Weekly European Monitor: Sarkophobia!

European Positions Update: Long German Bunds (BUNL); Covered France (EWQ) on 4/18


Asset Class Performance:

  • Equities:  The STOXX Europe 600 closed up +1.7% week-over-week vs -2.2% last week. Top performers:  Switzerland +2.7%; Sweden +2.7%; Denmark +2.6%; Germany +2.5%; UK +2.1%; Russia (RTSI) +2.0%.  Bottom performers: Cyprus -7.4%; Spain -2.9%; Luxembourg -1.3%; Poland -1.3%; Greece -1.3%.
  • FX:  The EUR/USD is up +1.03% week-over-week.  W/W Divergences: GBP/EUR +0.72%, SEK/EUR +0.46%; RUB/EUR -0.46%, CZK/EUR -0.70%, TRY/EUR -0.71%.
  • Fixed Income:  After a relatively flat week last week, Italian 10YR yields shot up +23bps to 5.65% week-over-week. This just trailed Greece's gain of 31bps to 21.37%.  French yields also bounced ahead of the presidential election and talks of Fitch making a decision on its AAA credit status in May, via a +20bps rise to 3.10%. Portugal saw the only notable inflection to the downside, with yields falling -64bps to 11.91%.  

Weekly European Monitor: Sarkophobia! - 11. yields



In Review:

The title of this note could have also been “Europe: The Best of Times, The Worst of Times.”  For yet another week, we saw substantial European capital market swings. As our Director of Research Daryl Jones succinctly said this week: One day bad news matters, the next day good news matters more. 


In particular, this week saw significant equity swings around two Spanish bond auctions, short term paper on Tuesday and 2YR and 10YR maturities on Thursday, both of which met demand but saw higher average yields versus previous auctions. Both were digested favorably by the market, yet once again the PIIGS were laggards w/w on the score of equity performance and high sovereign yields. We continue to warn of the larger risks associated with Spain’s banking leverage to housing and property prices, in particular because we think Spanish house prices could fall another 30% from here. (For more, see our web portal at for recent notes on the subject).


Further, we continue to signal that despite all the positives from such programs as the EFSF, ESM, LTRO, SMP, and increased funding to the IMF (see Call Outs below), programs designed to help firewall and provide liquidity to Europe’s fiscal and banking risks, they do little to bind Europe under a growth strategy.  A positive growth profile is critical for investor confidence to buy equities, countries to pay down their debt and deficits through tax receipts, and more broadly for the market to clearly diagnose that Europe is out from under its dark cloud. In short, we think there’s more downside not priced in.


Switching gears, this Sunday marks the first of two French presidential election votes. While the leading two candidates, the incumbent Nicolas Sarkozy and Socialist Francois Hollande, will advance to the second round vote on May 6th, recent polls suggest Hollande will beat Sarkozy 29% to 24% in Round 1 and 58% to 42% in Round 2, according to CSA.  Interestingly, Hollande may gain a significant share not on his merits alone, but due to Sarkophobia, or a repulsion of Sarkozy’s right-wing policy and social stance (which may sound nonsensical to an American audience) in a historically (post WWII) very left-leaning state. 


That said, sociology professor Michel Maffesoli at Sorbonne University makes the case that despite the French media being very much against Sarkozy (nit-picking every social gaff and his lack of intelligence), Sarkozy has far more of a “rapport than is ever acknowledged”. He argues, "Post-modernity, which is the condition our societies are moving into, is far more anchored around the emotional than the rational or intellectual…and he is far more in phase with ordinary people than are the intellectuals who govern public life.”  He adds, “in the voting-booth it is different. The booth is like a womb where people reconnect with the purely emotional. It means going with their gut rather than their brains…that's why I think Sarkozy can still do it."


Time will tell who captures the vote but what’s broadly clear is that both candidates plan to increase taxes and impose fees on financial transactions.  Both have declared to reduce the country’s deficit to 0% (as a % of GDP), Hollande by 2017 and Sarkozy by 2016.  Both guide to reduce the deficit to 3% by 2013 versus 5.3% in 2011. Taken together, we think these policy moves will disadvantage the broader economy versus its European peers.


Hollande specifically has signaled an even more socialist agenda, which we think should result in the inability of the state to meet its deficit and debt reduction targets. Hollande wants to increase spending by €20 MM over five years (by repealing €29 MM of tax breaks and generating revenue by separating retail and investment bank operations and raising the income tax on earners over €1 MM to 75%) and reduce the retirement age to 60 from 62.  With the country’s debt rising to the 90% level, we expect growth to be compressed, as proven by the work of Reinhart and Rogoff. Finally, Hollande has stated that if elected he will renegotiate the EU budget compact and that he will not accept austerity as rule for countries and promised to increase France's minimum wage.


Taking a step back, the implications of a change of guard in France and recent statements by Sarkozy that the ECB should have “massively” bought Greek bonds at the outset to prevent the Eurozone debt crisis, may spell the end of Merkozy, namely Sarkozy’s strong working relationship with German Chancellor Merkel.  Should France move further left and not find agreement with its German neighbor, the nation that we believe is carrying the big stick in Europe, it suggests the likelihood of further political instability, or at the very least a heightened improbability of attaining a united Eurocrat mind on the go-forward sovereign and banking policy decisions for Europe.


Call Outs:


Volkswagen: Europe’s largest carmaker, yesterday predicted a “very demanding” 2012 as the debt crisis threatens economic stability. European car sales dropped 6.6% to a 14-year low last month as deliveries in France and Italy tumbled by more than 20%.


IMF: Japan promises to provide $60B; Denmark, Norway, and Sweden added $26B; Poland lent $8B; and Switzerland pledged a "substantial amount" this week. The IMF continues to haggle over funding and influence from member counties in a Spring Meeting spilling into this weekend.  China and Brazil indicated that they are not ready to set a figure on IMF contributions and Reuters suggests they want to be assured they will play a bigger role before chipping in. 


John Paulson: the billionaire hedge fund manager who has said the euro may eventually unravel, told investors he is shorting European sovereign bonds, according to a person familiar with the matter.


Outgoing World Bank President Zoellick Suggests in FT Op-ed:   “Instead of quarrelling over firewalls, Europeans should add just a fraction – say €10B – to the capital of the European Investment Bank. Under current conditions, the EIB may actually have to reduce lending. Instead, the EIB could use more capital to borrow and then invest to support structural reforms, showing Spaniards and Italians that their sacrifices will draw productive investments.” 


France:  Fitch rumored to not make decision on downgrading France’s sovereign credit rating until after French elections (May 6th).


Holland: Fitch official says may cut Dutch AAA rating if the Netherlands does not cut the deficit.


Sweden: cuts growth forecasts to +0.4% in 2012 (vs a prior estimate of +1.3%) and +3.3% in 2013 (vs +3.5%).


CDS Risk Monitor:


Week-over-week CDS was up across the main countries we track.  Italy saw the largest gains in CDS w/w, +50bps to 476bps, followed by Ireland +21bps to 590bps; France +18bps to 199bps; Spain +17bps to 504bps; Germany +13bps to 84bps; Portugal +4bps to 1102bps; and the US +1bp to 30bps. The UK fell -1bp to 63bps.  


Weekly European Monitor: Sarkophobia! - 11  cds   a


Weekly European Monitor: Sarkophobia! - 11. cds   b


Data Dump:

Eurozone ZEW Economic Sentiment 13.1 APR vs 11 MAR

Eurozone Current Account -5.9B EUR FEB vs -10.1B EUR JAN

Eurozone Construction Output -12.9% FEB Y/Y vs -2.7% JAN   [-7.1% FEB M/M vs -0.5% JAN]

EU 25 NEW Car Registrations -7% MAR Y/Y vs -9.7% FEB

Eurozone CPI 2.7% MAR Y/Y (exp. 2.6%)

Eurozone Trade Balance 3.7B EUR FEB (exp. 5B EUR) vs 5.3B EUR


Germany ZEW Current Situation 40.7 APR (exp. 35) vs 37.6 MAR

Germany ZEW Economic Sentiment 23.4 APR (exp. 19) vs 22.3 MAR

Germany IFO Business Climate 109.9 APR (exp. 109.5) vs 109.8 MAR

Germany IFO Current Assessment 117.5 APR (exp. 117) vs 117.4 MAR

Germany IFO Expectations 102.7 APR (exp. 102.3) vs 102.7 MAR

Germany Producer Prices 3.3% MAR Y/Y (exp. 3.1%) vs 3.2% FEB   [0.6% MAR M/M (exp. 0.4%) vs 0.4% FEB]


UK CPI 3.5% MAR Y/Y (exp. 3.4%) vs 3.4% FEB   [0.3% MAR M/M vs 0.6% FEB]

UK RPI 3.6% MAR Y/Y (exp. 3.6%) vs 3.7% FEB    [0.4% MAR M/M vs 0.8% FEB]

UK Retail Sale w/ Auto Fuel 3.3% MAR Y/Y (exp. 1.5%) vs 1% FEB  [1.8% MAR M/M (exp. 0.5%) vs -0.8% ]

UK ILO Unemployment Rate 8.3% FEB vs 8.4% JAN

UK Jobless Claims Chg 3.6K MAR vs 4.5K FEB


Spain House Price Index -7.2% in Q1 Y/Y vs -6.8% in Q4  [-3.0% in Q1 Q/Q vs -1.8% in Q4]

Italy Industrial Orders -13.2% FEB Y/Y (exp. -6.2%) vs -5.6% JAN  [-2.5% FEB M/M (exp. -1.1%) vs -7.7% JAN]

Italy Industrial Sales -1.5% FEB Y/Y vs -4.4% JAN   [2.3% FEB M/M vs -4.9% JAN]


Switzerland Credit Suisse ZEW economic expectations 2.1 APR vs 0.0 MAR

Switzerland Producer and Import Prices -2% MAR Y/Y (exp. -1.8%) vs -1.9% FEB   [0.3% MAR M/M (exp. 0.5%) vs 0.8% FEB]


Netherlands Unemployment Rate 5.9% MAR vs 5.9% FEB

Portugal Producer Prices 3.5% MAR Y/Y vs 4.2% FEB


Bulgaria Unemployment Rate 11.5% MAR vs 11.5% FEB

Slovakia Unemployment Rate 13.7% MAR vs 13.8% FEB

Hungary Avg Gross Wages 6.9% FEB Y/Y vs 4.3% JAN

Slovenia Unemployment Rate 12.4% FEB vs 12.5% JAN

Czech Republic Export Price Index 4.2% FEB Y/Y vs 5.4% JAN

Czech Republic Import Price Index 5.8% FEB Y/Y vs 7.0% JAN


Turkey Consumer Confidence 93.9 MAR vs 93.2 FEB

Turkey Unemployment Rate 10.2% JAN vs 9.8% DEC


Interest Rate Decisions:

(4/18) Sweden Riksbank Interest Rate UNCH at 1.50% (as expected).

(4/18) Bank of England Minutes from 4/5 session:  votes 9-0 votes for no rate hike and 8-1 for No Asset Purchase increase.



The European Week Ahead

Sunday: First round of the French Presidential Election


Monday: Apr. Eurozone PMI Composite, Manufacturing, and Services - Advance; 2011 Eurozone Eurostat Govt Debt as a % of GDP; Apr. Germany PMI Manufacturing and Services – Advance; Mar. UK Consumer Confidence Index (Apr 23-27); Apr. France PMI Manufacturing and Services – Preliminary, Production Outlook Indicator, Business Confidence Indicator, and Own-Company Production Outlook; Apr. Italy Consumer Confidence Indicator


Tuesday: Eurozone Eurostat Discontinues the Release of Industrial Orders; Mar. Germany Import Price Index (Apr 24-30); Mar. UK Public Finances and Public Sector Net Borrowing; Apr. France Consumer Confidence Indicator and Business Survey Overall Demand; Mar. Spain Budget Balance YtD; Feb. Spain Mortgages-capital Loaned and Mortgages on Houses; Mar. Italy Hourly Wages


Wednesday: 1Q UK GDP - Advance; Apr. UK CBI Trends Total Orders, Trends Selling Prices, and Business Optimism; Feb. UK Index Services; Mar. Spain Producer Prices


Thursday: Apr. Eurozone Consumer Confidence – Final, Business Climate Indicator; Economic, Industrial, and Services Confidence; Apr. Germany CPI; Apr. UK GfK Consumer Confidence Survey, Nationwide House Prices, and CBI Reported Sales; Mar. UK BBA Loans for House Purchase; Mar. France Jobseekers; Apr. Italy Business Confidence


Friday: May Germany GfK Consumer Confidence Survey; Mar. France Producer Prices and Consumer Spending; 1Q Spain Unemployment Rate; Apr. Spain Consumer Price Index - Preliminary; Mar. Spain Retail Sales; Feb. Italy Retail Sales



Extended Calendar Call-Outs:

22 April:  French Elections (Round 1).


6 May:  Round 2 (Final) French Presidential Elections. 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.



Matthew Hedrick

Senior Analyst


An earnings beat is expected but we’re way above the Street.  



MPEL should beat even the recently rising consensus EBITDA estimates by a nice margin.  MPEL has been on a recent tear but could continue to run into the print as estimates keep going higher.  Of course, all bets are off once the numbers are out, since there was high hold once again.   


We estimate high hold contributed approximately $25MM to the quarter’s EBITDA.  Analysts with sell or neutral ratings will surely use the high hold to downplay the quarter’s results.  Overall, we are projecting $239MM of EBITDA for Q1, which is 14% above consensus of $210MM.  Some of the estimates comprising consensus no doubt have factored in the high hold but our estimate is still above consensus on a hold adjusted basis - $214MM vs. $210MM.


While most investors have been focused on the potential slowdown in the Macau VIP market, we would point out that MPEL’s Mass business has continued its momentum with over 60% YoY growth in Q1 and as well as for FY11.  MPEL remains the cheapest concessionaire with operations on Cotai Strip and a big project in the pipeline, trading below 9x 2013 estimates.



1Q Detail


We estimate that City of Dreams will report $715MM of net revenues and $194MM in EBITDA

  • Our net casino win projection is $691MM
    • VIP net win of $405MM
      • Assuming 15.5% direct play we estimate $19.1BN of RC volume (a 2% YoY increase) and a hold rate of 3.02%
      • Using CoD’s historical hold rate of 2.86%, EBITDA would be $12MM lower and net revenues would be $31MM lower
    • $249MM of mass win, up 71% YoY
    • $37MM of slot win
  • $24MM of net non-gaming revenue
    • $22MM of room revenue
    • $13MM of F&B revenue
    • $18MM of retail, entertainment and other revenue
    • $29MMM of promotional allowances or 55% of gross non-gaming revenue
  • $411MM of variable operating expenses
    • $337MM of taxes
    • $62MM of gaming promoter commissions in addition to the rebate rate of 90bps (we assume an all-in commission rate of 1.22% or 40.5% on a rev share basis)
  • $24MM of non-gaming expenses
  • $86MM of fixed operating expenses compared to $85MM in 4Q

We project $260MM of net revenues and $53MM in EBITDA for Altira

  • We estimate net casino win $253MM
    • VIP net win of $227MM
      • $10.75BN of RC volume (a 15% YoY decrease) and a hold rate of 3.07%
      • Using Altira’s historical hold rate of 2.80%, we estimate that EBITDA would be $13MM lower and that net revenues would be $29MM lower
    • $26MM of mass win, up 33% YoY
  • $7MM of net non-gaming revenue
  • $173MM of variable operating expenses
    • $139MM of taxes
    • $30MM of gaming promoter commissions in addition to the rebate rate of 96bps (we assume an all-in commission rate of 1.24% or 40.3% on a rev share basis
  • $3MM of non-gaming expenses
  • $31MM of fixed operating expenses, in-line with 4Q

Other stuff:

  • Mocha slots revenue and EBITDA of $36MM and $11MM, respectively
  • D&A: $95MM (guidance of $90-95MM)
  • Interest expense: $27MM (guidance of $25-30MM)
  • Corporate expense: $19MM (guidance of $18-20MM)


In an effort to evaluate performance and as a follow up to our YouTube, we compare how the quarter measured up to previous management commentary and guidance.



Overall, RCL was in-line with our expectations even though guidance was lowered.  This should've been expected.  Here is the report card evaluating actual results against management's assertions. 

    • WORSE – 1Q came in at the high end of guidance.  Midpoint FY 2012 EPS guidance was lowered by 15 cents.  FY 2012 constant currency yield guidance was lowered by 1% on the high end to 1-4


    • SAME – slow and steady improvement from Costa Concordia incident.   Cumulative bookings since early February are down mid-single digits.  During the 4Q call, RCL mentioned new reservations dropped in the low-to-mid teens.  North America bookings are improving at a faster pace than European bookings.


    • BETTER – More normal revenue management environment than 3 months ago


    • SAME – European summer itineraries continue to cloud the outlook but consistent with expectations


    • BETTER – Expect Caribbean yields to surpass 2008 level


    • SAME  –  Cruise sales and pricing remain very weak. Good performance from the Pullmantur tour groups lessens the blow a bit


    • SAME–  Australia and Brazil continue to be robust markets. Voyager of the Seas is generating some interest out of Asia


    • WORSE–  Even though FY2012 fuel expenses were only $2MM higher than previous guidance higher drydock, maintance, and tour-related expenses drove up NCC ex fuel guidance by 1% point.


    • SAME –  Still wary of booking

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Kind of what we thought. Stock giving up what it gained yesterday.



"First quarter results were satisfactory given the difficult and uncertain operating environment and we continue to see gradual improvement in the demand for our great vacations. We did not expect the impact of the tragedy to be long term and we are seeing evidence the effects are waning."


- Richard D. Fain, chairman and chief executive officer



  • So far they are actually tracking nicely against the guidance that they set out in February.  Bookings are slowly improving.  Outlook hasn't changed much from their February guidance with the exception of fuel.
  • Even so, they have seen enough positive evidence to increase the lower end of their yield range by 1%
  • Southern Europe is seeing the biggest impact in terms of booking origination.  Q3 and Q4 are pretty weak in that region right now.  1Q wasn't really impacted since so much of the bookings were booked pre-incident
  • Strength of their developmental itineraries
    • Brazil was strong
    • Australia is nicely absorbing a large capacity increase
    • Asia is improving from the Tsumani impact
  • Guess that 50% of their guests will come from outside the US in 2012
  • Rate of global expansion will slow going forward as births/population growth also slows
  • 1/3 of their footprint is allocated to Europe.  Arab Spring and the Concordia incident has had an outsized impact on their results.  However, longer term, their exposure will help them.
  • Their recent credit upgrades puts them 1 notch below being investment grade. Being investment grade won't necessarily reduce their cost of borrow since they already benefit from cheap financing sources.
  • Some of their highest yields came from their developmental markets
  • Onboard spending surprised to the upside this quarter  
  • Demand is still somewhat volatile and there is plenty of uncertainty, especially for summer European itineraries
  • Cumulative bookings are now down mid-single digits.  US YoY bookings are exceeding prior year levels.  4Q and 2013 are ahead but 2Q and 3Q are still below.
  • At this time last year, the Arab spring was in progress but they didn't feel the impact until May.  They expect some yield improvement in the Eastern Med but overall European pricing will be down YoY.  All other products/ itineraries will be up YoY.
  • Europe accounts from 32%, 54%, 27% of their capacity in the 2Q, 3Q, and 4Q, respectively.  Therefore 3Q will feel the largest impact of European weakness.
  • Shifted some marketing expenses out of the first quarter because of the Concordia incident. 
  • Pullmantur better tour sales accounted for some of the outperformance this quarter
  • They are just now returning to last years' booking levels. 
  • Expect Caribbean yields to be higher in 2012 than they were in 2008 for their Royal Caribbean brand
  • Although they reduced their European capacity by double digits from 2011, their pricing will still be down 
  • Voyager of the Seas has moved to Asia and sparked some interest in that market.  Asia is a last minute booking market though so they have less visibility in that market.
  • Celebrity Reflection is going to be delivered in October 2012.  They are also working on a program to upgrade onboard activities and dining options. 
    • Alaska product is performing well
    • Performance for summer Europe program is mixed but are starting to see the benefit from ongoing promotional factors
    • Load factors are up and pricing is encouraging
    • Solstice is coming to New Zealand and Australia this year



  • They don't have any scheduled ship sales planned
  • How much lead time do their European itineraries have?
    • Peak holiday season is July/August
    • April - June is the key booking period for Europe
  • Overall, with the exception of Europe, their itineraries are pricing at or above year ago levels. 
  • Most of their promotional activities have been focused on Europe but the rest of their activities haven't been really promotional
  • It's pretty clear today, that their historical promotional activities work to lift bookings as they have in the past. They are in a much more normal type of revenue management environment.
  • Quarterly yields:
    • They are confident that they will have YoY yield improvement in 2Q and 4Q, however, there is a lot of uncertainty on whether yields will be positive or negative in 3Q. 
  • Strength of onboard spend is mainly outside of Europe. Onboard spend has been pretty good across most categories: shore, beverage.  Casino has been a laggard though.
  • Too early to really guide to what Europe could recover back to in 2013.  While 4Q and 2013 bookings have been 'healthy' so far - they are just too small to draw conclusions from.
  • They have been trying to source more passengers for European cruises from North America.  Much of it depends on which ports their customers fly from.  They have been bundling airfare with some promotions to attempt to stimulate demand. 
  • See Asia and China as strategic market, but in the near-term, it is a money losing proposition.  But they do believe that the investment will pay off in a decent time frame. They are not that far away from breaking even in Asia today
  • Higher fuel costs from environmental compliance standards are not going to have an impact on 2012. 
  • Longer term cost reduction initiatives?
    • While they are looking at ways to reduce costs they are also looking at ways to enhance their revenues - for example, the product enhancement features and international strategies. Cost cuts are focused in areas that don't impact the guests.
  • They are really looking for margin growth in the future vs. just volume growth. 
  • Have seen an uptick from Pullmantur's tour activity which is basically break-even (50bps from higher tour sales)
  • Seeing a lot more hesitancy from the first time cruiser vs the repeat cruiser in the quake of the Concordia incident
  • They are continuing to operate their pricing systems in a methodical and disciplined way
  • They are still looking at $1.5BN of EBITDA, so their cash flows aren't really impacted by this's years' events.  Look at a 3.75x leverage rate as a bench mark for getting investment grade rated. Most sellsiders have them getting there in 2013/14.
  • If you take a rolling 12 months projection, they are about 50% booked in a linear progression. 
  • The $100MM increase in Capex was due to the Sunshine order



    • "Despite the extraordinary disruptions to our booking patterns this year, thus far the recovery is consistent with our forecasts.  The Caribbean and Alaska remain healthy and as expected, a wide range of outcomes still persist regarding Europe this summer. While the marketplace is still volatile and uncertain, we are narrowing our yield and EPS ranges to reflect our best estimates at this time."
    • "Booking activity has continued to gradually improve over the last several months"
    • "Overall, booking trends and pricing have been consistent with prior guidance"
    • "Pricing reductions within the range of the company's previous guidance have been implemented to address booking shortfalls on certain products through the end of the third quarter. Nevertheless, Constant-Currency booked APD's remain ahead of the same time last year in all quarters. Overall, pricing remains in line with or higher than the same time last year for all major itinerary groups with the exception of Europe."
    • "Bookings for the fourth quarter of 2012 and for 2013 sailings remain strong, with both load factors and pricing running ahead of same time last year. In addition, the company has seen an increase in summer demand for its Pullmantur brand's tour product."
    • "Forecasted consumption is now 56% hedged via swaps for the remainder of 2012 and 51%, 33% and 20% hedged for 2013, 2014 and 2015, respectively. For the same four-year period, the average cost per metric ton of the hedge portfolio is approximately $525, $545, $593 and $580, respectively...The company also has fuel options to further protect against escalating fuel prices. The company currently has options expiring in 2013 at a strike price of $90 bbl that cover an estimated 9% of 2013 consumption."


    • "Approximately 350bps of the Net Yield improvement and approximately 500bps of the NCC excluding fuel increase during the quarter related to previously announced deployment initiatives and changes to the company's distribution system.... these factors are expected to increase Net Yields by approximately 200bps and NCC excluding fuel by approximately 300bps for the full year 2012."
    • "Since the company's earnings announcement on February 2, 2012, the price of oil has risen which, at current levels and net of hedging, would increase bunker expenses $0.15 per share for the year."
    • "Debt maturities for 2012, 2013, and 2014 are $600 million, $1.6 billion, and $1.9 billion, respectively."
    • "Projected capital expenditures for 2012, 2013, 2014 and 2015 are $1.3 billion, $600 million, $1.1 billion and $1.0 billion, respectively."
    • "Capacity increases for 2012, 2013, 2014 and 2015 are 1.5%, 1.1%, 1.4% and 6.9%, respectively."

Earnings Week at Hedgeye: Spotlight on Energy


The next two weeks will be busy in the energy sector, with dozens of upstream, midstream, downstream, and oilfield services companies reporting 1Q2012 results, as well as their outlooks for the rest of the year.  The macro backdrop for the quarter is muddled – Brent crude averaged $118.70/bbl in the quarter, +13% YoY and +9% QoQ; NYMEX natural gas averaged $2.50/Mcf, -40% YoY and -28% QoQ; rig count growth slowed in North America to +12% YoY (vs. +19% YoY in 4Q11); and worldwide rig count growth slowed to +9% YoY (vs. +15% YoY in 4Q11).  Our proprietary US E&P inflation index shows that costs for producers were +8.1% YoY in 1Q12, the lowest level of inflation since 4Q10. 


Given those trends, we expect the oil-weighted E&Ps to deliver strong 1Q12 numbers and have positive outlooks on the rest of 2012; that is the only sub-sector we are interested in on the long side at this point.  Our overall view on the energy sector is negative, primarily because we are bearish on global growth and oil prices.  Brent crude has snapped TRADE line support, and we see further downside risk in one of the most-consensus commodity longs.  Should oil prices continue lower, there will be little in the way of macro tailwinds to take the energy sector higher.  That has started to play out with energy (XLE) down 8% over the last month, the worst performing sector in the S&P500.  The XLE is also the only sector that is bearish TRADE and TREND on our quantitative model, with resistance at $70.03 and $72.11, respectively.



Earnings Week at Hedgeye: Spotlight on Energy  - Screen Shot 2012 04 20 at 10.47.39 AM



Below is our outlook for what we think will be the three most interesting sectors to play this earnings season: oil-weighted E&Ps, natural gas-weighted E&Ps, and oilfield services.


Oil-weighted E&Ps:  Oil prices hanging in +$100/bbl coupled with cost pressures finally starting to ease is a recipe for margin expansion for the oil-weighted E&P group.  We expect rigs and equipment to continue to move out of gas plays like the Haynesville, Barnett, and Woodford shales, and into oil/liquids plays like the Eagle Ford, Permian, and Cana; the additional capacity in those plays will lead to lower cost inflation.  In terms of production growth, we expect big 1Q12 numbers and 2012 guidance from the group, particularly from those with production focused in the Eagle Ford and Bakken, where producers are moving from exploration to more efficient development drilling.  A non-consensus way to play this consensus sub-sector long is via SM Energy (SM).


Gas-weighted E&Ps:  NYMEX gas averaged $2.50/Mcf in 1Q12 and is hitting new lows today at $1.90/Mcf; there may not be a dry gas play in North America that is EPS breakeven at the current prices.  While the dry gas E&Ps have gotten beat up recently (KWK and UPL are down 40% YTD), we think that there is more to come, as consensus estimates and current multiples do not reflect even strip pricing.  Look for gas-weighted E&Ps to slash 2012 capex budgets and production guidance, especially those that have little liquids exposure in their production mix – SWN, UPL, and ECA are on the top of that list.


Oilfield Services:  Halliburton (HAL) kicked off the earnings season yesterday with a better-than-awful quarter and outlook, though concluded the conference call with this reply to a question on what could go wrong this year, “I would say the biggest single risk [to hitting forecasted margins] probably is more around ensuring – well, I'd say, not that we can ensure it, but it's more around the continued expected progression of rig count through the balance of the year than any other factor. It looks good right now, but we have been disappointed before by the amount of growth.”  In other words, macro matters more than anything else to HAL (and the OFS industry in general).  We are negative on global growth and oil prices, and think that rig count trends lower over 2012.  While many argue that these names look “cheap,” the most cyclical subsector in energy always looks cheap at the top of a cycle.  Stay away from this group, particularly small cap pressure pumpers and land drillers.



Earnings Week at Hedgeye: Spotlight on Energy  - Screen Shot 2012 04 20 at 10.47.48 AM















THE HBM: MCD, CMG - subsector





MCD: McDonald’s reported 1Q12 EPS of $1.23 versus $1.23 and global same-store sales of 7.3%.  Overall, we thought the quarter was not great but not terrible.  We believe that the market was pricing in a worse quarter than what transpired; during the first quarter of the calendar year, MCD traded down 2% versus the 10% gain that the S&P 500 posted. 


THE HBM: MCD, CMG - mcd us


THE HBM: MCD, CMG - mcd eu


THE HBM: MCD, CMG - mcd apmea


THE HBM: MCD, CMG - mcd ww



CMG: Chipotle reported another great quarter with EPS coming in at $1.97 versus $1.93 with strong top line trends helping the company to gain leverage over its costs.   Same-store sales continue to exceed lofty expectations and the growth profile of the company, with the ShopHouse concept showing good promise.  The same-store sales chart is below.


THE HBM: MCD, CMG - cmg pod 1 white




PNRA: Panera declined on accelerating volume.  The market does not like the COO departure news.


SBUX: Starbucks declined on accelerating volume.







PFCB: P.F. Chang’s declined on accelerating volume.


TXRH: Texas Roadhouse declined on accelerating volume.


THE HBM: MCD, CMG - stocks



Howard Penney

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