prev

Industrial Indicator: CAT in Last Resource Investment Bubble

Chart of the Day: CAT in 70s Resource Investment Bubble

  • Investment in mining and resources in the US and globally at cyclical highs, which has helped capital equipment producers like CAT. 
  • Below, we can see what happened to CAT when the 1970s resource investment boom gave way
  • CAT upped its exposure to these markets with the acquisition of Bucyrus last year, at what looks like the peak of resource investment spending
  • If history rhymes in this investment cycle, CAT holders may be looking at years of relative underperformance

 

Industrial Indicator: CAT in Last Resource Investment Bubble - cat lt rel

 

 

 

Industrial Indicator: CAT in Last Resource Investment Bubble - perf 7202012


Weekly European Monitor: Bulldoze It!

-- For specific questions on anything Europe, please contact me at to set up a call.

 

No Current Positions in Europe

 

Asset Class Performance:

  • Equities:  The STOXX Europe 600 closed up +0.7% week-over-week vs +0.6% last week. Top performers: Denmark +2.6%; Hungary +2.0%; Norway +1.8%; Switzerland +1.7%; Netherlands +1.6%; Greece +1.5%; Germany +1.1%. Bottom performers: Spain -6.3%; Cyprus -5.4%; Italy -4.7%; Finland -0.9%.
  • FX:  The EUR/USD is down -0.74% week-over-week vs -0.50% last week.  W/W Divergences:RUB/EUR +2.46%; SEK/EUR +2.11%; NOK/EUR +1.12%; PLN/EUR +0.49%; CHF/EUR +0.00%; DKK/EUR -0.01%; CZK/EUR -0.51%; RON/EUR -0.79%.
  • Fixed Income:  There was a notable break-out in the Spanish 10YR Yield this week to 7.27%!, or +61bps week-over-week. Greece rose +28bps to 25.50%, and Italy rose +9bps to 6.08%.  France was a notable decliner on the week, falling -19bps to 2.03%.

Weekly European Monitor: Bulldoze It! - 222. yields

 


Bulldoze It!


There was an interesting article from Bloomberg.com yesterday discussing how Ireland’s National Asset Management Agency, the state agency set up in 2009 to “purge banks of their most toxic commercial property loans, started the destruction of an apartment block for the first time.”

 

According to the article, Ireland has some 1,850 housing developments that have remained unfinished since the housing bubble popped in 2008.  Approximately 553,000 houses were built in the ten years through 2005, for a country of 4.5MM, and now an estimated 294,000 homes lie empty.

 

The bulldozing of this block and many more like it is an important step for Ireland and shows a willingness to start over. Getting an economy to a “start-over” spot includes in some cases destroying excess housing supply, but also embracing a level of austerity to reduce fiscal imbalances to healthier levels off which economies can begin to grow again. We’re not saying this process is easy or short, clearly the drag could have generational impacts, but the markets need to clear. It appears, it’s the European politicians, in particular, that don’t want to let this happen.

 

Today’s conference call of Eurozone finance ministers is a prime example. The group of 17 approved an initial €30 Billion (of the total €100 Billion originally proposed) to recapitalize Spanish lenders, following key parliamentary approvals this week by Germany and Finland.  Once again Eurocrats showed their willingness to issue yet another bailout band-aid, to deflect near-term pressures (and save their jobs) but neglect construction of a longer term roadmap. Spain’s banking loans will come initially from the remaining EFSF, with support by the ESM if Germany signs off on its terms in September, and will be directed at Spain’s Fund for Orderly Bank Restructuring (FOBR) by the end of the month.  

 

Socialist policy makers of the world unite!? Well if today’s European equity market performance is any indication – indices were down between -1 and -5% on the day and the EUR/USD cross is trading down -1% at $1.2160 – it’s a reflection of investors’ fears that Europe does not have a credible path forward to grow GDP and eventually exit the years of this sovereign debt and banking crisis

 

 

EUR/USD:


The cross broke through out intermediate term TREND line of $1.22. We’ll be monitoring this cross acutely. Our immediate term TRADE range is $1.21 to $1.23.

 

Weekly European Monitor: Bulldoze It! - 222  euro

 

 

Call Outs:

 

Spain - German Finance Minister Schaeuble told the Rheinische Post newspaper that Spain's government, not its banks, will be liable for the bailout of up to €100B of the Spanish banking sector.

 

Spain - May revise its GDP estimate for 2013 to reflect a contraction of 0.2% to 0.4% vs its previous forecast for growth of 0.2%.

 

Italy - Italian Prime Minister Monti expressed serious concern over a potential default by Sicily, which accounts for ~5.5% of Italy's GDP. Monti said in a statement that there were "grave concerns" that the autonomous region could default and noted that he had written to the governor Raffaele Lombardo seeking confirmation that he would resign by the end of the month.

 

Germany - A monthly survey of funds by Bank of America Merrill Lynch showed that a net 32% of money managers expect trouble in Germany, a sharp reversal since May. Worries may be linked to the Bundesbank's soaring claims (which now stand at €729B) on Eurozone central banks under the ECB’s “Target2” payment system.

 

Eurobonds/bills - Sharon Bowles, chairwoman of the European Parliament's Committee on Economic and Monetary Affairs, said that Eurobills have a better political chance than Eurobonds. She noted that "They are the most likely," adding that "There are a lot of people who believe they are possible and they would also pass muster under the German constitutional court," a major stumbling block for EU legislation.

 

Pan-European deposit protection scheme - Sharon Bowles, chairwoman of the European Parliament's Committee on Economic and Monetary Affairs, said that a pan-European deposit protection scheme is unlikely to gain political traction over the near-term due to limited funding availability. She noted that many member-state deposit guarantee funds are only funded after they are needed, adding that most are bankrupt due to recent bailout activity. She also pointed out that more than €10T in total deposits that would have to be insured dwarfs the €700B in ESM firepower.

 

Italy - The Italian lower house voted on Thursday to approve the ESM, the euro zone's new bailout fund, giving final parliamentary clearance after a vote in the Senate last week.

 

 

Risk Monitor:


Sovereign CDS rose across the peripheral countries this week. On a week-over-week basis Spain rose the most, up +26bps to 594bps, followed by Ireland +11bps to 562bps and Italy (+10bps) to 515bps. Germany saw the largest decline (-12bps) to 75bps, followed by Portugal (-8bps) to 827bps.  Both France and the UK fell -5bps on the week, to 168bps and 61bps, respectively.

 

Weekly European Monitor: Bulldoze It! - 222. cds   a

 

Weekly European Monitor: Bulldoze It! - 222. cds   b

 

 

Data Dump:

 

Eurozone ZEW Economic Sentiment -22.3 JUL vs -20.1 JUN

EU-27 New Car Registrations -2.8% JUN Y/Y vs -8.7% MAY

Eurozone CPI 2.4% JUN Y/Y vs 2.4% MAY

Eurozone May Current Account +€10.9B vs prior revised +€5.5B from +€4.6B

Eurozone Construction Output -8.4% MAY Y/Y vs -6.3% APR   [0.1% MAY M/M vs -3.7% APR]

 

Germany ZEW Current Situation 21.1 JUL (exp. 30) vs 33.2 JUN

Germany ZEW Economic Sentiment -19.6 JUL (exp. -20) vs -16.9 JUN

Germany Producer Prices 1.6% JUN Y/Y (exp. 1.8%) vs 2.1% MAY

 

UK CPI 2.4% JUN Y/Y = lowest level in 2.5 years (exp. 2.8%) vs 2.8% MAY   [-0.4% JUN M/M (exp. -0.1%) vs -0.1% MAY]

UK Retail Price Index 2.8% JUN Y/Y (exp. 3%) vs 3.1% MAY

UK Bank of England votes 7-2 to increase Asset Purchases

UK ILO Unemployment Rate 8.1% MAY vs 8.2% APR

UK Jobless Claims Change 6.1K JUN (exp. 5K) vs 6.9K MAY

UK Retail Sales w/ Auto Fuel 1.6% JUN Y/Y (exp. 2.3%) vs 2.1% MAY

UK Public Sector Net Borrowing 12.1B GBP JUN (exp. 11.2B) vs 16.1B GBP MAY

 

Italy Industrial Orders -9.4% MAY Y/Y vs -12.3% APR

Spain House Price Index -8.3% in Q2 Y/Y vs -7.2% in Q1   [-2.5% in Q2 Q/Q vs -3.0%]

Portugal Producer Prices 2.7% JUN Y/Y vs 3.2% MAY

 

Switzerland Credit Suisse ZEW Survey of Economic Sentiment -42.5 JUL vs -43.4 JUN

Switzerland Industrial Production 1.4% in Q1 Y/Y vs 3.6% in Q4

Switzerland Exports -2.6% JUN Y/Y (exp. -1.5%) vs 1.3% MAY

Switzerland Imports -3.1% JUN Y/Y vs 0.9% MAY

 

Netherlands Consumer Confidence -32 JUL vs -40 JUN

Netherlands Unemployment Rate 6.3% JUN vs 6.2% MAY

Netherlands Consumer Spending -1.9% MAY Y/Y vs -2.1% APR

Ireland PPI 3.2% JUN Y/Y vs 2.0% MAY

 

Slovenia Unemployment Rate 11.6% MAY vs 11.8% APR

Slovakia CPI 3.7% JUN Y/Y vs 3.4% MAY

Slovakia Unemployment Rate 13.3% JUN vs 13.2 MAY

 

Turkey Consumer Confidence 91.8 JUN vs 92.1 MAY

Turkey Unemployment Rate 9.0% APR vs 9.9% MAR

 

ZEW Eastern Europe Economic Survey:

 

Weekly European Monitor: Bulldoze It! - 222. EE

 

 

Interest Rate Decisions:

 

(7/19) Turkey Benchmark Repo Rate UNCH at 5.75%

 

 

The Week Ahead:

 

Monday: Jul. Eurozone Consumer Confidence – Advance; May Mortgages - Capital Loaned; Mortgages on Houses

 

Tuesday: Jul. Eurozone PMI Composite, Services, and Manufacturing – Advance; Jul. Germany PMI Services and Manufacturing - Advance; Jun. Germany Import Price Index (Jul. 24-30); Jun. UK BBA Loans for House Purchase; Jul. France PMI Services and Manufacturing – Preliminary, Own-Company Production Outlook, Production Outlook Indicator, Business Confidence Indicator; Jun. Spain Producer Prices

 

Wednesday: Germany IFO Business Climate, Current Assessment, and Expectations; Jul. UK CBI Trends of Total Selling, Trends of Selling Prices, and Business Optimism; 2Q UK GDP – Advance; May UK Index of Services; Jul. France Business Survey Overall Demand; Jun. France Jobseekers; Jul. Italy Consumer Confidence Indicator

 

Thursday: Jun. Eurozone Money Supply 3; Aug. Germany GfK Consumer Confidence Survey; Jun. Italy Hourly Wages; May Italy Retail Sales

 

Friday: Jul. Germany CPI; Jul. France Consumer Confidence Indicator; 2Q Spain Unemployment Rate; Jul. Italy Business Confidence

 

 

Extended Calendar Call-Outs:

 

18-19 October: Summit of EU Leaders

 

 

Matthew Hedrick

Senior Analyst

 

 


LVS: A WILD CARD OF A QUARTER

Uncertainty to how much will flow through pre-opening expense makes this a difficult quarter to predict and potentially, to analyze.

 

 

Q2 is even more of a wildcard than usual for LVS.  Singapore is always difficult to predict given the lack of public data made available from other jurisdictions.  We’re usually pretty close in Macau (thanks Anna) but the discretion involved in determining pre-opening expense means we could be way off on Sands Cotai Central which opened during the quarter.  Sentiment is lousy but we’re generally below the Street so what to do?  Too much risk either way so we’ll defer until we are wearing our post conference call analysis hats.

 

Here are our projections:

 

MACAU


Our estimate for Macau property-level EBITDA and net revenues is 10% and 5%, below the street at $443MM and $1.49BN, respectively.  More specifically, we’re below the Street on Sands, Venetian and Four Seasons, but above the Street on Sands Cotai Central’s performance –partly because we think that a lot will get tossed in the pre-opening bucket.  Sands and Venetian played unlucky this quarter, FS held a bit above their historical hold, and Sands Cotai Central held high on their baccarat play.  We estimate that EBITDA would have been $8MM lower if Sands held at its historical rate across its properties.

 

Venetian

 

Venetian is projected to report net revenue of $686MM and EBITDA of $249MM, 6% below consensus on both metrics.

  • Net gaming revenue of $587MM
    • $290MM of net VIP revenue    
      • RC volume of $11.1BN, down 17% YoY and 20% QoQ
        • Junket RC volume fell 20% QoQ to $8BN, no doubt as a result of some of the junkets moving over to SCC.  We assume that direct play also took a sequential hit, falling to $3.1BN from $3.8BN the last 2 quarters for similar reasons.  This implies a direct play rate of 28%.
        • Hold rate of 2.61%, which is 30bps below the properties historical hold rate.  We estimate that low hold negatively impacted net revenues by $21MM and EBITDA by $13MM.
      • Rebate rate of 85bps of 33% of hold
    • Mass table revenue of $324MM, up 24% YoY
    • Slot win of $68MM
  • $98MM of net non-gaming revenue
    • $55MM of room revenue ($245 ADR/88% Occ/$215 RevPAR)
    • $18MMof F&B revenue
    • $54MM of retail, entertainment and other revenue
    • $29MM of promotional expenses
  • Variable expenses of $318MM
    • $266MM of taxes
    • $35MM of junket expenses assuming a commission rate of 1.17% (rebate + promoter expense )
    • $24MM of recorded non-gaming expense
  • $95MM of fixed costs, up 3% YoY but down from an estimated $99MM last quarter

 

Sands


We expect Sands to report net revenue of $284MM and EBITDA of $73MM, 7% and 16% below the Street, respectively.

  • Net gaming revenue of $277MM
    • $161MM of net VIP revenue    
      • RC volume of $11.1BN, down 17% YoY and 20% QoQ
      • RC volume of $6.3BN (down 19% YoY) assuming 11% direct play and a hold rate of 2.56%
      • Rebate rate of 84bps or 33% of hold
      • Assuming historical hold of 2.94%, net revenues and EBITDA would have been $15MM and $9MM lower, respectively
    • Mass table revenue of $141MM, down 1% YoY
    • Slot win of $28MM
  • $7MM of net non-gaming revenue
  • $159MM of variable expenses
    • $129MM of taxes
    • $22MM of junket expenses assuming a commission rate of 1.19% (rebate + promoter expense ) or 33%
    • $4MM of recorded non-gaming expense
  • $49MM of fixed costs, up 7% YoY and flat QoQ

 

Four Seasons

 

We estimate $258MM of net revenue and $67MM of EBITDA, 11% below the Street on both metrics.    

  • Net gaming revenue of $235MM
    • $275MM of net VIP revenue    
      • RC volume of $9.5BN, up 188% YoY but down 25% QoQ
        • Junket RC volume fell 28% QoQ to $7.7BN, no doubt as a result of some of the junkets moving over to SCC. We assume that direct play took a small sequential hit, falling to $1.7BN from $2BN the last 2 quarters for similar reasons.  This implies a direct play rate of 18%.
      • Rebate rate of 96bps or 33% of hold
      • The historical hold rate at FS has been 2.75%.  Using historical hold rate, we estimate that net revenue and EBITDA would be $9MM and $7MM lower, respectively.
    • Mass table revenue of $40MM, up 9% YoY
    • Slot win of $11MM
  • $22MM of net non-gaming revenue
    • $9MM of room revenue
    • $7MM of F&B
    • $17MM of retail, entertainment and other
    • Promotional expenses of $11MM
  • $210MM of variable expenses
    • $166MM of taxes
    • $35MM of junket expenses assuming a commission rate of 1.22% (rebate + promoter expense )
    • $6MM of recorded non-gaming expense
  • $22MM of fixed costs, up 20% YoY and down $9MM QoQ

 

Sands Cotai Central

 

We estimate $266MM of net revenue and $54MM of EBITDA, 9% and 23% ahead of the Street, respectively.    

  • Net gaming revenue of $251MM
    • $214MM of net VIP revenue    
      • RC volume of $7BN
        • Junket RC volume of $6BN. We assume direct play of 15%, which gets us to hold rate of 3.04%. If direct play was 10%, that would imply a hold rate of 3.22%. No direct play, which we view as unlikely, implies a hold rate of 3.58%.
      • Rebate rate of 96bps
      • Assuming theoretical hold of 2.85%, net revenue and EBITDA would be $9MM and $7MM lower, respectively.
    • Mass table revenue of $85MM
    • Slot win of $19MM
  • $15MM of net non-gaming revenue
    • $16MM of room revenue
    • $5MM of F&B
    • $5MM of retail, entertainment and other
    • Promotional expenses of $11MM
  • $145MM of variable expenses
    • $124MM of taxes
    • $16MM of junket expenses assuming a commission rate of 1.18% (rebate + promoter expense )
    • $7MM of recorded non-gaming expense
  • $60MM of fixed costs

 

SINGAPORE

 

We project $777MM of net revenue and EBITDA of $407MM, 2% and 3% below consensus, respectively.

  • Net gaming revenue of $626MM
    • $205MM of net VIP revenue    
      • RC volume of $12.8BN, up 5% YoY
      • Hold rate of 2.85%
      • Rebate rate of 1.25%
    • Mass table revenue of $270MM
      • Drop of $1.2BN, up 7.5% YoY and 22.5% hold
    • $151MM of slot & EGT win
  • $151MM of net non-gaming revenue
    • $77MM of room revenue ($340 ADR/98% Occ/$333 RevPAR)
  • $77MM of gaming taxes and $41MM of GST
  • $245MM of fixed costs, compared to an estimated $243MM in 1Q           

 

LAS VEGAS

 

We estimate that Venetian and Palazzo’s net revenues will be $339MM with EBITDA of $88MM, which are 1% and 7% below Street estimates, respectively.

  • Net casino revenue of $100MM
    • Table revenue of $80MM
      • Drop of $443MM, up 5% YoY
        • 18% hold
    • $40MM of slot win
      • $453MM of slot handle, up 10% YoY and 8.8% hold
      • Last year was a very easy comp for LVS with slot handle down 39% YoY as they cut comps too deep
    • Rebates of $20MM or 4.5% of GGR
  • $116.5MM of room revenue - $183 RevPAR (+3% YoY)
  • $138MM of F&B, retail & other revenue
  • $15MM of promotional allowances or 12.5% of GGR
  • 5% YoY increase in operating expenses to $243MM, but down from $256MM last Q

 

BETHLEHEM  

 

We expect Sands Bethlehem to report $117MM of revenue and $29MM of EBITDA, 7% and 10% above consensus estimates, respectively.

  • $107MM of gaming revenues
    • Table revenue of $34MM
    • $73MM of slot win
  • $10MM of net non-gaming revenue
  • $46MM of taxes
  • $42MM of operating expenses

 

OTHER

  • D&A: $224MM
  • Rental expense: $11MM
  • Corp and stock comp expense: $57MM
  • Net interest expense: $63MM

the macro show

what smart investors watch to win

Hosted by Hedgeye CEO Keith McCullough at 9:00am ET, this special online broadcast offers smart investors and traders of all stripes the sharpest insights and clearest market analysis available on Wall Street.

The Credit Card Trade

American Express (AXP) just can’t get its act together. After reporting its second quarter earnings, it’s clear that our macro Growth Slowing call is kicking into gear. The company reported large sequential deceleration in every growth category.

 

The company isn’t growing card volumes and instead is watching them evaporate, particularly in Europe. Taking into account that 100 basis points equates to one percentage point, look at the downward spiral that is AXP below:

 

US volumes slowed 380 bps to 8.7% YoY in 2Q vs. 12.5% in 1Q. International volumes slowed 920 bps to 3.0% YoY growth in 2Q from 12.2% YoY growth in 1Q. Right now the business is split 2/3 US and 1/3 International. As a result, overall growth slowed 570 bps to 6.7% YoY in 2Q from 12.4% last quarter.

 

Conversely, MasterCard (MA) is doing quite well. Over the last five years, MasterCard is up 157% compared with American Express’ -12%.  It’s easy to see why we’re bearish on AXP and bullish on MA.  Visa (V) is also a winner, up over 95% during the same five year period. V and MA are doing well in the broader market. The Financials SPDR (XLF) lost 55% in that five year period, too.

 

 

The Credit Card Trade  - AXPvsMA

 

 

The chart says it all. While MasterCard may be a little pricey, trading at 19x earnings, it’s golden compared to American Express’ performance and outlook.


HAVE U.S. CORPORATE EARNINGS GONE TOO FAR?

CONCLUSION: When analyzed outside the vacuum of short-termism associated with quarterly reporting, US corporate profit margins appear particularly overstretched – from both an operational and a social perspective. This has potentially dire implications for corporate earnings growth over the long term.

 

In the note below, we explore the US corporate income statement with a long-term analytical lens. But before we dig into the graphical eye candy below, we must stress that it’s important to note that a handful of the metrics below are derived from our own calculations using a combination of BEA, BLS and Bloomberg data. In the process of compiling data for this analysis, we discovered that US corporate financial statement data is particularly scant at the macro level. That said, however, we were able to find and manipulate several readily-available data series into what we feel are decent proxies for a variety of key corporate operational metrics. As always, we’ll let you be the ultimate judge of our work; refer to the appendix at the bottom of this note for more details.

 

WHERE WE ARE IN THE LONG-TERM CYCLE

 

To say that US corporations are generating net income at historic rates would indeed be a very accurate statement. In fact, the ratio of US corporate earnings to Nominal GDP at year-end 2011 was 7.3% - good for the highest level since 1930 (data going back to 1929). Using the full data set, this ratio is 1.6x standard deviations above the long-term average. Using data from the modern/post-war period, this ratio jumps to 2.2x standard deviations above the long-term average.

 

HAVE U.S. CORPORATE EARNINGS GONE TOO FAR? - 1

 

From an operational perspective, US corporations have been increasingly productive; in 2011, US corporations produced an aggregated operating margin of 33% (as a percentage of gross profits; full explanation and methodology below) – an all-time high. As a result of this, and other key drivers, cash flowed through to the bottom line at a historically-elevated ratio of 12.8% of gross profit. That’s the highest ratio since 1930. Interestingly, as the chart below shows, ratios in the 10-12% range tend to be historic inflection points for rates of earnings generation.

 

HAVE U.S. CORPORATE EARNINGS GONE TOO FAR? - 2

 

HOW DID WE GET HERE?

 

Macro Drivers: The aggregated propensity of US corporations to generate earnings has benefited greatly from several key long-term macro drivers, including favorable regulation, easy money and secular weakness in the USD exchange rate(s).

 

From a  regulatory perspective, both lower tax rates and a higher degree of tax write-offs have helped US corporations reduce their overall tax burden (27.5% in 2011) to levels unseen since prior to 1940 (with the exception of 2002). Though depreciation as a percentage of gross profits has fallen -100bps from its 2009 peak of 13.4% to 12.4% in 2011, that level of corporate write-downs is unseen outside of the Great Depression era.

 

HAVE U.S. CORPORATE EARNINGS GONE TOO FAR? - 3

 

From a cost of capital perspective, the following chart highlights the obvious relationship between US monetary policy and corporate interest payments. More specifically, net interest payments as a percentage of corporate EBIT have fallen to 10.5% in 2011 – down from a whopping 32.1% during the Paul Volcker era.

 

HAVE U.S. CORPORATE EARNINGS GONE TOO FAR? - 4

 

The following two charts highlight arguably the most important long-term trend that we think is critically important to contextualize: Weak Dollar Inflates the Inflation. The first chart highlights the strong inverse relationship between the market value of the USD and US corporations desire to chase easy revenues afforded by commodity price inflation by incrementally investing in mines, shafts and wells. Interestingly, US corporations haven’t been this addicted to US dollar debauchery since the last time we had a Federal Reserve Chairman condition market expectations for perpetual easy money (Arthur Burns). The second chart perfectly highlights this broad-based chasing of price/revenues (using commodity price data going back to 1981).

 

HAVE U.S. CORPORATE EARNINGS GONE TOO FAR? - 5

 

HAVE U.S. CORPORATE EARNINGS GONE TOO FAR? - 6

 

Micro Drivers: While the aforementioned long-term macro trends have all played an important role in helping US corporations generate earnings at historically-elevated ratios in recent years, we’d be remiss to ignore several key micro strategies that US corporations have implemented to buoy their bottom lines.

 

The first long-term trend we’d focus your attention on are the substantial cost cuts over the last ~10yrs. To that tune, US corporations have taken to paying employees less and investing less in equipment and software (as percentages of gross profit) over that duration – no doubt creating particularly lean operations in the process. At 58.7% of gross profit, the former is at an all-time low; at 13.1% of gross profit, the latter – which includes computers and software, industrial equipment and transportation equipment – has retraced to levels seen just before the DotCom Bubble.

 

HAVE U.S. CORPORATE EARNINGS GONE TOO FAR? - 7

 

Another trend on the labor front that has been fairly additive to US corporate profits is outsourcing – particularly in the manufacturing (think: Pearl River Delta) and service industries (think: Indian call centers). Over the last ~20yrs, US wage and salary payments to the rest of the world has tripled as a share of Nominal GDP.

 

HAVE U.S. CORPORATE EARNINGS GONE TOO FAR? - 8

 

Another major micro trend that US corporations have strategically pushed for and taken advantage of is economies of scale. Using BLS data for the total number of employees on nonfarm private payrolls, we were able to calculate the number of employees it takes US corporations to employ in order to generate $1B in earnings. That number has declined exponentially over time and, in 2011, reached an all-time low of 100,404 workers. While general inflation over the years has certainly played a role in this trend, the fact of the matter is that US corporations have consistently been able to squeeze out incremental profits from their existing headcount or generate new sources of earnings by acquiring human capital at perpetually slower rates.

 

HAVE U.S. CORPORATE EARNINGS GONE TOO FAR? - 9

 

The following chart, which shows the ratio of US corporations’ gross profit to their nominal labor expense per employee, is highly supportive of our previous claim. The plot essentially shows the number of turns US corporations are able to generate from their labor assets; as such, we find this to be an interesting way to measure worker productivity. Importantly, this metric reached an all-time high of 1.7x in 2011.

 

HAVE U.S. CORPORATE EARNINGS GONE TOO FAR? - 10

CRITICAL IMPLICATIONS

 

It's abundantly clear that US corporations have become quite effective at generating incremental returns for shareholders, having broadly implemented successful strategies at the micro level while also taking advantage of several noteworthy tailwinds on the macro level. That said, however, a fair amount of corporate earnings growth in recent years has come directly at the expense of the US laborer. While this is most certainly not the proper medium to discuss the morality of this trend from an ideological perspective, we will offer the following analytical thoughts on the potentially negative implications of the current setup:

 

Over the last ~30yrs, corporate executives, whose compensation is primarily determined by the value of their stock price, have increasingly paid out a smaller share of gross profits to employees in favor of boosting dividends (via making more cash available for the bottom line). This trend has correlated quite nicely with the dramatic ascension of the US equity market over that same duration.

 

HAVE U.S. CORPORATE EARNINGS GONE TOO FAR? - 11

 

As a result of increasingly heightened corporate executive pay (via dividend increases and stock market inflation), income inequality in America has widened to generational highs (data back to 1979).

 

HAVE U.S. CORPORATE EARNINGS GONE TOO FAR? - 12

 

What is perhaps misunderstood by consensus are the potential negative long-term political and economic implications of this trend. As the following chart from The Nation shows, domestic income inequality has surpassed levels unseen since just prior to the Great Depression. Interestingly enough, as the previous chart highlights, you'd have to go back to the pre and post Great Depression era to find US corporate dividend payout ratios that exceed the levels reached in recent years. While it would certainly be a stretch to say that income inequality was the dominant factor in bringing about the Great Depression, it would be equally as reckless to completely dismiss it as a contributing factor.

 

HAVE U.S. CORPORATE EARNINGS GONE TOO FAR? - US L T Income Inequality

 

Refer to our DEC 8 note titled "SPREAD RISK: THE INVESTMENT IMPLICATIONS OF WIDENING INCOME INEQUALITY" for our extended analysis of this important political topic.

 

All told, when analyzed outside the vacuum of short-termism associated with quarterly reporting, US corporate profit margins appear particularly overstretched – from both an operational and a social perspective. This has potentially dire implications for corporate earnings growth over the long term.

 

Darius Dale

Senior Analyst

 

APPENDIX: The GDP, Fixed Investment and BOP data in the charts above are rather straightforward and can be easily accessed via the BEA’s Interactive Data Tables. As mentioned before, however, we did have to make a few judgment calls to back our way into a handful of corporate operational metrics. In the following list, we attribute our calculations to their respective definitions in BEA Table 1.14: 

  • Gross Profit = Gross Value Added of Corporate Business (NOTE: while certainly not equivalent to corporate revenues, this was the closest L/T proxy for topline data we could find)
  • EBITDA = Net Operating Surplus + Consumption of Fixed Capital
  • EBIT = Net Operating Surplus
  • EBT = Corporate Profits with IVA and CCAdj
  • Earnings = Profits After Tax with IVA and CCAdj
  • Depreciation = Consumption of Fixed Capital
  • Net Interest Payments = Net Interest and Miscellaneous Payments
  • Effective Tax Rate = Taxes on Corporate Income/Corporate Profits with IVA and CCAdj 

Additionally, to the extent you’d like to conduct a similar analysis on your own, we found the following four guides helpful in getting us up to speed on the BEA’s definitions and data collection methodologies: 


MCD JUNE SALES PREVIEW

McDonald’s is releasing 2Q12 earnings before the market open on Monday morning.  Investors will be listening keenly for commentary on the global economy.  Our view is that MCD is likely to miss the Street’s expectations for sales in June. 

 

On April 24th, 2012, we wrote, “we see plenty to be concerned about” regarding McDonald’s top-line trends going forward.  Price is running at roughly 3% in the United States and 2-3% in Europe.  While the price points at McDonald’s are compelling for consumers relative to much of the competition, when we consider that Food Away from Home CPI in the U.S. is running at ~3% this year, McDonald’s may be taking less share this year on account of its price points than in years past.  The company is now pricing in line with Food Away from Home CPI whereas last year, that difference was roughly -50 basis points.  We remain unconvinced that traffic trends will be sufficient to bring the overall June comp in line with consensus for the U.S. division.

 

Callout

 

On the topic of "Growth Slowing", which Hedgeye Macro was ahead of the competition on, we want to highlight the two charts below.  We won't be calling comps on a month-to-month basis on the back of these charts, the numbers are trailing twelve month averages, but they clearly highlight how economic activity does impact the fundamental performance of the McDonald's business. 

 

MCD JUNE SALES PREVIEW - mcd growthslowing


 

Below we go through our take on what comparable restaurant sales numbers will be received as good, bad, and neutral by investors.  For comparison purposes, we have adjusted for historical calendar and trading day impacts (but not weather).

 

Compared to June 2011, June 2012 had one less Wednesday, one less Thursday, one additional Friday, and one additional Saturday.  We expect a positive calendar shift impact in McDonald’s June results.

 

U.S. – facing a difficult compare of 6.9%, including a calendar shift of between 0.2% and 0.5%, varying by area of the world:

 

We expect that MCD U.S. same-restaurant sales grew +1.0-1.5% in June.

 

GOOD: A print of higher than 2.5% would be strong results, in our view, as it would imply a sequential acceleration in the calendar-adjusted two year average trend.  Commentary across the restaurant space indicates that the operating environment for restaurant companies has been deteriorating in the United States.  While a +2% print would imply negative traffic/mix, we believe that investors are taking that as a given considering the extremely strong traffic trends posted last year as a result of the beverage line offering.

 

NEUTRAL: A print of +1.5% would be considered a neutral result as it would imply roughly flat calendar-adjusted two-year average trends on a sequential basis.  

 

BAD:  A result of less than +1.5% growth in same-restaurant sales would imply a significant slowdown in two-year average trends on a calendar-adjusted basis and would likely cause the stock to sell off further.  While we do believe that McDonald’s sales trends are slowing, we do not believe that the number will be below +1%.

 

MCD JUNE SALES PREVIEW - mcd sales preview

 

 

Europe - facing a difficult compare of +9.1%, including a calendar shift of between 0.2% and 0.5%, varying by area of the world:

 

We expect that MCD Europe same-restaurant sales declined by between -1% and -1.5% in June.

 

GOOD: A positive same-store sales number would, in our view, be positive for MCD Europe as it would imply a sequential acceleration in calendar-adjusted two-year average trends.  Other companies in the consumer space have cited lower-than-expected sales lift from the Euro 2012 soccer tournament. 

 

NEUTRAL: A print of between -1% and 0% would be considered a neutral result as it would imply two year average trends picking up slightly from trough levels in May.  Investors will be eager to see some stability in the Europe business’ trends.

 

BAD: Same-restaurant sales below -1% would imply little or no sequential improvement in calendar-adjusted two-year average trends from low levels in May. 

 

 

APMEA - facing a compare of +4.8%, including a calendar shift of between 0.2% and 0.5%, varying by area of the world:

 

We expect that MCD APMEA same-restaurant sales grew by +1% in June.

 

GOOD: Same-restaurant sales growth of more than 1% would be a strong result, in our view, because it would imply a sequential acceleration in the calendar-adjusted two-year average trend following three consecutive months of decline.  Macro concerns around China were assuaged, to a degree, by YUM meeting analyst expectations of 9.8% comps in 2Q with a 10% print. 

 

NEUTRAL: A print between 0% and 1% would be a “neutral” result as it would imply a sequential stabilization of two-year average trends.  That said, the low level of growth would remain a concern.

 

BAD: Comparable restaurant sales growth below 0% for McDonald’s APMEA division would imply a continuation of sluggish two-year average trends.

 

 

Howard Penney

Managing Director

 

Rory Green

Analyst

 


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.

next