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MTW: NEXT ACTIVIST VALUE TARGET? (Correct)

Summary

 

We have been looking to “buy” niche construction equipment companies at reasonable prices, in part to pair with “short” CAT.  We “added” TEX in June, but we would turn to MTW here.  We see the potential for MTW to transition from a Crane segment orders story to a break-up/activist story.  A rough MTW sum-of-the-parts suggests a break-up value of around $27 - $44/share, indicating between 30% and 115% upside from the current price.  While we are not the first to observe that a crane OEM and a foodservice equipment business make strange bedfellows at a mid-cap industrial, we think several factors have changed that could force a reckoning in coming quarters:

  • Investors are having increasing difficulty finding undervalued investments with the market near all-time highs.
  • Activism has more frequently entered the picture with just a whiff of value to unlock; close MTW peer OSK has proven a notable success. 
  • The M&A market is picking up, potentially facilitating transactions.  The IMI PLC foodservice equipment unit sold this month to BRK competes with MTW.
  • A rebound in non-residential construction activity into 2014 is likely to draw greater interest in and scrutiny of MTW. 
  • Europe is less of a mess, U.S. state/local finances have improved and developed market infrastructures spending may have some light at the end of the tunnel (e.g. ARTBA data).

 

There are buyers for both MTW divisions, likely at much higher prices than reflected in MTW’s current market value.  While there had been an activist shareholder at Manitowoc until the middle of this year (they apparently switched to TEX), there was little motion and greater agitation seems likely unless the share price moves to better reflect a potential break-up.  MTW is not risk free here, but the downside appears fairly limited relative to both the potential return and investment alternatives, by our estimates.

 

MTW: NEXT ACTIVIST VALUE TARGET? (Correct) - mtw1

 

 

 

Key Points

 

Response to Weak 3Q:  MTW’s third quarter results last week were not exactly robust.  We held off MTW into the release, figuring that the shares would decline following disappointing Crane segment order results.  Implied orders in the Crane division fell 22.6% YoY, the worst showing since the financial crisis.  Worse, management did not lower guidance, backend loading 4Q and setting up a probable 4Q shortfall.  Inventories looked problematic.  While there were some rumblings of increased quote activity and new products, the report was weak.  However, MTW shares rallied.  Maybe the market reaction was wrong, but we don’t think so.  To us, this suggests that the focus is shifting to the broader MTW opportunity and has moved past the small ball of calling volatile quarterly crane orders.

 

Good Businesses, Good Price:  Finding undervalued industrials with solid market positions in good industries has become increasingly difficult with the market near all-time highs.  Manitowoc has two well positioned divisions in structurally favorable industries.  The crane industry is consolidated and profitable through the cycle, even if highly cyclical.  MTW is widely recognized as producing the Cadillac of cranes – no small benefit when operators have been criminally prosecuted for accidents.  The crane recovery is likely to be fairly muted given the long life cycle for the equipment (say 15-50 years), but it is likely to be a recovery nonetheless.  Foodservice equipment has many favorable characteristics that drive relatively high margins.  Foodservice equipment customers are sophisticated buyers that pay for equipment with superior performance.  That customer focus on product innovation and performance favors better resourced, larger competitors like MTW.

 

We invest in cranes from leading manufacturers that have a wide market acceptance, such as Liebherr, Manitowoc/Grove, Terex, Kato and Tadano….[and] avoid investment in less recognised brands, one-off, specialised, prototype or unusual model cranes.” – Boom Logistics LTD, 2013 Financial Report

 

MTW: NEXT ACTIVIST VALUE TARGET? (Correct) - mtw2

 

Scenarios to Consider

 

A benefit of a MTW break-up is the apparent flexibility in how it is executed.  For starters, who really wants to watch MTW stumble through ERP implementation into 2016?  Why are these two unrelated businesses supporting a chunky $70 million/year corporate line?  Acquirers would have the infrastructure and platforms to operate these businesses without so much effort and overhead.  On the other hand, if MTW were to sell one division and keep the other, it could build a better focused franchise.  Capital from the sale of one division could be redeployed to build the scale and product portfolio to serve the remaining division’s markets.

 

ITW is a conglomerate. They do a lot of other things. Foodservice is not their core competency. Manitowoc, even though they -- foodservice is a big part of their business, they still do cranes …and other stuff.” – Middleby on Manitowoc 3/12/12

 

Selling the Cranes Segment:  Mining & construction equipment companies are desperately trying to refocus on construction as mining equipment sales evaporate.  That is one reason pricing in many construction equipment categories has been weak (e.g. CAT’s Cconstruction Industries).  Bucyrus long ago manufactured cranes; it doesn’t take a rocket scientist to see that there are likely to be synergies between the Bucyrus shovel business and MTW’s crane division - certainly more than between cranes and ice machines.  We think CAT is a potential buyer, but Komatsu, Hitachi or other global construction equipment makers could also be interested.  Chinese crane manufacturers are likely to increase competitive pressure over the next decade.  A CAT or Komatsu might better manage those changing dynamics, and both would probably love a little more revenue right now.  We would expect a sale to competitors like TEX or Liebherr to hit antitrust hurdles.  

 

Selling the Foodservice Equipment Segment:  While Middleby is not perfect, the roll-up strategy certainly seems to be working for investors.  Middleby is focused on consolidating a relatively fragmented industry, while we are not quite sure what Manitowoc’s strategy is.  Potential buyers for parts of this business include Middleby itself, ITW (competed for Enodis in mid-2008, but 'lost' to MTW), Marmon or Electrolux.  This is not to say that Manitowoc is running the business badly, but rather that the assets would likely fetch a higher valuation if sold than what is currently reflected in MTW’s share price.

 

Keeping Foodservice:  A Crane segment sale while retaining the Foodservice Equipment segment is not such a bad option.  The proceeds of a Crane segment sale could be used to chase Middleby’s strategy.  As the table below shows, if the market applied Middleby’s valuation to Manitowoc’s Foodservice Equipment revenue, just that segment’s valuation would substantially exceed MTW’s current enterprise value.  We know there are differences in product categories, like refrigeration, and a MIDD valuation might be a stretch, but the potential is likely there.

 

Keeping Cranes:  If MTW divested the Foodservice Equipment division, it could allow entry into adjacent niche construction equipment markets.  While this may seem less attractive, MTW would still be investing or acquiring into a cyclically depressed market.

 

Worked for OSK:  While it was a bumpy ride for investors, the value opportunity at Oshkosh was eventually forced on the market by activist involvement and broader recognition of the value opportunity.  MTW could well be the next OSK.

 

Sum of Parts: While a sum of the parts based on related company or comparable transaction values can help frame the opportunity, we are not always big fans of the approach, only begrudgingly presenting one for FDX for instance.  There are differences between MTW and the businesses shown, the valuation is subject to market volatility, and it is subject to the biases inherent in the selection of comparable companies – there are a number of potential complaints.  However, when the gap between the estimated value and the current market value is large, as it is here, we think a sum of the parts can be very useful.  In this case, the sum of the parts valuation range is not far off of our updated base-to-bull DCF fair value range of $19 to $32.  It appears to us that this value will be unlocked one way or another.

 

MTW: NEXT ACTIVIST VALUE TARGET? (Correct) - mtw3

 

Background & Risk:  We have presented additional industry background in our Mining & Construction Equipment black book and expect to provide more detail on MTW.  Feel free to ping us for more background as well.  The most obvious risk is that we are buying into a likely 4Q Crane segment disappointment – and longer term, the crane cycle is likely to be fairly muted.  However, weak results may prove oddly beneficial as an activist incentive.   Our valuation highlights a favorable risk-reward tradeoff, but it is largely dependent on others accepting the re-framing of Manitowoc from an operating company traded on quarterly result to a prospective break-up, valued on a sum of its parts.

 

Implementation Challenges:  We do not see provisions that would necessarily preclude activist involvement, but they could be implemented in an attempt to thwart such efforts.  Manitowoc Crane segment distribution and service might be difficult to migrate to a CAT or Komatsu type dealer/distribution network.  We do not view these as insurmountable challenges, but we could certainly be proven incorrect in that assumption.

 

 

 

 

 

 


CZR 2Q YOUTUBE

In preparation for CZR's F3Q 2013 earnings release tomorrow, we’ve put together the recent pertinent forward looking company commentary.

 

 

3Q CORE EBITDA

  • We're working at generating a reasonable sequential growth in the third quarter over the second quarter in our core EBITDA contribution.

LV TRENDS 

  • While conditions in the gaming industry remained difficult... during the second quarter with visitation and casino revenues down across much of the network, we're beginning to observe several tangible, positive underlying trends, resulting from the enhancements we've made to our footprint, particularly here in Vegas.
  • The implementation of resort fees at the beginning of March is having a positive impact on revenues and has had a minimal impact on occupancy levels at our properties. We anticipate these resort fees will provide incremental boost prospectively.
  • We're optimistic that the positive trends related to Vegas F&B and hotel revenue will gain momentum, particularly in next year, as business disruption from our construction projects on East side of Las Vegas ends and new projects come online and gain traction.
  • We've also seen some encouraging developments in our Groups business. Based on the forward calendar, we expect Group business to strengthen next year, improving from the relatively soft trends we've experienced thus far this year. We anticipate the business will grow by high-single digits year-on-year in 2014.
  • I mentioned the quantity of rooms that we have in Las Vegas is very significant. Recoveries in ADR should drive disproportionate EBITDA impact. We're down approximately $35 from the peak. This is on a per-room-night basis in 2007, so a recovery of half that will be worth anywhere between $80 million and $100 million of incremental EBITDA to the company. So recoveries in Las Vegas are very material to us. We think 2014 is shaping up to be a good year. Time will tell in terms of how much compression there is in room rates, but we're fairly optimistic.

LV CONVENTION UPGRADES AND OUTLOOK

  • 2014 is shaping up to be a very strong year for the convention business. These rooms we took down at the beginning of the third quarter, and they're starting to come back on line. We have about six floors left to come on line, but they'll be in about another month and a half. The whole tower will be completely renovated and ready for the 2014 year.
  • One, just based on the cycle of certain large conventions, they come every three years or every two years. They seem to have lined up so that they're going to come in 2014. A couple of the very large ones come in the first quarter. So I think what you'll see is the first quarter being exceptionally strong.

AC

  • The market has been very challenged. For those of you in New York that visit Atlantic City, the weekends are very crowded and the midweek periods are very sparse in terms of visitation. We feel that there's an opportunity to invest in the convention business, and we're building a $125 million convention space that will have about 100,000 square feet of leasable space. The convention will be ... will be complete in approximately two years. It's under construction right now.
  • We believe our state-of-the-art facility will attract new segments of visitation to the market, particularly mid-week, which of course badly needed, and absorb excess hotel room and restaurant capacity.

SLOTOMANIA

  • We acquired Slotomania a few years ago. It's done tremendously well. We've continued to grow the business. We added to it Bingo Blitz last year, and that's also done very well. We now have roughly 400 employees.

MACAU GOLF COURSE

  • We've also completed or entered into a number of asset sales, most importantly, the sale of our Macau golf course. That sale hasn't closed yet but we have a sizeable, non-refundable down payment. The purchaser has 90 days to close that which about 60 have gone through, so we'd anticipate that closing by the end of the month or thereabout.  

DEBT MATURITIES

  • So for the next two years, we really only have about $125 million of maturities and then $1 billion to $2 billion in the following three years.

BALTIMORE TIMELINE

  • Baltimore... It will come online, as we mentioned, in the fourth quarter of next year. 

NV I-GAMING

  • In Nevada, the way it works is you open it up then you market later. So the market – marketing just started this weekend. So it's been relatively modest in terms of usage, but I think it's certainly within expectation.

NJ I-GAMING

  • New Jersey is much more of a large potential market, given just the increased population and the wealth effect. And then in addition, in New Jersey, we can operate with both slots and tables, as well as poker.

CAPITAL ALLOCATION

  •  I would think that we still have the balance of the shelf out there. There's no reason to say that we would or wouldn't issue shares, but I think our overall goal is to create a more equitized company. So at some point, when the price and the ratio of certain debt securities match up, I think it would make sense to issue more, I mean, potentially do additional buybacks.

LINQ

  • At the LINQ site, the Vortex, a visually-dynamic architectural element... has been erected and the facade at the front of the site is nearly complete. We plan to open the retail, dining and entertainment offerings in phases, beginning at the end of this year.
  • Our construction teams are progressing well on assembling the rim of the High Roller wheel and assembling the cabins. We plan to open the High Roller in the second quarter of 2014.

LAS VEGAS RENOVATIONS

  • At the Gansevoort Las Vegas, formerly Bill's, we've completed most of the internal demolition. We plan to reopen early next year with Drai's night and day club opening in the first half of 2014. At The Quad, we recently reopened about 40% of the casino floor. We expect to reopen the rest of the casino floor in the third quarter and to complete renovations by the end of this year.

2013 CAPEX

  • Approximately $300 million is to be financed and approximately $750 million to be spent directly from the balance sheet; approximately $500 million to be allocated to project-related capital expenditures and approximately $550 million to maintenance capital expenditure. Included in the $500 million of project-related capital expenditure is approximately $300 million of project financing associated with The LINQ, Gansevoort, Baltimore, and other development projects that we have previously financed, plus approximately $200 million of our equity. Included in the $550 million of maintenance CapEx is spending on room upgrades and facilities, especially in Vegas.
  • We plan to spend approximately $945 million in CEOC and approximately $85 million in CMBS, with the remainder to be spent primarily in CEC due to the Atlantic City Meeting Facility.

OHIO MARKETS

  • Both [Ohio] markets have been a little softer, almost entirely on the slot side of the mix, and we've been working on measures to build the database and get more people to come and experience the quality of the properties.


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HUNTING FOR ASIAN EQUITY ALPHA

Takeaway: With respect to the intermediate-term TREND, we like South Korean equities on the long side and Chinese equities on the short side.

This note was originally published September 03, 2013 at 18:13 in Macro

HUNTING FOR ASIAN EQUITY ALPHA - chinsk

 

HUNTING FOR ASIAN EQUITY ALPHA:

LONG SOUTH KOREA VS. SHORT CHINA?

 

SUMMARY BULLETS: 

  • At 14.8% and 15.6%, respectively, China and South Korea represent the two largest geographic weights in the iShares MSCI Emerging Markets Index Fund (EEM). More importantly, we think the latter is poised to take market share from the former, as we believe the South Korean and Chinese equity markets are poised to diverge with respect to the intermediate-term TREND.
  • All told, we think South Korean equities look increasingly attractive with respect to the intermediate-term TREND, while the attractiveness of Chinese equities on that same duration is poised to roll over after a proactively-predictable dead-cat bounce in both market prices and Chinese economic data.
  • This view is supported by our quantitative risk management setup, as the KOSPI Index is bullish TREND and the Shanghai Composite Index is bearish TREND. As an aside, we think the latter index is likely to threaten a TREND line breakout over the next few weeks on the strength of what is likely to be the last month of sequentially accelerating growth data (SEP), but ultimately fail to confirm any move north of our 2,123 TREND line.
  • From an intermediate-term TREND perspective: Chinese growth is poised to roll over in 4Q as inflation continues to accelerate from a low base; South Korean growth should continue its solid trend of acceleration as inflation accelerates from an extremely low base.
  • From a long-term TAIL perspective: Structural banking sector headwinds are likely to continue to depress Chinese economic growth; South Korea’s corporate earnings outlook is increasingly complicated by the likely resurgence of Japan Inc.

 

***Tomorrow (Wednesday, September 4th) at 11:30am EDT, please join the Hedgeye Macro Team for a ~15min conference call titled “Paddling Upstream?: Navigating #EmergingOutflows”. On the call, Senior Analyst Darius Dale will host a live Q&A session regarding recent developments in EM financial markets and our outlook for those asset classes and the economies that underpin them. CLICK HERE to download the accompanying 80-slide presentation, which we will allude to throughout tomorrow’s call. We look forward to your participation and fielding any follow-up questions you might have.***

 

 

At 14.8% and 15.6%, respectively, China and South Korea represent the two largest geographic weights in the iShares MSCI Emerging Markets Index Fund (EEM). More importantly, we think the latter is poised to take market share from the former, as we believe the South Korean and Chinese equity markets are poised to diverge with respect to the intermediate-term TREND.

 

We’ll begin our exposition of this thesis with the assumption that you’re familiar with our latest work in the context of our #EmergingOutflows and #AsianContagion themes. To the extent you are not, we encourage you to review the aforementioned 80-slide presentation; we detail our outlook for the Chinese economy on slides 6-11, 38 and 57-72; we detail our outlook for the South Korean economy on slides 6-11 and 38.

 

With that knowledge in hand, we think now is the time to buy dips in the Korean equity market and that we’re in a 2-4 week window of loading up on the short side of Chinese equities again, as the current dead-cat bounce has become increasingly long in the tooth.

 

This view is supported by our quantitative risk management setup, as the KOSPI Index is bullish TREND and the Shanghai Composite Index is bearish TREND. As an aside, we think the latter index is likely to threaten a TREND line breakout over the next few weeks on the strength of what is likely to be the last month of sequentially accelerating growth data (SEP), but ultimately fail to confirm any move north of our 2,123 TREND line.

 

HUNTING FOR ASIAN EQUITY ALPHA - dale1

 

HUNTING FOR ASIAN EQUITY ALPHA - China SHCOMP

 

HUNTING FOR ASIAN EQUITY ALPHA - China Iron Ore  Rebar and Coal YoY

 

From a GIP perspective, the South Korean economy is likely to reside in Quad #2 for the balance of the year, while the Chinese economy looks to be transitioning from Quad #2 to Quad #4 in the upcoming quarter, which is a headwind for equity market appreciation.

 

HUNTING FOR ASIAN EQUITY ALPHA - SOUTH KOREA

 

HUNTING FOR ASIAN EQUITY ALPHA - CHINA

 

The aforementioned GIP forecasts are determined by our predictive tracking algorithms for each country’s respective growth and inflation statistics and, like any model, are subject to varying degrees of tracking error – though a lot less than whatever the sell-side has been using to forecast growth, inflation and policy deltas over the past 3-5 years!

 

As such, we must rigorously track the relevant high-frequency economic data for clues to the degree and directionality of said tracking error – to the extent there is any:

 

CHINA: GROWTH POISED TO ROLL OVER AS INFLATION ACCELERATES FROM A LOW BASE

 

  • The respective trends in the YoY deltas of the monthly averages of rebar, iron ore and coking coal, as well as the respective trends in Manufacturing PMI, New Orders PMI, New Export Orders PMI, Real Estate Climate Index, Industrial Production, Retail sales and FDI support an improving near-term growth outlook. The respective trends in the monthly average of China’s sovereign yield spread (10Y-2Y), Backlogs of Orders PMI, Non-Manufacturing PMI, Fixed Assets Investment, Total Social Financing, Monthly New Loans, Industrial Sales, Industrial Profits, M2 Money Supply, Consumer Confidence, Exports, Imports, the Trade Balance and sovereign fiscal expenditures all suggest the current uptick in Chinese growth may be short-lived.
  • The respective trends in headline CPI, Food CPI, headline PPI, Raw Materials PPI and the trend in the YoY deltas in the currency market all support a hawkish inflation outlook.
  • The trend in OIS with respect to the benchmark rate supports a demonstrably tighter monetary policy outlook, though we’d argue much of this is due to the market’s expectation of persistent liquidity constraints (more on this below).

 

<chart6>

 

HUNTING FOR ASIAN EQUITY ALPHA - China PMI Table

 

SOUTH KOREA: GROWTH SOLIDLY ACCELERATING AS INFLATION ACCELERATES FROM AN EXTREMELY LOW BASE

 

  • The respective trends in Non-Manufacturing BSI, Employment, Retail Sales, Consumer Confidence, Capacity Utilization, CapEx, Construction Orders, Exports and Imports all support an improving growth outlook.
  • The respective trends in headline CPI and headline PPI both support a hawkish inflation outlook, as does the trend in the YoY deltas in the currency market.
  • The trend in OIS with respect to the benchmark rate supports a marginally tighter monetary policy outlook.

 

<chart8>

 

HUNTING FOR ASIAN EQUITY ALPHA - South Korea BSI

 

In addition to tracking high-frequency economic data, we must also have a good handle on the idiosyncratic factors that may influence or dictate a country’s 1-3 year GIP outlook:

 

CHINA: STRUCTURAL HEADWINDS AREN’T FULLY UNDERSTOOD BY MARKET PARTICIPANTS – LET ALONE PRICED IN!

 

  1. Across the maturity curve, interest rate swaps continue to trade well above the current cost of capital in China. In the past, we’ve interpreted this market signal as a sign that monetary policy tightening was increasingly probable over the intermediate term. We don’t view that scenario as likely at the current juncture; rather, we believe the market sees what we see: a prolonged erosion of financial liquidity, at the margins, will continue to apply upward pressure to money market rates over the intermediate-to-long term.
  2. That erosion of financial liquidity can be further identified via recent activity in China’s local currency bond market. In the QTD, there have been 27.1B CNY ($4B) of pulled bond sales, while AUG’s 240.9B CNY of issuance is down -17% MoM. Moreover, 10Y AAA bond yields have widened +53bps QTD to a ~2Y high of 5.67% and the spread between AAA yields and Chinese sovereign yields just hit a 3M-high of 168bps wide. Lastly, China’s 10Y-2Y sovereign yield spread has widened modestly off its JUN mini-crisis spread lows, but it has yet to buck the trend of tightening that has been in place for over one year now.
  3. The mere fact that both ends of China’s sovereign debt market is selling off should be interpreted as supportive of our view that the Chinese economy will be increasingly liquidity constrained, at the margins, as NPLs – both of the reported and unreported (i.e. debt rollovers/evergreening) genres – accelerate sustainably. A dour secular outlook for “capital” flows via the trade surplus is also supportive of our liquidity constraint thesis.

 

HUNTING FOR ASIAN EQUITY ALPHA - China 1Y OIS vs. PBoC Rates

 

HUNTING FOR ASIAN EQUITY ALPHA - China 10 2 Spread

 

HUNTING FOR ASIAN EQUITY ALPHA - CHINA REER

 

SOUTH KOREA: HOW WILL THE MARKET CONTINUE TO PRICE IN INCREASED COMPETITION FROM JAPAN?

 

  1. Just isolating its top three export markets, South Korea competes head-to-head with Japan in 41.6% of its exports, so naturally, the JPY’s -24.1% YoY decline vs. the CNY and its -21.3% YoY decline vs. the USD has weighted on the outlook for South Korean export growth. That’s a headwind for broader economic growth as exports are equivalent to 56.5% of South Korean GDP.
  2. Perhaps more importantly with respect to the thesis we are attempting to explicate, is the fact that an outlook for secular yen weakness directly calls into question the earnings outlook for KOSPI Index. Specifically, both South Korea and Japan are particularly exposed to the global CapEx cycle (Tech and Industrials) from an equity index perspective at 40.6% and 28% of total market cap, respectively (vs. a regional average of 20.2%).
  3. To the extent customers are competing on price in this naturally deflationary segment of the global economy, it can be argued that a meaningful portion of corporate profit growth in Japan (+24% YoY in 2Q vs. +6% YoY in 1Q) is likely to come at the expense of corporate profit growth in South Korea. It’s hard to be long and strong South Korean equities with respect to the long-term TAIL if you share our bearish bias on the Japanese yen (we think the USD/JPY cross can traverse its way to 125 over the next 12-18 months).

 

HUNTING FOR ASIAN EQUITY ALPHA - South Korea vs. Japan Export Markets 

 

HUNTING FOR ASIAN EQUITY ALPHA - South Korea vs. Japan Currency

 

HUNTING FOR ASIAN EQUITY ALPHA - South Korea CapEx Cycle

 

All told, we think South Korean equities look increasingly attractive with respect to the intermediate-term TREND, while the attractiveness of Chinese equities on that same duration is poised to roll over after a proactively-predictable dead-cat bounce in both market prices and Chinese economic data.

 

We look forward to your participation on tomorrow’s flash call.

 

Darius Dale

Senior Analyst


RT: NAIL IN THE COFFIN

Takeaway: We believe RT is in serious trouble and is likely headed for Chapter 11.

Today, Ruby Tuesday announced the resignation of its Chairman Matt Drapkin.  Drapkin, who recently sold 1.45mm shares, joined the board of RT three years ago as an activist that, along with Carlson Capital, was intent on enhancing shareholder value.


He is now being replaced by the company’s current CEO James Buettgen, who left Darden in December of 2012 in order to resuscitate the Ruby Tuesday brand.  Despite an attempt to revive the business, RT’s operating fundamentals remain some of the worst in the casual dining industry.  To make matters worse, there appears to be little hope for a turnaround – RT has only seen one quarter of positive same-restaurant sales, on a two-year basis, since FY3Q08.

 

RT: NAIL IN THE COFFIN - chart2

 

 

Furthermore, we believe the largest impediment to the revitalization of this fourth tier Bar & Grill brand is Chili’s, which is run by a very strong management team.  In EAT’s recent quarterly earnings call and our subsequent call with CFO Guy Constant, the company announced its intent to pursue an aggressive strategy in order to grow same-restaurant sales.  This includes increasing TV media spend to support new products (including the upcoming Tex-Mex platform), implementing new online ordering for its “to go” business, and rolling out its delivery service.

 

Importantly, Chili’s will be moving its successful re-image program to the state of Florida in the coming months.  Currently, 10.9% of RT’s system-wide domestic units are in the state of Florida, making it the company’s most important state.  This means that RT is heavily exposed to any success that Chili’s may have in the region.  If Chili’s is able to steal significant market share in Florida, RT’s business will suffer.  If the past is any indication, this could very well happen.  Look at BJRI’s recent quarterly results – they were downright ugly.  We believe that Chili’s re-image program in California had a significant impact on market share trends in the region.  On the margin, this is all good news for EAT and their core brand, Chili’s.

 

RT: NAIL IN THE COFFIN - mt

 

 

RT’s management team has guided to an improvement in sales directionally throughout the year and the street has reflected that in its estimates.  We are highly suspect that this will unfold as planned, and believe that further disappointments are likely.

 

Capex has been reduced significantly since FY08, as the company is having a difficult time making ends meet.  EBITDA was negative in 1Q14 and the company continues to lose money.  We could see a major restructuring charge coming and believe that a significant number of store closings are needed.  If not, the company could be headed for Chapter 11.

 

 

 

 

Howard Penney

Managing Director


What’s Big Tobacco Saying About E-Cigs in 3Q13?

For a second straight quarter there was significant buzz around Big Tobacco’s electronic cigarette offerings.  While LO remains ahead of the pack through its acquisition of Blu in early 2012, both MO and RAI joined the category through test market launches in individual states in Q3, and PM reaffirmed its plan to launch an e-cig in 2016/7.

 

A big surprise in the quarter was Blu’s market share gain to 49% vs 40% last quarter, on sales growth of +11% sequentially and +350% year-over-year  to $63MM in the quarter. This growth was driven squarely on severe discounting and couponing, resulting in break-even cost for the company, confirming CEO Kessler’s goal to forgo short-term profits for long term gains.  LO’s decision to buy SKYCIG in early October (2013), a three year old UK based e-cig maker with ~300,000 users that has mimicked Blu’s product packaging design, provides LO with an international platform, albeit with a much smaller size, scale, or relationship of Blu in the U.S.  LO’s estimated the “fragmented” UK market to be worth an estimated $300MM in 2013 and hinted that it would assess opportunities to scale across the EU down the road.

 

Much of the commentary from management in the quarter centered around the uncertainty of the FDA’s pending regulation on e-cigs.

 

We’re very pleased to further the e-cig discussion in an expert call with Craig Weiss, CEO of NJOY, this Wednesday (10/30) at 1pm EST.  NJOY, a private company, is a leading e-cig manufacturer of traditional tobacco and menthol offerings that are sold nationwide in 70,000 stores.  Email me () or , if you’d like to join the call.

-----

 

LO:  it’s clear CEO Murray Kessler’s e-cig strategy is to forgo short-term profits for long term gains. The company sold its new rechargeable starter kits (they began shipping in Q2) for break-even in the quarter, which increased its retail market share to 49% vs 40% last quarter!  With $63MM of e-cig sales (vs $14MM in the year-ago quarter  and $57MM last quarter), Blu earned a gross profit of $15MM with SG&A of $15MM to net operating profit of $0.  From Kessler’s comments, it appears that this break-even strategy could be expected for at least the next two quarters as LO attempts to boost awareness, trialing, and repeat purchasing of Blu. Other takeaways include:

  • Kessler reiterated forecast for 2013 e-cig sales to be worth around $1-2B at retail; no hard estimate for online.
  • Expects e-cigs to have a 1% impact on total cigarette category in 2013.
  • Believes that the deciding factor on how big the category can be is what comes out on the regulatory environment.
  • If there is reasonable regulation that allows for marketing and advertising, it has already been proven that the e-cigs category can drive strong repeat purchasing.
  • While technology will get better over time, it is not the deciding factor.
  • If the FDA is overly strict, just like cigarettes requiring substantial equivalence, the category will grow more slowly.
  • Quarterly product mix (in dollars): Disposables 47%; Cartomizers 27%; and Kits 26%.
  • In the quarter they saw the amount of rechargeable kits sold up dramatically compared to old format (discounted price also clearly driving purchases).
  • Blu now in 127,000 retail outlets.
  • Expects strong margins down the road for the company and retailers.
  • UK Market: estimated at $300MM with no clear leader. Could be another $1B market, but depends on the regulatory market – so far so good.
  • Believes SKYCIG acquisition expands its global presence, although it will not have a roll-out or growth curve like Blu in the U.S. given the lack of retail relationships and sales force.
  • Kessler contextualized the purchase of SKYCIG acquisition as a one-off, with plans to grow organically if it were to expand its reach across the EU.
  • Optimistic that the UK Parliament endorsed e-cigs for their harm reduction and has moved it away from being regulated as a medicinal product. 
  •  In the UK, the company can advertise e-cigs on TV, until at least 2016, but advertising regulations vary across EU countries.
  • On UK and EU Rollout – there has been no decision to roll out SKYCIGs to the rest of Europe. Has intention for Blu to become a global brand. Bullish that SKYCIG already has the same packaging as Blu (essentially they copied Blu from inception), and now is focused on increasing the sales force of SKYCIG. 

 

MO:  brought its e-cig brand MarkTen to the marketplace in August (to 3,000 retail stores) in its first test market in Indiana, which CEO Marty Barrington described as a very successful launch with good product feedback and consumer insight.  The company announced plans to increase its spend on MarkTen in Q4 and to distribute to 2,000 stores in Arizona. 

 

Marty suggested it was too early to talk about the performance on MarkTen. He said they are seeing dual use, as some adult smokers try e-vapor, but results are inconclusive.  On the category he said that while it has grown very quickly off low base, it is unclear if it can sustain this growth level. And in similar fashion to the reporting from Big Tobacco, he stressed that as products get better and more acceptable, he’d expect greater transition, but much depends on how they’re regulated by the FDA – heavy regulation would certainly not encourage adoption. 

 

He also said it was too early to tell if e-cigs will cannibalize smokeless or estimate the share they could take from traditional cigarettes.

 

 

RAI:  If you don’t think e-cigs matter to big tobacco – think again!  On the earnings call, the progress on VUSE, the company’s first e-cig that was launched in July in the test market of Colorado, was the first brand that management reviewed. CEO Delen said that VUSE is getting a great reception with leading market position in the state (we’d expect so given the strong couponing). He noted strong repeat purchasing and that its replacement cartridge was the largest selling SKU, and believes that VUSE can attain cigarette-like margins over the medium term. Further information on its plans around a national roll-out were indicated to come at next month’s Investor Day meeting.

 

Delen indicated that he has no further information on when the FDA may come out with a ruling on e-cigs (expected October timeline) and/or if the government shutdown will delay the announcement. He did note that RAI engaged with the FDA on VUSE, and the meeting was heavily attended by the FDA.

 

Given that Colorado is a test market, it’s hard to extrapolate the costs for a nationwide roll-out – certainly it’s a competitive category and RAI is playing slightly behind the 8-ball.  We look forward to monitoring VUSE’s performance.   

 

 

PM:  CFO Olczak is positive on the EU Tobacco Directive as it relates to regulating e-cigs as tobacco products and not as medical devices.  He reiterated that PM is working on a few alternative products (including an e-cig) that are slated for full commercialization in 2016-17. With regards to PM being late to the E-cig show, Olczak said that most e-cig makers now focus much of their attention on marketing, and less on the product, and PM’s focused on going to market with the right product, not about being the first mover.

 

While we think next generation products will turn more attention to product development to mimicking even closer a traditional cigarette, we would be concerned that PM’s big tobacco rivals and a few select private players also have significant budgets and R&D underway to bring better e-cig products to the market (and perhaps sooner than PM’s extended timeline). The caveat here is that as regulatory frameworks around e-cigs evolve globally, the landscape, and players involved, are subject to change.

 

 

Matthew Hedrick

Associate


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