Research Edge Position: Short the British Pound (FXB), Short UK via EWU
Our bearish conviction on the UK economy has held steady this year. Even with the UK reporting a sizable jump in its October Manufacturing PMI survey number (to 53.7 from 49.5 in the previous month) and a marginal increase in home prices over the last three months (Hometrack), broader fundamentals remain shaky: government debt continues to expand, leadership in critical positions lacks (think PM Gordon Brown and BOE Governor Mervyn King), and the country’s leverage to the banking sector remains glaringly negative for recovery. We’re comfortable with our short call on the Pound for a TRADE and today we shorted the UK via EWU in our model portfolio as we expect the FTSE to underperform major global equity markets.
The UK Treasury announced today it will inject another 25.5 Billion Pounds of capital into RBS, increasing the government’s ownership stake of the bank to 84% from 70%, while Lloyds Banking Group also received a boost of some 5.8 Billion Pounds. The bailouts continue to call into question the strength of the UK’s banking sector and suggest future handcuffs associated with acceptance of state aid.
Today’s decisions comes on the heels of a contracting Q3 GDP print of -0.4% in the UK, shocking forecasters that expected a mildly expansionary number after significant government stimulus expenditures over the last year. Discussion has now intensified over increasing the Bank of England’s current bond purchasing program of 175 Billion Pounds, a topic we should get more color on tomorrow when the BOE meets to discuss rates. We expect no movement in rates from the current level of 0.5%, as monetary tightening would be imprudent given the country’s negative GDP.
We hold that throwing additional tax payer’s money into the banks won’t end well for an economy suffering from ballooning government debt, lack of leadership, and waning investor appetite with rates at historic lows. The chart below of FXB shows that the Pound is trading just below its shark line, an important line of momentum in our models.
As you prepare for the DG/KKR one-two punch of why the dollar store business model is worth your hard-earned capital, turn to Google for a reality check on 'Knowing your Customer."
We're all over this Dollar General IPO for several reasons, not the least of which is that it epitomizes our "Banker Bonanza" theme, where mediocre businesses that went private in the recent LBO wave are now coming to market in a last ditch effort for bankers to get a paycheck.
I can almost guarantee that half of the people who are looking at this deal have never shopped in a Dollar General store. Aside from stating the obvious...that you should get out there and see what you're buying. I'd also recommend checking out non-conventional venues for becoming familiar with the business -- like Google. Come to think of it, do yourself a favor and see the store first. Otherwise a Google search might scare you away. See our simple search over the past few days below speks for itself.
The fundamental outlook for FDO is not rosy, nor is the stock. DG's bankers better hurry. The good news for KKR, DG's owner, is that its parent registered as a broker/dealer in 2007, so now it can benefit from selling its own deals. No joke...
Let us now if you'd like to see our Dollar General Blackbook for more analysis on the issue.
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Position: Long gold via the etf GLD
“The dynamics of the gold market differ greatly from other traditional commodity markets. Gold is accumulated, not consumed, and acts as the ultimate store of value.”
-Paul Tudor Jones, October 15th, 2009
As part of his third quarter letter to investors, Paul Tudor Jones and his team added an appendix outlining their bullish case on gold. In hedge fund parlance, this is called “pushing your book”. That said, Jones’ long term record in trading global macro markets is an enviable one and when “he pushes his book” it is likely worth listening, even if we disagree. In this instance, we too are long gold and it is currently a major position in our asset allocation model.
In fact, we have been long gold most of the year and for most of the last two years. In our last detailed gold note, on May 13, 2009, we wrote:
“Keith and I have been readers of Dennis Gartman's (aka Garty) in the past and have enjoyed his ability to uncover interesting data points, even if his timing is sometimes suspect. This morning, though, we are drawing the line in the sand, while Garty may be short of gold, we are long of the glittery metal.”
A lot has changed since early May, including the fact that Garty is now long gold. A trend follower is as a trend follower does it seems.
Coincident with our reading of Jones’ thesis on gold today was of course the announcement from the IMF that they had sold 200MM metric tonnes to India’s Central Bank for $6.7BN. The transaction was no surprise to gold markets as the plan of the IMF to diversify from their gold position to solidify their finances has been in the works for a year, and this is roughly half of their 400 ton estimated allotment. The purchase by India, of course, is also part of a continuing trend of nations diversifying away from U.S. dollar based reserves.
The broader dynamic at work here is comparable to the GDP chart we showed yesterday. There are a number of countries that are global share takers below the G7 and therefore their reserves are growing at a dramatic pace. According to some estimates, non-G7 nations have seen their reserves grow by $2.2 trillion over the last five years, which is roughly half of all global reserve growth. In contrast to the G7 countries that have roughly 35% of their reserves in gold, the remaining countries that make up the G20 have only 3.5% of their reserves assets in gold. Obviously, and especially in context of the weakening U.S. dollar, there will be additional transactions like the one announced by India today as the G20 nations below the G7 continue to broaden their reserves diversity into a more normal allocation to gold.
Another important point that Jones’ makes in his letter is related to production of gold. His idea here is similar to our thesis on oil, which is that despite massive investment in oil exploration, overall production has remained largely stagnant. According to Jones, “despite a three-fold increase in worldwide metal exploration expenditures, new mine production has remained stagnant at 80 million troy ounces over the last decade.” Jones’ statement is corroborated by many independent studies and supports the idea that there are constraints on gold production, which in a world where demand for gold, either from emerging markets consumers or from nations looking to diversify their reserves, will increasingly lead to upwardly trending prices as supply and demand are tight.
The other incremental point of demand is coming from exchange traded funds. According to Jones’ analysis, there is only $50BN of total gold assets in listed funds. The implication is that there is potential for massive inflows when, and if, investors continue to want to own gold as an asset class, particularly in the private wealth world. As one example, one of the largest gold etf’s is GLD, which is sold by State Street and has a total asset value of ~$37BN. This fund did not exist five years ago, so its creation has led to massive incremental demand for the metal. In the last 12-months inflows into gold etfs have varied between 20 and 30% of production over that time period.
So, where could gold go? Obviously assigning a value to a commodity, or a reserve metal, such as gold is very difficult and can be done based on various econometric or quantitative methodologies. Longer term, though, one way to think about the upside is where it has been in the past on an inflation adjusted basis. The inflation-adjusted all time high for gold was January 21st, 1980, which was $2,422 versus $1,085 today. Therefore, and this is obviously nothing more than a benchmark, there is more than 100% upside from gold’s current price to its inflation adjusted high. Now a lot would have to happen to drive gold back to those parabolic highs, but many also said the same about oil in mid-2008 . . .
Below we’ve outlined our risk management levels on gold.
Daryl G. Jones
Cheaper than the peer group? Depends on which metric. Don't forget about the JV debt.
Lodging stocks have been pounded over the last 2 weeks so the "discount valuation" thesis is not as compelling as it once was. There is another issue with that thesis. Whisper valuations around the Street pegged the EV/EBITDA multiple at 10-11x. "You gotta include the JV EBITDA". Fair enough - we do - but you also have to include the JV debt of $500 million, the amount of which is disclosed only in a footnote.
At the stated range of $23‐26, we estimate the EV multiple on 2010 EBITDA is 11.8x‐13.4x. That doesn’t sound cheap unless you compare it to the lofty peer group multiples. The midpoint of the Hyatt offering range is at a slight discount to the peer group average multiple of 13.2x. The chart below details the valuation comparisons.
A bull may argue that given Hyatt’s positive net cash position, it should be valued at a premium to HOT (4x leveraged) and MAR (3x leveraged). On the other hand, Hyatt’s complicated and shareholder‐unfriendly voting structure should punish the valuation. If you think your Class A shares (worth 1 vote per share versus 10 votes for a Class B share) will ever influence management I've got a bridge to sell you. One only needs to look at Orient Express (OEH) for an example of investor disdain with complex voting structures.
On a free cash flow basis, Hyatt’s valuation looks expensive with a 2010 yield of only 4%, as shown in the chart below. However, Hyatt has the financial resources to make accretive acquisitions. We estimate that for every $1 billion in acquisitions, Hyatt could generate 10-18% free cash flow per share accretion.
If one is a lodging bull, the Hyatt deal could make sense, particularly at the low end of the range. Hyatt will generate approximately 60% of its gross profit from hotel ownership, much larger than the HOT/MAR peer group, which gives the company higher operating leverage to a recovery. Moreover, Hyatt's balance sheet can absorb a lot more debt to acquire assets and further lever the company to the recovery. However, If you share our view that the duration of this downtown will be longer than expected, Hyatt is probably not the best stock play.
Two of the earlier reads on October trends were less than positive with MCD and SONC citing sequentially softer trends. Since then, most of the comments about trends in early calendar Q4 pointed to sequentially improved YOY trends.
It is important to remember that comparisons are getting easier on a sequential basis and that outside of PNRA and BWLD, these sequentially better numbers point only to less bad trends as the numbers are still down on a YOY basis.
Those easier comparisons are meaningless, however, in that they are not enough to yield positive growth in Q4. To that end, the street’s Q4 expectation for restaurant revenue growth to improve significantly on a sequential basis (included in the chart below based on Bloomberg estimates) appears aggressive. Same-store sales growth is likely to remain negative, albeit less negative, and seeing that industry development is so muted this year, unit growth will not be enough to offset that decline for FSR and make up the rest for QSR.
MCD: “As we move through October, consolidated comparable sales remain positive with Europe and APMEA contributing strong results. In the U.S., despite continued gains in market share and advancement in our industry-leading position, we're expecting flat to slightly negative October comps.”
In September, MCD’s U.S. comparables sales growth was up 3.2% and the company is lapping a +5.3% number from October 2008. A flat result in October 2009 would point to a sequential slowdown in 2-year average trends.
SONC: “We have seen a little more challenging weather as this fiscal year has gotten off to a start.”
In fiscal 4Q09 (ended August), SONC’s partner drive-in same-store sales declined 5.3% and franchise drive-ins fell 4.4%.
BKC: Management did not comment on fiscal 2Q10 trends, but it did talk about its recent October 19 national launch of its $1 double cheeseburger. Specifically, management stated that in markets where the $1 double cheeseburger was already launched with media support in fiscal Q1 (25% of U.S. markets) that the product was helping traffic and gross dollars, but hurting gross profit margins.
In fiscal 1Q10, U.S. and Canada total system same-store sales declined 4.6%.
TAST: “In terms of recent sales trends, Pollo Tropical was a little under 1% positive in October, Taco Cabana was down about 3.5%, while Burger King was around 5% negative. Now it’s been about two weeks since the Burger King $1 Quarter Pound Double Cheeseburger was launched, and while it's still pretty early, we believe that the improvement in sales trends so far indicate that Burger King same store sales should be positive for the balance of the quarter.”
PNRA: “By period, on a calendar basis, last night we announced 6.9% comps for the first 27 days of the 28-day October period, and we're targeting 4 1/4% to 5 3/4% comps for both November and December.”
“We also believe that our comps received some additional lift in October with easy compare to the year-ago period given the Lehman and stock market meltdowns and the corresponding impact on consumer behavior in late September and October of 2008.”
“To be specific, company comps were up 3.3% in Q3. In fact, in each period in Q3, company comps grew sequentially stronger. In July, company comps were up 2.6%; in August, comps were up 3%; and in September, comps were up 4.4%.”
PFCB: “As measured by average weekly sales, we remain hopeful that the third quarter was the low watermark for this cycle. Bistro average weekly sales declined about 9% in the third quarter. Trends have improved in the fourth, but average weekly sales are still down about 6.5% quarter-to-date.
Pei Wei, on the other hand, finished the quarter with a strong September, which is carried over into October. Overall, we expect average weekly sales to fall 6% for the bistro, but increase roughly 1% at Pei Wei in the fourth quarter.”
TXRH: “On the sales side, we experienced sequential improvement each month during the third quarter, and this trend has continued into October.”
“On the negative mix, we actually did see it get a little bit better. I mean, it's only been one month, but as we've gotten into October, our negative mix for the quarter –for the third quarter was down about 1.4%. And as we got into October, we saw it'd be negative by about 0.8 as opposed to 1.4. And really half of our negative mix has been coming from alcoholic beverages and about half of it continues to be from entrée trade down.”
In 3Q09, TXRH reported -4.6% comparable sales growth at company-owned restaurants and -3.6% at franchise units.
Trends from last year:
“October was down 4.3%, November was down 3.4% and in December was down 5.9%.”
BWLD: “The excitement of football season is here and we’re experiencing same-store sales increases of nearly 6% in company-owned locations and just under 4% in franchised locations in the first four weeks of this quarter “
This improvement is relative to +0.8% company same-store sales and +1.9% franchised growth in 3Q09.
Trends from last year:
“Well the October of last year we had highlighted had been like in the 3% range for company stores, and our quarter last year ended at 4.5%.”
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