Takeaway: Mass and VIP volume well below expectations. Premium Mass table conversions to Direct VIP only partly to blame for the Mass disappointment.

October numbers look much worse than previously thought.



Please see our note:

CAT: 5 Reasons to Stay Bearish into 2015

There are more than five reasons, but we will start with these.



S.E.C. Subpoena:  In a Halloween 10-Q filing, CAT disclosed an S.E.C. subpoena from September 10, 2014 saying “…SEC issued to Caterpillar a subpoena seeking information concerning the Company’s accounting for the goodwill relating to its acquisition of Bucyrus International Inc. in 2011 and related matters. The Company is cooperating with the SEC regarding this subpoena and its ongoing investigation. We currently believe that this matter will not have a material adverse effect on the Company's consolidated results of operation, financial position or liquidity.”  We reviewed this accounting issue in the summer of 2013 CAT Short Review: Short Thesis, Long Tail: Replay: CLICK HEREMaterials: CLICK HEREInvestors love S.E.C. subpoenas and potential restatements.


CAT: 5 Reasons to Stay Bearish into 2015 - sfdsdfs



Oil Price Decline:  Oil & Gas is a large, high margin end-market for CAT.  After the collapse in mining equipment demand, CAT management directed attention away from Resource Industries and toward Energy & Transportation.  We continue to think that will prove an error.  On their earnings call, CAT commented that “the feedback we've been getting that say, mid-$80s - say $80 to $90, somewhere in there on a sustained basis, certainly will take the really agitated top off of it. …. I think if you'd see low $70s on a sustained basis there would be a chill across the market.   Markets are closer to the “chill” level now and time will tell if it is on a “sustained basis”.  Still, it sets up what are likely to be tough comps for E&T in 2015, which already had tough comps elsewhere.  Our recent call on tight oil suggests the chill may not thaw soon.  


CAT: 5 Reasons to Stay Bearish into 2015 - asdad2



Mining Can Get Worse:  Mining capital spending may be at or near a bottom, but results from Resource Industries can get worse.  We expect pricing pressure, which was mentioned in the 3Q 2014 earnings press release, to persist.  Orders in revenue likely reflect better pricing than those backlogged in today’s weaker market.  With mined commodity prices continuing to see pressure (e.g seaborne iron ore under $80/t) and MATS rules set to impact coal in 2015, idled equipment may well be parted out or resold/repurposed.  CAT Financial may be impacted if used equipment prices decline, potentially exposing the receivables portfolio to losses.  As we understand it, not all of CAT’s mining exposure is categorized under the “Mining” section of CAT Financials disclosures, as much of it is presented by geographic region.


Tier IV Pre-Buy:  While the locomotive pre-buy ahead of new emissions regulations was largely telegraphed and quantified at “less than 2% impact on Energy and Transportation” next year, the rest of the Tier IV impact was not.  We expect to see an impact on larger gensets and other very large engines in 2015.


Inflated 2015 Estimates:  CAT hasn’t guided revenues conservatively in recent years, with the 2014 top line mid-point staying constant since last October.  Given the evaporation of Resource Industries, likely pressure on Energy & Transportation (Tier IV, Lower Oil), and tough comps in Construction Industries (dealer inventory build, record margins), flat revenue growth seems reasonable, and perhaps aggressive, in 1H 2015.  The street lowered 2015 sales estimates a bit following the guidance, but remains above guidance (consensus at ~$56.9 bil vs. guide of ~$55 bil).  EPS are expected to grow to an adjusted $7.00 from an estimated $6.50 in 2014.  By our initial estimates, CAT would have to buy in a huge amount of stock to get there.  



CAT: 5 Reasons to Stay Bearish into 2015 - wrf3




PODCAST | McCullough: Panic Is Coming as ‘Policy to Inflate’ Experiment Ends In Tears


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BKW: Quick Recap

We still have reservations about BKW, but the company as we know it is diminishing after this quarter.  Like WEN, JACK and SONC, BKW is a net beneficiary of the significant share losses that MCD is giving up.  Since MCD is far from getting its act together, further share losses are expected and will continue to benefit other sandwich/burger chains.


We recently expressed our reservations about the BKW/THI deal:

  • Levering up to pay a premium for a slow growth CDA company
  • The lack of synergies with the transaction; in fact, costs will accelerate to jumpstart unit growth
  • We doubt the merger will accelerate the growth of THI globally
  • The two companies have fundamentally different views on franchising
  • The Burger King franchisee base is weak and getting weaker by the day
  • BKW is likely to miss 3Q14 estimates
  • The social media backlash, on both ends of the spectrum, to this transaction cannot be underestimated
  • The conference call announcing the deal was far from impressive; in fact, it was rather discouraging
  • The transaction is dilutive to current shareholders
  • Current valuation is unwarranted


Trading at 18x EV/EBITDA, we simply can’t get behind this stock, but there were a few things to like about the quarter:

  • Global comparable sales increased 2.4%, primarily driven by growth in the U.S. and Canada
  • System-wide sales increased 8%
  • Adjusted EBITDA increased 12% to $194 million
  • Adjusted diluted EPS increased 18% to $0.27 per share
  • Net restaurant growth of 152, a 14% increase from the prior year


Investment Positives

BKW reported +3.6% same-store sales growth in the U.S. and Canada, making it the fourth consecutive quarter of positive same-store sales growth and the best rate of growth since early 2012.  BKW is launching fewer, more impactful high margin products, complemented by value offerings.  In 3Q14, they introduced the A1 Ultimate Bacon Cheeseburger and re-launched Chicken Fries.


Internationally, BKW expanded its brand presence around the world, opening 152 net new restaurants in the quarter.  The brand now has just under 14,000 restaurants worldwide.  November and December are typically the busiest months of the year for BKW and the company looks like it is on track to hit its target unit openings for the year.  At the end of FY15, the Burger King Brand will be in 100 countries.


BKW delivered 18% adjusted EPS growth and 12% organic adjusted EBITDA growth in the quarter.  To its credit, it has grown adjusted EBITDA and adjusted EPS every quarter since becoming a public company in mid-2012.


Reimaging continues to be a focus area and management expects to hit its stated target of 40% of the U.S. system on the modern image by the end of 2015.


EMEA was also strong, delivering its 15th consecutive quarter of comparable sales growth.  Performance was driven by strength in Turkey, the UK and Spain.


Year-to-date, BKW has generated $537 million in adjusted EBITDA and $366 million of free cash flow.  The company also paid down $57 million of debt and paid out nearly $77 million in dividends.  At quarter end, the company’s cash balances increased from approximately $790 million at year end 2013 to $1,014.


Investment Negatives

Despite strong same-store sales in the U.S. and Canada, organic adjusted EBITDA growth decreased 4.2%.  Although management expects North America to return to positive organic EBITDA growth in 4Q14, this is something we need to keep a keen eye on.   We have serious concerns over the health of Burger King’s franchisee base.


LAC was the most challenged region in 3Q14, as same-store sales declined due to weakness in Mexico and Puerto Rico.  Weakness in Mexico was the by-product of a sluggish eating out category and BKW’s ineffectiveness at driving value.


3Q14 marked the beginning of non-recurring (yet, recurring) expenses related to the THI transaction.  BKW incurred approximately $31 million of transaction and strategic realignment costs related to the transaction.


BKW also incurred $148 million of net losses on derivatives related to the transaction, as management was required to recognize a mark-to-market loss on transactions due to the weakening of the Canadian dollar.


BKW: Quick Recap - 1


BKW: Quick Recap - 2


BKW: Quick Recap - 3


BKW: Quick Recap - 4


Howard Penney

Managing Director


Fred Masotta


CHART OF THE DAY: Not Even Putin the Great Can Stop Gravity | $RSX #Oil

Takeaway: The Russian stock market is down -25% year-to-date. Coincidentally, or not, the price of Brent crude is down right around -25% YTD as well.

CHART OF THE DAY: Not Even Putin the Great Can Stop Gravity | $RSX #Oil - chart of day 11 5

Something is Rotten in The District of Columbia

Horatio: He waxes desperate with imagination.

Marcellus: Let’s follow. Tis not fit thus to obey him.

Horatio: Have after. To what issue will this come?

Marcellus: Something is rotten in the state of Denmark.            

-From Shakespeare’s “Hamlet”


Undoubtedly in Republican circles there are a lot of celebrations going on today.  After all, according to the scoreboard, they handed President Obama and his party a decisive loss.


In the Senate, the Republicans have already won a confirmed +7 seats and the count currently stands at 52 seats for the Republicans, 43 seats for the Democrats, and 2 seats for Independents. There are still three races that are considered undecided.


In the undecided races, it appears that Democrat Mark Warner will ultimately prevail in Virginia as he has the edge (though the margin is less than 13,000 votes and Republican Ed Gillespie has the option of a recount.)  Meanwhile in Alaska, it appears that Republican Mark Begich will ultimately prevail as he has received 49% of the vote with 97% of votes having been counted.  Finally, Louisiana is headed to a December run-off between incumbent Senator Mary Landrieu and Republican Bill Cassidy.


So in the Senate, Republicans will gain a minimum of +7 seats and perhaps as many as +9 seats.  In the House, the Republicans have already gained a net +13 seats to solidify their majority with approximately 19 seats still considered undecided.   In Governor mansions across the nation (outlined in the map below courtesy of Politico) Republicans also solidified their hold on state capitols.


Something is Rotten in The District of Columbia - dj


According to Politico, “even optimistic Republican operatives didn’t anticipate this”, but to be fair, as we wrote yesterday in an intraday note, almost every major media outlet was predicting a decisive Republican victory.  And decisive it was.  In large part this victory can be attributed to the fact that exit polls showed President Obama’s approval rating at a dismal 41%.


In our view, the bigger story from the election is really how despondent Americans have become about the future of America.  According to the exit polls, 2/3s of voters think the country is on the wrong track, a mere 22% believe their children will be better off than them, and more than 72% worry about a terrorist attack on American soil.  That is just plain sad.


But, the fact that Americans are despondent about the future shouldn’t really be a surprise.  This election was characterized by negative attack ads.  In the 34 states with Senate seats up for grabs, there were 1 million TV ads shown and more than 46% of them were attack ads.  While on one hand those ads were seemingly successful in leading the Republicans to victory, on the other hand, what was the cost?


Heading into the election, Congressional job approval was a mere +12%, with more than 80% of voters disapproving of the job that Congress is doing.  As well, consistent with exit polling data above, heading into the election a mere 28% of voters believe that the country is headed in the wrong direction.


So, was this a resounding Republican victory? Perhaps, but the bigger issue we all have to deal with is that something is truly rotten in the District of Columbia.


Back to the Global Macro Grind...


As depressing as the state of U.S. politics may be this morning, there is always a bright side.  The bright side is that we all live in America and can, if we set our minds to it, fix some of the endemic problems, such as distrust in our politicians.  In countries like Russia, of course, the people have much, much less influence.


While certainly being a voter in Russia would be depressing, even more depressing would have to have been being invested in the Russian stock market this year.  Specifically, for the year-to-date the benchmark Russian equity index is down -25%. Coincidentally, or not, the price of Brent crude is down right around -25% for the year-to-date as well.


As many of you know, we are big fans of looking at stock prices as leading indicators, which begs the question: what is the Russian stock market signaling?  Since the market is in full on crash mode, it is truly fair to consider whether the market is signaling a somewhat imminent collapse of Putin’s Russia.  While raising interest rates to strengthen the Ruble is a cute trick, the fundamentals of Russia remain highly dependent on energy exports.


According to the Energy Information Administration, in 2013 a full 68% of Russian exports, or more than $350 billion dollars, came from energy, with more than half of that from crude oil.   For comparison, the United States exports no crude oil and petroleum products comprise a mere 8%.   Given this dependence, it is really no surprise that in 2009, after crude oil declined by 80% in 2008, that the Russian economy shrunk by 7.8% in 2009, the most of any G20 economy.


Tomorrow at 1pm eastern we are going to be hosting a conference call for our institutional macro clients with former U.S. Ambassador to Russia Michael McFaul.  (Email us at for details.)  Mr. McFaul has been called, “the leading scholar of his generation, maybe THE leading scholar, on post-Communist Russia.” He was President Obama’s chief advisor on Russia through his first term and was a main policy architect of “Reset” in U.S. - Russian relations.


 A high-profile figure during his time in Moscow, McFaul was harassed and accused of orchestrating a coup.  Perhaps in light of his considerable work and reputation as an expert on anti-dictator movements and revolutions, Putin reportedly stared at McFaul across a meeting table and remarked, “We know that your Embassy is working with the opposition to undermine me.” 


We hope you can join us for the call tomorrow, which will help illuminate exactly what is happening in Putin’s Russia.  And remember, as depressing as some of the election exits polls, things are still worse in Russia.


Our immediate-term Global Macro Risk Ranges are now:


UST 10yr Yield 2.21-2.38%


VIX 13.41-17.80

USD 86.31-87.65

Yen 109.11-114.91

WTI Oil 76.43-80.51 



Keep your head up and stick on the ice,


Daryl G. Jones

Director of Research


Something is Rotten in The District of Columbia - chart of day 11 5

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