Closed our long Chinese equities (CAF) position in our Virtual Portfolio.
Earlier today, Keith took advantage of higher prices to book a 15% gain by selling our long Chinese equities Virtual Portfolio exposure. The Shanghai Composite appears to be failing at our intermediate-term TREND line of resistance, a key signal to us that China is not yet out of the woods from an intermediate-term growth and inflation perspective.
As far as the “woods” are concerned, we continue to believe that as long as inflation remains elevated – as evidenced by the CPI accelerating in JAN to +4.5% YoY – the scope for Chinese policymakers to ease monetary and fiscal policy in support of economic growth dissipates on the margin. Look no further than to Chinese interest rate markets to see how our view is being priced-in real-time:
We continue to like the long-term mean reversion opportunity t of Chinese equities, which are down -28.1% since the start of 2010 (Shanghai Composite Index) and at historically low valuations. That said, we remain price sensitive and are looking for strength in the U.S. Dollar Index/a deflation of global food and energy prices to get us back into Chinese equities on the long side at better [i.e. lower] prices. In effect, we continue to view ~$100+ Brent oil as a tax on global consumption, industrial production, and fixed investment.
We are concerned that that an additional round of quantitative easing out of the Federal Reserve is a risk to Chinese economic growth over the intermediate term. China (an most other economies) spent much of 2011 in the “penalty box” from a growth/inflation/policy perspective. China’s trailing G.I.P. dynamics are highlighted in the chart below; Qe3 has the power to force China (and other economies) back into Quadrant #3.
As we have been writing consistently in the run up to today’s earnings, we are buyers of PFCB on down days over the next three months (TREND duration). 4Q11 performance was below consensus, with EPS ex-items of $0.30 versus $0.45 consensus. Management’s statement at the top of the press release, that 2012 will be an inflection point, was lent credence by top-line beats at the Bistro and at Pei Wei in 4Q11 as well as positive commentary on current trends at both concepts. While 4Q11 results were disappointing from an EPS perspective, management articulated a comprehensive plan to fix the P.F. Chang’s Bistro brand and provided evidence that the plan is working. Given that PFCB is trading at 6.1x EV/EBITDA NTM versus one of the worst run companies in the restaurant space (RT) at 6.6x, we continue to believe this gap will close as people become more comfortable with management’s strategy to turn around both concepts. Today, management also upped the dividend by 10% so the stock has a yield of 3.2%.
Nearly every restaurant concept gets a second chance; for the P.F. Chang’s brand its time is getting closer. There remains much work to be done but the risk/reward favors the longs at this price.
Coming into today, the street was not in tune to the reality of the current numbers thus the miss relative to consensus. It was really hard to get aggressively long the stock ahead of this quarter, but we believe the stock is near the bottom from an earnings revisions standpoint and may even overshoot to the downside given the severe bearishness surrounding the stock. That being said, we’re betting that the turn in operating performance for PFCB will begins to take hold in 2012. As management suggested today, that will be more evident in 2H12. If the current initiatives are real and sustainable 2012 will be the inflection point for PFCB.
PFCB is focused on altering the price value proposition in four core areas:
- Menu innovation
- Improved service
- Lower price dining options
- Reimaging of the restaurants base
At the PF Chang’s concept initiatives have led to a number of changes:
- Introduction of the specific lunch menu (increase frequency)
- The Irvine Project (elevate the guest experience)
- Investments in both labor and technology (focus on guest satisfaction)
- Broader brand marketing (more communication with customers)
At Pei Wei the changes include:
- Rollout of new small plates
- Introduction of a lower priced complete meal offering called Diner Selects
- Advanced plans for a new Pei Wei format called Pei Wei Asian Market
- New LTO - Thai Basal Chicken
PFCB has launched a more compelling lunch experience with lower priced offerings (smaller portions), faster ticket times, and more lunch-specific menu items. The test includes 20 menu items served with a choice of soup or salad, each priced under $10 in stores throughout Arizona and two stores in Dallas; the test included a marketing campaign on television, radio, print ads, billboard and social media. The tests have driven guest traffic up around 20% at lunch, which more than offset the average check declined 10%, leaving lunch with positive comps around 10%. The company plans to introduce the new lunch menu across the Pei Wei system.
As we have written before, the benefits of the Irvine Project will be broad and varied. The exercise is allowing management to plan meticulously for the reimaging and remodeling program that is expected to elevate the Bistro business. Using the Irvine Project as an example, management is selecting the best aspects of that design and incorporating them into the system-wide program. Along with the new look and feel of the restaurant itself, changes at the Bistro will include a new menu with enhanced small plates, a separate lunch menu, a new wine list and enhanced beer selection, new staff uniforms, and an updated music system. In short, the restaurant is still called P.F. Chang’s but almost everything everything else that the customer sees has changed: new look restaurant, staff, menu, and new music. All of this equals a new customer experience.
April 2nd will be an important date to be aware of as management will launch the Bistro Triple Dragon initiative which blends “a number of the key initiatives including our new lunch menu, some of the best items from our innovation Bistro menu; new music and a new look for our service teams. All of these are designed to elevate our guest experience and energize our employee team”.
The company is planning significant media support behind the April 2nd launch of the Triple Dragon initiative to help ensure that the changes are effectively communicated. A second initiative is being planned for the fall which will include adding sushi and other vegetarian items to the menu. Consumer research conducted by the company has indicated that these items would be well-received by customers.
Turning to Pei Wei, the company had previously expressed awareness that the price-value proposition at the concept needed improvement. Along those lines, on October 10th, management rolled out several new lower priced menu offerings to the entire Pei Wei system. This initiative was labeled “Diner Selects” and a 400 basis point improvement in traffic and a “negligible” decline in average check at Pei Wei since October 10th, as a result of the initiative, was underscored by management. The initiative was supported by nationwide marketing. “Diner Selects” has a starting price point of $6.25 and features five (smaller portions) of signature entrees combined with rice and the customer’s choice of a spring roll, soup, or Asian slaw. There are also three new small plates included in the offering that are priced at $3.95 each.
The most important initiative at Pei Wei is the introduction of the Pei Wei Asian market which is a higher margin form of the current Pei Wei format. According to management, Pei Wei Asian Market was developed based on direct consumer research and addresses both price point and speed of service issues that were identified as main barriers to greater guest of frequency at Pei Wei. The new format gives the company greater real estate flexibility and carries a smaller store footprint of about 2,500 square feet versus the current format’s area of 3,200 square feet. The end game is that the concept will carry higher operating margins as well as a lower sales hurdle requirement than the existing store base. Importantly, management is changing three or four of the planned new stores for 2012 are Pei Wei Asian Market.
The Global Brands business continues to perform exceptionally well, with the company seeing accelerated development in 2012 and beyond. Additionally, the company ended the year with $50 million in cash and announced it will be buying back 16% of the current enterprise vale on the company as soon as they can.
There is no question in my mind that there are still a number of skeptics about the PFCB turnaround plan. After all, the stock is at the bottom of our Hedgeye Restaurants Sentiment Score Card. 4Q11 was a mess and 1Q12 will likely be another. After that, we expect better sales trends and margins at the Bistro and Pei Wei to head back to 18% and 16%, respectively. Rarely does anything move in a straight line, but we think that earnings revisions are now in a bottoming process and The Queen Mary (2/6 post) is starting to turn.
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Current Virtual Portfolio Positioning: Short Japanese equities (EWJ).
Earlier today, Keith re-shorted Japanese equities via the iShares MSCI Japan Index Fund (EWJ) in our Virtual Portfolio. The Nikkei 225, which is up +2.6% week-to-date, is being propelled to the upside largely on the strength of FX translation relief (the yen is down -1.6% against the USD in the-week-to-date vs. a regional median of -0.3%).
To be clear, we think consensus risks going back to the well one-too-many times on this one, as the sequential ramp in sovereign debt maturities in MAR (¥57.1T or $725B or 5.8% of total marketable JGBs) provides a potential starting point for a Japanese sovereign debt issues. Broken from our long-term TAIL perspective (despite the YTD beta-rally across global equity markets), the Nikkei 225 index is signaling to us that there is at least some degree of tail risk that we must appropriately explore.
To be even clearer, we are not calling for a Japanese sovereign debt crisis in MAR. Rather, our analysis of the drivers within the JGB and JPY markets suggest that a number of key tailwinds have inflected/look to inflect in 2012. Coupled with an all-time high amount of JGB issuance that needs to come to market throughout this calendar year, we think the tea leaves suggest being appropriately hedged against what may be the next stop in our Sovereign Debt Dichotomy theme (originally published in 2Q10).
One of those tea leaves is the yen’s underperformance in the YTD (down -2.6% against the USD vs. a regional median of +2.5%). While much of the yen’s underperformance has been fueled by decreased risk aversion, which manifests itself via higher U.S. rate expectations on a relative basis (as measured by the spread between U.S. and Japanese 2yr OIS swaps), we don’t view a -500bps negative divergence as something to shrug off ahead of increased stress in the Japanese sovereign debt market. Should the risks we are flagging materialize, we ultimately think this trade plays out in the currency market via yen weakness vs. the USD.
Email us is you’d like to dialogue further on this growing topic.
Positions in Europe: No Active Positions
Asset Class Performance:
- Equities: European equity performance has been mixed over the last 5 days, with the balance towards the negative led by the periphery. This bucks the trend of strong performance from the PIIGS over the last month. Top performers: Russia (RTSI) 2.9%; Denmark 2.5%; Norway 1.2%; Sweden 1.0%; and Switzerland 80bps. Bottom performers: Greece -4.7%; Cyprus -4.7%; Spain -3.9%; Hungary -3.6%; Austria -3.3%.
- FX: The EUR/USD is down -0.4% week-to-date. Divergences: HUF/EUR +1.3%, CZK/EUR +0.8%, PLN/EUR +0.5%
- Fixed Income: 10YR sovereign yields were mixed week-to-date. Portugal led the move on the downside, falling -98bps to 11.99% followed by Germany (-14bps) to 1.83%. Greece increased the most, gaining +44bp to 33.35% followed by Italy (+26bps) to 5.78%.
Deadlines for decision on the PSI and second Greek bailout came and went for another week as Molotov cocktails flew in the streets of Athens…. As Keith has noted in his Early Looks, Greece is but a tree in the forest, yet Greece isn’t going “away” anytime soon, which we stressed in our note “Greek PSI Is NOT Getting Done” (2/8)— we think Eurocrats will continue to suspend gravity around Greece to maintain the Eurozone project.
As we show in the extended calendar below, there are many political zig-zags ahead, including the German Bundestag’s vote on Greece’s second bailout package on February 27th. The vote could be far from a resounding “Ja”, which increases the probability that we drift towards an 11thhour decision on a Greek bailout (and PSI) ahead of the country’s €14.5 Billion bond due March 20th. Finally, this week saw elevated “rhetorical” brewing between German Finance Minister Wolfgang Schaeuble and Greek officials, yet we are not of the camp that Schaeuble speaks for Merkel.
"But it's important to say that it cannot be a bottomless pit. That's why the Greeks have to finally close that pit. And then we can put something in there. At least people are now starting to realize it won't work with a bottomless pit." -Schaeuble
- Eurozone Q4 GDP (Q/Q) contracts for the first time since Q2 2009 (see chart below).
- Moody's cut its ratings on Italy, Spain (2 notches), Portugal, Slovakia, Slovenia, Malta, and placed the Aaa ratings of UK, France, and Austria on negative outlook yesterday evening.
- EU thinks Spain overstated its 2011 deficit figures to make this year’s deficit look better, and that it's also moving too slow in addressing a deterioration in public finances that is expected this year.
- Spain’s regulator announced that it is lifting its ban on short selling of financial stocks effective February 16th.
Key Regional Data This Week:
Germany ZEW Current Situation 40.3 FEB (exp. 30.5) vs 28.4 JAN
Germany ZEW Economic Sentiment 5.4 FEB (exp. -11.8) vs -21.6 JAN
UK CPI 3.6% JAN Y/Y (exp. 3.6%) vs 4.2% DEC [slowed to the least in 14 months]
Eurozone Industrial Production -2.0% DEC Y/Y vs 0.1% NOV
Greece Q4 GDP -7.0% Y/Y vs -5.0% in Q3
EU 25 New Car Registrations -7.1% JAN Y/Y vs -6.4% DEC
Portugal Unemployment Rate 14% Q4 vs 12.4% in Q3
(2/16) Riksbank Repo Rate CUT 25bps to 1.50% (in-line with expectations)
CDS Risk Monitor:
On a week to date basis, CDS was largely up across European sovereigns (vs up last week), with Spain leading the charge at +63bps to 416bps, followed by Italy (+56bps) to 438bps (see charts below).
Charts of the Week:
The European Week Ahead:
Monday: Eurogroup Meeting; Feb. France Production Outlook and Business Confidence Indicator; Dec. Italy Industrial Sales and Orders
Tuesday: Feb. Eurozone Consumer Confidence – Advance; Jan. UK Public Finances
Wednesday: Feb. Eurozone PMI Composite, Services, and Manufacturing – Advance; Dec. Eurozone Industrial New Orders; Feb. Germany PMI Manufacturing and Services – Advance; UK BoE Minutes; Feb. France PMI Manufacturing and Services – Preliminary; Jan. France CPI; Jan. Italy CPI – Final
Thursday: ECB Policy Meeting; Feb. Germany IFO Business Climate, Current Assessment, and Expectations; Feb. UK CBI Trends Total Orders and Selling Prices; Jan. UK BBA Loans for House Purchase; Feb. Italy Consumer Confidence
Friday: Q4 Germany GDP – Preliminary, Domestic Demand, Exports, Imports, Capital Investments, Government Spending, Construction Investment, Private Consumption; Q4 UK GDP and Total Business Investment- Preliminary, Private Consumption, Government Spending, Capital Formation, Exports, Imports, Index of Services; Feb. France Consumer Confidence Indicator; Jan. France Jobseekers; Dec. Italy Retail Sales
Extended Calendar Call-Outs:
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.
April: Greek Presidential Elections.
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.
RevPAR and Baccarat have been the focus areas of investors but high margin slot revenue has been quietly creeping up and growth looks sustainable.
Could slots be the next big thing? We think slots will be the big delta for the Strip and relative to expectations and margins, that’s where the leverage is. Consider this, the incremental margin on an increase in slot play per visitor is around 90%. The incremental margin on an increase in slot play due to an additional visitation is nearly the same. There is no other important revenue driver in Las Vegas that has this type of economics.
Without a doubt, slots are a profitable business. Yet, they’ve been in a long time slump, until recently. Every other Las Vegas revenue driver has been in recovery mode for some time. Slot volume growth was consistently negative from November 2007 until October 2010 (with the exception of a slight gain in February 2010). Since then they've been inconsistent. It’s only during the 2nd half of 2011 did we see more a trend of positivity. We think 2012 will be the first meaningfully positive year for slot growth since 2006.
The following chart shows the recent monthly performance of the Strip’s slot business and our projections for 2012. We model sequential seasonality using a 3 month moving average, adjusted for historical seasonality and GDP. We would caution that the monthly projections can be volatile but directionally, our model has been accurate. For instance, we think it is unlikely that we will see a double digit growth month, but we do think March growth will accelerate. Annually, our model is less volatile and is currently projecting 2012 growth of 4-5%.
Most importantly, if the slot business recovers as we expect, the flow through should be a major tailwind for Strip earnings (MGM and the 2nd derivative, BYD) and the stocks with significant exposure to the Strip. There is still a long way to go for slot volume. In Q4 2011, slot volumes were 21% lower than levels achieved in Q4 2006. If our projection for 2012 is met, slot volumes would still be 19% below 2007. Now if only the Macro will behave.
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