YUM - Two Pictures Tell the Story

YUM management can talk all it wants about what it is going to do to fix KFC and Pizza Hut, but the reality is that the company needs to slow its growth. Same-store sales are one of the factors that make up the sustainability model and with trends like you see below it should be done sooner rather than later. Senior management compensation is dependent on growth in system wide sales, so it is not likely to change its tone any time soon. Unfortunately, the longer YUM grows without acknowledging the real issues, the worse things will get.

With the stock looking down today following YUM's beating 2Q EPS expectations but missing on the top-line, we are seeing a shift in pattern as the trend has been for companies' stock prices to outperform after reporting weaker than expected revenue performance but having cut costs enough to report in line or better than expected earnings.

YUM - Two Pictures Tell the Story - YUM China 2Q09

YUM - Two Pictures Tell the Story - YUM YRI 2Q09




MPEL and LVS have agreed a junket commission cap of 1.25%, effective since July 1st.  The Macau government has said it plans to limit commissions paid to junket operators, but that didn't stop MPEL and LVS taking the initiative to agree to implement a cap on the commission paid to junket operators.    The companies are effectively coordinating in order to squeeze the middle man.  Ho states that there has been no ill effect on volumes as a result of the new policy, "Our volume has been stronger than ever."

This is the first significant instance of cooperation between gaming companies since they formed a coalition in April to limit competition in the face of declining revenues. 


We've maintained that 2009 will be an extremely difficult year in the Las Vegas locals market.  While the actual gaming revenues through the first 5 months of the year haven't been that bad, we're not out of the woods.  More importantly, a bottoming housing market and population growth should provide positive growth in gaming revenues in 2010.  The following chart shows the Locals gaming revenue trends.  Note that revenues have been getting "less bad" since December and have been stable since January.

BYD: LV LOCALS SETTING UP FOR 2010 GROWTH - LV locals delta may 

We put forth our Las Vegas Locals macro model in our 2/05/09 post.  The conclusion then was that the macro variables of housing prices, unemployment, interest rates, and population growth explain virtually all of the growth in gaming revenues.   If this relationship holds up, the LV locals market could be one of the best performing markets next year.  Given the inputs of flat housing prices, unemployment rising to 11.5% from 11% in 2009, and 1% population growth, our model projects gaming revenue growth of 5%.

The recent housing data have shown a bottoming in prices, at least sequentially, while the year-over-year decline has improved.  The average home price has been stable since March at around $170k.  Velocity has actually improved which gives us some confidence that the recent stability is sustainable.  Home sales have increased sequentially for 5 straight months.  Year-over-year home sales are up huge as can be seen in the following chart.



With 30% exposure to the LV locals market, Boyd Gaming has been hit hard by the economic calamity but will also be the prime publicly traded beneficiary of the recovery we see next year.  Considering the 25%+ free cash flow yield on the stock, investors are certainly not pricing in a recovery.

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Looking at all the "factors"

As a follow up to our First Look callout on the CIT situation we'd like to point out some additional facts.

- CIT is one of the largest (and oldest) "factors" to the apparel trade, but it's not the only one. Wells Fargo, GE Capital, and Bank of America are also some of the larger players in the space. A quick Google search also lists numerous smaller and regional players which routinely service manufacturers. If CIT were to cease purchasing receivables then you don't have to be a rocket scientist to figure out that there'd be a temporary setback to the small and middle market manufacturers that require receivables based financing. After all, CIT's $6bn in its trade finance asset portfolio represents about 6-8% of total industry receivables. However, it is likely that alternate sources of funding would be found as market share would accrue to the other large players in the space.

- Looking below the surface, it's important to note that CIT is predominately a lender to the middle market and small businesses. The issue of potential failure here is really confined to the trade originated by smaller businesses that, in aggregate, could have a broader impact on the overall environment. Clearly any failure or disruption in the availability of credit is relevant, but the impact on the larger publicly traded manufacturers and retailers (indirect impact from potential product shipment disruption) is not likely to be noteworthy.

- The real risk in this situation lies in the cost of capital. As Keith and our Macro team have repeatedly pointed out, the risk in the current market lies with companies that are saddled with financial obligations in a rising cost of capital environment. This holds true for the mom and pop, local, or regional player that is most dependent on factoring to boost the cash flow cycle. Even if vendors are to find new sources of financing it is likely to be at an increased cost, resulting in further pressure on sales and margins. The flip side of this equation is that the larger players with clean balance sheets are likely to gain share at the expense of their smaller competitors. With our day to day focus centered on the public markets, we tend to forget that there is still a substantial amount of small business activity centered in the retail and apparel trade. Of the approximately $200 billion in US apparel retail sales, the top 20 national brands account for only 30% of the total volume. We also estimate that about 60% of apparel in the US is sold through a publicly traded entity.

- With the decks already stacked against the smaller player whose financing options may already be limited, the CIT situation may force the hand of owners to seek partners or outright sales of their businesses in an effort to stay afloat. We've been talking about consolidation moving up the spectrum to larger scale deals, but a sustained dislocation in financing could lead to a change in activity as it relates to size. At the end of the day, this is yet another driver of consolidation albeit in a less efficient manner than the likes of a Linens or Circuit City.

Looking at all the "factors" - cit portfolio


Bottom Forming in Home Furnishings

We know that government data tends to lag the "real time" information we get on same-store sales day.  However, it's worth taking a look at the latest chart tracking home furnishings' sales, which was updated this morning with the June report.  Consistent with anecdotal evidence that the home category continues to improve, the government data supports commentary from the horse's mouth.

Bottom Forming in Home Furnishings - Home Furnishings Chart

Now what does this mean for BBBY?

- BBBY has demonstrated substantial outperformance and market share gains in both positive and negative environments. The 2001-2002 spread is just about the same magnitude as the 2008-present spread. I would chalk up the earlier period share gains to aggressive store growth and the original "category killer" positioning. The latter is part Linens, part independents going away, part overall superior execution.

- When looking at the big picture, the longer term chart clearly indicates a positive inflection point in what appears to be the worst period for the industry in a decade. Even more interesting is how BBBY underperformed the industry when the housing boom was at its best. This to me further indicates a point I have made in the past that BBBY is much more consistent than people think.

- Finally, the 3 year trend on PCE for home furnishings has finally turned. This delta is notable albeit just a very minor inflection point. With BBBY already showing acceleration in comp trends versus the overall industry it isn't far off to assume positive comps by year end. The worst comp in the past 10 years was in 4Q08. Yes we know all of this already, but this momentum has legs and profitable ones at that. Remember, the key here is a more rational competitive environment with BBBY regaining control of its promotional destiny. Less coupons=profitable market share gains.

Bottom Forming in Home Furnishings - BBBY Comps and the Industry

Bottom Forming in Home Furnishings - Spread BBBY

Bottom Forming in Home Furnishings - PCE Consumer


During our Q3 themes call we talked about inflation returning in Q4.  We are not calling for STAGFLATION but the possibility is there. 

As a result of sharply higher energy and food price increases, the headline producer price index rose for the third consecutive month.  After gains of 0.3% in April and 0.2% in May, the PPI rose 1.8% in June. The increase was above the consensus projection of 0.9%.  June's 1.8% advance is the largest since the 2.4% gain posted in November 2007.  The 6.6% rise in energy prices suggests that there is upside risk to June's consumer price index reading.


While the core PPI surged 0.5% -the biggest increase in almost a year,  almost all of this upside reflected a surge in car & truck prices which can be an unreliable indicator.  Not including autos, the core was up only about 0.1%.  Not so bad!

A Commerce Department report today showed U.S. retail sales rose in June, helped by incentives on autos and higher gasoline prices which boosted service-station receipts. The 0.6% increase was larger than forecast and was the biggest gain since January.  Importantly, excluding automobiles and gasoline, sales dropped for a fourth consecutive month.  

The headline retail sales number in June looks positive on the surface, but the recession has limited retail sales increases to only four of the past 12 months.  Most consumers continue to be cautious in the face of rising unemployment and falling home values.

So where do we go from here?  According to Bloomberg, GDP growth will average 1.5% in 2H09 after declining in 2Q09.  Betting that the consensus is nearly always wrong, the 1.5% GDP figure looks aggressive and the risk is to the downside. 

A soft economy in 4Q, coupled with our 4Q inflation call and the possibility of stagflation cannot be ruled out yet.

Howard W. Penney

Managing Director

Early Look

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