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Takeaway: We like $YUM for a longer-term TAIL investment but are concerned by China macro picture and difficult 4Q compares in the immediate term

Yum! Brands reported $0.99 in EPS versus consensus expectations of $0.97.  The China division drove almost three-quarters of the EBIT growth as lower COGS helped profitability in YUM’s most important market. 


3Q Report Card


YUM: CHINA IS WHAT MATTERS - yum earnings recap


YUM is trading up 8.5% as, during the earnings call, management provided bullish commentary on China and the growth opportunity that market presents for the company’s brands.  With that said, we view China’s volatile economy as the greatest risk in the stock.  Management acknowledged this reality but came across as confident that China would continue to perform profitably.  Historically, buying this stock on “China scares” has proved profitable, particularly over longer durations.  


However, given difficult 4Q compares for YUM’s business in China and the persistence of concerning economic data from the region, we remain on the sidelines for the immediate-term TRADE.  It is worth bearing in mind that YUM’s 3Q ended September 8th; the macro data for September, so far, pertaining to China were, generally, sub-consensus.  Longer-term, this remains one of the best growth companies in the industry.  From a fundamental perspective, depending on the macro backdrop, we would likely become more positive on the stock on an immediate-term basis at $65 per share.


Press Release & Earnings Call Details

The China Division drove almost 75% of the consolidated EBIT growth of the company as unit count grew 18%, same-restaurant sales grew 6%, and restaurant level margins improved year-over-year on lower than expected food costs.  Management expects China comps to be in the flat-to-low-single-digit range in the fourth quarter.

  • Transactions declined 1% versus 27% growth in 3Q11
  • Opening 750 restaurants in China this year (18% growth) versus initial expectation of 600
  • Difficult to know how much of sequential slowdown in comps is due to economy
  • Pizza Hut comps gained 8% in 3Q
  • KFC comps gained 6% in 3Q
  • 3Q labor inflation was 8%, commodity inflation was 2%

China Outlook

  • 4Q is toughest SSS compare…expecting flat-to-LSD comps with 5% price (negative LSD transactions)
  • Expecting slight y/y improvement in 4Q restaurant operating margins in China due to deflation in commodity prices
  • Development focus is shifting from Tier 1 cities to lower tier (better returns, margins)
  • Continuing 20% margins “over the long run”
  • Current development rate is 18% which lowers SRS required in FY13 to hit earnings growth target

Potential Issues for the China Division

NEAR-TERM: Price cycling off the menu and sequential economic deterioration

INTERMEDIATE-TERM: Economic deterioration in excess of what management is anticipating

INTERMEDIATE-TERM: Management growing too fast.  Currently, returns imply that “over-growth” is not yet a problem


YUM: CHINA IS WHAT MATTERS - china quadrant 1



The United States Division has gone from abysmal to impressive in little over a year.  Whether or not this performance can be sustained remains to be seen.  The US generated 6% in same-restaurant sales growth and management highlighted the completion of the KFC and Pizza hut refranchising as a positive. 

  • Doritos Locos Tacos and Cantina Bell have been key product introductions – should drive sales in FY13
  • KFC sales and profits benefitting from new items and advertising
  • Pizza Hut business in the US is stabilizing – added stores in 2011 after 10 years of unit decline
  • Commodity costs were flat (below industry) in the U.S. due to supply chain initiatives

US Outlook

  • 4Q will be weaker than YTD for US
    • Overlap of 53rd week
    • Lapping toughest comps of last year
    • YTD refranchising of 340 restaurants in US will be profit dilutive  in 4Q
  • Ongoing growth model for the US calls for same-restaurant sale growth of 2-3%

YUM: CHINA IS WHAT MATTERS - yum us quadrant1


The YRI Division delivered same-restaurant sales growth of 2%, including 5% in emerging markets.  Ramadan negatively impacted comps by 1%.  The division drives roughly 8-9% of the company’s overall EBIT growth. 

  • Building 900 new units this year
  • Opportunities in developed countries like France, Germany, Russia where YUM underpenetrated
  • KFC Russia business improving dramatically, AUV’s at $1.8m from $1.2m two years ago

YRI Outlook

  • 4Q comps should benefit by 1% due to Ramadan timing
  • Positive earnings growth for YRI in 4Q offset by impact of lapping 53rd week in 2011
  • Ongoing growth model for YRI calls for  unit growth of 3-4% and SRS of 2-3%
  • 45% of YRI units are in emerging markets

YUM: CHINA IS WHAT MATTERS - yum yri quad1



Howard Penney

Managing Director


Rory Green







Despite record comparison, October 2012 should post solid YoY growth


  • Assuming post-Golden Week trends in 2011 are carried forward in 2012, we believe Macau table revenues growth for October may come in at the high end of our 4-9% projection range.  Even when adjusted for high hold in October, the calculation yields growth in the middle of our range.
  • Last October, average daily table revenues (ADTR) post Golden Week slipped 2% relative to that for Sept 2011
  • October gaming revenues could hit a new record month.  Easier comps should contribute to accelerating growth in November and December.




Strong quarter and guidance




  • Exceptionally strong group demand fostered solid rate growth across all segments of their business
  • 3Q marked the second straight Q where they exceeded peak 2007 occupancy levels
  • Comparable F&B revenue growth benefited from outlet sales at several of recently renovated restaurants which saw significant increases in activity

  • Strong rate performance and tight cost controls, coupled with lower utility costs, led to strong expansion in operating margins
  • Key driver of 3Q results was the 20% increase in corporate group demand, which led to a more than 6% increase in group room nights.  Larger group hotels, especially those in Boston and several resort markets, outperformed the overall portfolio.
  • Luxury hotels also experienced strong group activity, especially on the rate which were up >6% in the Q
  • Benefiting from both mixed shift and higher absolute rates in both the corporate and discount segments, average group rates were up almost 3.5% and group revenues were up nearly 10%.
  • Given the increase in group, their managers were able to focus on driving rate growth in transient. Overall growth exceeded 5% - spread across all segments of transient.  1.5% increase in retail room nights, which further increased transient rates.  Luxury transient demand also increased by more than 3%.  Transient revenues increased 6% in 3Q.
  • Current Q booking activity for groups are likely to slow given reduced capacity of vacant rooms
  • Overall bookings in the third quarter were up nearly 9%.  Group revenues on the books are up 7.5% for 4Q. 
  • Likely that the closing of some of the $300-400MM of sales they are planning for 4Q could slip into 2013
  • HST's rent has already increased by more than $6MM annually as a result of the Vornado deal and would expect significant additional rent increases as the project is completed and leased

  • HST is at an advanced stage for negotiating (with Hyatt) on a 131 unit timeshare development on their excess land at Hyatt Regency Maui.  Timeshare units will have access to the amenities at the existing hotel.  In addition to making money on the timeshare unit sales, they will also be making incremental revenues on their existing amenities and have the ability to spread costs across more rooms.  HST will contribute land and some cash.  They expect to create value of $400-500MM from this project.
  • Recent REVPAR results in September have been weaker than recent trends.  This was anticipated though given the timing of the Jewish holidays.  Halloween occurring mid-week and the Presidential elections will also impact the 4Q. However, all of this was expected and is not an indication of any fundamental slowdown. 
  • Too early for guidance for 2013, but they are bullish as occupancies will be in record levels. 
  • Managers should be able to get good increases on special corporate rates, supply remains low, and international travel continues to grow at a high single-digit pace
  • PA REVPAR:  +20.8%.  Both the Downtown Marriott and the Four Seasons had excellent growth in rooms and F&B revenues. Easy comp since there was renovation in 2011.  Expect Philadelphia hotels to underperform our portfolio in 4Q due to a decline in group and transient demand as well as a renovation at the Philadelphia Airport Marriott.
  • Tampa REVPAR:  +18.8%: Tampa Waterside Marriott hosted the Republican National Convention and the REVPAR growth was driven by improvements in ADR for both group and transient business for the quarter
  • Boston REVPAR:  +15.4%: Outperformance was driven by strong group demand, which allowed rate compression for both group and transient business.  Expect Boston hotels to have a good 4Q due to strength in group revenues and an expectation of continuing strong transient rates. 
  • San Fran REVPAR:  +12.7% due an ADR improvement of over 9%. Strong occupancy allowed operators to shift the mix of business to higher-rated transient segments. Expect San Francisco to continue to perform very well in 4Q.
  • Miami/Ft Lauderdale REVPAR:  +11.4%.  Expect Miami/ Fort Lauderdale hotels to have a good 4Q due to solid group bookings. 
  • LA REVPAR:  +9.1%:  Strong group demand created compression to drive both group and transient rate.  Expect Los Angeles to have a great 4Q due to robust group and transient demand.
  • Hawaii REVPAR:  +7.7%: all due to increased rate from mix shift.  Strong group and transient demand allowed shift in the mix of business to higher-rated categories.  Expect our Hawaiian hotels to have a good 4Q.
  • NY REVPAR:  +4.6% due to occupancy and rate growth. They were impacted by renovations at most of their hotels.  Expect a challenging 4Q.
  • Chicago REVPAR:  +3.5% due mostly to rate growth.  Underperformed our portfolio due to lower levels of city wide and group demand compared to the third quarter 2011.  Expect much better performance in 4Q due to better group and transient demand.
  • DC REVPAR: -0.80% (due to occupancy declines).  Group and transient were weak.  Series of room renovations for 4Q so it should continue to underperform.  Expect 2013 to be better.
  • European REVPAR:  +4.1% (ex Sheraton Roma), EBITDA up over 9%.  Inbound international travel into Europe continues to be strong.
  • Wages and benefit only increased 1.4% on a per occupied basis.  Despite a big increase in revenue, costs that are variable with revenues such as sales and marketing and cluster and shared service allocations were well controlled. 
  • SG&A and marketing, and repairs and maintenance increased only 3.2%
  • Utility costs were down 9.6%
  • Expect that comparable RevPAR growth will be increasingly driven by rate in 4Q and good flowthrough as a result
  • Expect lower F&B growth in the 4Q
  • Expect unallocated costs to increase in-line with inflation
  • Expect utility costs to decline in the 4Q



  • Expect that calender 3Q would have been closer to 6% 
  • Group bookings have been very strong.  Transient bookings have been very strong.  Gives them confidence in the continued strength of the business.
  • Expect that corporate activity will be more condensed.  Still expect group to be up meaningly but not as good as 4Q since they have less availability, but ADR should be very good.
  • The Grand Hyatt acquisition cost was a little lower than they projected
  • Feel like this will be an extended recovery cycle.  In 2013, whether they are a net seller or buyer will depend on what the acquisition pipeline looks like.  Think that they will be neutral.
  • NY- think that supply addition pressure will abate.  Their numbers are impacted by renovation disruptions.  Almost all their NY hotels will have no construction disruption next year so they should do well in that market.
  • Renovation impact in 2012?  They know that there has been a material impact but it's tough to quantify it.  Fairly confident that their capital spending should significantly decline in 2013 and therefore there should be much less disruption.
  • Will not disclose the timeshare capital commitment until all the documents are executed in a few weeks
  • Canada: A lot of the increase in the quarter was currency driven.  There was a small increase in local currency too.
  • The booking cycle has lengthened a little bit. Rooms that they booked in 3Q held up well.  Didn't expect that the final group revenue growth would be as good as 10% in the Q.  Given stronger close in booking and better retail bookings, they were able to push rate.
  • $25MM increase in capex budge?  Some was an acceleration of spend from 2013 to 2012.
  • Why does their guidance imply a margin slowdown in 4Q?  Some of that was due to the real estate tax bill.  YTD they have been growing at less then inflation, but for the year they still expect a 6% increase - so it's heavily back-end loaded.  Same thing with insurance.  F&B and other: they aren't as optimistic on that category as they were earlier this year.
  • How much of the guidance increase/better performance was due to sandbagging vs. just improving fundamentals? REVPAR has trended better, saved money in real estate taxes which they didn't expect, lower unallocated costs than expected, and reduction in utility costs.
  • CMBS market does seem to be strengthening.  That is a key source of financing in M&A.  They continue to want to be an active seller over the next 2 years in order to improve the quality of their portfolio.  Expect that their sales targets for 2013 will be even more aggressive than 2012.
  • Continue be interested in investing in Europe, Brazil and Asia.  However, they expect that the bulk of their activity will be in the US.
  • Groups continue not to commit to a lot of F&B in advance unless they are forced to but end up spending a decent amount anyway
  • Without putting a specific number on it, they fell very optimistic about 2013. Occupancy being so high, combined with the level of group activity, they expect a lot of rate growth next year.
  • Do not expect a material level of disruption from Vornado's redevelopment activity. 
  • Still have more transient and less group today than they had in 2007.  More group is going to benefit them - it's not just rate but it's also higher F&B spend.  As they get less availability for transient, the low end discount transient business is what gets displaced, not the high end.
  • Hotel acquisition in Nuremberg:  Bought it all cash and they intend to finance.  It's small so there is a fairly liquid market in Germany that will provide attractive (south of 4%) financing at the 50% ATV.  Multiple was also attractive - significantly below replacement cost.  The market in Europe is not extremely active.  Most of the sellers are "motivated."
  • As they start off a year, expect that about 70% of their Group rooms would be on the books.  Group represents 37-38% of total rooms.  They are likely going to be closer to 38-39% of total this year.
  • Saw a significant increase in their corporate group bookings.  That continues to be the area where they see the biggest improvement.  Association is a bit less consistent. 
  • As they look at 2013, there is more business on the books each quarter YoY
  • Benefit from RNC at their Tampa hotel - not that material
  • European debt portfolio:  would be happy to own it



  • YTD 2012 revenues benefited by $61MM from the acquisition of 10 hotels (~4,000 rooms) in 2011 and the acquisition of the Grand Hyatt DC on July 16, 2012 
  • Investment & Capex summary in 3Q:
    • ROI investment capex: $24MM
      • "Three properties where we recently completed extensive redevelopment work, the Atlanta Marriott Perimeter Center, the Chicago Marriott O'Hare and the Sheraton Indianapolis, have performed exceptionally well. On average, RevPAR increased 38% for both the quarter and year-to-date 2012 when compared to the pre-construction period in 2010. Due to the significant capital expenditures affecting nearly every aspect of these properties including, in the case of the Sheraton Indianapolis, the conversion of one hotel tower into apartments, these properties are excluded from our comparable results."
    • Acquistion capex: $25MM 
      • Finished the repositioning of the NY Helmsely Hotel to Westin NY Grand Central on October 1, 2012 which will have its grand opening later this month
    • Renewal and replacement capex: $66MM
      • Completed renovation of the 834 rooms at the Hyatt Regency Washington and 45,000 of meeting space at the NY Marriott Marquis
  • On July 30, 2012, HST "leased the retail and signage components of the New York Marriott Marquis Times Square to Vornado Realty Trust. Vornado will redevelop and expand the existing retail space, including converting the below-grade parking garage into high-end retail space and creating six-story, block front, LED signage spanning over 300 linear feet at an estimated cost of $140 million. As a result of the agreement, the annual base rental income is now well in excess of the previous rental income for the leased space.  Furthermore, once Vornado completes the planned redevelopment, the Company has the potential to realize significant additional incentive rental income. The lease has a 20-year term with options that, upon exercise, would require title to the retail space to be conveyed to Vornado for a sales price based on future cash flows in the year of sale."
  • YTD HST "has issued $1.5 billion of debt, with a weighted average interest rate of 3.7%, and used the proceeds, along with available cash, to repay $1.8 billion of debt with a weighted average interest rate of 6.6%. As a result of these transactions, the Company has decreased its weighted average interest rate by approximately 80 basis points, to 5.5%, and lengthened its weighted average debt maturity to 5.4 years."
  • In 3Q, HST "entered into a $500 million term loan through an amendment to its credit facility. The term loan has a five-year maturity and a floating interest rate of LIBOR plus 180 basis points, approximately 2.0%, based on the Company's leverage level at September 7, 2012. Additionally, the Company issued $450 million of 4¾% Series C senior notes due 2023 at the lowest interest rate for senior notes in the Company's history.  The proceeds from these issuances were used to redeem the remaining $650 million of 6⅜% Series O senior notes due 2015 and$150 million of 6¾% Series Q senior notes due 2016 and for general corporate purposes."
  • "On July 26, 2012, the second fund of the Company's joint venture in Europe ("Euro JV Fund II"), in which the Company holds a 33.4% interest, acquired the 192-room Le Meridien Grand Hotel in Nuremberg, Germany, for approximately €30 million ($37 million). The Company contributed approximately €10 million ($13 million) to the Euro JV Fund II in connection with this acquisition."
  • "On September 17, 2012, the Company's board of directors authorized a regular quarterly cash dividend of $.08 per share on its common stock."

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Global Slowdown Continues

As we head further into earnings season, it is becoming more and more apparent that our thesis on Growth Slowing and Earnings Slowing is correct. With companies like FedEx (FDX), Caterpillar (CAT) and Chevron (CVX) offering cautious or lower guidance, the market is looking more negative day after day. 


While we consider JP Morgan’s (JPM) Q3 earnings report on Friday to be the “true” kickoff of earnings season, yet another big company is offering guidance with caution. Rio Tinto (RIO) said the company would defer large capital programs due to cautious outlook on the next few quarters and a delay in Chinese stimulus spending - keep in mind China isn’t keen on seeing higher fuel and food prices anytime soon.The company is also expecting to materially reduce spending over the next few years.



Global Slowdown Continues  - Chart of the Day


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






  • BETTER: HST raised FY RevPAR and EBITDA guidance.  Group bookings are improving and have given management confidence in a robust 2013.



  • LITTLE BETTER:  Group bookings were up 9% in 3Q while group bookings for 4Q are up 7.5% YoY.  2013 group activity is now 8% higher YoY.  Much of the improvement has involved HST's larger group's hotels.  
  • PREVIOUSLY:  "We continue to be encouraged by the positive trends in group business. Total bookings for the remainder of the year are now more than 7.5% ahead of last year's pace, and the overall rate for the third and fourth quarters has increased well over 2%, indicating revenue improvement of 10%. We're also seeing the positive booking activity extend into 2013 in both demand and rate, indicating that our group hotels are benefiting from increased business spending and should continue to perform well for the remainder of this year and next."


  • SAME:  Still expect to sell $300-400MM of assets by the end of 2012 although some closings may slip into 2013.  HST expects to be an active seller in 2013 with the goal of improving the quality of their portfolio
  • PREVIOUSLY:  "While the sale market is difficult to predict, the guidance assumes we complete incremental sales in the $300 million to $400 million range by year-end. We do intend to be an active seller over the next two and three years. And as we are consistent with what we've described in the past, a number of these suburban assets, both in core and non-core markets and airport locations, leaving out the ones that are sort of directly attached to the airport, those are the hotels that would be high on our priority list in terms of hotels that should be sold."


  • BETTER:  The recently renovated hotels have seen REVPAR increases of 38% in 3Q and YTD when compared to the pre-construction period in 2010.
  • PREVIOUSLY:  "It is worth noting that we are seeing great results at 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 pre-renovation levels."  


  • SAME:  REVPAR grew 20.8% (occupancy: +11%, ADR: +3%) due to excellent growth in rooms and F&B revenues
  • PREVIOUSLY:  "We expect Philadelphia to be a top performing market in the third quarter due to strong group and transient demand, which should allow us to drive pricing."


  • SAME:  REVPAR grew 3.5% (occupancy: slight improvement, ADR: +3%).  Poor city-wide and group demand led to underperformance in 3Q.  
  • PREVIOUSLY:  "We expect our Chicago hotels to underperform our portfolio in the third quarter due to lower levels of citywide and group demand when compared to the third quarter of 2011."


  • SAME:  REVPAR grew 15.4% (occupancy: +2%, ADR: +12%). Outperformance was driven by strong group demand, which allowed HST to benefit from rate compression for both group and transient business
  • PREVIOUSLY:  "We expect our Boston hotels to have a strong third quarter."


  • SAME:  REVPAR 12.7% (occupany: +3%, ADR: +9).  Strong occupancy level allowed for better mix shift to higher-rated transient segments
  • PREVIOUSLY:  "We expect our San Francisco hotels to continue to perform very well in the third quarter as strong demand will allow us to continue to drive rate."


  • WORSE:  REVPAR increased 4.6% (occupancy: +2%, ADR: +2.1%).  Results were affected by renovations at three hotels.  Driving ADR growth has been challenging.
  • PREVIOUSLY:  "REVPAR for our New York hotels increased 4.8% due to growth in ADR. Results were 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....We expect our New York hotels to perform better in the third quarter."


  • BETTER:  REVPAR improved 11% (occupancy: +2%, ADR: +9%) on the back of group and transient strength
  • PREVIOUSLY:  "Our Miami and Fort Lauderdale hotels struggled in the quarter as REVPAR declined 20 basis points....The weakness was due to less transient and group demand. We expect our Miami and Fort Lauderdale hotels to perform better in the third quarter due to better group bookings."


  • BETTER:  Excluding the Sheraton Roma under renovation, REVPAR (in constant euros) increased 4.1%. Inbound travel to the Eurozone from the U.S., UK, and Asia, and the Middle East continues to be strong and a major source of euro lodging demand.
  • PREVIOUSLY:  2H vs 1H Europe REVPAR:  "We generally would expect it to be in line with what we've seen in the first half of the year."


  • BETTER:  REVPAR was strong in 3Q
  • PREVIOUSLY:  "The one market that's underperformed year-to-date has really been Brussels. But we have a sense that that will do a little bit better in the second half of the year." 


  • WORSE:  While F&B was good in 3Q, HST expects lower F&B revenues due to tough comps and an unfavorable calendar (e.g. election, Jewish holiday) in 4Q
    • We continue to see improvements in catering, meeting room rental and audio-visual revenues, as well as reductions in food and beverage cost as a percentage of revenue.  We expect the positive trends in group demand to continue which should help drive growth in banquet and audio-visual revenues and good F&B flow through.


  • SAME:  In 3Q, most of the comparable REVPAR increase came from rate.  Rate increased 4.7% while occupancy increased 2.1%.  The improvements led to strong margin growth in the Q. Rate growth will be increasingly more important in 4Q.
  • PREVIOUSLY:  "Looking to the rest of 2012, we expect that comparable hotel REVPAR will be driven more by both occupancy and rate growth, but rate growth should be increasingly more important throughout the year. The additional rate growth should lead to solid rooms' flow through even with growth in wage and benefit cost.”


  • SLIGHTLY BETTER:  Increased 3.2% in 3Q.  HST expects unallocated costs to increase in line with inflation particularly for sales and marketing.
  • PREVIOUSLY:  "We expect unallocated cost to increase more than inflation,particularly for sales and marketing where higher revenues will increase cost.


  • BETTER:  Utility costs declined 9.6% in 3Q. Expect utility costs to continue to be lower in 4Q but not as much as 3Q.  Property tax estimates remain unchanged at +6% for 2012.
  • PREVIOUSLY: “We also expect utilities to decline slightly for the full year."


  • SAME:  HST remains very confident that their managers will have success in negotiating higher special corporate rates this fall.
  • PREVIOUSLY:  "We will certainly be pushing for higher pricing next year to reflect the more competitive market conditions."

KORS: A Fashionable Setup

We’ve been a fan of Michael Kors (KORS)  for some time; the company has been able to consistently grow comps and retail/wholesale distribution. With yesterday’s pullback in the stock, we no longer consider KORS to be expensive. Our quantitative setup is in line with our fundamental view; thus we’ve added it to our Real-Time Positions. 


Our nine-factor fundamental model, outlined below, makes the case for KORS. With only two unfavorable setups on the cash flow side of the business, we believe KORS is a winner.



KORS: A Fashionable Setup  - KORS TTT 9Factor

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