INDUSTRIALS: Planes Feeling the Pains

Airlines aren’t exactly the most profitable industry as it is known. Many aren’t able to turn a profit after expenses save for a few select names like Southwest (LUV) and AirTran. Our Managing Director of Industrials Jay Van Sciver recently took an in-depth look at the industry and highlighted three main underlying issues:


  1. Airlines get screwed by competitors that are emerging from bankruptcy and, as a result, have lower costs.
  2. Some investors are mistaking the benefits of a weak competitor in AMR and “optimistic accounting” for industry improvement // this one should definitely be changed because I don’t think airlines have been squeezed by inflation
  3. Consolidation is unlikely to meaningfully improve performance for legacy carriers.


INDUSTRIALS: Planes Feeling the Pains - AIRLINES slide2


Regarding bankruptcies, the name in the headlines is American Airlines (AMR). It was the last legacy airline to go into bankruptcy and thus, had the opportunity to eliminate numerous expensive and restrictive collective bargaining agreements and other sources of higher costs relative to competitors. Companies like Delta and United/Continental will have a tough time ahead competing with American going forward. Van Sciver outlines some of the cost reductions AMR may effect in bankruptcy below: //benefits will piss people off since they are firing people and screwing the industry


Key Collective Bargaining Agreements Inclusions for AMR

  • Restrictions on domestic codesharing: This is a substantial disadvantage since it curtails the breadth of route offerings and the value of loyalty systems
  • Limitation on operating more than 47 regional jets with >70 seats, force AMR to use less efficient/less flexible 37/44/50 seat regional jets.  These jets make up just ~8% of AMRs fleet vs. 32% for US Airways and 36% for Delta.
  • Limitations on the performance maintenance work on weekends and maintenance outsourcing
  • Restrictions on the sale of the first class seat next to the relief pilot rest seat on long haul flights
  • Requirement for flight attendant rest area on 777s in the main cabin
  • Other legacy carriers are not winning, they are just beating AMR


All of that was in addition to the highest labor costs in the industry by far.


Writes Van Sciver:

AMR was the highest cost large competitor prior to its bankruptcy, leaving it unable to compete effectively on price.  Now that AMR’s costs are coming down through bankruptcy, it will become more competitive.  Historically, that has pressured industry margins and driven airline equity underperformance. “


In the short run, changes in fuel prices can impact profitability.  In the long run, all competitors are price takers for fuel and other commodity inputs.  The advantage of lower fuel prices tend to be competed away.  Sustained increases in fuel prices can competitively favor airlines with younger, more efficient fleets.  Legacy carriers like UAL, LCC and DAL have older fleets than low cost carriers like Southwest and JetBlue (JBLU).


Lastly, consolidation may at first seem like a viable option for some airlines. Look at what United and Continental did and follow their lead, right? In this case, it’s not the best idea. Canada’s airline industry has tried playing the consolidation game before and it did not benefit customers or airlines.  Worse, United Continental appears to have higher costs than when the two airlines operated independently and the attempted integration has been enormously disruptive.  The failure of the United Continental integration over the past two years should give the AMR creditors committee pause in considering a tie-up with US Airways.



INDUSTRIALS: Planes Feeling the Pains - AIRLINES slide3



In our view, consolidation will not matter for US legacy carriers because they are high cost.  In an industry with low barriers to entry, growing low cost competition and price based competition, a high cost position is a losing position.  We would avoid the equity of LCC, DAL and UAL.


Big Trouble In Little China







Tuesday’s Rumor of the Day is brought to you in part by China. We have said again and again that China cannot afford another round of rate cuts right now. Food and fuel prices are already too high and the country just can’t send ‘em any higher. Well despite common sense, word on the Street is that President Hu will increase fiscal and monetary support to the economy in the second half of 2012.


This comes from Xinhua, the official press agency of the People’s Republic of China. We’d still take it with a grain of cautionary salt.



The Bailout Bulls are back in action begging for more QE. We remain on the sidelines to see what Fed Chairman Ben Bernanke will do exactly, but should the bulls get their wish, gold will rip to the upside. Currently, we have $1606 as our TRADE line of support, which was formerly our line of resistance. This thing could run all the way up to $1679, so keep an eye out and be careful out there. People have a tendency to gravitate toward bright and shiny objects.



As the Olympics continue to sneer in the face of viewers, retailers aren’t faring much better. Sales and growth that were expected from London hosting the games this year are tepid and just aren’t meeting retailers’ expectations. Throw in the time delays associated with the various networks showing the Olympics and you’ve got a mess on your hands of epic proportions. It’ll take a hell of a climax and break through from an underdog athlete or something of the like to revitalize both sales and viewership.




Cash:  Down              U.S. Equities: Flat


Int'l Equities: Flat     Commodities: Flat


Fixed Income: Up         Int'l Currencies: Flat





This company is transitioning from cash burn to $75mm annual free cash flow generation thanks to completion of a reimaging program and refranchising of JIB units. Qdoba is the leverage; a maturing and growing store base will bring higher margins. We see 8.5% upside over the next 6-9 months.




TAIL: LONG            



The former Liz Claiborne (LIZ) is on the path to prosperity. There’s a fantastic growth story with FNP. The Kate Spade brand is growing at an almost unprecedented clip. Save for Juicy Couture, the company has brands performing strongly throughout its entire portfolio. We’re bullish on FNP for all three durations: TRADE, TREND and TAIL.







We continue to expect outpatient utilization to pick up in 2H12 alongside stabilization in acuity with ortho and cardiac/ICD volumes supporting both pricing and inpatient admissions growth. Births should serve as a tailwind into year-end, recent and prospective acquisitions offer some upside to 2012/13 numbers and the in place repo offers some earnings flexibility. With European and Asian growth slowing, we like targeted domestic revenue exposure as well.








Tweet of the Day: "Bernstein u/g $FB to hold, lowers TP to $23. "Display advertising worth $19/share, $4/share to upside from social advertising & new biz"” -@BergenCapital


Quote of the Day: “The end of the human race will be that it will eventually die of civilization.” –Ralph Waldo Emerson


Stat of the Day: The EFSF sold 1.48 billion euros of three-year bonds at an average yield of 0.54%. The cover ratio--a gauge of demand--was 3.7.



In preparation for HYATT's 2Q earnings release tomorrow, we’ve put together the recent pertinent forward looking company commentary




  • "In North America, full service hotels where group business represents about 45% or 50% of our room revenue, our group pace for 2012 is currently up in the mid single-digit range with one-third of that increase due to increase in rate."
  • "Industry supply growth in North America is in and around the 1% level, which is a real plus for us as we move forward and given our owned asset base."
  • "We expect to open more than 20 hotels this year, including our first select service hotels outside of the US."
  • "The former LodgeWorks Hotels are doing very well, on track to exceed our original forecast and showing strong RevPAR and market share performance."
    • "LodgeWorks, we expected that we would generate roughly $40 million of EBITDA this year; we're on track to do that."
  • "From a hospitality perspective, upper tier hotels in Mexico City continue to perform well. The market RevPAR progression expected this year is about 10% and our hotel [Hyatt Regency Mexico City] is up over 20% RevPAR was year-over-year through April."
    • "With respect to Mexico City, we expect this year to earn somewhere between $8 million and $10 million in EBITDA from the property."
    • "We expect to improve operations in this hotel both from our branding of it, but also we're committing to spend about $40 million to complete a rooms renovation that is largely completed, but we're also adding meeting space and doing some repositioning of the food and beverage operations in the hotel. That will be spent over the next few years. So we expect the expansion of meeting space to allow us to shift some mix into group business and with a more proactive and integrated revenue management process, we expect to be able to significantly improve operations. So our outlook for earnings for this hotel is more than $25 million of annualized EBITDA upon stabilization."
    • "Most importantly, it's really consistent with our strategy of how we intend to use our balance sheet, which is to
      really secure opportunities in gateway cities, and eventually this hotel will – we will look to recycle it, and sell it,
      but retain the long-term management contract. But we really believe the repositioning of the hotel, the branding
      of it and some other work that we are going to do will have a positive impact."
  • "We have signed contracts for more than 170 hotels representing over 38,000 rooms. On a hotel basis it's about 37% of our hotel base. On a rooms basis it's about 30% of our room base. Over a third of those properties are under construction and about 80% of the contracts for these hotels and the pipeline require little or no capital from us. About 70% of them are outside of North America and about 50% of the total are in China and in India."
  • "We expect the increase in second quarter adjusted SG&A to be similar to the increase we saw in the first quarter, excluding the special items. For the full-year, we expect total adjusted SG&A to increase in the low teen's percentage range versus 2011."
    • "I would say that over time we expect by virtue of increasing fee base for the increase in SG&A as a proportion of the revenue base to actually flatten out over time, because the base of openings will increase our revenue base. So it's really difficult to peg it to a percentage of revenue."
  • [Park Hyatt New York] "It's under construction right now. It is on 57th Street opposite Carnegie Hall. That hotel, we have a fixed price purchase contract for that property. We're anticipating returns – cash-on-cash returns in the high single digit percentage range unlevered."
  • "HYATT House is a brand that we just re-launched; many of the LodgeWorks hotels that we acquired have been converted to HYATT House. So we have a lot of momentum on that side. Same thing with Hyatt Place; we have a lot of conversion activity, more urban penetration of Hyatt Place. So that's helping those brands, and then frankly, on the full-service side, given some of the mix issues I talked about, both the concentration of group business and Hyatt Regency being a big part of our full-service representation in North America, as group business continues to pick up, you should see increased market share growth there."
  • "Hotels in North America tend to be higher base fees relatively speaking, lower incentive fee contributions with higher hurdles; internationally, generally slightly lower in base fees, relatively speaking, with lower hurdles on the incentive fees and higher incentive fee potential. So I would say, roughly speaking, those generally have not changed even despite the fact that there's more competition in the space. The margins tend to still be quite good and it's a good business for us to be in."
  • [Renovation cycle] "We're at the very tail end of that cycle with regards to those large-scale renovations. We have one project, the Grand Hyatt in San Francisco, where we're finishing up the meeting space and some of the food and beverage space in the hotel and the lobby."



  • [Hyatt Regency Mexico City] "The hotel currently has roughly a 15% group mix, and we expect that to expand over time, both because of our revenue management, and our group base of business, but also because we're doing some reprogramming within the hotel."
    • It's clearly below peak [cycle]. But the comparability of that to the operation of the hotel under our management is really difficult to establish, especially in view of the fact that we do expect to change the mix of business in the hotel. We clearly expect that there will be a lift from the branding as well as the renovation, which we expect to execute over the next two-and a- half to three years."
  • "We completed the acquisition of a site in Rio and we continue to refine the design plans and the construction estimates for the project. So, at this point it's predevelopment costs that we are incurring to move the project along, which we will continue to do. We are looking forward in time to the Olympics in 2016, and ensuring that we put ourselves on a path to have the hotel open and ready for that prior to that. And, we will over time engage with potential partners and look to establish a partnership or JV of some kind in taking that project forward."
  • "In terms of the sectors, as I mentioned, is really consulting, technology and IT being strong. In terms of least strong, less strong, is really the pharma and the financial sector."
  • "I would say as I think about the bookings, for 2013 and 2014 continue to grow. 2013, I think we probably have about 45% of the business on our books. And 2014, we probably have 30% of the business on our books. And, rates are picking up, I mean, rates are up 2%, when you compare this for the bookings this time last year. So I think overall trends are looking decent."
  • [Andaz] "We have about half a dozen in the pipeline at this point, mostly outside of the U.S. and in some really attractive and important cities, both for the Andaz customer base but also for Hyatt overall. We are less than five years into the rollout of the brand post launch. I think the traction has been very good.  There's been a positive impact to the rest of the portfolio, as Gold Passport members are discovering Andaz. And so, it remains a significant brand in the dialog with developers that we are already doing business with, in China and India, and in other markets."
  • "I think New York has been good. I think the market's seeing mid-to-high single digit increases for us. We've got a newer product, whether it's the Andaz which are new or the recently renovated Grand Hyatt Hotel. So, we're seeing increases higher than that on our overall market basis."
  • "I wouldn't say that there's a fundamental shift at this point in terms of actual transaction volume increasing. We'll see how this evolves over the course of the year, the debt markets are not backing up for sure. But neither are they really expanding significantly or at a fast pace. We have seen some improvement in securing financing for some specific projects, but those projects have tended to be in great locations in key cities with great sponsorship. And I think that the – with those factors, financing seems to be more accessible now than it has been in the past.
    But again, I don't consider that a sea shift."
  • [Park Hyatt opening] "It looks like they are on track to complete late next year or early 2014 and we will establish an opening date a little later."
  • "The contracts that we have in some of the major cities, Chicago, San Francisco, Los Angeles, and Waikiki for example, expired in late 2009 and in one case early 2010. We've been in negotiations and dialog with the local unions in those cities since then. We have not been able to bring those negotiations to closure. There was a recent round of negotiations in both New York and in Washington. And those have progressed relatively more quickly. And the terms of the arrangements there are being finalized at this point. we have about 25% or 30% of our workforce in North America is unionized. So we remain highly focused on this."

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The Search for Value

“Freedom, however is not the last word.  Freedom is only part of the story and half of the truth. Freedom is but the negative aspect of the whole phenomenon whose positive aspect is responsibleness.  In fact, freedom is in danger of degenerating into mere arbitrariness unless it is lived in terms of responsibleness.”

                -Viktor E. Frankl


“Man’s Search for Meaning” by Victor Frankl is one of my favorite books.  It is the chronicle of Frankl’s experiences in Nazi Germany’s concentration camps and was written in 1946 shortly after the end of World War II. The book has sold over 10 million copies and is often noted on the lists of the most influential books in the United States.


Frankl was uniquely qualified to analyze the experiences in a concentration camp as he was a psychologist by training.  Undoubtedly, his academic training allowed him to separate his actual experiences from the analytical lens under which he observed his, and other prisoners, broad experiences in the camp. 


Ultimately, Frankl concluded, from analyzing the broad collection of experiences in the concentration camps of Nazi Germany (he himself lost the vast majority of his family), that life never ceases to have meaning.  In fact, according to Frankl, there is meaning in every moment.  Further, we all have the freedom of choice, even if our circumstances are incredibly dire.  In fact, the only scenario that truly dooms a person is when they lose all hope.


Now, admittedly, this is deep stuff for a Tuesday morning.  Further, it is obviously not even close to analogous to compare our lives as stock operators to Frankl’s analysis of life in a concentration camp, except for the fact that both are about a search.  For Frankl, it was the search for the meaning of life.  While for stock market operators, it is the search for value.


At the end of the day (to use an overused expression), investing is solely about value.  For those that follow more quantitative strategies, value can simply come in the form of the price and volatility of the asset.  For those steeped in more fundamental company analysis, value comes from deriving a value for company on both a standalone basis and versus comparable companies.


As many of you know, the vast majority of our firm is comprised of fundamental analysis.  In fact, we currently have seven sector heads doing fundamental company and industry research.  In aggregate, we cover energy, industrials, retail, gaming lodging & leisure, healthcare, financials, and restaurants & food processing.  Similar to a multi-strategy fund, we also integrate both macro analysis and quantitative analysis into our research process. 


In earnings season, we get bottom up data points that combine to inform our macro view.  On face value, based on data from Zack’s, earnings season has been reasonably positive.  In fact, as of yesterday 300 companies in the SP500 had reported earnings and aggregates earnings were up 5.5% versus the same period last year and almost 2/3rds of them beat earnings estimates by an average median surprise of 2.8%.  As always though, the devil is in the details, especially in the search for value.


A key driver of this “not too bad” earnings season is the easy comparisons of the financial sector.  In fact, if we back out the financial sector earnings reports, the positive 5.5% growth noted above actually becomes a year-over-year decline of -1.5%.  Moreover, revenue performance has been particularly anemic with revenue coming in basically flat versus the same quarter last year (including financials) and only 1/3 of companies beating revenue expectations.


If you are a fundamental equity investor, you are likely either looking for stability of cash flow or cash flow growth to justify your valuation.  Unfortunately, not many discounted cash flow models spit out compelling valuations if cash flow is declining on a year-over-year basis.  Thus, from a top down perspective, the old adage that the market is cheap based on its multiple doesn’t hold much credence when earnings are declining, and not growing, versus the prior year.


Just as important as this quarter are future earnings and revenue expectations.  Typically, fundamental investors focus on earnings seasons as a key catalyst to for the market to reward them for the hidden value in their investments.  Currently though, future earnings growth expectations are very high with Q1 2013 consensus earnings growth at 12.9%, Q2 2013 at 13.0%, and Q3 2013 earnings growth at 16.4%.  Given the GDP growth outlook, these numbers will be coming down meaningfully.


The search for global macro value will begin in earnest tonight and tomorrow.  Tonight, we have Chinese Purchasing Manager’s Index at 9pm.  While tomorrow we get the PMIs for both Europe and the United States.  Based on the collective macro data points we’ve been analyzing, there is no reason to believe this slew of data points will do anything but reinforce our thesis that growth is slowing.


Ironically, the Chinese stock market seems to be the one market that is credibly signaling this continued slowing of global economic growth.   Chinese stocks were down another -0.3% over night and are now down -14.5% since May.  This despite rumors that Premier Wen will boost stimulus measures in China in the second half of 2012.


In the Chart of the Day, we once again highlight the VIX.  Currently at 18, the VIX is not completely bombed out, but we would stress that it is at a level where you don’t want to begin your search for value in earnest.  This is a point that has already been fundamentally validated by earnings season and will be reinforced as future earnings expectations are lowered.


Our immediate-term support and resistance ranges for Gold, Oil (Brent), US Dollar, EUR/USD, Spain’s IBEX, and the SP500 are now $1, $102.52-108.36, $82.33-83.23, $1.20-1.23, 6, and 1, respectively.


Keep your head up and stick on the ice,


Daryl G. Jones

Director of Research.


 The Search for Value - chart2


 The Search for Value - VP


In preparation for ASCA's 2Q earnings release tomorrow, we’ve put together the recent pertinent forward looking company commentary



Ameristar breaks ground on Lake Charles casino (July 19) 




  • "We did a transaction subsequent to the end of the quarter raising $240MM as an add-on to our existing 7.5% senior notes, which are due 2021. The terms are exactly the same as that note. They were issued at a premium of 103% generating yield of 6.88%, total amount of notes outstanding now are $1.4BN. Proceeds from the offering were used to completely pay down our revolver including $25MM we borrowed early in April... This obviously creates great flexibility for us to finance the Ameristar Lake Charles project"
  • Guidance: 
    • Stock base compensation: $3.5MM to $4MM for 2Q12 and $14.8MM to $15.8MM for FY2012
    • Deprecation: $26.5MM to $27.5MM in 2Q12 and $105MM to $110MM for FY2012 
    • CapEx: $20MM to $25MM in 2Q12 (including some small amounts for Louisiana) and FY2012: $160MM to $165MM (including expenditures on Louisiana)."
    • Tax rate:  "going forward should be somewhere in the neighborhood of 39% to 41%... 43%, 44% it was historically... the weighted average rate for this year should be somewhere roughly 27% to 29% based on the impact to the tax rate during the first quarter."
    • Interest expense:  "should range between $20MM and $29MM it will increase slightly on an annualized basis to $109MM to $114MM. Beginning in 2013 as you would expect there'll be capitalized interest, it will start to grow related to Louisiana probably which will offset the net increase we're seeing in interest expense from the increase in the outstanding notes versus the revolver."
    • Non-cash interest: $1.1MM to $1.6MM in 2Q12 and $5.3MM to $5.8MM for FY2012 million 
    • Corporate expenses: $12MM to $13MM in 2Q12 and $52MM to $53MM for FY2012. 
    • Share count: 34MM to 34.5MM
    • Dividends: "Board of Directors just recently approved a $0.125 dividend for the second quarter. If the dividends are continuing to be approved by the Board in the third and fourth quarter total amount of dividends for the year will be $0.50."
  • New Lake Charles casino
    • Completion: 3Q 2014
    • Gaming: 1,600 slots/ 60 table games
    • Hotel: 700 roomswith approximately 70 suites
    • Other amenities: Variety of food and beverage outlets, spa, pools, golf, tennis and other resort amenities, 3,000 parking spaces including 1,000 of them in a garage. 
    • Capex: $500MM
    • "We don't expect to borrow much under the revolver in 2012 as we believe we can fund much of the CapEx with free cash flow. And we think the strength of the market is actually proven up by the first quarter results and we expect that to continue to be a growing market."
  • "In Springfield the demolition and site grading are almost complete. We expect to take control of the property by
    the end of May."
  • [Kansas competition] "I think another quarter or two and we'll start to get a more stabilized trend line of what things are going to look like, but we're very encouraged by the strength of our Kansas City property. We've always said it's the best quality property in the market, it's the furthest away from the competition and I think we're going to do just great."
  • [Lake Charles market] "There'll be probably some cannibalization, but I think we're probably going to be cannibalizing some of the operators perhaps more than we will L'Auberge."
  • "I don't think consumer confidence has seen a huge boost... They've had lower utility bills this year versus last year where they've had a little bit higher gasoline prices. Employment is changing in some respects in some of the markets. But I think ... people are still being a little guarded with how they're spending. I don't see long-term trend lines developing yet."
  • "East Chicago I think will continue to be a strong player in that market. I think the bridge will help us some if it can happen, but we're moving along on the assumption that it never happens and running the property accordingly and I think it's working very, very well."