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CONCLUSION: Contrary to consensus speculation, we are of the view that Chinese policymakers are likely not readying a stimulus package to be announced and administered over the intermediate term that would be substantial enough to meaningfully inflect the slope of Chinese economic growth. As such, it would be prudent to fade any incremental Chinese stimulus rallies for the time being.


ACTIVE THEME(S): Growth Slowing’s Slope


In a JAN ’11 note titled “PONDERING CHINESE GROWTH”, we wrote, “To date, we haven’t heard anyone mention the possibility that [the not-yet-released 2011-15 5YR Plan] may come with a more explicit slowdown in the Chinese growth model from the current high-single-digit-to-low-double-digit trajectory to a more modest mid-single-digit pace. While we won’t know until we know, we do know that this scenario is outside of consensus expectations.”


Those thoughts were the then unknowns; the known-knowns of today are as follows: 

  1. Chinese policymakers did, in fact, guide to lower economic growth target(s) in the so-called 12th Five-Year Plan (+7% per annum, down from a consistently-exceeded +7.5% per annum in the five years through 2010); and
  2. A structurally slower rate of Chinese growth is being increasingly priced into consensus expectations. 

To the latter point, global currency market participants have dramatically revised down their expectations for NTM yuan strength in both the onshore (Shanghai) and off-shore (Hong Kong) markets. The discount relative to the spot price embedded in 1YR USD/CNY non-deliverable forwards is -0.7%, which is down from an all-time high premium of +13% (MAR ’08). The discount relative to the spot price embedded in 1YR USD/CNH non-deliverable forwards is -1.3%, which is down from an all-time high premium of +1.9% (MAR ’11). Perhaps a greater callout is the sheer length of time the secular yuan-appreciation story has been more-or-less priced out of the market; at roughly 8MO, you’d have to pull the chart back to 2002 to see a comparable prolonged period(s) of expected yuan dormancy.




As a result, we interpret the aforementioned FX trends as a sign that international investors hold a generally neutral-to-bearish long-term view on the Chinese economy, particularly from a GROWTH/INFLATION/POLICY perspective (i.e. slow growth = lower interest rates; widespread credit quality headwinds = fiscal expansion). That was certainly not the case in JAN ’11!


As an aside, we place substantially more emphasis on actual flows of capital to gauge investor and corporate sentiment rather than on traditional sell-side polls. Looking to flows of hard capital, Foreign Direct Investment growth in China slowed to -6.9% YoY in JUN, which is the slowest rate since DEC. From a 1H12 perspective, FDI inflows dropped -3% YoY. It’s clear that corporations, too, are revising down their expectations for Chinese economic over the long-term by slowing their rates of capital investment into the Chinese economy. In spite of Chinese policymakers’ recent +167% increase in QFII quotas to $80B (APR ’12), growth in capital inflows, as measured by Chinese bank’s foreign exchange positions, have slowed dramatically since last SEP.






Needless to say, international investors and corporations simply aren’t buying into the sell-side-generated Chinese growth machine like they used to. While we certainly aren’t arguing for the Chinese economy to pack it in and go away, we do stick with the conclusion of our OCT ’11 note titled “PUTTING CHINA INTO PERSPECTIVE” as it relates our expectations for Chinese economic growth over the next three years:


“…a structural downshift in rates of Chinese economic growth is not at all out of the band of probable outcomes over the long term and this has major implications for a great many corporations and investor portfolios worldwide.”


In light of these expectations, it may very well be that consensus expectations for the Chinese economy over the long-term TAIL are as close to our subdued expectations as they’ve ever been. From an intermediate-term TREND perspective, however, they have farther to travel as it relates to narrowing that delta.


It was as clear as day to anyone at their desk last Friday that U.S. equity investors equated the sharp slowdown in China’s 2Q12 Real GDP growth into Pavlovian expectations of further rate cuts and perhaps a meaningful fiscal stimulus package (CNY4 trillion during 2008-10) fully-equipped with another state-directed lending spree (CNY17.5 trillion during 2009-10).


As we penned in a research note last Friday, titled “CHINESE GROWTH: STICKING TO THE [CENTRAL] PLAN”:


“…we maintain conviction in our view that Chinese economic growth is not poised to meaningfully inflect over the intermediate term. Furthermore, we can’t stress how much the late-year transition in leadership or the growing official realization that the 2008-09 stimulus package and central plan (i.e. state-directed lending) contributed heavily to a rapid and potentially unhealthy expansion in credit (+96.6% since the end of 2008) may slow Chinese policymakers’ fiscal/regulatory response [if any] to an incremental deterioration in economic growth.”


In terms of updating our thoughts here, Chinese Premier Wen Jiabao was back in the media today guiding down expectations for Chinese growth [again], this time stating that China’s labor market will become “more severe” and “more complex”. He’s calling on Party Commissions and municipal governments to fulfill their role in promoting “proactive labor policy” by “maintain[ing] steady and relatively rapid economic growth”.


While it has been our official view that Chinese policy makers will surprise consensus expectations to the downside with regards to any announcement(s) of a fiscal stimulus package and/or a state-directed lending initiative, this does, on the margin, sound like the Chinese leadership is willing to turn an increasingly blind eye to local governments to do what they feel needs to be done to protect growth. That does not, however, include loosening restrictions on property investment – a clear directive Chinese policymakers have made repeatedly in recent weeks.


While it’s too early to tell if this is a meaningful inflection point in Chinese fiscal policy – which would provide a far-more substantial boost to economic growth than merely lowering the cost of capital – we are concerned by the fact Chinese equities simply aren’t pricing in any meaningful inflection point in China’s GROWTH/INFLATION/POLICY dynamics (the Shanghai Composite is still in a Bearish Formation). This leaves us to believe that it would be prudent to fade any incremental Chinese stimulus rallies for the time being.




In contemplating the other side of this view, the Shanghai Composite bottomed just five days prior to the State Council’s economic stimulus announcement in NOV ’08, which does call into question the discounting mechanism of the Chinese equity market to some degree – though we’d argue NOV ’08 was a more panicked and rushed response to a negative growth shock vs. a deliberate and partially policy-induced growth slowdown. Net-net, either Chinese policymakers are being uncharacteristically tight-lipped about their plans to “stabilize” growth or they simply don’t have any a’brewing at the current juncture.


Needless to say, confirmation of the latter would likely deliver a crushing blow to consensus expectations of broad-based fiscal and monetary expansion in China over the intermediate term.


Darius Dale

Senior Analyst

LINSANITY: The End of an Era

Jeremy Lin's move to the Rockets is expensive not just for Knicks fans but Modell's Sporting Goods. Remember in the 2011-2012 basketball season we had a little thing in New York called Linsanity? The hype surrounding Knicks point guard Jeremy Lin was incredible. Like the flavor of the month (Baloteli, Smarty Jones, etc.), everyone simply had to have Lin gear. And now it appears that manufacturing all that gear will cost Modell's to the tune of $1 million.



LINSANITY: The End of an Era  - MODELLS lin



With Lin poised to move to Houston, guess who’s sitting on 40,000 Lin-related items across its 150 stores? Modell’s Sporting Goods. The company is expected to dump these goods at true fire sale prices. Expect $5 t-shirts and the like. This will prove to be a huge headache and cost for the company. Per Hedgeye Retail:


If we assume a conservative $30 ASP per unit, this would equate to a 80%+ discount (t-shirts: $24.99, Jersey $89.99) to flush inventory resulting in over $1mm in lost sales. With Modell’s revenue nearing an estimated $700mm in 2011, each store (105 of 150 stores in tri-state area) could have nearly $7K of the quarter’s ~$1.03mm/store at risk.”


With that kind of loss, the least Lin could do is swing by the Times Square location and sign a couple of jerseys before he hops on his jet to Houston.


Solid earnings and guidance boosted by lower CostPAR




  • Strong F&B flowthrough led to above consensus results, driven by better banquet business
  • Strong increase in demand in their group business accelerated in the quarter with occupancy increasing more than 5%.  Rate increase was 1.5%.  7% increase in group RevPAR this quarter which was better than transient growth
  • 6% increase in special corporate rates
  • Government business declined by less than 3%
  • Transient volumes decreased a little and overall transient grew just under 5% due to less availability of rooms
  • Total bookings for the remainder of the year are 7.5% of less year and revenue improvement should be 10%.  2013 should benefit from increased business spending.
  • Acquired Hyatt DC for a better price than the one they had orginally negotiated last year
  • Have one smaller asset under contract, which is expected to close in late summer.  Also actively marketing several additional properties which are expected to close during 4Q.
  • Seeing great results from our three recently redeveloped hotels, the Chicago O'Hare Marriott, the Atlanta Perimeter Marriott and the Sheraton Indianapolis, where RevPAR is running better than 35% ahead of three renovation levels
  • Doing some incremental renovations on the Helmsley, NY (lobby and new restaurant)
  • Expect industry fundamentals to remain solid for the remainder of the year
  • Believe that the growth cycle in lodging will be sustained
  • Individual market performance commentary:
    • Philadelphia:  Top performing market with RevPAR+ 23.7% (Occupancy: +13%, driven by strong group and transient demand, ADR: +4%). Results for the Q benefited from the 2011 rooms and meeting space renovations at the Downtown Marriott.  Excellent F&B growth. Expected to be a top performing market in 3Q due to strong group and transient demand, which should allow us to drive pricing.
    • Chicago:  RevPAR: +11.1% (ADR: +7% and Occupancy:+3%); both citywide and overall group demand were excellent. The increase in group business helped drive a 15% increase in F&B.  Expect hotels to underperform in 3Q due to lower levels of citywide and group demand YoY.
    • Boston:  RevPAR: +10%(ADR +8%; Occupancy +1.5%) despite the ongoing renovation of the Boston Copley Marriott.  Outperformance was driven by strong corporate group and transient business which allowed HST to shift the mix of business and benefit from rate compression.  Expect to have a strong 3Q.
    • Atlanta:  RevPAR up 8.3% (Occupancy: 4% and ADR: +1%).  Strength in citywide association and transient demand, while ADR increased over 1%. Expect to underperform in 3Q due to renovations at the Ritz-Carlton Buckhead and the Four Seasons.
    • San Francisco:  RevPAR +8.2% (ADR +7%). The improvement in ADR was driven by rate increases for both group and transient business and F&B revenues increased over 11%. Expect to continue to perform very well in 3Q.
    • New York:  RevPAR 4.8% due to growth in ADR.  Negatively impacted by the second and final stage of the rooms renovations at the New York Marriott Marquis and the Sheraton New York and a rooms renovation at the W Union Square.  The renovations at the Marquis included the addition of eight new rooms at a cost of under $300,000 per key but HST had to shut down the whole floor in order to finish the construction.  Expect better performance in 3Q.
    • Miami Fort Lauderdale: RevPAR -20bps (ADR +3%; Occupancy -3%). Weakness was due to less transient and group demand. Expect better performance in 3Q due to better group bookings.
    • Year-to-date: Los Angeles +10.6%. 
    • Our worst performing market has been San Antonio with a RevPAR decrease of 4.6%.
    • European JV: Results continue to exceed expectations.  Inbound travel to the Eurozone from the U.S., UK, Asia and the Middle East continues to be strong and as a major source of euro lodging demand. The Hotel Arts Barcelona, the Sheraton Warsaw and the Crowne Plaza Amsterdam, all had strong RevPAR increases for the quarter while Brussels and Madrid hotels struggled.
  • Comparable RevPAR should be driven by both ADR and Occupancy 
  • Continue to see improvements in catering, meeting room rental and audio-visual revenues, and better F&B margins.
  • SG&A and marketing,repairs and maintenance increased 3.5%, primarily driven by expenses that are variable with revenues (credit card commissions, guest reward programs and clustered and shared service allocations). 
  • Utility costs were down 3.5% and property taxes increased 6.6% while property insurance increased roughly 14%.
  • Expect unallocated cost to increase more than inflation particularly for sales and marketing where higher revenues will increase cost
  • Property insurance all renewed by June 1 - rate increases they received were only 7% vs the expected increase of 15%
  • Property taxes are only increasing 6% vs their prior expectation of 8-9%
  • Utilities will be down slighly for the year vs. prior expectations for a 1-2% increase 


  • Group business in 2012:  roughly 25% of that business was booked when rates were softer. Very little of that "soft" business left on the books for 2013.
  • Special corporate rates tend to be below rack rates, and given the amount of special corporate they had probably held back pricing a bit in the quarter
  • Expanded the scope of their Orlando renovation and the net effect of that including adding a bar/restaurant at the Helmslely should result in better EBITDA from these hotels going forward
  • Mid 13 range on their acquisition price
  • Attrition/ cancellation clauses: they are seeing the ability to negotiate better terms on these clauses where occupancy is stronger
  • More than 90% of their group business is already on the books for 2012 so they may not book as many rooms YoY as last year given the reduced capacity
  • RevPAR growth rate in the 4Q vs. 3Q? Don't necessarily see a big difference in trends between the 2 quarters
  • Do expect that a number of the hotels that they are marketing will close by the end of the year, however, only one of the hotels met the standard of being excluded from ongoing operations. 
  • Expectations for a pick of M&A activity in 2H12 have moderated, however, there are more opportunities in the market today. For the full year, they still expect to be a net acquirer of assets.
  • Washington market is closer to their prior peak than other markets, but the Hyatt DC is about 8-10% below prior peak. The upside from owning this hotel is the good location and their long term view on DC.  They believe that this will continue to be a very strong convention market.  Seeing increase in 2015-2016 booking volumes.  Expect to see an accelerated level of activity in that market in 2013.  The location is also in the heart of convention activity in town. 
  • Depending on where pricing goes will influence whether they will be a net buyer or seller of assets
  • Wages and benefit increased a little more than 3% this past quarter, but on a per occupied room basis it was only about 1%. Expect that increases for the rest of the year will be a little north of 3% but on a per occupied room basis only about 1%. 
  • Is food inflation an issue?  HST actually had a margin improvement due to better menu management and procurement synergies.  They are not seeing food inflation as an issue.
  • Still expect the bulk of their investment to be in the US.  In Europe, they would be interested in London, Paris and Germany which they feel are more defensive and would perform better.  In Brazil, they would like to buy more full service hotels there.  They believe that there is also an opportunity in Select Service to capture the rising middle class.  In Asia, their efforts are mostly focused on Australia, Singapore and HK. 
  • Want to be a lower leveraged company then where they were at the last peak cycle - so at or below 3x leverage level 
  • Expect European RevPAR to be similar for the remainder of the year.  Expect similar 3-4% RevPAR growth for the full year.  Seeing relatively good group activity throughout Europe.  Seeing some benefit from weak Euro on US travel to the region. 
  • Major 2013 renovations planned? 
    • Nothing as major as the ones they had this year, although they would be surprised if one or 2 hotels don't creep into their capital plan where they see opportunity.  Think that that they are fairly caught up on capital projects.  Don't expect as much disruption next year. However, they are not done with their capital allocation plans so it's a bit early to say.
  • Some of their planned capital spend does consider improving assets that they want to sell so that they don't get dinged on the sale price.  Room renovations may not make sense since there are a lot of rebranding opportunities upon a sale but some things like roofs and maintenance do make sense. 
  • Last cycle they sold 35-36 hotels. Not sure that they will be as active of a seller but they do want to reduce non-core exposure.





  • "The increase in total revenues for the second quarter and year-to-date 2012 reflect the improved performance of the Company's owned hotels due to improvements in comparable hotel RevPAR of 6.1%... and year-to-date and improvements in comparable food and beverage revenues of 5.7%, respectively. In addition, the improvement in operating results for year-to-date 2012 includes operations for the ten hotels (nearly 4,000 rooms) acquired in the first half of 2011, which increased revenues by an incremental $56 million. If the Company reported its results on a calendar quarter basis, then comparable hotel RevPAR would have increased 6.8% for the second quarter 2012"
  • "On July 16, 2012, the Company acquired the 888-room Grand Hyatt Washington, D.C. for approximately $400 million....The acquisition has been funded with available cash and a draw under the revolver portion of the Company's credit facility. The Company intends to repay a portion of the revolver draw, as well as other debt, with proceeds from a five-year term loan currently under negotiation. The Company has received commitments from a number of banks"
    • Preliminary terms: 
      • $400MM
      • L+180bps (2.1%)
      • Closing by end of July  
  • "The Company continued to actively pursue its strategy of extending its debt maturities and lowering its overall cost of debt."
    • On June 7, 2012 the Company entered into a $100 million mortgage loan secured by the Hyatt Regency Reston and due in 2016, with an additional one-year extension at the Company's option
      • Terms: 1 month LIBOR+310bps (3.34%)
    • HST issued $650MM of debt in 1Q12 at an average interest rate on 5.3% and used the proceeds to reduce approximately $1BN of debt during the quarter, with an average GAAP interest rate of 6.8%. 
    • Proforma for the Hyatt DC acquisition and new term loan, HST will have $760MM of availability under its R/C, cash of $150MM and total debt of $5.3BN
  • In 2Q HST issued 3.1MM shares of stock at $15.75 with net proceeds of $48MM. $350MM of issuance capacity remains under the April 2012 Sales Agency Financing Agreements
  • Capex spend in 2Q12:
    • ROI: $50MM
    • Acquisition: $50MM
    • Renewal and replacement: $79M

Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.


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




  • BETTER - Demand outlook similar to last quarter's but costs look a little lower resulting in a solid quarter and guidance.




2013/2014 COMMENTARY

  • SAME:  Industry fundamentals will remain solid due to strong group business and low supply growth
  • PREVIOUSLY:  "We believe this positive cycle will gain momentum through the remainder of this year and into 2013, an increase in demand combined with projected low supply growth in our markets of roughly 0.5% in 2013 and 2014, should support a solid and sustained recovery....we are also seeing positive group booking activity extend into 2013, indicating that our group hotels, which lag during the early stages of this recovery, are now benefiting from increased business spending.....We're hearing signs from our operators that the associations are thinking in terms of bigger events, both in days and attendance, as they look out into 2013 and 2014 and beyond." 


  • SLIGHTLY WORSE:  Group bookings for 3Q and 4Q are averaging +9% YoY   
  • PREVIOUSLY:  "Group bookings for the remainder of the year surge by more than 13% compared to the prior year and are now approximately 7.5% ahead of last year's pace for the remaining three quarters and meaningfully positive in every quarter. The average rate for these bookings is up approximately 2% and our recent bookings have exceeded last year's rates by more than 8%. Both trends bode well for the future."


  • SAME:  Rate growth continues to drive HST's transient segment.  As expected, government transient business was weak as demand declined by less than 3%.  The strong increase in group business did result in a slight decline in transient room volume as midweek availability was constrained.
  • PREVIOUSLY:  "Our transient bookings also continue to run well ahead of last year's levels and suggest strong rate growth. The combination of these trends suggests that we should continue to see improvements in occupancy in 2012, which will ultimately drive higher rates and additional mix shift. We are also seeing positive group booking activity extend into 2013, indicating that our group hotels, which lag during the early stages of this recovery, are now benefiting from increased business spending."


  • BETTER:  On a revenue basis, HST is trending at 10% for 2H 2012
  • PREVIOUSLY:  "Overall booking pace for the full year is up actually about 8.5% on a revenue basis for the full year. But that is much stronger for the last three quarters of the year than it was for the first part. So actually if you look at the last three quarters of the year, we are running – on the revenue basis, we're running in the 9.5% to 10% area."


  • SAME:  Expectations for the transaction market have moderated a bit.  HST will remain active and be a net acquirer by the end of 2012.
  • PREVIOUSLY:  "We would expect to be a net buyer this year, but we intend to remain disciplined. If pricing levels move too high, we will look to take advantage by accelerating our sale activities. Given the unpredictability of the timing of these transactions, our guidance does not assume any additional acquisitions or dispositions this year beyond what we have already announced."


  • SAME:  Philly is still the top market. REVPAR was up 23% YoY in 2Q
  • PREVIOUSLY:  "We expect Philadelphia to be a top-performing market in the second quarter due to strong group demand, which should allow us to drive pricing."


  • SAME:  REVPAR rose 11% in 2Q
  • PREVIOUSLY:  "We expect our Chicago hotels to continue to perform very well in the second quarter due to strong group and transient demand."


  • WORSE:  Less transient/group demand drove a negative REVPAR print
  • PREVIOUSLY:  "We expect our Miami and Fort Lauderdale hotels to continue to perform well in the second quarter."


  • WORSE:  RevPAR +4.8% YoY.  Rooms renovations at the NY Marriott Marquis, Sheraton NY, and W Union Square affected performance.
  • PREVIOUSLY:  "We expect our New York hotels to have a good second quarter."


  • SAME:  REVPAR declined 4.6% in 2Q
  • PREVIOUSLY:  Lastly, our worst performing market for the quarter was San Antonio. RevPAR declined 8% due to a slight drop in occupancy and a decrease in ADR of over 7%. City-wide and group demand were weak. We do expect our San Antonio hotels to perform better in the second quarter but to continue to underperform our portfolio.


  • SAME:  REVPAR gained 8.3% YoY in 2Q
  • PREVIOUSLY:  "Atlanta was actually up 4.9%. Very good group, city-wide demand. We actually expect an even better second quarter. We've got really good group and transient pace on the books. And then for the rest of the year it will basically end up about where it was in the first quarter."


  • BETTER:   HST mentioned that the JV continues to exceed their expectations.  Inbound travel to the Eurozone continues to be robust. 
  • PREVIOUSLY:  "Inbound travel to the euro zone from the U.S., U.K., Asia and the Middle East continues to be strong and is a major source of euro lodging demand. The Westin Europa & Regina in Venice, the Sheraton Warsaw, the Sheraton Skyline in London and the Paris Versailles, all had double digit RevPAR increases for the quarter."        


  • SAME:  G&A, Sales/Marketing, Repairs, and Maintenance increased 3.5% in 2Q, primarily driven by variable expenses e.g. credit card commissions, guest reward programs, clustered, and shared service allocations
  • PREVIOUSLY: "We expect unallocated cost to increase more than inflation particularly for rewards in sales and marketing where higher revenues will increase cost. "


  • BETTER:  Q2 property taxes ended up 6.6%
  • PREVIOUSLY:  "We also expect property taxes to increase roughly 8%."


  • BETTER:  utility costs declined 3.5% in Q2
  • PREVIOUSLY:  "Utilities to increase between 1% and 2% for the year."


In preparation for CMG’s 2Q12E earnings release on 7/19, we’ve put together some recent forward looking company commentary and important consensus metrics for the upcoming 2Q12 earnings release.


Summary Thoughts

  1. CMG is comparing against very weak 2Q11 results, due to significant food inflation last year
  2. Street modeling 10.1% SSS for 2Q12, a 250 bps slow down in 2-year trends
  3. Consensus expectation for 2H12 food costs look low
  4. Short interest is 7.45% of the float, and trended lower during the quarter
  5. CMG has lost ground on the Hedgeye Restaurant sentiment scorecard over the past 8 weeks
  6. New store performance continues to be the future for this stock




“In March, we raised prices in our Pacific region by about 4.5% to reflect the higher cost of doing business in the region, and to help narrow the pricing gap with other U.S. markets. This price increase was completed in March. And because it laps a similar increase in the Pacific region at about the same time last year, it will have no additive effect to our comps going forward.”


“While we continue to believe we have pricing power, we do not have plans for any additional menu price increases during 2012 to offset expected food inflation.”


HEDGEYE – Every management team has pricing power until they don’t – just ask the management of DRI about the pricing power at Olive Garden.  The bottom line is that consumers determine whether you have pricing power or not, and if you abuse the privilege you can get burned badly.  Yes, even Chipotle.




“Our comps held up well in the first quarter despite the toughest quarterly comparison in 2011 of 12.4%. Unseasonably mild weather through much of the quarter helped transaction trends remain strong. And in addition, we benefited from the leap day in February, which added about 1% to the comp.”


“Our sales comps continue to benefit from the menu price increases taken during the second and third quarters of 2011. At the current menu price increase run rate of 4.9%, we will lose 3.9% of the benefit over the next two quarters as we lap the price increases from last year, with about 30 basis points dropping off in Q2 and about 360 basis points dropping off in Q3. We also face tough sales comparisons in the back half of 2012, as beginning in the third quarter we will comp against two full years of double-digit comps for the first time since before the recession. Taking all this into account, we reaffirm our full-year comp guidance of mid-single-digits.”


HEDGEYE – Expectations are loftily for CMG, but this is not new.  Some of our own internal metrics suggest that 10% same-store sales figure is likely a good estimate for the quarter.





“G&A was 7.7% in the quarter, up 140 basis points from last year, due primarily to higher non-cash, non-economic stock compensation expense, and higher payroll tax expense related to the exercise of options during the quarter. The non-cash, non-economic stock comp expense was about $20.5 million in the quarter, or $11.5 million higher than last year. About half of the increase, or $5.6 million, was due to a one-time catch-up adjustment for performance shares issued during 2010. These performance shares have a three-year vesting schedule ending in October 2013. And the amount of the award can increase or decrease depending on our financial performance during the three years.”


HEDGEYE – Outside of another “one-time” adjustment compensation expense with 10% same-store sales, there should be no surprises in this line item for the quarter.





“Restaurant level margins increased by 220 basis points to 27.4%, just 30 basis points shy of our highest quarterly restaurant level margin set back in Q3 of 2010. The higher margins were driven by sales leverage, including the benefit of the menu price increase, and from lower promo costs due to the large promotion in Q1 of 2011. Operating margins increased by 130 basis points, lower than the restaurant level margin expansion because of increases in non-cash stock comp, which I'll talk about in more detail shortly.”


HEDGEYE – The Street is expecting a 156bps improvement in restaurant level margins as the company should be able to leverage labor costs and other expenses with 10% same-store sales.  Food costs appear to be the wild card.





“We continue to expect food inflation in the mid-single-digit range over the next few quarters, due primarily to rising costs of beef, dairy, and avocados.”  “Contributing to these higher costs is the expectation that all of our sour cream will come from cows that are pasture raised beginning in the second quarter, and from seasonally higher avocado costs as we return to buying avocados from California this summer.”


“Right now we think that over the next two quarters it's going to be mid-single-digit inflation. We think that if things go as planned then the fourth quarter will level off a little bit. So I think when you take that mid-single-digit inflation and convert that into impact on food costs, I think you are looking at somewhere between 100 basis points to 150 basis points of higher food costs over the next couple quarters.”


“But more importantly, from the fourth quarter to the first quarter, we had the same food costs. So we didn't see any net effects of food inflation so far in 2012. And that's, I think, the most reflect – I think the most – the best way I think to look at it is kind of sequentially from the fourth quarter.”


“If you look at the fact that we had a – we've got a run rate of about a 5% menu price increase, and our food costs went up by 20 basis points, you could just back in to the fact that we had like a, call it a 6% or 7%, in that kind of ballpark inflation year-over-year.”


“But more importantly, looking at it sequentially, didn't get hit in the first quarter. We do think that the mid-single-digit inflation going forward will kick in, and we think it'll hit over the next two quarters.”


“And we expect higher costs as we move into the second quarter and the third quarter. It's coming from three principal places. We continue to see inflation in beef costs. We will see seasonally higher prices. Even though avocados year-over-year will be lower, as you get into the second and third quarters, they're going to be higher than they are in the first quarter, because we're going to start buying from California and they will be more expensive.”


HEDGEYE – The Street is modeling a YoY 5bps decline in the cost of sales for the quarter and a 61bps sequential increase.  CMG is losing some benefit from pricing, and food inflation in the company's P&L is accelerating quarter-to-quarter.





“Our new restaurants continue to perform very well, reflecting the success of our real estate development strategy and the growing awareness of the Chipotle brand across all U.S. markets. Our new restaurants are opening at or above our $1.5 million to $1.6 million communicated range. And A-Models continued to perform well with sales just below traditional sites, but they generate higher returns.”


HEDGEYE – All eyes are on this metric as investors seek to gain a clearer idea of how big this company can be!


CMG - THE 2Q12E REMIX - cmgmetx


CMG - THE 2Q12E REMIX - cmgsss


In preparation for YUM’s 2Q12E earnings release on 7/18, we’ve put together the recent pertinent forward looking company commentary from 1Q12 including Hedgeye commentary and important consensus metrics for the upcoming 2Q12 earnings release.


Summary Thoughts

  1. YUM is comparing against a more difficult 2Q11 results.  It’s unlikely they raise full-year EPS forecast above the current 12% pace.
  2. Short interest is very low at 1.82%, but has risen sharply in the last month.
  3. Sentiment has turned down over the past eight weeks but remains one of four names in the restaurant space with a Hedgeye sentiment ranking of 90 or better.
  4. The sentiment surrounding YUM China drives this stock.  Given the news flow from China, it will take nothing short of a spectacular quarter for the street to be comfortable with how 2H12 is shaping up.    



“KFC now has 3,819 restaurants with average unit volumes of $1.7 million; in 800 cities throughout the country and continues to expand into new cities as well as increase its penetration levels in existing markets. KFC is deeply rooted in China with its localized menu and broad appeal. Virtually all KFCs in China serve breakfast, which accounts for about 6% of sales. Nearly half our KFC restaurants offer delivery service and over half have 24-hour operations. These service and day part extensions are all in the early phases of development and provide tremendous growth potential for years to come as we further leverage our restaurant assets.”


“Next, I want to provide an update on our China margin expectations. Let me start by discussing our pricing strategy in China as our approach continues to evolve. Historically, our pricing actions have been implemented nationally and all at one time. Going forward, we will take pricing across our system at various levels and at different stages, depending on the trade zone. This will allow our team to more effectively monitor the consumer reaction to pricing."


“In 2011, we had a 3% price increase at the end of January. With the phase-in pricing approach, we have a relatively small impact from new pricing in the second quarter. As a result, we will likely see a decline in margins in the second quarter that is somewhat higher than what we saw in the first quarter. However, we are still roughly on track with what we outlined in our December meeting.”


“As you may recall, we estimated that first quarter margins would be about two points below last year. As the year progress, we expect the combination of our cumulative staged pricing and moderating inflation to result in year over year margin improvement of up to 2% in the second half of the year. I'm confident the team will continue to generate annual Restaurant margins of about 20%.”


“As we look into the balance of 2012, I believe that this will be another year of improvement to our competitive position and our business model. Our new unit development opportunities are as robust as they have ever been. Higher return new unit development continues to be the foundation of our growth in China. As I've said before, it's a pretty easy decision to improve capital investments when you have average cash paybacks of less than three years. It's even easier when you know how much discipline our China team incorporates into the development process."


"Now I want to provide a brief update on Little Sheep. As indicated on our fourth quarter call, with revenue of about $300 million, the Little Sheep business will add about 5% to our revenue base in China this year. In 2011, the Little Sheep business started strong but struggled in the second half of the year. Operating profit was about $20 million for the full year. We are still in the process of getting our arms around Little Sheep as we transition this business into Yum! China. We will begin reporting Little Sheep numbers in our second quarter results."


"I want to reiterate when you take into account transaction and transition costs, we expect only a modest profit benefit, if any, in 2012. However, we remain excited about having Little Sheep in our portfolio and we believe in the long-term potential of the brand and will invest behind its future success.”





“The biggest impact, we said we expect sales to moderate, but the impact is really inflation was very, very high in the third and fourth quarters last year. We got behind from a pricing standpoint. We think this staged pricing will start to have an impact in the second half of the year."


"Plus we expect inflation to moderate in the balance of the year. Again, to put things in perspective on the inflation side, on the commodity side in particular, we said going into the year, we expected 6%. We had 10% in the first quarter. If anything, we're gaining more confidence that 6% is the high end of what we expect from commodity inflation. So you have that benefit plus the cumulative pricing coming in that should help the margins in the second half.”


HEDGEYE – For YUM, the MACRO outlook on China is difficult to read.  The Chinese government is trying to make the

economy more dependent on consumption and less on exports.  To the degree that it is successful, YUM’s brands will benefit.  Consumer confidence has been trending lower since 2007, but has improved in early 2012.  Longer-term the potential for a housing bubble could hurt consumption.  The biggest hurdle the company faces are difficult same-store comparisons from 2011.



“Our ongoing model does not meet the high level of same-store sales growth that we've recently experienced. We expect same-store sales to moderate at some point, although it's difficult to tell when that will occur. The important point is during 2012, we are again building up day parts and initiatives that can help drive sales well into the future.”


“I think it's really hard to forecast same-store sales in a year, in 2012 coming off a year like 2011, which was so strong from a same-store sales perspective. On the positive end you have momentum, on the negative side you know you're going to be lapping some big numbers, especially as we get into the second half of the year. We're not going to give a forecast for the second quarter. What I would say is traditionally we let people know if there's a significant bending in the trend. And we're not saying there's a huge change in the trend versus what we saw in the first quarter. So we're obviously off to a very good start.”


HEDGEYE – The comments are referring to the fact that SSS will slow in China sooner rather than later, but primarily as a result of difficult comparisons.  News from other consumer product companies would suggest that YUM could see a significant slowdown this quarter.



“For Yum! Restaurants International, our sales results have been mixed in Western Europe and we expect this to continue, at least in the near term. Our focus in our strategic growth markets remains, driving profitable new growth development.”


HEDGEYE – Fortunately for YUM, Western Europe is a small part of the business and it’s primarily franchised.  That being said, “Slowing growth” compresses equity multiples! 



“In the United States, we expect strong second quarter sales at Taco Bell. The first quarter included only a few weeks of the Doritos Locos taco sales. This has been an enormously successful product introduction and thus far the second quarter sales at Taco Bell are running higher than they were in the first quarter. For the second quarter, we expect same-store sales at Taco Bell to be in the high single digits or low double digits.”


HEDGEYE – The Company reiterated the comment about Taco Bell’s performance on 5/8 but failed to mention it in two other conference appearances.  How refreshing after a five year drought that we are seeing YUM’s business in the USA post strong numbers.  Especially compared to what’s happening in a number of key regions around the world, the USA is looking stable, and Taco Bell has some momentum.  





“In our U.S. business, the 53rd week provided $18 million of operating profit benefit in the fourth quarter of 2011. This benefit was offset with higher spending throughout the year including franchise development incentives and higher than normal costs from restaurant closes. While the combined full-year impact is modest, the 53rd week will have a significant operating profit headwind for the U.S. in the fourth quarter of this year.”


"It will also negatively impact Yum! Restaurants International profits by about $8 million in the fourth quarter. International development continues to be quite strong. We opened 297 new units in the first quarter and our new unit pipeline is solid. We are expecting to open over 1,500 new international units in 2012, including 800 at Yum! Restaurants International, 100 units in India, and at least 600 in China. This is a key growth driver in 2012 and 2013 and I am encouraged by this pace of development."





“Our expected full year tax rate is about 26% prior to special items. This is almost two points higher than our 2011 effective tax rate of 24.2%. A full year rate of 26% would result in a drag of about three points on full-year EPS growth. We expect the year over year impact on tax to be severe in the second quarter, due to the unusually low rate of 16.7% last year. This will materially impact our second quarter EPS growth.”


HEDGEYE – Both of these issues are cosmetic and can be fodder for the bear case.  This is not a substantial concern and might be the least of the company’s concerns if the operating environment in China is as difficult as some believe.


YUM - THE 2Q12E REMIX - yummetx




YUM - THE 2Q12E REMIX - yumchinasss


Howard Penney

Managing Director


Rory Green


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