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MCD BOTTOMING PROCESS

We believe the bottoming process in McDonald’s will take longer than some are anticipating.  This morning’s upgrade is pushing the stock higher but we see reasons to avoid McDonald’s on the long side for now.

 

Reasons to Become More Constructive:

 

The Yield: This is the #1 reason we hear for people to get bullish on MCD.  While we agree that the 3.47% yield is attractive, we believe that buying MCD here for anything more than a short-term TRADE is fraught with risk.  Consensus is expecting a “hockey-stick” recovery in earnings growth that we do not expect to materialize

 

Sentiment Has Reset:  There is an argument to be made that consensus has become too bearish on the immediate-term TRADE but we believe that mistakes on MCD’s part, yet to be acknowledged by management, will continue to hamper same-restaurant sales growth in the important US market.

 

MCD BOTTOMING PROCESS - mcd macro usa

 

 

Compares Will Begin To Ease Post-1Q13:  Several weeks ago, we were eyeing this thesis as a potential reason to get long MCD in late FY12/early FY13.   We have come to the conclusion that there are self-inflicted wounds impacting McDonald’s sales performance that management has not yet owned up to.  The aggressive move to value has not been effective and we do not believe it will be effective next year, despite easing compares.  Stiffer competition in the QSR segment in the US makes forecasting FY13 comps difficult.  For instance, yesterday at the YUM Analyst Day, we learned that Taco Bell is increasing its target rating points (TRPs) by 44% year-over-year as it transitions to an exclusively nation-wide marketing strategy (no regional advertising).

 

 

Reasons to Look Elsewhere:

 

MCD Not the Restaurant Cockroach: We read an interesting paper recently on the long-term resilience of “cockroach” portfolios that yield stable returns through economic cycles.  There is a perception that MCD is the “safety trade” in restaurants.   We would argue, from an operating income perspective, that YUM is more attractive in this regard given its geographical diversification and best-in-class growth profile. 

 

MCD BOTTOMING PROCESS - yum mcd sbux opinc

 

 

Valuation Is Not A Catalyst:  Valuation is being cited as one reason to get long MCD but, on the contrary, we would argue that it remains a reason to look elsewhere.  The Street is valuing the stock at 15.3x FY13 EPS and, while this is not a rich multiple historically, we would take issue with the Street’s earnings estimate.  Our FY13 EPS estimate of $5.29 implies a much less attractive multiple of 16.8x.  Ultimately,

 

 

MCD November Sales Preview

 

McDonald’s reports November sales on Monday morning before the market open.  Consensus is calling for a sequential acceleration in two-year average trends in November. 

 

Below we go through what we would view as good, bad, or neutral comparable restaurant sales numbers for McDonald’s three regions in November.  For comparison purposes, we have adjusted for historical calendar and trading day impacts (but not weather).

 

Compared to November 2011, November 2012 had one additional Thursday, one additional Friday, one less Tuesday, and one less Wednesday.  We expect this to have a modestly positive impact on the headline numbers for November although some negative impact will be felt in the U.S. from Sandy. 

 

MCD BOTTOMING PROCESS - MCD srs cons hedgeye

 

 

United States – facing a compare of 6.5%, including a calendar shift of 0.3%, varying by area of the world:

 

GOOD: A positive print would be received as a strong result as, on a calendar-adjusted basis, it would imply acceleration in two-year average trends from October.  In October, performance in the U.S. was negatively impacted, according to management, by “modest consumer demand and heightened competitive activity offset the impact of local Dollar Menu advertising, the Monopoly promotion, and the recent launch of the Cheddar Bacon Onion premium sandwiches.”  We believe that the heightened competitive activity in QSR is likely to ramp further over the coming months and quarters.

 

NEUTRAL:  A print between -1% and 0% would imply calendar-adjusted two year average trends roughly flat versus October.  While the first chart of this post implies an over-bearishness on the part of consensus, self-inflicted wounds on MCD’s part lead us to conclude that slower same-restaurant sales growth is possible from here.

 

BAD:  Same-restaurant sales growth less than -1% would imply a sequential deceleration in two-year average trends in the U.S. from what was a disappointing month in October.  We would expect the stock to react negatively to this print. 

 

MCD BOTTOMING PROCESS - mcd us sss

 

 

Europe – facing a compare of 6.5%, including a calendar shift of 0.3%, varying by area of the world:

 

GOOD:  A positive print would be received as a strong result as, on a calendar-adjusted basis, it would imply acceleration in two-year average trends from October.  Performance in Europe was hampered by economic uncertainty in November that has continued, if not worsened, in November.  This morning, the Bundesbank slashed a percentage point off its forecast for economic growth in Germany next year.  We expect broad-based sluggishness to persist in Europe for MCD.

 

NEUTRAL: A print between -1% and flat would be received as neutral by investors as it would imply calendar-adjusted two year average trends roughly flat versus October. 

 

BAD:  Less than -1% same-restaurant sales growth would imply, on a calendar-adjusted basis, trough two-year average trends for the year in Europe. 

 

MCD BOTTOMING PROCESS - mcd eu sss

 

 

APMEA – facing a compare of 8.1%, including a calendar shift of 0.3%, varying by area of the world:

 

GOOD:  A print of -0.5% or better in APMEA would be a positive result for MCD.  We are not expecting much from APMEA this month given the worse-than-expected commentary from YUM on its China business.

 

NEUTRAL:  A print between -1.5% and -0.5% would be received as neutral by investors as it would imply calendar-adjusted two year average trends roughly flat versus October. 

 

BAD:  Same-restaurant sales growth slower than -1.5% in November would imply sequential deceleration in two-year average trends in APMEA and would likely be received negatively by investors.

 

MCD BOTTOMING PROCESS - mcd apmea sss

 

 

Howard Penney

Managing Director

 

Rory Green

Analyst

 

 

 


Vegas Strip Surprise Data

Las Vegas Strip gaming revenue rose 3.6% in October on a year-over-year basis. The upside exceeded expectations and was due in large part to higher slot hold. Since September ended on a Sunday, due to an accounting policy, ~$50 million in slot revenue was carried into October; hence, a higher than normal hold rate (8.1%) resulted. With the Vegas gaming market still in a depressed state, future data is expected to remain weak.

 

Vegas Strip Surprise Data - SLOT666


STRIP: OCTOBER DISGUISE

High slot hold masks disappointing fundamentals

 

 

Las Vegas Strip gaming revenue rose 3.6% YoY in October.  While this was better than we expected, the upside surprise is entirely due to higher slot hold.  Since September ended on a Sunday, due to an accounting policy, ~$50 million in slot revenue was carried into October; hence, a higher than normal hold rate (8.1%) resulted.  On a hold-adjusted basis, total gaming win would have fallen 6.4% YoY.  More importantly, slot handle fell back into the red (-3.7% YoY), abruptly ending its one month gain.  According to our trend projection model, we believe slot handle, on a rolling 3-month basis, will remain weak for the rest of the year.

 

Baccarat volume rose a meager 5%, a rate similar to September but much slower than the 20-30% growth seen in June-August.  Table volume ex baccarat was up 2%; on a rolling 3-month basis, table handle ex baccarat fell 1%.

 

STRIP: OCTOBER DISGUISE - SLOT666


Early Look

daily macro intelligence

Relied upon by big institutional and individual investors across the world, this granular morning newsletter distills the latest and most vital market developments and insures that you are always in the know.

Sandy Vs Katrina

Yesterday, we discussed how Hurricane Sandy has essentially stopped affecting economic data points such as jobless claims numbers. Today, we examine how the numbers are getting back to normal (initial jobless claims fell 23k to 370k from 393k) and look back at Hurricane Katrina factored into economic data points. The comparisons between Sandy and Katrina are similar, but Katrina lasted a few weeks longer.

 

Sandy Vs Katrina - image011


Sandy Vs Katrina - image012


CONFERENCE CALL TODAY AT 11: COULD HOUSING'S RECOVERY GO PARABOLIC IN 2013?

Takeaway: Please join us today at 11:00am EST for our conference call entitled Housing Heading Higher in 2013.

CONFERENCE CALL TODAY AT 11: COULD HOUSING'S RECOVERY GO PARABOLIC IN 2013? - Housing.Call

 

Please CLICK HERE to access the materials for this call and dial in 5-10 minutes prior to the 11:00am EST start time using the number provided below. If you have any further questions email .

  • Toll Free Number:
  • Direct Dial Number:
  • Conference Code: 314729#

 

Today we will be hosting a call at 11:00am EST entitled Housing Heading Higher in 2013. Housing market fundamentals continue to strengthen and are expected to maintain, and possibly accelerate their momentum through 2013. The call will detail the changes in key housing metrics including inventory levels, pricing, and household formation. The call will also cover some of the top long ideas for playing the ongoing housing recovery in 2013.

 

Topics will include:  

  • Housing recovery to accelerate in 2013
  • Why 2012 was the year of supply, but 2013 will be the year of demand
  • The role of the distressed market in fueling an accelerating recovery
  • Rate reductions driving further upside
  • Impact on the Financials Sector
  • Some top ideas: BAC & TCB

Home Base

Client Talking Points

Burning Down The House

It seems like the housing crisis was only a few months ago and yet it’s been nearly six years since it first started. Since then, the housing market has slowly but surely recovered. We have a long way to go before everything is “right” again but we’re seeing data that’s positive to say the least. Inventory is declining, prices have increased and mortgage rates are low. CoreLogic data indicates that home prices rose 6.3% in October on a year-over-year basis. We believe that this positive momentum is accelerating and will cover this on our 11:00 AM call with Hedgeye Financials Sector Head Josh Steiner titled “Could Housing’s Recovery Go Parabolic in 2013?” We encourage you to listen and if you don’t have access, please email us at sales@hedgeye.com for more information.

Asset Allocation

CASH 52% US EQUITIES 12%
INTL EQUITIES 6% COMMODITIES 0%
FIXED INCOME 18% INTL CURRENCIES 12%

Top Long Ideas

Company Ticker Sector Duration
YUM

New unit openings in China and strength in YRI and US should offset China weakness in 1H13. China SRS growth is sensitive to the economy but new unit growth and ROIIC are likely to be supported by continuing growth of the consuming class in China. Looking at operating income by geography for YUM/MCD/SBUX, we can see that YUM is the most geographically diverse. This is manifest in YUM’s more stable EPS growth and price performance over the last 10 years.

SBUX

Uncertainty in US from a macro perspective (jobless claims uptick) gives us pause from TRADE perspective although coffee prices will serve as a tailwind going forward. Company is becoming more complex, taking on risk as it acquires new brands. Longer-term, we view Starbucks, along with YUM, as one of the most attractive global growth stories in our space.

ASCA

We believe ASCA is greatly undervalued due to its potential to follow a OPCO/PROPCO model like PENN in two years or so. A high FCF yield and a healthy balance sheet make this gamer an attractive investment.

Three for the Road

TWEET OF THE DAY

“Bill Gross said the investment company may reduce its risk profile in 2013 after posting higher-than-average returns this year.” -@MrTopStep

QUOTE OF THE DAY

“There is no stigma attached to recognizing a bad decision in time to install a better one.” -Laurence J. Peter

STAT OF THE DAY

Non-Farm Payrolls rise by 146,000, exceeding estimates. Unemployment falls to 7.7% in November.


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