 million which will reflect full-year growth of 23% over 2010. We project FFO per diluted share between $0.86 and $0.88 which has been reduced by $0.03 per share for acquisition, debt repayment, and impairment costs.”
  • “While we are not prepared to offer any specific guidance relative to RevPAR or revenue growth for 2012 and we fully appreciate the event risk that may threaten overall economic growth for next year, we would confirm the sentiments offered by others in the industry that the fundamentals for our business continue to be attractive. We would start by noting that supply growth in 2012 is projected to be roughly 0.5% which is a small fraction of the long-term industry average. This would suggest that occupancy rate should continue to grow even if economic growth is more modest than expected earlier in the year.”
  • “The group booking pace for next year is strong, with room nights up over 4% at higher rates, especially in the important second and fourth quarters where room nights are ahead by more than 9%.”
  • “The recently issued government per diem rates which increased an average of 5% across our major markets, plus expectations for successful special corporate negotiations, all point towards higher transient rates. Given the significant recovery in occupancy rates over the last two years, we should be starting the year in a position of strength, which suggests that we should benefit from both mix shift and absolute rate increases across most segments. In short, there is a clear opportunity for very solid RevPAR growth for next year.”
  • “On the disposition front, we are marketing a few selected properties for sale but would expect that these transactions would most likely not close until the first quarter of next year.”
  • “For the year, we expect to spend approximately $300 million to $320 million on maintenance capital expenditures.”
  • “Margins for the quarter benefited from better productivity as wages and benefits on a per occupied room basis were essentially flat. Rooms flow-through was good at roughly 75%.”
  • “F&B flow-through was approximately 26%, which was better than the first half of the year, but profits were still lower than expected. There were two primary reasons. The first is that we had a number of restaurants and some meeting space under renovation in the quarter where the negative impact on F&B profits was higher than anticipated. In addition, a few hotels had lower group spend only a portion of which was anticipated.”
  • “Looking forward to the fourth quarter, we expect margins to generally perform in-line with what we experienced in the first three quarters of the year. We should get some benefit from a RevPAR increase driven more by rate growth than occupancy and the potential for improvement in F&B flow through. We do; however, expect unallocated cost to increase more than inflation, particularly for awards and sales and marketing cost or higher revenues will increase cost and we expect property taxes to rise well in excess of inflation due to refunds received in the fourth quarter of 2010 that will not recur in the fourth quarter of this year.”
  • “With the extension of the closing until mid-December, our current guidance assumes that there would be minimal EBITDA from the acquisition in 2011. If we do not acquire the hotel, we would forfeit our $15 million deposit and reduce our 2011 adjusted EBITDA by $15 million.”
  • “If we do not close the acquisition, NAREIT FFO would be an additional $8 million or roughly $0.01 per share lower than our current guidance. This amount represents the loss of the deposit partially offset by the transfer taxes and interest expense that we would not have to pay.”
  • “Net-net the bookings for the fourth quarter are better than where they were earlier in the year. As we've worked our way through the year, we've seen continued improvement in the fourth quarter. Probably more importantly as we look at what has actually happened over the course of the last 60 to 90 days; our bookings for the fourth quarter were stronger than they had been in 2010. So we booked more room nights in the last 60 days for the fourth quarter than we did last year. And those bookings were also ahead of the pace that we had seen in 2007.”
  • “Overall, we continue to feel that the quarter is going to be good. Our property level forecasts are frankly stronger than the guidance that we're giving. I think the properties are a bit more optimistic than we are, but I think we felt like it made sense to dial back a little bit on that…We're not going to outperform in the fourth quarter, but we still expect to perform in-line in Q4.”
  • “To achieve 6.5% that means we need to achieve 7% growth in the fourth quarter. So, that's the 7% that you were just talking about. And obviously, if we hit 7% that would be the strongest quarter of the year.”
  • “Generally I think our philosophy on this is stock purchases are best funded from the proceeds of asset sales, where you are effectively selling a part of the company at a market level price and getting an opportunity to buy part of it back at a discount price.”
  • Group bookings for 2012: “room nights were up about 4% and then rate was up roughly 1%.”
    • “Right now, we're at about 55% of our – what we would, at this point, estimate would be our total room nights for 2012. And I don't think that that's too far off of where we would normally be. We would expect to get to the end of the year and be around 70% of our room nights for next year booked.”
  • “If we included all of the acquisitions, so in other words, our acquisitions were up over 14% in the third quarter. So if we looked at that on a pro forma basis compared to last year, that would have added an incremental 70 basis points to our third quarter RevPAR growth. So 6.4% would have gone to 7.1% and obviously if you add the hurricane disruption then you end up at 7.7% for the quarter.”
  • “On the group side, we're still 9% to 10% below where we were in '07; we are not that far below on rate, but we are way behind in terms of room nights. So, when I think about '12, I think that's the area where we have an opportunity for outperformance as group activity continues to improve.”
  • “I would expect that as you look at that opportunity next year it tends to be more on the rate side than on the room night side, simply because the demand piece of that has already been quite strong”

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CNY IN MACAU: A POST MORTEM

Chinese New Year becoming less of a factor?

 

 

As the following chart shows, there certainly was a traditional pattern of a pre-CNY slowdown followed by a jump in Gross Gaming Revenues during the celebration.  However, we still haven’t gotten the post-CNY slowdown.  It is unclear, how much hold played a role in the recent strength but the historical post-CNY slowdown skipped at least this year.

 

Importantly for Macau, YoY growth has been surprisingly strong, with the exception of the actual CNY weeks.  Growth during those two weeks was only 4% but 24-38% the other 4 weeks presented.  We acknowledge that the comparisons are not perfect but the data is good enough to support our conclusions.  We’d say the data leans bullish for Macau.

 

CNY IN MACAU: A POST MORTEM - chart2


European Banking Monitor: Is the ECB Making Up the Numbers?

Positions in Europe: Short EUR/USD (FXE)

 

The ECB's Security Market Program, or secondary sovereign bond purchasing program, bought a paltry €59 Million in the week ended 2/10 versus a mere €124 Million in the week ended 2/3, and €63 Million in the week ending 1/27 to take the total program to €219.5 Billion. These diminutive figures compare to €2.243 Billion purchased in the week ended 1/17 and many weeks of low to mid single digit buying in the BILLIONS in previous months.  Frankly, we’re surprised that sovereign bond auction demand has been so strong across peripheral countries in the last three weeks -- successfully issuing paper at lower yields (versus previous auctions of similar maturity) -- without the ECB playing a critical role to fill demand.

 

With record levels of money being parked at the ECB’s overnight facility, much of which is a result of the 1st 36 month extension of the LTRO, we wonder just who is filling this sovereign paper demand.  Is the ECB making up the numbers?   We welcome your feedback on the issue.

 

European Banking Monitor: Is the ECB Making Up the Numbers? - 1. SMP

 

 

Below are key European banking risk monitors, which are included as part of Josh Steiner and the Financial team's "Monday Morning Risk Monitor".   If you'd like to receive the work of the Financials team or request a trial please email .

 

Euribor-OIS spread – The Euribor-OIS spread (the difference between the euro interbank lending rate and overnight indexed swaps) measures bank counterparty risk in the Eurozone.  The OIS is analogous to the effective Fed Funds rate in the United States.  Banks lending at the OIS do not swap principal, so counterparty risk in the OIS is minimal.  By contrast, the Euribor rate is the rate offered for unsecured interbank lending.  Thus, the spread between the two isolates counterparty risk. The Euribor-OIS spread tightened by 4.7 bps to 70.9 bps over last Monday.

 

European Banking Monitor: Is the ECB Making Up the Numbers? - 1. euribor

 

ECB Liquidity Recourse to the Deposit Facility – The ECB Liquidity Recourse to the Deposit Facility measures banks’ overnight deposits with the ECB.  Taken in conjunction with excess reserves, the ECB deposit facility measures excess liquidity in the Euro banking system.  An increase in this metric shows that banks are borrowing from the ECB.  In other words, the deposit facility measures one element of the ECB response to the crisis.

 

European Banking Monitor: Is the ECB Making Up the Numbers? - 1. ECB

 

European Financials CDS Monitor – Bank swaps were wider in Europe last week for 26 of the 40 reference entities. The median widening was 10.1%.

 

European Banking Monitor: Is the ECB Making Up the Numbers? - 1. banks

 

Matthew Hedrick

Senior Analyst


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