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Visitors Down In Macau?

Visitor arrivals in Macau declined 2.0% year-over-year for December 2012 to 2,495,851. For the entire year of 2012, visitor arrivals increased a tad by 0.3% year-over-year to 28,082,292. Visitors from Mainland China increased slightly by nearly 1% to 1,495,316 for the same time period. The more visitors, the better the hold for the casino operators like LVS, WYNN and MPEL.


Visitors Down In Macau? - visitation1

Heinz Wants to have its cake and eat it too

The press release from Heinz (HNZ) this morning is reasonably straight forward, but doesn't sit well with us – it reads more like a commercial than a financial release (“Foodstar has delivered excellent results and has performed well beyond our expectations since joining Heinz.”)  The meat of the release is that HNZ owes an incremental $60 million earn-out payment related to its acquisition of the Foodstar business in China back in November of 2010 – the original purchase price was $165 million.  The earn-out will be treated as an extraordinary item, resulting in a $0.04 charge in the upcoming quarter.

Just to review, Heinz made this comment regarding Foodstar at a conference back in September of 2011:


“Approaching $150 million in FY12 expected net sales.”


Shortly after making the acquisition (February 24, 2011), HNZ commented


“Expecting >$100 million sales in FY12.”


Today, HNZ said:


“The business has grown to well over $200 million in sales.”


So it seems that sales have approximately doubled since the purchase, while the purchase price has gone up by approximately 40% - good stuff.  We have a couple of issues, however.

  1. As mentioned, the press release is highly promotional
  2. Why is the incremental cost treated as extraordinary?

It appears to us that HNZ wants to have its cake and eat it too - get the benefit on the top line and to EPS, but have the cost broken out as an item.  To be clear, the accounting treatment is correct, but it just doesn’t sit well with us, nor does the highly promotional nature of the press release. Keeping with the food metaphors, it seems like the company is positioning itself for a free lunch.


Bottom line, HNZ remains one of our least preferred name in staples.


Call with questions.


- Rob

Robert  Campagnino

Managing Director





IGT: Still On The Top

After reporting solid fiscal Q1 earnings, International Game Technology (IGT) remains one of our top long ideas in gaming. Our full fiscal 2013 estimate goes from $1.26 to $1.30; we believe our thesis on IGT remains intact: strong EPS grwoth, stabilized market share, better capital deployment (which will lead to a higher return on investment) and a cheap valuation.


IGT: Still On The Top - IGT

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MCD: An Espresso-Based Conspiracy Theory

The Street believes that we are close to an inflection point and that McDonald’s sales trends will bounce right back.  If you were reading only the today’s headlines from the McDonald’s 4Q12 earnings release, there are some signs of hope. 


However, with USA same-restaurant sales up 0.3% in 4Q12 and company operating margins down 150bps it would appear that there are other operational issues rooted deeper in the company results.  Global same-restaurant sales trends are expected to be negative in January.  If US trends are also negative, domestic company margins may compress further in 1Q13. 


The real key to driving sustainable top line sales and margin improvement will be running efficient stores.  We continue believe that management needs to address some operational issues that are having a negative impact on store-level margins.  The following note goes through the rationale behind our contention that operational changes need to take place for the US business to get back on track.



Historical Context


McCafé was first launched in Melbourne, Australia in 1993.  It reflected a growing consumer trend toward espresso-based coffees.  In the USA, Starbucks was changing the coffee landscape in the USA, educating the consumer about higher quality coffee and espresso-based drinks.  Bringing McCafé to the USA was the brainchild of Charlie Bell (an Aussie) who was brought in to be CEO following the death of Jim Cantalupo.  Sadly, Mr. Bell died in January 2005 shortly after being appointed as the first non-American to lead the company. 


McDonald’s first started testing McCafé domestically in the Chicago area in May 2001.  The program was designed to take on the growing competitive threat of Starbucks and, later in the decade, the potential incursion of Tim Hortons.  The Starbucks impact went well beyond the coffee and brought to life the theory of the “third place” or “a café” setting.  It was a place to a have a pastry and read the paper or, as it now turns out, connect to the internet. 


In the 2001-2003 timeframe, McDonald’s saw the new Starbucks business model as one factor in its own same-restaurant sales declines.  Complicating matters for McDonald’s was the company trying to open 1,000 units per year in the United States alone.  The focus was on unit growth and not unit productivity.


In 2003, the Plan-to-Win was unveiled but it was not until 2005 that management began upgrading its drip coffee by using higher quality beans, filtered water, and better-tasting cream.  After two years, drip coffee sales were surging, giving management the confidence to upgrade their hot-drinks menu.  Beginning in 2006, management began to put forth the argument that the success of the drip-coffee business gave the company credibility to expand into espresso-based drinks.  McDonald’s shift in focus from being a fast food concept to more of a beverage concept was underway.


The greatest successes in McDonald’s history, like the Egg McMuffin, have stemmed from franchisee initiatives while some of the biggest disappointments, like Arch Deluxe, have been driven by Oakbrook.  In the case of the complete beverage strategy, it was driven by Oakbrook; franchisees had little to do with the shift in focus.


Strategically, I can see the reason for management wanting to drive the sales of higher margin beverages but, absent almost-prohibitive investment, McDonald’s will likely never become a beverage destination over a sustained period of time.  The DNA of the company lends itself to executing on food, as Starbucks’ lends itself to executing on beverages.  Unfortunately for McDonald’s the capital thus far-committed to shifting toward beverages has come at a significant cost. 



Early Test Markets


In 2007-2008, the company expanded the McCafé test in Chicago into Kansas City.  The original strategy called for McDonald’s to spend $100,000 per store, incorporating separate McCafés in each restaurant that could serve a new line of espresso-based products and assorted baked goods.  The strategy also included expanding the drive-thru to ameliorate though-put issues.  In the end, the construction costs exceeded the budgets and, more importantly, the level of consumer acceptance was not meeting expectations. 


So, for the first time in McDonald's history "testing" became irrelevant because the test markets did not go well, the franchisees said "we don't want this, take it out."  Instead, the Oak Brook based initiative went national in 2009 with a roll out strategy that was changed had to be altered from its original form.


Late in 2008, I documented that the company was clearly behind plan in converting restaurants to McCafés in order to nationally promote the product by mid-2009.  In the US, the company was running behind schedule and a lack of enthusiasm among franchisees to absorb rising costs posed a problem for Oakbrook.  In the end, the decision was taken to abandon the plan for a separate “McCafé” within the store, as was the prototype developed in other markets, and move forward with espresso machines being integrated behind the existing front counters. 


Does MCD Know Its Audience?


Selling expensive beverages at McDonald’s in the USA has always been a curious notion, given the brand’s perception among consumers as a value chain. 


Why did McDonald’s take the decision to proceed with the rollout in 2009/2010? Why was there no slowdown?  It seems that the reason behind this decision was the business plan at the time calling for phase II of the “beverage strategy”: cold drinks.  After four years of upgrading the menu and successful new product introductions, management needed to drive traffic and beverage sales were deemed the way forward. 


Back in 2008, a McDonald’s executive was quoted as saying, about the company’s beverage strategy, “That's the great part about McDonald's is that we are actually offering affordable luxuries, so for us we know our customers are looking for those affordable luxuries."  Are “affordable luxuries” going to resonate with the consumer in 2013?  Longer-term acceptance of the McDonald’s as a beverage destination is key to the success of this strategy and a return on the considerable capital investment that has supported it. 


We’re now told that the expensive and complicated espresso machines behind the counter only serve a handful of espresso drinks per day.  The espresso machine is separate from the machine that produces the traditional drip coffee, of which McDonald’s sells a large amount, and is a piece of equipment that requires regular maintenance.  Additionally, the shaved-ice drinks (smoothies and frappes) have no connection with the espresso machine.  Below are some thoughts from the franchisee community on the subject of the expensive drinks machines:

  • History has proven that the more complicated a piece of equipment is the shorter it's [sic] lifetime in a MCD restaurant.
  • The machines were installed in 2008 and early 2009.  What will happen when the machines need replacing? Will franchisees refuse to spend the $15,000 plus to replace them to continue to sell a few drinks a day?
  • The maintenance required for the machine is huge and may end up 'out of control'. We all bought Cadillac’s but at GM, 16 year olds don't do the oil changes.

The most important operational dilemma that senior management faces is the level of media spending that has, and continues to be dedicated to beverages.  We believe investors will increasingly question the allocation of marketing dollars.  Should those media dollars be re-allocated to helping grow other parts of the business? Then what does that say about the potential for beverage trends actions?  Lastly, what are the implications to corporate margins as beverage transactions slow and incremental maintenance expenses?


A core tenet of the Plan to Win, established under Jim Cantalupo, was something called “simplification” which applied to the menu and kitchen operations.  Over time, the tension between the desire to drive traffic and simplification led to an expanding menu including a significant number of beverages varieties.  Franchisees are finding the menu too large and kitchens are far from the streamlined centers of operation that the Plan to Win envisaged.  Service times in the lobby and drive-thrus are likely to suffer if the back of the house has become disorganized due to the expansion of the menu.  Given the ownership that individuals within the McDonald’s organization take of different menu items and/or initiatives, it is unlikely that a menu item cull is forthcoming.   If anything, the complications of the four-wall operation at McDonald’s could be getting worse.



Howard Penney

Managing Director


Rory Green

Senior Analyst




Quick Look at Unilever Results

Unilever (ULVR LN) is up over 3% in European trading this morning, after releasing full-year and Q4 results.  Underlying sales growth (excluding the impact of exchange rates, acquisitions and disposals) was 7.8% with strength in Personal Care (+11.5%, 4.0% price, 7.2% volume) and Home Care (+10.4%, 3.1% price, 7.0% volume).  Foods were a laggard at +1.3% underlying sales growth with price contributing 1.4%.

These results represent a sequential acceleration in underlying sales growth (+6.0% in Q2 and +6.1% in Q3) and represent strength on strength as the comparable result in Q4 2011 was a +6.6%.


We would like to highlight a couple of items from these results.

  1. Unilever is a transformed company, with the transformation beginning with the appointment of Paul Polman as CEO, formerly of Nestle
  2. Unilever is what PG should aspire to be in terms of growth and investment in brands
  3. Personal and Home Care results are favorable on the margin for PG
  4. Food results still struggle to find a balance between price and volume growth

It's been fun to watch the transformation of Unilever over the years from a sluggish, inexpensive staples name to a global growth company.  If anyone suggests that the jockey doesn't matter in a horse race, point them toward Unilever.

Kind regards,




Robert  Campagnino

Managing Director




Growth's Roadblock

Client Talking Points

Tread Lightly

Since 2013 started, stocks have ripped to the upside nearly every day and the S&P 500 is a few handles away from touching 1500, an impressive feat considering that the financial crisis was only five years ago. And while the move in stocks is actually justified this time, we begin to worry about inflation slowing global growth. If commodity prices (oil in particular) keep heading higher, that can stop growth right in its tracks. When consumption slows because of $8 a gallon gas and $5 boxes of Gushers at the supermarket, so does global growth. There is no way that $100/barrel WTI crude is going be OK with the American consumer; Jamie Dimon can kiss his 4% GDP growth rate goodbye if that happens. 

The Big Miss

Apple’s (AAPL) earnings release after the close is the big catalyst for the market. If they miss, people are likely to freak out. People freak out when bad things happen to Apple because it makes up 17% of the tech sector ETF (XLK) and is king of the NASDAQ. “In the meantime, the SP500 is immediate-term TRADE overbought at 1496 inasmuch as the VIX is oversold at 12.19,” says Keith this morning. And if we want to enjoy a market above 1500, we’re probably going to need to see a beat from Apple after the close.

Asset Allocation


Top Long Ideas

Company Ticker Sector Duration

We believe ASCA will receive a higher bid from another gaming competitor. Our valuation puts ASCA’s worth closer to $40.


ADM has significantly lagged the overall market in 2012 over concerns that weakness in the company’s bioproducts (ethanol) and merchandise and handling segment will persist. Ethanol margins suffered from higher corn costs, as well as weak domestic demand and low capacity utilization across the industry. Merchandising and handling results were at the mercy of a smaller U.S. corn harvest. Both segments could be in a position to rebound as we move into 2013 and a new crop goes into the ground. With corn prices remaining at elevated levels, the incentive to plant corn certainly exists, and we expect that we will see corn planted fencepost to fencepost.


HOLX remains one of our favorite longer-term fundamental growth companies given growing penetration of its 3D Tomo platform and high leverage to the 2014 Insurance Expansion from the Affordable Care Act.

Three for the Road


“Economists lowered 2013 economic growth expectations for Asia for the fourth time in a row. However expectations are 2013 will beat 2012.” -@Bain_Energy


“Philosophy is a battle against the bewitchment of our intelligence by means of language.” -Ludwig Wittgenstein



U.S. chains store sales were up 3.2% in January over where they were a year ago.

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