As we discussed last week, GC reported EBITDA of $34MM and margins of 35.6%, beating Street estimates by 12% on EBITDA and margins by 450 bps and our estimates by $700k and 200bps, respectively. Revenues came in light, primarly due to continued general economic malaise.
The three ongoing redevelopment projects - additional slots at View Royal and at Georgian Downs and the opening of the parcade and Canada Line station at River Rock - were completed on time and on budget. Initial results from the Canada line opening and expansion at Georgian Downs were positive, while View Royal has yet to see a pick up in gaming volumes as a result of the expansion. The British Columbia Lottery Commission (BCLC) is also in the process of refreshing many of GC's old and underperforming slots. As a reminder, in BC the BCLC is responsible for buying slots which comes at no cost to GC.
Now that it looks like Great Canadian has gotten its (finally) cost structure under control, it's all about topline growth, which unfortunetely is highly leveraged to what the BC economy does. We do expect a lift from the Winter Olympics, but management needs to keep its focus on existing operations rather than straying down the familiar expansion path.
PROPERTY LEVEL DETAIL:
- River Rock revenues declined by 12% y-o-y, driven by lower gaming and hospitality revenues. Excluding table hold, which was comping against a high 24.8% hold in 3Q08, drop fell 4% and slot handle fell 5% (a relative improvement from the 16% y-o-y drop experienced in 2Q09).
- Costs decreased by 26%, spread over promotional spend, HR, property, marketing, and administration; resulting in 10% y-o-y expansion in EBITDA margins to 48.4%.
- River Rock should benefit from a slot refresh and expansion that will add roughly 150 slots. The product slots at River Rock haven't been updated in over five years.
- While table drop was flat y-o-y, slot handle fell 20% for the second sequential quarter, resulting in a 9% y-o-y decline in revenues at the property. Hospitality revenues actually held up well at the property and were up 10% y-o-y.
- Costs decreased 15%, resulting in 360 bps of EBITDA margin improvement to 48.4%.
- The property looks to be losing some market share to its revamped nieghbor Grand Villa. Grand Villa's contribution to the Local Goverment Share of Provincial Casino and Community Gaming Centre Revenues grew 12% y-o-y in 3Q09 and 14% 2Q09 (y-o-y).
- While table drop declines were less bad this quarter, falling 13% (vs 25% in the 1H09), slot handle fell 10% y-o-y, showing no benefit from the incremental slots added at View Royal. The increased FDC revenues softened the y-o-y decline to 6% at the Vancouver Island properties
- The 17% decline in costs at the property helped grow EBITDA 5% and improve margins by 560 bps
- Table drop only fell 2% y-o-y but there was a difficult hold comparison to 3Q08 resulting in an 8% table revenue decline. Coin in was down 5%, showing no improvement over 2Q09
- It appears that there were about 100 slots removed from the Nova Scotia properties
- Costs declined another 200k sequentially, or 16% y-o-y, and look like they will remain at these levels barring another drop off in demand.
- EBITDA decreased 7% but margins increased by 120 bps to 33.3%
BC Racinos (Hastings, Fraser, TBC)
- Gaming revenues increased 2% due to the slot additions to Hastings and higher slot win, while racetrack revenues fell 12%
- Revenue weakness was more than offset by an 18% reduction of costs which resulted in a 67% EBITDA increase and 10.4% expansion in margins
- Gaming revenues increased 3.4% y-o-y compared to being flat y-o-y last quarter. Seems too early to tell whether the slot addition will be accompanied by more demand.
- Costs fell 18% y-o-y resulting in 24% EBITDA growth and 10.5% margin expansion to 50%
As I have said before, there is a lot to love about MCD. After listening to management speak all day, it is hard to poke too many holes in the story (though being pumped full of MCD food all day left me feeling less than pleasant. This is not meant to be an insult. The food was good. I particularly liked the Mac Snack Wrap, which the company is currently testing and I heard only positive reviews of the oatmeal at breakfast, but I did eat too much).
CEO Jim Skinner said he attributes some of MCD’s success every day, everywhere to “daily miracles.” I will give MCD’s management more credit. Management knows what it is doing and is running an efficient, strong-cash generating company. It leaves little to miracles.
Things to love:
-Margins are moving higher across the board.
-International growth is impressive, particularly in Europe where reimages, drive-thrus and new products are driving share gains (even posting positive same-store sales growth in Germany with the rest of QSR negative). MCD is increasing its unit growth outside of the U.S. in 2010 by 100 units and expects to allocate more capital spending dollars to reimages in Europe next year as well.
China continues to be the laggard in APMEA with comparable sales down 6.7% YTD through October. Management attributed the weakness to economic challenges in the south where MCD has its most restaurants (represents 40% of China comp number). Specifically, management said that visits to Western QSR is down 30%. After paring back on unit development plans in China in 2009 to about 140 units as a result of the consumer pull back, MCD expects to open about 150-175 restaurants in 2010. Management did highlight that despite the top-line weakness, restaurant level margins have moved higher in China.
-The cash flow story is still intact; though MCD is no longer providing targets around how much cash it will return to shareholders. Management said there is no change to its capital allocation strategy and that it remains committed to paying out all of its free cash flow in the form of dividends and share purchases. Management’s prior 3-year target was to return $15-$17 billion. When asked why the company will no longer provide targets, management said that it deemed it necessary to provide targets to give some comfort to investors in the early stages of its revitalization process to show that “they would put their money where their mouth was.”
-ROIIC remains high. There was some concern over the fact that management’s current long-term ROIIC high teen target could suggest that returns are coming down as MCD reported consolidated ROIIC of 41% in 2007, 38% in 2008 and 39% YTD in 2009. Based on all of the questions around the high teens target, even if management is just being conservative in an attempt to under promise and over deliver on this metric, despite the target, investors will continue to expect results that far exceed them.
-There are some definite near-term tailwinds: Commodity costs in both the U.S. and Europe are expected to be down about 3% YOY in Q4 after being up in the prior three quarters and expected to be flat in FY10 (so still favorable on a YOY basis in 1H10). Management is also forecasting a $0.06 positive EPS FX benefit in Q4 after currency translation negatively impacted earnings by $0.22 per share in the prior 9 months. And, based on current rates, MCD guided to a $0.10-$0.13 EPS benefit on a full-year basis in 2010. G&A as percentage of sales is expected to continue to come down as well.
Problems in the U.S. remain. When it comes to presenting, MCD’s management team again knows what it is doing. The company showed a lot of charts that highlight MCD’s sequential improvements in annual U.S. operating income growth and margins. It then included a slide that just said same-store sales in the US are up 3.1% YTD through October. I could be wrong, but I don’t think management wanted to show a time series that would highlight the sequential decline in top-line trends. Management did address the sales softness by saying that informal eating out category growth continues to be stagnant and MCD is gaining share of a shrinking pie. That being said, I do not think the same-store sales chart was inadvertently left out of the presentation.
-Management did say that its new beverage platform, including McCafe, is exceeding its initial $125K in incremental sales per restaurant target in the test markets where it has been completely rolled out (including frappes and smoothies). This $125K in incremental sales has been the source of some confusion since based on my recollection, management first provided the number at its meeting 2 years ago (at that time, MCD said the entire beverage roll out would be complete by 1Q09). So to clarify, the $125K includes sales from McCafe, sweet tea, iced coffee, frappes, smoothies and a new bottled beverage lineup. I was surprised to hear that this platform is proving successful in test markets, but I suspect MCD might have completed the roll out in the markets where initial McCafe results were performing best. We should know more, however, once the entire platform is rolled out on a national basis, which is now not expected to be complete until mid-2010.
-YTD through October, coffee sales are up 28% (94% of that growth was driven by McCafe with the balance coming from continued growth in premium roast coffee sales). The national Angus burger launch in August exceeded internal expectations by 25% and have remained strong (I don’t think management ever quantified those initial projections). The Dollar Menu has not increased as a percentage of sales, remaining at about 10%-11% excluding the $1 double cheeseburger changes to the menu, so the Dollar Menu’s impact on average check should be holding relatively stable.
This all sounds like good news, but looking at U.S. comparable sales growth on a 2-year average basis, there is a definite deceleration in trends. So if McCafe and Angus sales are incremental, what do the core menu sales trends look like?
Like the chart we posted on CKR earlier this week, margins in the U.S. cannot keep moving higher with sales falling as shown in the chart below (margins have been helped by the company’s refranchising strategy which will continue). Though as I already outlined, commodity cost tailwinds will help on this front in the next couple of quarters. If MCD’s stock performance is driven largely by reported sales trends in the U.S., we could see continued weakness. For reference, some pricing rolled off in October on a YOY basis which will continue to impact trends for the rest of the quarter and management said it will hold the line on pricing in this environment.
Some notable changes:
-MCD’s capital spending is expected to move higher in 2010 to $2.4 billion from the projected $2.1 billion in 2009. Relative to the U.S., spending is expected to be flat YOY but management is allocating more dollars to reimages (spending roughly the same amount on reimages in 2010 as the company spent on the beverage initiative in 2009). MCD’s President of McDonald’s USA Don Thompson said sales increases at remodeled restaurants are typically 6%-7% higher than the system average. For reference, nearly 45% of the current U.S. system has been reimaged, rebuilt, relocated or newly built in the 2003-2008 timeframe.
-Management said that more of its new openings will be skewed to freestanding restaurants with drive-thrus, which it says provides better returns. Drive-thru business in the U.S. is up 4% YTD through October.
-Management is also expected to buy more real estate when and where it is possible (buying 20% more in the U.S. in 2010)
-MCD is committed to maintaining its current credit ratings but said it does have the flexibility to increase its leverage if deemed necessary.
-Management downplayed the media noise around going national in the U.S. with the Dollar Menu at breakfast, saying that it has been used in some markets for some time and is directionally consistent with overall Dollar Menu performance. Management did say we will learn more about core breakfast initiatives in 2010. And, we also learned that the company is expecting to allocate more advertising dollars to its Dollar Menu (to 15%-20% of resources from its current 10%-15% level).
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Herman Melville’s last major novel was entitled, “The Confidence Man.” According to Wikipedia:
“The novel's title refers to its central character, an ambiguous figure who sneaks aboard a Mississippi steamboat on April Fool's Day. This stranger attempts to test the confidence of the passengers, whose varied reactions constitute the bulk of the text. In this work Melville is at his best illustrating the human masquerade. Each person including the reader is forced to confront that in which he places his trust.”
The riverboat of the U.S. economy is having its own crisis of confidence in consumer land.
As our sage and savvy U.S. Strategist, Howard Penney, wrote in the Early Look this morning:
“Today we are going to get the preliminary November University of Michigan confidence numbers. The consensus is expecting a slight improvement to a 71.0 reading. A slowing to below the prior reading of 70.6 is more likely.”
Either Penney is clairvoyant or, which is more likely, the fact that he knows the restaurant sector better than most, and thus has an inside look on consumer spending, it came as no surprise that the preliminary Michigan Consumer Confidence reading this morning was a disappointing 66.0, which is a sequential decline from 70.6.
As we’ve outlined in the chart below, the trend in this measure of consumer confidence remains intact and certainly isn’t being helped by low saving rates and accelerating gas prices. We’ve now seen another monthly sequential decline. Confidence is waning, rather unambiguously.
Daryl G. Jones
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