UA: Comfortably Numb?

The data is pretty clear -- negative reports on near term trends at UA are indeed having less of an effect on UA shares (best measured as relative to the MVR index). The first chart represents the performance of UA shares relative to the MVR over the 2-day period after a negative research note. Tough to miss that relationship. As you can see from both the trendline as well as the higher lows, the market is increasingly shrugging off incremental bearishness.


Casey Flavin


UA: Comfortably Numb? - UA Market Reaction to NegReports 7 09


UA: Comfortably Numb? - UA Reaction to SS

SBUX - Onward and Upward...

First, it’s safe to say MCD is not hurting SBUX.  U.S. same-store sales declined 6%, in line with my expectations and 200 bps better than Q2.  Traffic was down 4% in the quarter, which showed a sequential improvement from 1Q and 2Q when transactions were down 6% and 5%, respectively.  International same-store sales declined 2%, better than the -3% number in 1H09 and consolidated same-store sales improved 300 bps on a sequential basis from Q2 to -5%. 

Management commented on its earnings call that same-store sales improved on a sequential basis throughout the quarter in both the U.S. (as indicated by my May “Grass Roots” survey) and internationally, reflecting better traffic trends.  In the prior three quarters, SBUX had attributed the soft international same-store sales trends to weakness in the U.K. and Canada, which make up about 80% of the comparable sales store base.  Today, management stated that the U.K. market, like the U.S., has stabilized and is improving on a sequential basis. 

The strong operating model returns.  SBUX 3Q EPS came in at $0.24 versus my estimate of $0.22 and the street at $0.19.  SBUX reported a return to double digit operating margins and the U.S. segment’s first quarter of margin expansion following 12 quarters of decline.  Consolidated operating margin came in at 10.6%, excluding restructuring charges, with the U.S. segment posting a 13.4% number (up 460 bps YOY). 

Going forward, the company’s operating margins will continue to benefit from its cost savings initiatives.  That being said, the company delivered $175 million of savings in Q3 versus its $150 million goal and now expects to implement $550 million of cost savings in FY09, exceeding its prior $500 million target.  This reduced cost structure will result in an excess of $700 million in annualized cost savings in FY10 and beyond.

As a result of stabilizing sales trends and increased cost savings, SBUX now expects FY09 EPS of $0.74-$0.75, excluding restructuring charges, versus the street at $0.71.  The company is guiding to 13%-18% non-GAAP EPS growth in FY10 with U.S. segment operating margins growing 150-200 bps.  Management stated on its earnings call that SBUX should take a meaningful step in FY10 toward achieving mid-teen operating margins in its U.S. and international segments.  For reference, that is relative to the 13.4% and 8.1% operating margins reported in Q3 in those respective segments.  SBUX did not provide any same-store sales guidance for FY10 but its FY10 margin guidance is based on a continuation of the current soft sales environment.  Achieving mid-teen operating margins will ultimately rely on positive comparable sales growth.

A strong cash flow story.  I knew SBUX would pay down debt in the quarter but the company exceeded my expectations on this measure as well by reducing its short-term borrowings to a zero balance at the end of Q3.  The company expects the balance to remain below $50 million for the remainder of the fiscal year.  SBUX again lowered its FY09 capital spending needs to $550 million from $600 million, thereby improving SBUX’s free cash flow position.  The company continues to expect its FY09 free cash flow to exceed $500 million. 

Advertising.  CEO Howard Schultz stated that he is seeing an unprecedented level of investment in coffee advertising by a host of companies, the likes of which he has never seen.  He thinks this increased level of spending around coffee builds awareness and trial for the entire category and has benefited SBUX, particularly following the launch of the company’s own national advertising campaign in May.  To me, this means that MCD’s increased spending around its specialty beverage platform is not hurting SBUX as so many people had expected.  Instead, it is increasing trial at SBUX.



Five straight months of revenue declines without any positive delta.  On a moving average basis, Louisiana now looks like one of the worst performing gaming markets.


Well, it was fun while it lasted.  After a dreadful September, Louisiana was the best performing market in the country for a four month stretch.  That was a critical piece of our positive outlook on PNK beginning in November.  Not only did business turn “less bad”, but three out of the four months post September showed positive same store sales.

Since January, however, gas prices have been steadily increasing.  The impact of government stimulus and transfer payments has dwindled.  Unemployment and the savings rate continue to climb.  As can be seen in the following chart, the same store revenue picture reflects the harsh economic environment.  Moreover, the 3 month moving average is decidedly negative and the slope of that line is the steepest of all the gaming markets.


These results do not bode well for PNK which maintains 69% of its EBITDA exposure to Louisiana.  We’ve adjusted our model to reflect the state issued revenues, including these Louisianan numbers just released.  We are now expecting Q2 EPS of $0.02 on an adjusted basis versus the Street at $0.05.  Our adjusted EBITDA estimate is $47 million, approximately $2.5 million below the Street.  Our revenue estimate is $260 million versus the Street at $272.  We do think better margins will partially offset the revenue shortfall.

PNK will release earnings this Friday before the open.

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MCD - Looking Forward to Thursday

There is a lot to love about MCD – it’s a unique global brand with a strong business model that generates lots of cash!

It’s not cheap trading at 9.4x our NTM EBITDA estimates, but carries a 3.4% dividend yield!  The company’s value positioning during the economic downturn has allowed the company to capture more market share than I ever thought possible.  

Going forward, in order for the company to continue to capture more market share, it is clearly dependant on its US specialty coffee initiative and premium products to not just drive comps, but help mitigate margin decline from the significant discounting the company is doing. 

I remember a time when the McDonald's management team could not do anything right!  While most of those individuals are now gone, right now the investment community believes that this management team can do no wrong!  Either extreme is probably not right, but the truth is somewhere in the middle.

It’s not out of the realm of possibilities that senior management has “misread” the market or it could be an unfortunate case of bad timing.  Given the size of the organization, once a new product initiative is determined to be a “go,” it’s nearly impossible to stop the process if the timing is off.  Rolling out a $4 sandwich and $3.50 cup of coffee into the teeth of a 10% unemployment rate could be a case of unfortunate timing.

Most QSR operators that are focused on “high-end” products are seeing soft sales and are not taking additional market share because people are not spending money on expensive items.  Burger King is the poster child for corporate missteps and it recently had to change its strategy to focus more on discounting because its premium products failed to drive traffic.  I contend that McDonald’s current product strategy is not focused on its core market – family and value-minded customers. 

While it might take some time to manifest, MCD’s focus on specialty beverages and its premium Angus burger could result in the company’s losing market share versus street expectations of continued market share gains. 

To that end, I am not surprised by the recent slowdown in US same-store sales on a 2-year average basis.  I would expect the sequential slowdown to continue in Q2 based on my estimate of 3.9% US same-store sales versus 4.7% in Q1.  I also expect more of the same in Q3.

Systemwide sales should continue to come down on a reported basis, though the currency headwind appears to have peaked in April when the negative impact on sales hit nearly 10%.  Based on July currency levels for the Euro, the British Pound, the Australian dollar and the Canadian dollar, which collectively represent approximately 70% of the Company’s operating income outside the US, foreign currency rates should become less of a headwind in Q3 on a YOY basis and prove beneficial in Q4.

All in, MCD should report EPS of $0.96 (consensus at $0.97).  The tax rate and nonoperating income/expense line, which includes gains and losses on company investments, are extremely volatile quarter to quarter and difficult to forecast so I would not be surprised to see a penny of upside/downside from such items.  Operating margins should improve nearly 200 bps in the quarter as I would expect continued SG&A cost discipline to offset a slight decline in restaurant margins. 

Talking about things to love, MCD should easily hit its FY07-FY09 goal to return $15-$17 billion to shareholders through share repurchases and dividends.  Unfortunately, MCD is such a cash machine that investors have become accustomed to such shareholder returns.  MCD’s stock price will react to top-line momentum, largely in the US, and I think that momentum is slowing.  The company will have a difficult time lapping its 6.7% US same-store sales comparison in July even with all of the coffee it is giving away as of late.

MCD - Looking Forward to Thursday - MCD US SSS 2Q09E

MCD - Looking Forward to Thursday - MCD total company FX

MCD - Looking Forward to Thursday - MCD Currency

German PPI Unwound

On a compare the data signals managed deflation 

The German Federal Statistics Office reported yesterday that Producer Prices fell 4.6% in June compared with a year earlier.  At first glance, the plunge looks dangerously deflationary, yet the delta here is better understood in the context of last summer’s manic energy prices.  With the decline in energy costs and pull back in demand, on the compare, PPI levels signal a deflationary environment, but not an alarming one. On a monthly basis, PPI fell 0.1%.

Of the components, energy prices accounted for the largest declines on an annual basis: Petroleum -24.9%; Heating Oil -42.9%; Diesel -27.5%; and Gas -11.8%. Intermediate metal-based products also fell considerably: Scrap metal -61.0% and Rolled metal -31.2%. In a third segment, Consumer goods showed an annual decline in Foodstuffs (4.0%) and Milk products (12.4%). Cigarettes were one of the few components that were more expensive on a year-over-year basis, up 1.6%.   

Last week’s EuroStat CPI report for June indicated German consumer prices held stable at 0.0% year-over-year for the last two months. Despite a mild 0.4% increase in CPI on a monthly basis, taken together the data supports the case for an environment in which both the producer and consumer are benefitting from cheaper prices. “Imported” deflation from a cost perspective yields a bullish runway for Germany’s export-heavy economy, especially as the country gets little advantage from an export standpoint in the immediate term with the Euro trading $1.42.

With the DAX trading mostly flat to negative YTD (much like the S&P 500), Germany (via the etf iShares EWG) presents a country we may look to get long on a TREND (3 months or more) duration.

Matthew Hedrick

German PPI Unwound - DeutschlandPPI

HST 2Q09 Earnings Preview

2009 guidance looks reasonable. We expect 2Q09 to be in line if not slightly better than street expectations. However, similar to other lodgers, 2010 estimates look way too high.


Our 2010 estimates are about 8% below the street for EBITDA and a lot lower on 2010 FFO.  The stock is trading around 13.0x 2009 EBITDA and over 15.0x 2010 EBITDA.  On a per key basis, at $165k, it doesn’t look a whole lot cheaper than the few comps we’ve seen, especially given that a third of the owned rooms are subject to ground leases and another 5% aren’t wholly owned or simply leased.

As the composition of lower RevPAR skews to rate and cost cut comparisons become more difficult, margins will become more strained.  The weekly Smith Travel surveys indicate that industry RevPAR is not getting worse but it’s not exactly getting better either.  There’s not a lot of positive news out there... group bookings remain bad, conference attrition isn’t improving, business booked during better times continues to roll-off and replaced by lower quality AAA and flights attendant business, and people are still losing their jobs.  More rooms are being booked through discount channels – one member of our team just got 75% off a villa in Mexico which was $1,500 per night. You get the point.  The chances of a guidance increase are remote. 

2Q09 Preview Details:

We expect RevPAR to decrease 23%

  • For the past four-out-of-five quarters, HST moderately underperformed MAR branded system-wide operated rooms; they’ve been better at having occupancy lead the way down (i.e. occupancy has been a greater contributor to RevPAR declines) and therefore they’ve been able to keep direct room costs down (“COSTPAR”)
  • HST has de minimis FX exposure to its NA room-base (only 2400 rooms are non USA based)
  • They only have one hotel in Mexico so the impact of swine flu has been minimal

Property EBITDAR of $244MM, margins down 700 bps to 22.8% vs Street at $244MM

  • Room margin only down 350 bps since we assume a little over 50% of the decline in RevPAR is still occupancy driven

FFO of $0.23 vs Street at $0.22

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