Manheim Index Gets A Boost

The Manheim Index of used car values tends to closely correlate to the S&P 500 and right now we're seeing upside in both indices. The Manheim Index rose 0.6% month-over-month in November to 122.6 but declined on a year-over-year basis by 1%. 


Hurricane Sandy played a role in the November numbers by reducing supply and increasing demand for used cars, which is expected to continue into December and part of early 2013. Interestingly, Manheim co-integrates with the labor market. A generally improving labor market means more people need cars to get to work and most cars on the road are…wait for it….used. This is one reason why we're so interested in the decline in Manheim over the last few months. It seems to be a contradictory data point compared with what the other labor market series are telling us.


Manheim Index Gets A Boost - CACC vs Manheim


Manheim Index Gets A Boost - Manheim vs S P

JCP: Fake Estate

Takeaway: The ‘Real’ Estate angle with JC Penney is overhyped. A transaction could provide near-term relief, but may ultimately prove problematic.

Just about any development that gives the investment community ‘hope’ in JCP these days gets the stock rallying. That’s exactly what happened yesterday with a newly formed REIT structure out of Loblaw – Canada’s largest food retailer. But one consideration people should keep in mind is that if JCP creates a REIT, it may not be able to make its rent.


After five years of starving its store base of capital and pushing out leases to preserve cash flow, we’re left asking what levers the company has left to pull if sales and profitability growth fail to materialize. The most obvious option is to leverage the company’s real estate assets, a strategy that Bill Ackman & Co. have considerable experience with. Here’s an option JCP could consider to unlock its real estate value:

REIT Option: Back in January 2011, Dillard’s announced its intent to form a REIT in order to “enhance its liquidity” by transferring “real properties” that are currently owned and lease back the properties under triple net leases. Given an improved environment and recent transactions in the REIT sector, this strategy is likely under consideration for other retailers as well in an effort to unlock real estate value.

Loblaw’s announcement is similar to Dillards in that it is planning to spin off roughly 70% of its property assets worth more than $7Bn into a REIT. The funds from the transaction will be reinvested in the operating business. With cash flow from operations YTD down -$655mm and net debt-to-equity at historical highs at 0.67x, the probability of JCP pursuing this option is still low, but increasing on the margin.

Since the formation of a REIT provides the greatest benefit for retailers that own a substantial percent of their real estate, we’ve looked at the likely candidates (see chart below).  Both Macy’s (55%) and Nordstrom (46%) own a greater portion of their store base compared to JCP, but even with 39% of its real estate owned, this is an option for Penney’s to consider.


JCP: Fake Estate - JCP RE


JCP currently owns approximately 39% of its real estate, or 44.6 million sq. ft. Based on current rent and cap rates, we estimate JCP’s potential REIT value at $1.85Bn-$2.55Bn, or $8.25-$11.50 per share. 


JCP: Fake Estate - JCP REIT


While forming a REIT is not likely, one thing to keep in mind that Steven Roth is on JCP’s board. While Loblaw’s announcement may have roused speculation in the start of a potential trend, recall that Roth was one of the first to execute such a strategy when he bought Alexander’s out of bankruptcy in 1993 and converted it to a REIT. Roth has “been there and done that” before.

Here’s an obvious but big consideration.

Also, this 39% that is owned carries very low cost on the land. Yes, the company is depreciating the property (some of which is fully depreciated). But if it created a REIT, it would actually have to start paying market rent on this property. Funds from a transaction would provide operating cash and cushion initially, but rent expense could ultimately prove problematic for JCP over time.

In a perfect world, the 39% of JCP’s stores that are owned will be the 400 stores that are not going to be converted into the new format. After all, keeping the old format in these stores will default them to a very high cost infrastructure.  But that’s a very fat chance of perfect overlap. In fact, it makes the most sense to run a chain of only 700 stores – so they logistically and structurally only have to serve stores that are converted. Otherwise these remaining assets will do nothing but weigh down the core.


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.





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. 





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. 





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.





Howard Penney

Managing Director


Rory Green





Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.43%
  • SHORT SIGNALS 78.35%

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


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%.



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

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