SBUX VERSUS MCDONALD’s – The debate rages on

I still believe that there is a significant catalyst coming for Starbucks when the world realizes that McDonald's McCafe is not taking significant share from SBUX.

The other night, not knowing I was an analyst (not that it matters), an acquaintance of mine was talking about "investing". So I asked him about McDonald's and if he had tried the new coffee drinks. He said yes and that he was very disappointed and it's not likely he will have another one. The McDonald's media blitz is clearly stimulating significant trial, but if they don't have the products engineered perfectly, that all its going to be - a onetime purchase.

The amount of media that McDonald's is throwing at coffee is coming at the expense of other parts of the menu. In the areas where they have reduced media spending, it's only natural that the trends for those products will slow. Is the coffee news enough to keep the overall sales growing? Coffee is not a core competency for McDonald's and there is a big risk that McDonald's is too focused on coffee! If June is like May, McDonald's will have a hard time explaining away a soft comp. This will be good for SBUX!

Given my friends response I sought out the bloggers to see if he the exception or the norm. All of the following comments are from the blogs debating the issue:

If anything, I think the McCafe launch has made people appreciate the taste and quality of Starbuck's beverages. I remember the first time I tried the McCafe Mocha - when I asked how many shots of espresso was in it, the person working at McDonalds didn't even know what espresso was. Starbuck's specialty is coffee and good, quality beverages. McDonalds specializes in... Sandwiches! The companies should stick with what works best for them.
The companies should stick with what works best for them." Unfortunately, Starbucks doesn't know how to do that and has alienated many a customer with decisions such as not brewing decaf and bold after noon etc. I don't really see a McCafe hurting sbux so much as the economy and the fact we raised prices during a recession....ummm...can you say stupid move

Had a few customers comment that their experience was not good at McD's. Cheaper price but less quality beverage. As for trends, seeing lots of iced coffee sales rather than iced lattes or blended beverages. I think the 1.95 price point is good for people. My opinion is that McD's can't really compete right now with espresso. If they get a good iced coffee, then it could compete. Their current iced coffee is weak tasting. Sbux breakfast sandwiches don't compare. Not fresh enough. I don't eat fast food breakfast for health reasons. Personally, I think it is dangerous for Sbux to compete with fast food... FOOD. The less like a coffee house and focus on drinks means less quality of beverages and service speed.

I'm not a SBUX employee, I'm a regular customer. The McDonalds rollout hasn't affected my consumption patterns one bit. I'll go to McDonalds if I want a fast-food hamburger. The McCafe marketing plan just sounds like a clumsy attempt to get some of Starbuck's and Dunkin Donuts' market share.

Truthfully, having a mcd's ten feet away has NOT affected my store. They post signs pointing directly at my store for their mccafe' and yet...we still get THEIR employees buying our coffee. We've had customers go there and get a drink, only to dump it out and get a drink from us.

Ugh, I had a vanilla latte at McDonald's for the first time yesterday. So gross. It tasted exactly like the vending machine coffee I used to get in college. This is about right, considering it was "made" by pushing a button.
We have a McDonald's across the street from my store and I have made it a point to ask many of our regulars: "Have you tried any of the McCafe drinks? What were your thoughts?" I also tried the iced mocha myself. The results were simple... You pay for what you get. Argue the details all you want. The fact remains that value is up for the customer to decide.

We have three McDonalds within a five minute drive of us (including one within four blocks) and our trends are:
-increase over target sales by at least 25%
-increase in average check by almost a dollar
-increase in customers asking us at the window if we can throw away their nearly-full McCafe cups after we hand them our coffee and I believe that says all I need to know about it.

I'm seeing a really interesting effect because our store is just a row of parking spaces away from a McDonald's. We're getting customers who come in saying they tried the McCafe and were thoroughly disappointed. A couple of days ago they weren't able to make any iced coffee for some reason and I actually had a customer tell me they suggested they come to our store! I had another customer who said they got mocha there, took a few sips, and drove right over to our store to get something that didn't taste awful. Also, I'm seeing more customers recently who are totally unfamiliar with anything Starbucks. I'm wondering if the McCafe got some of those people who don't normally drink coffee interested in coffee drinks, tried it, left disappointed and decided to compare it to Starbucks.

I agree with the comments that it has not hurt my SBUX at all and I would argue that it has helped exponentially. My store has been in the same location for over ten years and it has NEVER seen business like we are experiencing now. Our store is up 25% in sales over last year alone. We have a DD right next door with a drive-thru (my SBUX has no drive-thru thank god), and there is a McDonalds 2 minutes down the street. I agree that McDonalds has done us a GREAT service in drawing attention to coffee. Unfortunately for them, once people try both, they then realize that you DO get what you pay for and maybe paying a little more for a perfectly customized beverage is a better value for their money. People are certainly entitled to their opinion and if they like McD's better, then good for them... I just don't see the masses embracing their coffee products. I continually express my belief that the draw to SBUX is also the feeling that people get when they carry around a SBUX cup. It sends a subliminal message, "I'm successful, I'm trendy, and I'm sophisticated". Anyone who thinks otherwise is not in touch with the human psyche.



Floating lower, for now

In the UK, where fixed rate loans of durations over 10 years are not typically available, floating rate and variable mortgage products comprise a significant portion of the total. According to the Council of Mortgage Lenders, fully 49% of total mortgage debt in the UK is either variable, discounted variable (a variable rate with a  teaser) or a tracker, which follows the BOE rate in lock step.

As such, the current low rate environment is having a significantly larger impact on the UK consumer than their US counterparts. National Statistics Office retail price Index levels reported today registered at -1.07% on a year-over-year basis but at +1.58% Y/Y with mortgage payments excluded from the basket (see chart below).

Clearly the impact of changing rates will be felt earlier and harder by consumers in the UK than in the US.

Andrew Barber




Squirrel Hunting: SP500 Levels, Refreshed...

Barber and I have re-run the math on today's intraday price moves enough times to drive myself squirrely. Good thing AB has a massive bag of Costco nuts on his desk!

When the US Dollar was down on the open and stocks REFLATED, that made sense. Intraday, the US Dollar has rallied, but remains down -0.57% at the time of this note. At the same time, all of the REFLATION trades have collapsed, leading the US stock market to its intraday lows - what gives?

Sometimes the answer is I don't know. Sometimes I just call it squirrely. All of the time, real-time prices end up discounting something that I can't quite see, yet...

Are we starting to discount the end of the inverse correlation between REFLATION and the US Dollar? At this juncture, that would be a very premature conclusion to make - we don't have anywhere near the amount of days or volumes in the data series to confirm anything other than what you see in front of you today. That said, extremely high r-squares like this aren't perpetual. When consensus hits its crescendo, correlations start to unwind.

Below I have outlined my immediate term TRADE line of support for the SP500 at 915 (dotted green line). At the time of my whacking these keystrokes, the SP500 is trading below that. In context, a drop down to the 904 line would be a 3-standard deviation move on the short term duration model I have been using. Those are hard to achieve - but when they do, something squirrelly is brewing.

From here, the market could go to 952 in a straight line and I wouldn't call that a squirrel. That's my immediate term line of upside resistance.

Confused yet? Have a nut.



Keith R. McCullough
Chief Executive Officer

Squirrel Hunting: SP500 Levels, Refreshed...  - cos

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US Housing - A Disconnect?

Finding a bottom always seems easy, in hindsight....

As measures by the NAHB Housing Market Index (HMI) home builders remain cautious and concerned about prospects for the housing market, but that was yesterday;  today's key data point was Commerce Department numbers showing that U.S. builders broke ground on more houses than forecast in May, another sign of a "bottom" that the manic media has leapt on.

Since the end of Q408, our call on housing has been that it would bottom in 2Q and today's news provides further validation for our thesis.  The 17% month-over-month increase in housing starts to an annual rate of 532,000 followed a 454,000 number last month, handily beating both consensus and our expectations.  Last month we described the housing start numbers as an industry "acting rationally". This month's number is not strong enough to indicate that home builders are acting irrationally, but one has to wonder if the demand is really improving. 

The divergence between starts and completions has narrowed by 35% from the high in November of last year -but at 280 thousand units the potential inventory overhang is still both significant and ominous.

While government tax incentives are helping to bring in first time buyers, the bulk of the benefit is in the rear view mirror.  Last week average 30-year fixed mortgages jumped 30 basis points to 5.6% percent, (the highest since November 26, 2008) which suggests that the trends could slow as we head into the summer.  At 5.6%, mortgage rates are 75 basis points higher since April, when the rates were 4.8%. Meanwhile, the Mortgage Bankers Association said total mortgage applications fell 7.2% last week. 

With unemployment at a 25 year high and likely headed higher more consumers are likely to hold off on purchases of big ticket items and the savings rate is on the rise.  The housing market has bottomed for now, that is for sure.  The next move on the margin is less clear, as there is enough cold water to throw on an accelerating rate of improvements.

Howard W. Penney

Managing Director


US Housing - A Disconnect? - cha1

US Housing - A Disconnect? - cha2


As reported by the American Press, CEO Dan Lee intimated that PNK may begin construction of Sugarcane Bay by August.  The Lake Charles sister property to L'Auberge is now expected to cost $407 million, up from $350 million.  The improving credit markets were cited as the catalyst to resume construction.

Now, there is a lot to like about PNK.  Lumiere Place is ramping faster than expected, no doubt aided by the removal of the $500 loss limit in Missouri.  The company maintains significant exposure to Louisiana which has been the strongest performer among the gaming states.  The valuation at about 6.5x EV/EBITDA is reasonable and the FCF yield of almost 15% is attractive.  Last but certainly not least, PNK management has shown uncharacteristic restraint in terms of capital deployment, until recently.

My issue is not that Sugarcane Bay will be a disaster.  It's just that levering up to build at 8x EBITDA (maybe even higher if there is cannibalization of L'Auberge), when the incremental cost of borrowing will fall in the 7-10% range, doesn't seem to make sense.  We calculate only $0.09 in free cash flow accretion per share from Sugarcane Bay.  PNK could generate that level of accretion from the repurchase of only $50 million worth of stock.  PNK's cost of borrowing is going higher anyway - making the 15% FCF unsustainable - but pursuing Sugarcane Bay will expedite and elevate the hike.


Given the higher incremental cost of capital, exercising any development options would seem to detract from the company's value.  A story of harvesting cash flow and open development options seems like the better story for now.

Performance Tension

"Tension is who you think you should be.  Relaxation is who you are." 
~Chinese Proverb
A considerable amount of predictable tension was revealed in yesterday's global market trading. With the US Dollar up +1.5% on the day, the interconnectedness of global asset flows was revealed. Dollar up = lots of stuff that's priced in Dollars down.
After one US market down day from the YTD high, should we all freak out and run for the exits? Some tried. But managing money hysterically on the first day of the week (after global markets hit fresh 2009 highs last week) isn't going to get you paid. Price action was obviously negative across global currency, commodity, and equity markets, but it came on extremely light volume and nothing other than the noises people make when they don't understand macro correlation.
Relaxation is what you can thank your Asset Allocation to cash for. Tension is what you get when you're choking on a "fully invested" mandate AT THE YTD high for the SP500. Did I have a down day in the Asset Allocation Model Portfolio yesterday? Sure. When the market's breadth is 16% advancers to 82% decliners and you don't have shorts, you're not going to have an up day! That's what Asset Allocation is - it's not a hedge fund.
Post registering those YTD highs, hedge funds have been snagging a lot of headlines as of late. People in this business love to talk about performance, especially when it's good - and they should. This is a game where we keep real-time score. But don't forget that in the last 18 months that many a hedge fund manager has proven to be nothing but a glorified levered long investor.
Inclusive of yesterday's "oh my God - the market is going to crash again" calls to arms by the manic media, for the quarter to-date (Q209') the Dow is +13.2%, SP500 +15.8%, Nasdaq +18.8%, and Russell 2000 is +21.1%. Even a clanging monkey like me can make money on the long side in this environment!
So if you're having a great quarter - congratulations. Riding the REFLATION trade has been nothing short of bliss. I get that, and I fully support the message. What I don't get is the perpetual tension associated with anything that goes red. Just relax, and buy them when they are down. The next narrative of a "Great Depression" will be reserved for those who haven't come to grips with The New Reality: Buy red, sell green, and remember that calling for crashes AFTER they occur doesn't work.
Until the crescendo of consensus crushes it's R-Square, the most dominant global macro factor across asset classes will remain the US Dollar Index. Keep it dialed up on your screen - maybe play some classical music as it gyrates. It's one quote. It's easy to see. It's your massage table. Take deep breaths...
The US Dollar Index is trading down -0.79% this morning, and global equity, commodity, and currency markets are stabilizing again as a result. Asia's overnight equity market selloff came before we saw this morning's US Dollar weakness. Europeans woke up to the predictable, which was Russian rhetoric going back to beating the drums with their "colleagues" (the Chinese) and comrades about a new world currency reserve.
Putin Power broker, Dmitry Medvedev, took the conch to kick off the BRIC (Brazil, China, Russia, India) Summit in Russia this morning. What his finance minister (Kudrin) rattled people's cages with yesterday was a one-day, immediate term, TRADE. The Research Edge, intermediate term, TREND is the one that matters. The US Dollar remains broken across durations and it will remain the target of what we have been calling Replacement Rhetoric, for months and quarters to come.
The US Dollar's Credibility Crisis is what we get for paying off American Bankers, Politicians, and Debtors via the REFLATION trade. The world gets it, and with every tick on your screens on Dollar up days, most of the "I don't do macro" guys get it too. Don't stress about it. Just deal with it. "Tension", when it comes to "who you think you should be" isn't productive. Until the US Federal Reserve and Treasury systems lose their political polarization, the US Financial System will be as credible as the bed that said leaders of this system have made it to be.
My immediate term downside support for the SP500 is now 917. If that line were to break alongside a US Dollar Index breaking out to the upside above $81.89, I'll start making some sales. Otherwise, I'm going to stick with what's been working for the last 6 months, and get "longer of" REFLATION  on market weakness as the US Dollar rallies to lower-highs.
Best of luck out there today,


SPY - SPDR S&P 500 - The S&P500 corrected on 6/15 from the YTD high on low volume.  The S&P 500 is positive from both a TREND and TRADE duration. This is a market that has a very predictable range, one we'll trade with a bullish bias.

QQQQ - PowerShares NASDAQ 100 - We bought Qs on 6/10 as a better way to be long the US market than the SP500. The index includes companies with better balance sheets that don't need as much financial leverage.

FXA -CurrencyShares Australian Dollar Trust-Thanks to recovering Chinese demand for commodities, the sure handed management of RBA Governor Glenn Stevens and comparatively modest consumer debt levels -Australia's GDP continued to expand in Q1 while other industrialized economies saw double digit declines.  As with Canada, we like the Australian economy as an offset to the toxic US balance sheet. 

XLV - SPDR Healthcare -Healthcare looks positive from a TREND duration and moved to negative territory for a TRADE. We bought XLV on 6/08 to get long the safety trade. 
EWC - iShares Canada - We want to own what THE client (China) needs, namely commodities, as China builds out its infrastructure. Canada will benefit from commodity reflation, especially as the USD breaks down. We're net positive Harper's leadership, which diverges from Canada's large government recent history, and believe next year's Olympics in resourcerich British Columbia should provide a positive catalyst for investors to get long the country.   

XLE - SPDR Energy - We bought Energy on 6/05. We think it works higher if the Buck breaks down.  Bullish TRADE and TREND remain. 

CAF - Morgan Stanley China Fund - A closed-end fund providing exposure to the Shanghai A share market, we use CAF tactically to ride the wave of returning confidence among domestic Chinese investors fed by the stimulus package.  To date the Chinese have shown leadership and a proactive response to the global recession, and now their number one priority is to offset contracting external demand with domestic growth. 

TIP- iShares TIPS -The iShares etf, TIP, which is 90% invested in the inflation protected sector of the US Treasury Market currently offers a compelling yield on TTM basis of 5.89%. We believe that future inflation expectations are currently mispriced and that TIPS are a compelling way to own yield on an inflation protected basis, especially in the context of our re-flation thesis.

GLD - SPDR GOLD -We bought more gold on 5/5. The inflation protection is what we're long here looking ahead 6-9 months. In the intermediate term, we like the safety trade too. 


SHY- iShares 1-3 Year Treasury Bonds - If you pull up a three year chart of 2-Year Treasuries you'll see the massive macro Trend of interest rates starting to move in the opposite direction. We call this chart the "Queen Mary" and its new-found positive slope means that America's cost of capital will start to go up, implying that access to capital will tighten. Yields are going to continue to make higher-highs and higher lows until consensus gets realistic. 

UUP - U.S. Dollar Index - We believe that the US Dollar is the leading indicator for the US stock market. In the immediate term, what is bad for the US Dollar should be good for the stock market. Longer term, the burgeoning U.S. government debt balance will be negative for the greenback. 
EWW - iShares Mexico - We're short Mexico due in part to the repercussions of the media's manic Swine flu fear.  The country's dependence on export revenues is decidedly bearish due to volatility of crude prices and when considering that the country's main oil producer, PEMEX, has substantial debt to pay down and its production capacity has declined since 2004. Additionally, the potential geo-political risks associated with the burgeoning power of regional drug lords signals that the country's economy is under serious duress.

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