prev

SHO: NO HOME COOKING FOR LODGING INVESTORS

SHO is not yet one of core followings but they do typically provide a thoughtful preview of quarterly hotel trends.  Despite the huge moves in hotel stocks, SHO provided little optimism to justify such enthusiasm.

Below are our takeaways:

·         No sign that RevPAR has stabilized or bottomed - RevPAR decreases continues to increase

·         While SHO agrees with our thesis that occupancy bottoming out is the first sign of a bottom, they haven’t seen it yet

·         Future booking pace continues to slow in line with the accelerating decline in RevPAR

·         1Q is a seasonably slower quarter, and therefore the only way to fill the rooms is to try to steal market share by cutting rate.  Unfortunately, it’s now the beginning of Q2 and there are no signs of the ADR slide abating

·         Specific market commentary:

o   Continued weakness in Chicago, Detroit & Minneapolis

o   Mid Atlantic being propped up by DC

o   Continued weakness in Orlando & Atlanta

o   Houston relatively strong

·         On the positive side, they have had some success in offsetting some of the revenue declines by cutting costs – this has been a theme across the industry and is the silver lining

·         Asset sales are likely to remain difficult to consummate until:

o   There’s more visibility on how 2009 will shake out

o   There is some sense on when we reach bottom and what the numbers look like at trough

o   The financing environment improves

·         Following in the footsteps of DRH, AHT, BEE, and Interstate Hotels, SHO is making headways in negotiating an amendment to its credit facility that would result in covenant relief

o   In exchange, SHO will reduce the size of the facility, provide a pool of 10 unencumbered assets as security for the facility, and pay a premium on its borrowing cost

·         Sunstone is also making some headway in securing mortgage financing but at materially less favorable terms than we’ve seen in the past

o   50% Loan-to-Value

o   Value based on ~20%  haircut to 2008 NOI and cap rate ranging from 9-11%

o   Pricing around L +550 with a 1% LIBOR floor

 

SHO provided evidence that this early cycle move in lodging stocks my ultimately prove to be too early.

 

SHO: NO HOME COOKING FOR LODGING INVESTORS - us revpar trends


MAR: FORAY INTO LV CONVENTIONS BUSINESS

Conventions and group meetings comprise approximately 30% of all occupied room nights at full service hotels in the United States.  MAR generates 40% of its US business from the same segment yet the company maintains no presence in the largest convention market in the world.  With its database of 30 million Marriott Rewards members, MAR is clearly missing out on some huge cross-marketing opportunities.

Luckily for MAR, MGM MIRAGE is selling assets.  One of the crown jewels in the MGM portfolio is Mandalay Bay which just happens to operate a 1.7 million square foot convention center and 4,300 hotel rooms.  Could there be a better time to buy?  Maybe, but I would think MAR buying at close to trough EBITDA from a forced seller should result in a pretty attractive price.  Given the likely $1 billion+ price tag, I doubt there will be many other bidders.

The near and intermediate term outlook for Las Vegas is pretty dour.  We can argue about the timing of the turn, far off in our opinion, but what is fairly certain is the favorable long-term outlook of the convention business.  The following chart shows the tremendous growth in annual convention attendance over the last 15 years.  Almost 6 million people attended Las Vegas conventions in 2008, a fairly steady climb from the 2.6 million conventioneers in 1994.  The affordability and value of conventions and hotel rooms in Las Vegas will not be matched in my opinion.  The casino acts as a subsidy leaving Vegas with the highest quality rooms and convention facilities in the country.  The value proposition vis-à-vis other convention markets will always be there.

MAR: FORAY INTO LV CONVENTIONS BUSINESS - lv convention attendance

Of course, MAR is not a casino company so they would need an operator.  I’m sure ASCA, BYD, PENN, PNK, and maybe Crown would all be interested in a management contract and an equity slice.  PNK could be the best fit given its corporate presence in the city and CEO Dan Lee’s Mirage experience.  In any case, Las Vegas is definitely a good fit for MAR and the timing looks right.     


YUM – CHINA, NOT WITHOUT ISSUES

YUM needs its Holy Grail, China, to save the day in Q1, which could be a challenge.  YUM is facing difficult comparisons and although economic news out of China has improved on a sequential basis in March, overall trends in Q1 were less than favorable.

 

In 4Q08, we learned that same-store sales trends in China slowed considerably in December as YUM had reported that quarter-to-date comparable sales were up 4% through November 30, but closed out the quarter only up 1% (a timing shift in December hurt by 1%). YUM was lapping a difficult 17% comparison in the fourth quarter but this slowdown was worse than expectations.   Also, EBIT margins declined in China in 4Q08 (down 190 basis points) as a result of continued commodity and labor inflation.

Looking to 1Q09, I expect YUM to face similar challenges as YOY commodity pressures will be more severe in 1Q09 and the company is lapping 12% same-store sales growth and 33% operating profit growth.

And the news from China is not all that good.  The slide in December retail sales trends looks to have continued into January and February, but March suggests some consumer resilience.    

YUM – CHINA, NOT WITHOUT ISSUES - China Retail Sales

The Chinese Government is doing what they can to get consumers to spend again.  As you can see from the chart below, credit is flowing rapidly in China creating positive momentum.  Yesterday, China reported an 11.2% year-over-year increase in urban disposable income for 1Q09 (the rural population realized 8.6% cash income growth in the same period) and the CPI declined by 1.2% Y/Y for March – the second sequential negative growth month.  YUM needs government stimulus to motivate Chinese shoppers to increase their willingness to spend for the balance of 2009 in order to hit its 15%-20% operating profit growth goal in China.

YUM – CHINA, NOT WITHOUT ISSUES - China Liquidity

 


real-time alerts

real edge in real-time

This indispensable trading tool is based on a risk management signaling process Hedgeye CEO Keith McCullough developed during his years as a hedge fund manager and continues to refine. Nearly every trading day, you’ll receive Keith’s latest signals - buy, sell, short or cover.

CANARIES & COAL MINES

The market for coal in China suggests buyers are anticipating a big increase in power demand

 

At -4.6%, Chinese PPI for March arrived at the lowest year-over-year change in a decade as contracting demand for exports and lower commodity prices impacted the cost of doing business.

 

CANARIES & COAL MINES   - che1

One core commodity component that has still seen double digit inflation levels is coal. Since becoming a net importer last year the PPI breakout has remained in double digits despite global price declines with February data (the most recent available) registering at 18.3% Y/Y.

 

March imports registered at the highest level in two years, and the divergence between spot prices in China have held at price levels significantly higher than global averages since the end of last year, with some data showing a 50% premium to European and South American prices.

 

CANARIES & COAL MINES   - che2

 

CANARIES & COAL MINES   - che3

 

Chinese coal producers’ experienced significant setbacks last year with massive snow storms and the Sichuan earthquake interrupting operations and transportation, while at the same time government programs to modernize the industry and close antiquated, unsafe mines have trimmed capacity. The persistent demand for Thermal coal in the face of the Q4/Q1 Industrial production slowdown and sequential Y/Y declines in reported electric power production over the same period however, would appear to be more than enough to offset these capacity setbacks.  This continued rapid demand expansion suggest something that may be significant for our thesis:  stockpiling by utilities in expectation for rapidly increased electricity demand for the remainder of 2009 as a stimulus fed recovery picks up steam.

 

We remain bullish on the ability of China to kick start internal demand with the stimulus measures adopted and will continue to monitor all factors looking for more data to support or challenge our thesis.

 

Andrew Barber
Director


MACAU: A SUMMER OF TOUGH COMPARISONS

As can be seen in the following chart, Macau year-over-year comparisons have been extremely difficult due to primarily to the flood of credit that boosted the Rolling Chip (RC) segment in the first half of last year.  The Mass Market comparisons, while difficult on the surface, were boosted by the opening of The Venetian, which obviously remains open.

MACAU: A SUMMER OF TOUGH COMPARISONS - macau comps

We remain unperturbed about the tough comparisons.  September is not that far off.  Visa restrictions may already have been loosened and most certainly will be when the new CE takes over in November.  For those of you looking for a nearer term catalyst, the June event calendar looks favorable including:

·         The opening of Crown’s City of Dreams in early June

·         G2E on June 2-4

·         The International Indian Film Academy (IIFA) Awards on June 11-13th – “Bollywood” is a big deal these days.


ONE SIZE DOESN’T FILL ALL

Back in the day, it was easy to compare the EV/EBITDA valuations of fundamentally similar companies.  EV/EBITDA is now failing as a useful valuation metric due to disparate credit issues.  A low and sustainable cost of capital is a valuable asset versus debt with a near-term maturity or a likely covenant breach.  Yet, even if estimates are adjusted for refinancing, the impact won’t show up in the standard EV/EBITDA calculation.

We can blame the markets, dumb financial management, the government, and so on.  Pick your scapegoat but the credit environment has changed dramatically in the last 6-9 months.  The easy money era is over and companies can no longer financially engineer returns.  Consider: 

·         For more leveraged companies, credit spreads have blown out from several hundred basis points to several thousand basis points

·         For less leveraged companies, bonds have gone from trading in the mid single digit yields to high teen yields

·         The CMBS market has largely become inaccessible

·         Banks have a much smaller appetite for risk, even at generous spreads, as they seek to shore  up their balances sheet

·         Underwriting future cash flow or giving credit for non-income producing assets is a rarity

·         Loan-to-Value (LTV’s) are down from 75% to 50%, with much more conservative assumptions on the “V” portion

·         Leverage covenant tolerance is down from 7.0-8.0x to 5.0x

·         Senior leverage tolerance is down from 5.0x to under 3.5x

·         LIBOR floors are the new future - say goodbye to sub 5% all in rates

Prospective or distressed borrowers are facing very large mark-ups in interest cost when they refinance or issue fresh debt.  For companies that rely heavily on bank debt, the mark up will be particularly ugly, as new credit facilities will not only be materially more expensive, but also a lot smaller, forcing these companies to tap the high yield market.  Even when fundamentals stabilize and begin to recover, companies may not get any cash flow benefit, as much of the EBITDA improvements will be eaten away by higher interest costs.  Therefore, simply applying historical EBITDA multiples will not capture the new reality of higher capital costs.

Unlike EBITDA, FCF accounts for differences in capital structure, and therefore we believe it is more appropriate to apply a multiple to FCF when thinking about valuation for leveraged sectors such as Gaming & Lodging.  Of course, fundamentals, stability, and growth can justify disparate multiples as they’ve always done.  Now, cost of capital can vary significantly across similarly leveraged and fundamentally exposed companies.  FCF yields and multiples do a better job of capsulizing that important metric.


investing ideas

Risk Managed Long Term Investing for Pros

Hedgeye CEO Keith McCullough handpicks the “best of the best” long and short ideas delivered to him by our team of over 30 research analysts across myriad sectors.

next