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MCD SALES SLOWING

McDonald’s reported a global comparable sales rise of 3.3% in April, which represented a slowdown from March on a two-year average basis.  Four weeks ago, management told us that it expected global comps to come in at 4%.  The 3.3% print suggests that the last ten days of the month fell below management expectations.

 

MCD SALES SLOWING - mcd global1

 

This was a disappointing number for McDonald’s.  The Hedgeye Macro Team’s “Global Growth Slowing” theme is being confirmed by this April number as the U.S. and APMEA missed expectations.  This disappointment is driving the stock lower.  Given the significant calendar adjustment, the underlying trends may not be quite as significant as the headline numbers suggest but clearly these numbers are calling for a resetting of investor expectations; McDonald’s is unlikely to astound the investment community with its same-store sales numbers this summer.  We still see McDonald’s as the QSR leader in the U.S. but, even in that position of power, the company is having difficulty maintaining its traffic trends.

 

With inflation pressuring margins, particularly in the United States, and 3% of price flowing through the P&L, sales trends are taking on a higher degree of importance for investors.  We are looking for management to offer some more definite guidance on how it will comp the comps this summer. 

 

 

United States

 

U.S. comparable sales rose 3.3% in April versus +4.8% consensus as the company had its first full month of the Extra Value Menu.  With price running at 3%, traffic trends are weak in McDonald’s domestic business.  The calendar impact (one less Friday and one less Saturday than April 2011) seems to have dressed down the headline numbers but we remain concerned about whether the company can comp the comps this summer.  As we wrote on 4/23: “The evidence suggests that beverages are increasingly becoming a less important part of the vocabulary from McDonald’s’ management team.  With that in mind, foremost in our thoughts is what the company’s strategy will be to maintain top-line momentum over the next few months.”

 

MCD SALES SLOWING - mcd us 1

 

 

Europe

 

Europe exceeded analyst expectations in April, coming in at 3.5% versus +3.2% consensus.  Macro continues to be the most important factor in Europe.  Europe represents 40% of total revenues and 39% of total operating profit for McDonald’s.   While the print exceeded expectations, the two-year average did decline and continuing turmoil in Europe remains a business risk for the company.

 

MCD SALES SLOWING - mcd eu 1

 

 

APMEA

 

Positive results in China were offset by negative comps in Japan as APMEA reported 1.1% same-store sales versus 1.9% consensus.  Much of McDonald’s long-term growth hinges on its APMEA division but, in the near-term, we expect the company’s fortunes in U.S. and Europe to dictate the stock’s performance.

 

MCD SALES SLOWING - mcd apmea 1

 

 

Howard Penney

Managing Director

 

Rory Green

Analyst

  


MCD: WHERE TO FROM HERE?

McDonald’s continues to be the de facto safety trade of the restaurant space.  Our opinion at this point is that there are some subtle changes taking place as the new Chief Executive Office takes over that are worth noting.

 

On Friday we took the opportunity to ask Don Thompson what he thinks his legacy will be when he finds himself – hopefully long from now – closing in on retirement as Jim Skinner currently is.  His response was, in our view, interesting in that he mentioned the “Plan to Win” but also spoke of the importance of growing organically and building new restaurants coincidentally.  Specifically, Thompson stated that “we are much smarter now” and that McDonald’s “can walk and chew gum at the same time” [organic unit growth].  We do not view this as a negative for the company but it does represent a lower return growth profile for the company than we have seen over the past five years.

 

Thompson’s three “global priorities” are:

  1. Optimizing the menu [transitioning from dollar menu]
  2. Modernizing the customer experience [remodel/reimage program]
  3. Broadening accessibility to Brand McDonald’s [unit growth]

Unfortunately, the McDonald’s conference call was littered with headwinds facing the company that are, on a relative basis, greater than those facing competitors such as Yum Brands.  McDonald’s highlighted three major hurdles facing the company in 2012.  Firstly, the economic climate remains challenging, particularly in Europe.  Secondly, consumer confidence remains varied across markets.  Finally, the company highlighted “economic pressures and inflationary costs”.  Beef has been a key driver of these cost pressures.

 

Simply comparing McDonald’s to Yum Brands under the specter of these three factors paints McDonald’s in an unfavorable light relative to its rival. Yum has shrugged off concerns related to China’s rate of growth but McDonald’s’ exposure to Europe seems to be causing some concern among management personnel and investors alike. 

 

 

WHAT WAS NOT SAID

 

Changes on the margin are all-important and we see the decrease in emphasis on beverages as a strategy going forward as being important.  While management said that “the U.S. also continues to strengthen its position as a as a beverage destination”, total beverage units were only up 6% versus up 20% in 4Q11, 16% in 3Q11, and 29% in 2Q11.  In fact, the word “beverage” was only mentioned twice on the 1Q12 call.  The 4Q11, 3Q11, and 2Q11 calls included 4, 8, and 18 mentions of the word “beverage”, respectively.  The word “McCafé” was mentioned twice on the 1Q12 call.  The 4Q11, 3Q11, and 2Q11 calls included zero, 7, and 11 mentions of the word “McCafé”, respectively. 

 

The evidence suggests that beverages are increasingly becoming a less important part of the vocabulary from McDonald’s’ management team.  With that in mind, foremost in our thoughts is what the company’s strategy will be to maintain top-line momentum over the next few months.

 

MCD: WHERE TO FROM HERE? - mentions mcd

 

UNITED STATES

 

The beverage initiative last year clearly helped McDonald’s take share from competitors.  Don Thompson did provide an interesting take on the industry when he said, “around the world we continue to gain market share in an industry with minimal-to-negative growth”.  For a frame of reference, the Justice Holdings presentation touting the upcoming Burger King presentation cited an industry growth number of +6%!

 

For McDonald’s, one of the core initiatives in the U.S. this year is an attempt to evolve the company’s value proposition with the new Extra Value Menu and, in doing so, turn away from the existing dollar menu.  Beginning in April, McDonald’s is focusing the menu on four tiers (excluding combo meals):

  1. Premium ($4.50-5.50)
  2. Core ($3.50-4.50)
  3. The new Extra Value Menu ($1.20-3.50)
  4. The Dollar Menu

Given that the company is guiding to 4.5-5.5% inflation in the U.S. in 2012, we believe that management is attempting to manage check and margin by forcing customers to trade up to the Extra Value Menu from the Dollar Menu.  This belief is supported by the fact that one of the biggest changes that the company is undertaking is the addition of fresh baked cookies and ice cream cones to the Dollar Menu in place of small drinks and small fries. 

 

Our view remains that this is a big risk for McDonald’s.  If this change goes against consumer preference, there is a

possibility that satisfaction scores will be negatively impacted.  When we spoke to the company in March when the menu changes were first announced, we learned that a “mini-combo meal” offering may bundle the fries, burger, and drink but a decision has not been made on that yet.  Still, ordering the $1 items individually is no longer an option. 

 

MCD: WHERE TO FROM HERE? - mcd us

 

 

EUROPE

 

Turning to Europe, McDonald’s has been significantly impacted by the macroeconomic environment there, more so than any other multi-national restaurant company due to its relatively larger exposure to the region.  Europe represents 40% of total revenues for McDonald’s and 39% of operating profit.  As Don Thompson said, Europe is a region that “continues to experience unprecedented economic challenges from widespread austerity measures, concerns over the sovereign debt crisis and unemployment levels averaging about 10%”.

 

The company has long been focused on upgrading the customer experience; 80% of the system’s interiors have been refreshed as well as 50% of the exteriors.  Roughly 150 McCafés will be added to the Europe system in 2012.

 

MCD: WHERE TO FROM HERE? - mcd eu

 

 

APMEA

 

In APMEA, McDonald’s called out the challenging economic conditions in China (8.5% same-store sales), ongoing “tightening” in Australia, and uneven results in Japan.  Again, the company is looking to value as a strategy with the recent launch of the Loose Change Menu in Australia last month.

 

We think that APMEA is an important component of the long-term strategy for McDonald’s but, given that it only comprises 18% of EBIT, the near term story will be dictated far more by business in the US and Europe, which account for 43% and 38% of EBIT, respectively.

 

MCD: WHERE TO FROM HERE? - mcd apmea

 

 

CONCLUSION

 

McDonald’s trends are not disastrous but going forward, we see plenty to be concerned about.  Specifically, lapping the outsized performance of the U.S. business last summer, which was driven by impressive beverage sales, and maintaining momentum in Europe are two key issues.  As we wrote earlier, beverage unit growth is sequentially slowing so we believe that catalyst is no longer a major factor. 

 

Given the pending IPO of Burger King and our view that the brand is “too big to fix”, it struck a chord when McDonald’s management emphasized that it is “willing and able to invest for continued growth and to widen our competitive advantages”.  In reimaging 2,400 restaurants globally (800 U.S., 900 Europe, and 475 APMEA) and rebuilding 200 U.S. locations, the company is clearly in a position of strength versus its closest rivals.  The longer-term outlook for McDonald’s is positive, with competitors like Wendy’s and Burger King floundering, but growth in that segment of quick service pales in comparison to fast casual/specialty.  We would look elsewhere for top long QSR ideas at this price.  Jack in the Box is one company that we believe has upside potential from here.

 

Globally, the price factor flowing through the company’s income statement is roughly 3%.  With inflation pressuring margins, particularly in the U.S., sales trends will take on an increased importance.  Given the difficult top-line compares and uncertainty around the transition from Dollar Menu to Extra Value Menu, our conviction on the top-line continuing to meet consensus is tenuous at best.

 

MCD: WHERE TO FROM HERE? - mcd quadrant

 

 

Howard Penney

Managing Director

HPenney@hedgeye.com

646.455.0992

 

Rory Green

Analyst

RGreen@hedgeye.com

646.455.0992  


GENTING S: REVISED Q1 PREVIEW

Our hold assumptions were too high

 

 

Our relatively neutral thesis on Genting Singapore remains intact - only our Q1 estimates are lower.  We failed to account for a quirk in the Singapore tax receipts when estimating GGR.  The good news is that the oversight mostly impacted our hold percentage estimate.  So while our Q1 EBITDA projection is lower, investors should be adjusting for hold anyway.

 

 

Q1 Projections:


We estimate that Genting Singapore will report net revenue of S$763 million of revenue and S$381 million of EBITDA.  We’re still above consensus EBITDA of S$367 million.  Here are the revised details.

  • Gaming revenue, net of commissions of S$618M
    • Gross VIP revenue of S$450MM and net revenue of S$238MM
      • We expect RC volume to increase 25% sequentially to S$15.0BN
      • Hold of 3.0%
      • Rebate of 1.3%
    • Gross Mass table of S$286MM and S$236MM net of gaming points
      • Gaming points equal to 3.75% of drop or S$50MM
    • S$174MM of slot and EGT win
      • The incremental slots/EGT expansion was installed the second week of January so the quarter should have benefited from healthy growth
  • Non-gaming revenue of S$145MM
    • Hotel room revenue of S$38MM
      • Hotel revenues should see a sequential lift with the added capacity of the Equarius rooms
    • S$25MM of F&B and other revenue
    • USS revenue of S$82MM
  • Gaming taxes of S$86MM
  • Implied fixed costs of S$185MM compared to S$185MM/Q in 2H11

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Willing To Learn

This note was originally published at 8am on April 24, 2012. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“No nation is fit to teach unless it is also willing to learn.”

-Teddy Roosevelt

 

That was just an outstanding leadership quote from President Theodore Roosevelt as he was working his way towards getting the “Gentlemen’s Agreement” in 1908 between San Franciscans and the Japanese.

 

While I was on my pseudo vacation last week, I thought about the context of this leadership lesson while I was reading “Pacific Crucible” by Ian Toll. Then I thought about it again, and again, and again.

 

If you don’t have empathy, you don’t have much. As the world becomes more politically polarized, we run the greatest risk of all – we stop learning. The only way to lead is to learn the other side’s perspective. If you don’t take the time to understand it, you’ll never be able to resolve it. Leadership includes not making the same mistakes, over, and over, and over again.

 

Back to the Global Macro Grind

 

You don’t have to read much to understand that the divide between segregation and immigration is always bridged by education. Neither do you have to study economic history much to acknowledge the wide gap between Keynesian and Hayekian economics.

 

When I moved to this country, I learned quickly that people want to label other people in buckets. ‘Oh he’s a Democrat and she’s a Republican’ or ‘he’s a socialist and she’s a capitalist.’ But, somewhere along the way, I also learned that’s ridiculous. Maybe it’s because I was a 20 year-old bumpkin from 22 hours north of Toronto. Maybe it’s just because I don’t like being put in a bucket.

 

With the upcoming election in France you are starting to see the outcrop of political polarization that we’ll likely see in the US Presidential Election. The Germans are taking this opportunity to call the French Socialists, and the French are preparing to call the Germans something back. In the meantime, that’s not going to solve the European Debt Crisis, just fyi.

 

Neither are we going to solve the world’s debt problems with more debt. We aren’t going to solve anything by printing more and more moneys either.

 

I’m not saying that there shouldn’t be a time and place for printing money. I’m just saying that you shouldn’t have a policy to be perpetually printing money and debauching your country’s currency. History is already littered with politicians making that mistake.

 

If you want a European and American perspective on politicizing money consider the following:

  1. Give me control of a nation’s money and I care not who makes its laws.” –Mayer Rothschild
  2. I believe that banking institutions are more dangerous to our liberties than standing armies.” –Thomas Jefferson

When you read those quotes, you should feel something. If you are a central banker, you don’t like the Jefferson quote – but that’s not the point. Neither is feeling what it means to you – being empathetic to what the other side feels is leadership.

 

What I feel about this is no longer a minority voice. The Most Read story on Bloomberg this morning has the following title:

 

“Bundesbank’s Weidemann Says What No Politician Wants To Hear”

 

That’s a critical quote at a critical time because our politicians have put us all in a critical position. If the fiscally and monetarily conservative voice of the Bundesbank in Germany is Willing To Learn from the history of the Weimar Republic’s mistakes, I suggest you and I should too. Printing money and debauching Dollars doesn’t end well, so stop cheering it on.

 

Think about that, again and again. I beg you.

 

Rather than begging for bailouts from Ben Bernanke at tomorrow’s FOMC meeting, take a step back and try to learn what all of us who haven’t been blowing up your hard earned capital since late 2007 are saying.

 

We’re not crazy. We’re Willing To Learn from whomever can show us why the Germans are wrong this time. We’re Willing To Learn how this time really is different.

 

But fear-mongering about what could have been in 2008 is no longer teaching anyone anything. It’s 2012 and now we need to see some positive proof on price stability and employment that lasts more than a few quarters to believe that the Fed, ECB, and BOJ Policies To Inflate aren’t going to slow global growth. They just did, again.

 

My immediate-term support and resistance ranges for Gold, Oil (Brent), US Dollar Index, Japanese Yen (vs USD), EUR/USD, and the SP500 are now $1630-1652, $118.35-119.28, $79.04-79.49, $81.09-82.14, $1.30-1.32, and 1360-1377, respectively.

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Willing To Learn - Chart of the Day

 

Willing To Learn - Virtual Portfolio



Ugly Beautiful

“Some are ugly and some are beautiful.”

-Ray Dalio

 

That’s what Bridgewater’s Ray Dalio wrote recently about Deleveragings. Spell (and box) checkers take note: the plural of deleveraging doesn’t yet register on Wikipedia as a word. By the time this Sovereign Debt Cycle is over with, it will.

 

I was flying back to New York from Toronto last night and Dalio bubbled up to the top of my Research Pile alongside another one of the most credible Global Macro Risk Management sources to emerge from 2007’s top, Eclectica’s Hugh Hendry.

 

Not surprisingly, both Dalio and Hendry are talking about the same risk to asset prices (stocks, bonds, commodities, etc. ) that have been supported by Policies To Inflate – deflation. But both have different views on the pace and timing of what asset price inflations and deflations could look like.

 

Back to the Global Macro Grind

 

If your risk management process doesn’t embrace the uncertainties associated with a Globally Interconnected Marketplace of colliding factors, it’s more difficult to apply the principles of Chaos (or Complexity) Theory to what it is that you do every day.

 

People get whipped around by questioning what is “causality versus correlation” all of the time. Our process embraces the idea that both can occur at the same time.

 

In Chaos Theory you have Emergent Properties and Phase Transitions. The Correlation Risk born out of an emergent property like the World’s Reserve Currency (USD) and asset prices is very real. So are the phase transitions (crashes) born out of that Correlation Risk.

 

The US Dollar Index is up for the 5thconsecutive day to $79.58 this morning. Look at the immediate-term TRADE correlations that our model is spitting up versus the USD:

  1. WTIC Oil = -0.72
  2. Brent Oil = -0.64
  3. Gold = -0.77
  4. Copper = -0.76
  5. Wheat = -0.71
  6. Soybeans = -0.81

In other words, that’s how I can show you, in real-time, the answer to both Dalio and Hendry’s question on timing asset price inflations and deflations. US Dollar driven Correlation Risk doesn’t matter all of the time. Neither is it perpetual. But some of the time, it matters big time. And that’s when you get paid to be long or short beta.

 

If you believe (like I do), in the causal relationship between Monetary Policy and Currency moves, you’ll absolutely love learning about this. It forces us to Re-Think and Re-Learn, every day. If you believe, like a dogmatic Keynesian (Bernanke) does, that monetary policy doesn’t infect currency prices which then, in turn, affect inflations/deflations, this will drive you right batty.

 

Chaos Theory is not part of the current Western Academic Curriculum in Economics. By the time I am dead, it will be. It’s math. And the math will ultimately trump the social science of studying the 1930’s depression in a vacuum.

 

Don’t take my word for it on this. Read economic history. Overlay Reinhart & Rogoff teachings about the relationships between deficits, debts, and inflation/deflation with what modern day practitioners are writing about. It’s all out there. Educate yourself.

 

Dalio’s February 2012 research note is titled “An In-Depth Look at Deleveragings” and in it he does exactly what Professor Robert Shiller taught me to do here at Yale – study the long-term cycles, across countries, so that you can begin to understand the scenarios, probabilities, and mean reversion risks.

 

Dalio considers both the “Ugly” (1920’s Germany) and the “Beautiful” Deleveragings. The most relevant scenarios I thought he nailed down to the risk management board were:

  1. UK Deleveraging 1
  2. Japan Deleveraging 1990-Present
  3. US Delevergaing 2008-Present

Not one of these deleveragings were the same in terms of numbers of years and/or asset price % moves, but the monetary policies that were engaged in by central planners during all 3 certainly rhyme.

 

Dalio calls the UK and US Deleveragings of 1 and 2008-Present “beautiful.” I’ll call what happened in the UK thereafter (1970s) and what is about to happen in the US (if we abuse the US Dollar through debt monetization further), his version of “ugly.”

 

Hendry said he was long asset price inflation (Equities and Agricultural Commodities) in February. That’s was a good call until the end of February and early March when Global Equity and Commodity price inflations stopped.

 

Now what you see is what we call Deflating The Inflation. It’s not what Hendry calls “hyper-deflation”, yet. Neither is it the “ugly deflationary deflation” that Dalio warns of. Unless you are long of anything Spanish, Italian, or Greek Equities, that is…

 

My immediate-term support and resistance ranges for Gold, Oil (Brent), US Dollar Index, EUR/USD, and the SP500 are now $1, $112.42-113.87, $79.36-79.68, $1.30-1.32, and 1, respectively.

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Ugly Beautiful - Chart of the Day

 

Ugly Beautiful - Virtual Portfolio


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