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Did anyone else notice the 50% off promotion Starwood has running on their website?


Starwood reported 2Q09 Adjusted EPS of $0.22 and EBITDA of 200MM, beating the quarter by 5 cents on EPS and EBITDA by 4MM (vs. consensus) and 10MM (5%) on our numbers.  The theme of weak top line saved by deep cost cuts continues.


Of course, next quarter’s guidance cut was deep:

  • EBITDA guidance of $165MM to $175MM was 11% below our number and 20% below the street
  • EPS guidance of $0.06 to $0.10 - even if we take the top end, it’s still 35% below our number and 57% below street estimates
  • As we wrote about in the preview, FX is less bad so next quarter’s RevPAR guidance is better by 1% on a constant dollar basis but looks 4% better sequentially (only down 20-22% vs this quarter’s guidance of being down 24-26%)

2Q09 Review:

  • RevPAR was disappointing, especially given the weakening of the dollar which should have helped the worldwide (WW) stats
    • RevPAR on owned hotels came in 2.4% below the low end of guidance
    • WW system-wide RevPAR came declined 27.7% vs guidance of down 24-26%
    • Starwood experienced higher attrition in the system than we expected, and only added 200 net rooms to the system this quarter
      • HOT added 2100 less room than we estimated, but still had healthy y-o-y growth of 4.9% in management and franchised rooms (12.2k rooms)
      • Owned, leased and consolidated JV expenses declined 2.5% more than we expected, producing an 11MM benefit to expenses, offsetting the disappointing revenue results
      • Overall operating cash flow came in 8MM stronger than we expected due to better cost controls on the owned/leased/JV and VOI side
      • Fee income of $187MM was $7MM better than our number
        • The beat was solely attributed to higher “other management & franchise fee revenue”
        • The amortization gain was $20MM
        • Bliss and “other” was also a little better
        • Probably higher affinity fees as well
        • VOI sales were 8MM below our estimate, however, expenses were also 8MM lower, hence net came spot in line

 Full year guidance was in line with our numbers, which were below the street:

  • SS Company Operated WW RevPAR -20% (vs -18% prior guidance) and RevPAR on branded SS owned hotels WW down 25% (vs - 21% previously)
  • $750MM of EBITDA vs. our estimate of $746MM and street at $791MM
  • EPS guidance was $0.65 spot in line with our number which was 18% below the street
  • Management and franchise revenues projected to decline 15% vs. previous guidance of -10%
  • VOI and residential down $10MM more than original guidance, however, adjusted for the note sale FCF from timeshare was raised to $150MM from $25MM
  • SG&A projected to come in $10MM lower than prior guidance of $70MM, we were actually modeling SG&A declines of $100MM
  • Guidance on tax rate, D&A, and capex was unchanged

Other tidbits:

  • The extension of the AMEX co-branded card is interesting.  As we wrote about in our Marriott note on 7/21/2009, “LOOKING UNDER THE HOOD OF THE MARRIOTT MARGIN CAR”, affinity fees flow right to the bottom line. We’re curious where Starwood includes these fees.  The $250MM in cash received from American Express seems unusual.  Is this an advance?  If so will there be some negative amortization to offset affinity fees (aka the gain amortization on mgmt contracts that HOT like to recognize as fee income)?
  • What are the “special items”
    • Like Marriott, HOT took an impairment on its retained interest in one of its timeshare securitization deals.  We’d like a little more information.  As we wrote about, these may not be one time.  We also would like to know whether HOT retained any equity interests in past deals.  MAR has historically had the highest quality deals so they did not – but we’d like to confirm this for HOT as well.
    • How will the step up in Italian tax rates effect HOT’s future profit margins, we assume that this “tax incentive program” wasn’t simply a gift from the government. 

Tidal Pools

 "All the busy little creatures chasing out their destinies... living in their pools they soon forget about the sea..."
- Neil Peart

Ok, Keith quotes Nietzsche, and McGough quotes lyrics from Canada's most successful progressive rock trio.  Poke fun if you'd like, but no one can ever claim that we at Research Edge are not open to inspiration from all angles!
But this quote hit home with me yesterday as I drove down I-95 from Boston to Connecticut. I had the pleasure earlier in the day of having lunch with one of the future leaders of Wall Street.  Half of our conversation revolved around the obscenity surrounding how so many people are trying to time little ripples of info related to 3Q and 4Q EPS instead of focusing on 30-foot waves forming on the horizon. Ever sit on a surfboard and get caught up watching the beach instead of the horizon? I don't suggest you try. It hurts...
But that is what we're seeing now on the Street. There's no shortage of stats that should make us step back and question where the long term opportunity really is. Consider the following...

1.      US retail sales growth came in at -8.99% last month, and the 'chatter' was all about how this was a positive development because it was better than expectations. But what about the 15% growth number we saw in China?
2.      860k autos were sold in the US in June per Motor Intelligence. But that compares to 1,142k in China in the same period.
3.      510,563 total new accounts opened throughout the second quarter at Etrade, TD Ameritrade and Charles Schwab combined. Yes, that's a big number. But what about the 484,799 new individual equity accounts opened in China LAST WEEK?
I won't beat this China horse any more. Our Macro team just published a China Black Book that more than covers everything any investor needs to know on the topic. (If you'd like a copy, feel free to email )

But what about investors that are staying closer to home (either by choice or by mandate)? Even within the US, I feel like people are hyper focused on the tidal pools. The best example is CIT.
I can't even count the number of calls I got last week on this whole CIT situation. "Hey McGough... what name can I play on this theme?"  The answer? No one. To try and pick one company that will get hurt is a useless exercise. Spending effort on that is completely missing the potentially HUGE call, which is picking the second and third derivative of this situation. This all boils down to private equity as a three-legged bar stool. What do I mean?

a.       Let's look at all the PE deals done over 5 years at peak multiples and peak (single digit) margins. Now layer on a weaker consumer and 100% debt to total capital. Cash flow ain't looking too good. These smaller and/or private companies are the ones that will be most impacted by tightening credit/factoring.
b.      Now let's look at the portfolio of companies for each private equity firm - it's not that tough to do. All it takes is for one domino in the portfolio to topple, and then others could follow as they trip covenants, and act irrationally as they try to keep their heads above water. (2nd derivative).
c.       Then this plays into the third derivative (mathematically speaking, there's probably a better way to frame this up - but you get the drift). This includes the impact of the vendors, retailers, sourcing companies, and other trade partners that will be impacted as dominos fall. You can go to your little one-on-one meeting at a conference and have a CEO tell you that all is hunky dory. But I can all but guarantee you that 90%+ of them are not spending a whole lot of time on whether this key critical uncertainty even exists - nevermind how to come out on top.
This is when investors get paid to not only think a step ahead of the competition, but to think a step ahead of the people running the companies.
Rock on...

Brian McGough


CYB - WisdomTree Dreyfus Chinese Yuan
- The Yuan is a managed floating currency that trades inside a 0.5% band around the official PBOC mark versus a FX basket. Not quite pegged, not truly floating; the speculative interest in the Yuan/USD forward market has increased dramatically in recent years. We trade the ETN CYB to take exposure to this managed currency in a managed economy hoping to manage our risk as the stimulus led recovery in China dominates global trade.
COW - iPath Livestock - This ETN tracks an index comprised of two thirds Live Cattle futures, one third Lean Hogs futures. We initially began looking at these commodities because of recession inspired capacity reductions combined with seasonal inflections. A series of macro factors including the swine flu scare, a major dairy cattle cull in response to collapsing milk prices and the collapse of the Argentine agricultural complex due to misguided policy provided us with additional supporting fundamental data points for the quantitative set up in price action.  
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 - Buying back the GLD that we sold higher earlier in June on 6/30. In an equity market that is losing its bullish momentum, we expect the masses to rotate back to Gold.  We also think the glittery metal will benefit in the intermediate term as inflation concerns accelerate into Q4.

LQD - iShares Corporate Bonds
- Corporate bonds have had a huge move off their 2008 lows and we expect with the eventual rising of interest rates in the back half of 2009 that bonds will give some of that move back.

XLI - SPDR Industrials - We don't want to be long financial leverage, which is baked into Industrials.

EWI - iShares Italy - Italian Prime Minister Silvio Berlusconi has made headlines for his private escapades, and not for his leadership in turning around the struggling economy. Like its European peers, Italian unemployment is on the rise and despite improved confidence indices, industrial production is depressed and there are faint signs, at best, that the consumer is spending. From a quantitative set-up, the Italian ETF holds a substantial amount of Financials (43.10%), leverage we don't want to be long of.

DIA  - Diamonds Trust- We shorted the financial geared Dow on 7/10, which is breaking down across durations.

EWJ - iShares Japan -We're short the Japanese equity market via EWJ on 5/20. We view Japan as something of a Ponzi Economy -with a population maintaining very high savings rate whose nest eggs allow the government to borrow at ultra low interest levels in order to execute stimulus programs designed to encourage people to save less. This cycle of internal public debt accumulation (now hovering at close to 200% of GDP) is anchored to a vicious demographic curve that leaves the Japanese economy in the long-term position of a man treading water with a bowling ball in his hands.

XLY - SPDR Consumer Discretionary
- As Reflation morphs into inflation, the US Consumer Discretionary rally will run out of its short squeeze steam. We shorted XLY on 7/9 and again on 7/22.

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.

PFCB – The Burt Vivian Discount Factor

PFCB’s 2Q09 earnings came in better than expectations at $0.51 per share versus the street at $0.41 per share and raised its FY09 guidance to $1.60-$1.65 from $1.45-$1.50.  Pei Wei is performing better with same-store sales relatively flat and operating margins at the concept up nearly 300 bps YOY.  Additionally, year-to-date, the company cut its credit facility borrowings in half to $40 million and repurchased $20 million worth of stock.

Most of the good news ended there.  Management comments on the earnings call regarding the outlook for the remainder of the year were less than favorable.  PFCB’s full-year guidance assumes operating margin contraction in the second half of the year after over 100 bps of expansion in both Q1 and Q2.  Management expects this margin degradation going forward will come from increased labor pressure in 2H09 as the YOY cushion from increased labor efficiencies will begin to diminish at the same time the company is faced with the minimum wage increase in July.  The company’s marketing spending will also be greater in the second half of the year, which will further hurt margins.  And, the bulk of PFCB’s new unit development will occur in 2H09 (6 new units in both Q3 and Q4) so a higher number of inefficient new restaurants will weigh on results.

Management’s guidance assumes a sequential improvement in comparable sales growth, which has not yet happened in July.  As Co-CEO Burt Vivian stated, “While comparative results should get easier once we get to the fourth quarter, there are no sign posts yet leading to that particular promise land.”

Specifically, the company is assuming a 5.5% decline in average weekly sales at the Bistro in 3Q followed by a -3.5% number in 4Q relative to -7.6% in 2Q.  In the first 3 weeks of July, management stated that traffic trends are not great.  Bistro sales trends have not improved in July on a sequential basis despite the easy comparisons with average weekly sales running down 7%, down 1% at Pei Wei.

When asked if management was being overly conservative, Mr. Vivian responded:

“We expect in our forecast for the comparison year-over-year to improve, as I said in my comments, that's not happening, yet.  So there are a number of things, again, if we're simply going to assess the odds, you may think we're being conservative.  I think we're being appropriately conservative.  The fact of the matter is, is there a chance we'll do better?  Sure.  There's a chance.  There is also a chance we'll do worse.  So I think investors need to understand the risks, and if it turns out better, that's fine.  But I don't want anyone coming back in a few months saying, gees,  Burt, you didn't tell me there was going to be pressure on operating cost, you didn't tell me you were going to spend any more on marketing and you didn't tell me the sales were soft.  And all of those things are true.”

I have questioned in the past whether Mr. Vivian’s overly cautious tone in front of investors is partly to blame for PFCB’s relatively weak valuation, particularly versus CAKE.  PFCB is currently trading at 6.1x on a NTM EV/EBITDA basis versus CAKE at 8.2x and the FSR group average of 6.7x.  The CEO’s comments today, which could very well be warranted given the difficult operating environment, will most likely not help the company’s discount valuation.  To that end, PFCB’s stock started trading down rather significantly right when Mr. Vivian started talking on the company’s earnings call at 1 pm ET today. 

Although the stock definitely reacted to his comments, the street appears to think the CEO is overly cautious because FY09 consensus estimates were already at $1.64 prior to the company raising its FY09 guidance to $1.60-$1.65 today from $1.45-$1.50.  PFCB beat Q1 EPS estimates by $0.23 and Q2 EPS estimates by $0.10.  The more the company under promises and over delivers, the less of an impact Mr. Vivian’s gloomy outlook should have on valuation.  Even with the company raising guidance and in light of the expectation for a challenging sales environment for the balance of the year, I continue to believe that the FY09 EPS guidance numbers could prove conservative.


PFCB – The Burt Vivian Discount Factor - pfcb

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Athletic Footwear Remains Week (again)

Weekly trends for footwear remained weak for the third week in a row, but the overall trajectory was essentially unchanged.  We suspect there will be a lull in near-term in momentum as retailers clear inventory for the back to school season and await help from the calendar to drive demand.  With overall industry trends remaining soft, there were few brand callouts this week.  Converse picked up some momentum, with a 10.6% increase vs. only 1% last week.  Van’s showed the most volatility, with sales declining 13% after increasing 31% last week.  As we highlighted the other day, Under Armour appears to be in clearance mode in the sporting goods channel.  ASP’s for the brand decreased from $81 to $75 over last week.  Overall, athletic footwear trends remain stable but decidedly negative and it remains much too early to make a call on back to school.

Athletic Footwear Remains Week (again) - Sporting Goods Channel Table

Athletic Footwear Remains Week (again) - Footwear and Apparel in Sports Retailers

Athletic Footwear Remains Week (again) - Footwear APparel ASP

Russian Banking Woes

OAO Sberbank reported today that first-half net income fell 92% to 5.3 Billion Rubles or $170 Million from a year earlier. In our post “Ripples In Russia” from 7/17 we highlighted the underlying fundamentals that may pose intermediate to TAIL term risk to the performance of the Russian stock market (RTSI). Sberbank’s 1H ’09 numbers today underline the precarious situation of Russian banks, struggling with low capital levels due to the rise in bad loans, the depreciation of asset values and non ruble debt -while the Kremlin continues to provide assurances that banks will continue to lend. Can the center hold?

Prime Minister Putin, who has increasingly taken on responsibility for leading the economy, was on the tape today saying that Sberbank, the country’s largest bank, should keep lending and not close branches, calling 14% an acceptable interest rate for banks to charge. (In context, 14% represents a 300bp premium over the central bank’s current refinancing rate.) 

Transparency and accountable remain major issues when talking about the Russian economy. That said, it’s painfully obvious that the undercapitalized banking sector is in a precarious position and something has gotta give. At this point a bank bailout would be a tall order that would certainly blow out the government’s debt ratings, and further delay the country’s longer-term recovery process.

We’ll have our Eye on Russian banks, while respecting the high correlation between RTSI energy/commodity prices.

Matthew Hedrick