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MCD: COVERING OUR SHORT

We continue to be bearish on MCD, but we are removing it from the Hedgeye Best Ideas list as a SHORT.

 

Our bearish thesis is centered on structural (internal and external) issues within the McDonald’s U.S. business.  While the company addressed some of its issues with the rollout of high density tables, we believe McCafe’s status as a “sacred cow” will continue to cause throughput issues.

 

On the positive side, however, it appears Europe has stabilized despite persistent softness in the region’s most important market – Germany.  Asia also looks to be stabilizing despite Japan finding itself in the same boat as Germany.

 

McDonald’s business model is resilient and the stock has benefitted from a healthy 3.4% dividend yield, which we expect to increase in 2014.  What concerns us the most in being short the name is the potential for an activist to step in or the potential for a “financial engineering” event.

 

Whether it is the real estate or the potential for incremental leverage, there is inherent value in McDonald’s balance sheet.  We believe someone, at some point, will come along and take advantage of this.  If Carl Icahn can push APPL to buy back more stock, we surmise he’d be able to do so for MCD as well.

 

For the time being, McDonald’s is treading water.  The business plan the company presented to the investment community at last November’s analyst meeting is, in our view, unlikely to deliver the intended results.  We believe the required changes this company needs will happen soon – and they are significant.

 

Below we highlight a few changes that we believe need to be made at MCD:

  1. Higher Food Costs – CMG has permanently changed the way consumers view fast food and MCD knows it.  In January, MCD announced its commitment to begin purchasing “verified sustainable beef” by 2016.  MCD currently sells over one billion pounds of beef and it will take a couple of years for them to “listen, learn, and collaborate with stakeholders from the farm to the front counter to develop sustainable beef solutions.”  These trends suggest higher food costs for MCD as they begin to compete in the new era of sustainability.
  2. Cutting Capital Spending – At the 2013 analyst meeting, MCD revealed their shift in strategy from “better not bigger” to “bigger and better.”  It is unlikely this strategy will improve returns.  McDonald’s capital spending has increased 100% since 2006.  The only way to fix the inherent issues within the company today is by cutting capital spending.
  3. Rethink the McCafe strategy – For Don Thompson, McCafe is a “sacred cow.”  We continue to believe McCafe is the largest culprit for declining traffic trends at lunch.  Since he pushed the strategy aggressively while running the U.S. business, it will be difficult for him to admit defeat.

Given the changing consumer needs, wants, and desires, the MCD business model is in need of a major overhaul.  Thanks to CMG and these developing consumer trends, MCD is being forced to look into selling sustainable beef.  This is only the tip of the iceberg for McDonald’s.  Its entire menu, packaging and carbon footprint will eventually need to be reengineered.  The question is: at what additional cost?

 

 

Howard Penney

Managing Director

 


DO YOUR COUNTRY ALLOCATIONS ACCOUNT FOR #GROWTHDIVERGENCES?

Takeaway: Our intermediate-term view calls for investors to be OVERWEIGHT/LONG UK, Germany, Eurozone and China vs. UNDERWEIGHT/SHORT US and Japan.

SUMMARY

All week we’ve been pounding the table on our #InflationAccelerating Q1 Macro Theme, which continues to broadly manifest itself in buy-side PnLs (in one direction or the other). Today, we wanted to briefly update you on our #GrowthDivergences Q1 Macro Theme, which called for investors to be OVERWEIGHT/LONG UK, Germany, Eurozone and China vs. UNDERWEIGHT/SHORT US and Japan.

 

Like our #InflationAccelerating theme – which continues to be VERY non-consensus based on a number of dialogues we’ve had with our always-sharp subscriber base – this theme has, on balance, worked like a charm:

 

  • UK FTSE All-Share Index: -1.4% MoM (the market is reacting to Carney’s hawkish tone in the near term; #BuyingOpportunity)
  • Germany DAX Index: +1.3% MoM
  • Eurozone Stoxx 600 Index: +0.6% MoM
  • China Shanghai Composite Index: +4.4% MoM
  • US S&P 500 Index: -0.3% MoM
  • Japan Nikkei 225 Index: -7.2% MoM

 

These deltas are generally supported by each of the respective GIP (i.e. Growth/Inflation/Policy) outlooks. Below, we offer up some quick-and-easy one-liners summing up our intermediate-term view on each economy. Lastly, we outline what we are seeing in the model that makes us sound so directionally negative on the macroeconomic setup in the US (vs. leading the bull charge in 2013).

 

GIP ONE-LINERS

UK: Probably the best looking economy of the bunch; the threat of +6% nominal GDP growth in 2014E plus deteriorating BoP dynamics underscore Carney’s increasingly hawkish bias – which only insulates our #StrongPound = #StrongUKConsumer view.

 

DO YOUR COUNTRY ALLOCATIONS ACCOUNT FOR #GROWTHDIVERGENCES? - UNITED KINGDOM

 

Germany: Our model has German GDP growth continuing to materially accelerate in 1H14, helping the country achieve 3Y highs in economic growth for 2014E. The acceleration in inflation should lend marginal support to the EUR by allowing Draghi to back off of his easing bias to some degree.

 

DO YOUR COUNTRY ALLOCATIONS ACCOUNT FOR #GROWTHDIVERGENCES? - GERMANY

 

Eurozone: Very similar [bullish] setup to Germany, though we see less upside in both GDP growth and CPI on a full-year basis as structural headwinds persist throughout the periphery.

 

DO YOUR COUNTRY ALLOCATIONS ACCOUNT FOR #GROWTHDIVERGENCES? - EUROZONE

 

China: Our lowest-conviction bullish bias. If Chinese GDP growth doesn’t show strength against ridiculously easy compares in 1H14, the back half of the year could be a disaster from a growth perspective. Still, our analysis shows that the PBoC has adopted a marginal easing bias in the YTD, which should be supportive of our base case scenario.

 

DO YOUR COUNTRY ALLOCATIONS ACCOUNT FOR #GROWTHDIVERGENCES? - CHINA

 

US: Inching towards a deep trip to Quad #3 (i.e. growth slowing as inflation accelerates). Refer to the analysis below for more details.

 

DO YOUR COUNTRY ALLOCATIONS ACCOUNT FOR #GROWTHDIVERGENCES? - UNITED STATES

 

Japan: Careening towards a deep trip to Quad #3. The only call to make here is whether or not the BoJ accelerates its timeline for incremental easing, which, on the margin, would be bearish for the JPY and the Japanese consumer, but bullish for manufacturing, exports, employment and wage growth. We’ll learn more post the BoJ’s policy meeting next week, but our base case scenario is that they’ll be dangerously slow to react as a result of their previous guidance and out-year inflation targets.

 

DO YOUR COUNTRY ALLOCATIONS ACCOUNT FOR #GROWTHDIVERGENCES? - JAPAN

 

MODELING THE US ECONOMY

Growth: As compares get tougher at the margins, think real GDP growth comes in at the low end of our current forecast range for 2014E. This is a markedly different setup from 2013E, where we thought GDP would come in at the high end of our target range and accelerate throughout the year on a sequential basis.

 

Now we are below both the Street – which continues to take up their numbers in recent weeks – and the Fed. If we’re right on growth, the FOMC will be forced to react to a fair amount of negative economic surprises as the year progresses, likely forcing them to shift back to an easing bias.

 

DO YOUR COUNTRY ALLOCATIONS ACCOUNT FOR #GROWTHDIVERGENCES? - 1

 

DO YOUR COUNTRY ALLOCATIONS ACCOUNT FOR #GROWTHDIVERGENCES? - 3

 

It’s important that we make the following statistical point regarding our predictive tracking algorithm: when compares for any rate-of-change series get tougher at the margins, you need a commensurate increase in sequential momentum to prevent a deceleration in the first derivative.

 

In light of that, it’s important to note that recent trends in the broad balance of economic data do not support expectations for an increase in said momentum over the intermediate term. Consumption growth continues to accelerate on a trend-line basis, but industrial production growth and PMI data is clearly slowing, while confidence readings are more-or-less flat (on a trend-line basis).

 

DO YOUR COUNTRY ALLOCATIONS ACCOUNT FOR #GROWTHDIVERGENCES? - PCE

 

DO YOUR COUNTRY ALLOCATIONS ACCOUNT FOR #GROWTHDIVERGENCES? - Industrial Production

 

DO YOUR COUNTRY ALLOCATIONS ACCOUNT FOR #GROWTHDIVERGENCES? - Composite PMI

 

DO YOUR COUNTRY ALLOCATIONS ACCOUNT FOR #GROWTHDIVERGENCES? - Manufacturing PMI

 

DO YOUR COUNTRY ALLOCATIONS ACCOUNT FOR #GROWTHDIVERGENCES? - Services PMI

 

DO YOUR COUNTRY ALLOCATIONS ACCOUNT FOR #GROWTHDIVERGENCES? - Consumer Confidence

 

DO YOUR COUNTRY ALLOCATIONS ACCOUNT FOR #GROWTHDIVERGENCES? - Business Confidence

 

Inflation: The confluence of easy compares, annualized currency weakness, a commodity base effect and the recent acceleration in commodity reflation continues to support our directionally hawkish view of the domestic inflation outlook. Moreover, we are now well ahead of both the Street and the Fed with respect to our full-year expectations for CPI. If that view proves correct, consumption growth (i.e. ~70% of GDP) will slow domestically.

 

DO YOUR COUNTRY ALLOCATIONS ACCOUNT FOR #GROWTHDIVERGENCES? - 4

 

DO YOUR COUNTRY ALLOCATIONS ACCOUNT FOR #GROWTHDIVERGENCES? - 5

 

DO YOUR COUNTRY ALLOCATIONS ACCOUNT FOR #GROWTHDIVERGENCES? - US CPI

 

DO YOUR COUNTRY ALLOCATIONS ACCOUNT FOR #GROWTHDIVERGENCES? - CRB Index

 

DO YOUR COUNTRY ALLOCATIONS ACCOUNT FOR #GROWTHDIVERGENCES? - 2

 

In summary, hopefully this note was helpful to further elucidate our views and is additive to your individual thought process around where to allocate risk capital. As always, feel free to ping us with any questions, comments, concerns, etc.

 

Happy Valentine’s Day,

 

DD

 

Darius Dale

Associate: Macro Team


WTW: Staying Short

Takeaway: The other shoe has yet to drop. Management needs to make a decision; it's a lose-lose either way

WTW 2014 GUIDANCE

Guidance was a considerable disappointment, missing consensus EPS estimates by over 45% at the midpoint.  Below are the main guidance takeaways from its earnings call.

  • Revenue: ~$1.4 billion vs. consensus of $1.5 billion
  • EPS: $1.30-$1.60 vs, consensus of $2.72
  • North America: Revenue & Attendance down low 20% (vs. -11% & -15% in 2013)
  • Online: Revenue to decline high-teens (vs. 4% growth in 2013)
  • United Kingdom: Revenue to decline 20% range (vs. 20% in 2013)
  • Europe: Revenue to decline mid-single digits (vs. flat in 2013)
  • Marketing: to decline $20mm y/y (-7% y/y)

 

SHORT THESIS UPDATE

WTW didn't offer anything concrete as to how it plans to reignite growth, or address the growing competitive threat from free apps and activity monitors.  

 

Management chose to focus on Weight Watchers being the market leader while implying it has the best product in the industry.  While that could be true, it's not a question of the value of the Weight Watchers product, but whether the end-user values its product as much as the company is looking to charge for it.  

 

Free apps have been out there for a while.  That's not the main issue.  The main issue facing WTW is that access to these apps continues to climb; with smartphone penetration nearly doubling over the last 3 years to 74% in 3Q13 from 40% in 1Q11.

 

WTW: Staying Short - Smartphone penetration 3Q13

 

We don't believe WTW can right the ship without taking a more aggressive approach to membership growth and retention. It's plans to cut marketing in 2014 suggests it's going the opposite way, which we believe will only exacerbate it's member retention issues.  

 

WTW: Staying Short - WTW   Revenues vs. Marketing 4Q13

 

More importantly, WTW has a decision to make.  It can maintain its current pricing ($43 for a monthly pass, $19/month for its online product) and continue to cede share, or it can reduce pricing to become more competitive.  In either event, revenues will take a hit, whether it's membership or ARPU.  

 

Consensus is assuming that revenues stabilize in 2015, which suggests the street is discounting the secular threat facing WTW.  So we'll remain short from here, until the street finally gets it.

 

 

Hesham Shaaban, CFA

@HedgeyeInternet

 

 

Thomas W. Tobin

@HedgeyeHC

 


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PAR FOR THE 2014 COURSE: January Industrial Production

A sub-title in our analysis of the weekly Initial Jobless Claims data yesterday was:  #Deceleration:  Par for the 2014 Course.  HERE

 

And since I feel like I’ve written the same note highlighting the deceleration in the rate of improvement in the domestic, fundamental macro data about 20X to start 2014, it felt fitting to just recycle that Title also. 

 

INDUSTRIAL DECELERATION: That industrial production slowed in January isn’t particularly surprising given the soft ISM data and the slowing sales and rising inventory of auto’s  - See yesterday’s note for more detail  PANGLOSSIAN PIQUE: JANUARY RETAIL SALES

 

Consumer Durables, led by the 5% decline in vehicle production, was the biggest loser but Non-Durables, Business Equipment and Industrial Supply all decelerated on both a MoM and YoY basis.  Capacity Utilization slipped to 78.5% in January, with the -0.4% MoM decline the largest since August of 2012.

 

MAPPING THE SLOWDOWN:  We detail IP and Capacity Utilization data specifically in the table below but, with most of the significant data points for January now in, it’s probably more worthwhile to provide a summary refresh on the prevailing slope of improvement across the preponderance of the fundamental macro series. 

 

Perhaps the most efficient way to get a feel for the broader trend in the slope of growth is just to look at the Economic Summary Table (below) and simply observe if there is more ‘more red’ or ‘more green’ staring back at you. 

 

As can be seen, the sequential rate of improvement across most of the latest higher frequency data is Worse.    

 

Looking a little closer, even the data currently flagged as “Better” is less than inspiring. 

 

Let’s take a quick tour of each of the “Better’s” in turn: 

 

  • NFP:  NFP employment improved sequentially in January but that’s only because December was a brick.  Employment gains are decelerating vs the 3M/6M/12M averages. 
  • Consumer Confidence:  The data here has been middling and largely equivocal to start 2014.  The Conference Board measure improved in December, the preliminary Univ. of Michigan number for Feb was unchanged vs. January, and Bloomberg’s Weekly measure is tracking below the January average thus far in February. 
  • ISM Services:  ISM services improved in January but that was really only because it completely tanked in December as New Orders saw its largest sequential decline since 1980.  
  • Case-Shiller HPI:  Media pundits still (for whatever reason) love monitoring and citing the Case-Shiller home price data.  The fact is that the Case-Shiller HPI is one of the most lagging housing measures there is.  The “better” reading in the table below is actually a November number and we already have preliminary January Corelogic data – Home price growth as measured by Corelogic has been decelerating for 3 consecutive months.  
  • Inventories:  It’s a bit of a toss-up on whether to classify accelerating inventory growth as a positive or negative.  From a strict GDP accounting perspective, rising inventories can be a positive for reported growth.  However, when end demand is slowing and inventories are rising, the other side of that inventory build drags on both corporate profitability and reported economic growth.

 

So, on the back of the decelerations reported in Job Openings (JOLTS), Mortgage Purchase Applications, Retail Sales, and Initial Claims earlier in the week, Industrial Production and Capacity Utilization in January both deteriorated.

 

I haven’t checked but I’ll bet the dollar is down, gold is outperforming and #hashtags lamenting the distortive impacts of the weather are still in crescendo  – yep, par for the 2014 ……

 

Happy Valentines Day. Enjoy the long weekend

 

PAR FOR THE 2014 COURSE: January Industrial Production - Eco Summary 021414

 

PAR FOR THE 2014 COURSE: January Industrial Production - IC CU Table

 

PAR FOR THE 2014 COURSE: January Industrial Production - Confidence Table 021414

 

 

Christian B. Drake

c

@HedgeyeUSA



NCLH 4Q 2013 YOUTUBE

In preparation for NCLH's FQ4 2013 earnings release Tuesday, we’ve put together the recent pertinent forward looking company commentary.

 

 

NEW SHIP PREMIUMS

  • Breakaway operates a healthy premium to both ticket pricing and onboard spend 
  • The new ships are pricing at about a double-digit premium to the Epic, and the Epic has been pricing at a double-digit premium to the rest of the fleet. 

2014 NCC

  • Looking to 2014, expect adjusted net cruise cost excluding fuel to stabilize and decrease in the range of 1% to 2%, as NCLH return to our more normalized dry-dock schedule and new build launch expenses roll-over year-over-year.

2014 EPS

  • Expect earnings to grow approximately 60% in the coming year.

1Q 2014 

  • The first quarter is booked a little bit behind.  There is a couple of reasons for that. One being that the Easter break, which is a big time off especially in the Northeast is toward the end April this coming year versus it was March 31 for 2013. So, that booking momentum has changed a little bit into the second quarter.
  • Solid pricing for 1Q. Pricing is above the mid single digits.

2014 YIELDS

  • Something that hopefully begins with a 4%, whether it's a low-4s or the mid-4s, it's too early to say

CARIBBEAN

  • In the first couple of quarters in the Caribbean, we have a healthy pricing environment right now
  • It is a little bit more promotional.

EUROPE

  • Pricing has been a positive. Feeling pretty good about Europe right now.
  • Mid single-digit range is a fair assumption

ONBOARD

  • Fourth quarter starting out is strong...has exceeded our expectations. Feel very confident with our onboard revenue.

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