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Scratch This

The 7-Year Itch of reliquifying $550 billion in levered loans from the 2003-2008 PE shopping spree is in full force. It needs to be medicated.


One of our key themes in 4Q09 was the ‘7-Year Itch’, the crux of which is that the spend-a-thon that occurred in the private equity world from 2003-2008 at peak valuations and peak margins needs to reliquify to save pro-cyclical buyers from their own bad bets. The tally is a frightening $550billion in levered loans that need to come to market.


Scratch This - 7 YEAR ITCH


With the Piggy Banker Spread (between 10s to 2s) near all-time highs, the average CEO just having seen their net worth pop by over 50% from a scary bottom, and the Mensa Society running our investment banks showing their propensity to dole out the big bonuses for performance that is grossly misaligned with what is needed for a healthy US financial system, it should not come as a shocker that deal activity is ripping.


Can you please quantify ‘ripping’ McGough?  Ok.

  1. We saw 90 equity offerings worth $40.2 billion come to market since 1/1/08.  Ironically, one transaction – Visa – accounted for 45% of this total. Excluding this, we’re looking at $22.3bn gross over 2 years.  A full 62% of that occurred since September, when ‘the most hated rally in history’ was a stone cold reality and the spread between 10s and 2s hitting all-time highs was acknowledged as the gift that it is.
  2. Aside from IPOs, we’re seeing stepped-up M&A activity. Heck, if you’re a banker, you get paid more on a merger/acquisition than you do an IPO – so why not?  Just this week we saw Walgreens buy Duane Reade. Not a lot of detail was given, but based on facts given, our analysis is getting us to a (levered) loss of about 45% for Oak Hill on the deal.
  3. Back in IPO land, now there’s talk of Toys R Us coming back to market. Dollar General is one of the biggest pigs thus far to don enough lipstick to switch hands. Toys R Us is bigger. We think Sports Authority will follow. We’re gonna need a lot more lipstick.

Scratch This - IPO COUNT vs SPREAD


But it’s not all positive, folks. In fact, over the past month, we’ve seen 15 IPOs and 16 debt offerings pulled. One of the more notable retractions is this morning’s announcement from Blackstone that Travelport is not ready for Prime Time (actually, they’d argue that Prime Time isn’t ready for them).


What is almost ready for prime time is a BX short, which has a broken TREND line on Keith’s models of $13.97. Stay tuned on that one.


Scratch This - BX


Brian McGough



Despite the stock’s slight outperformance in the last month (+4.6% vs. the QSR group’s average 3.1% move higher), JACK’s fiscal 1Q10 EPS results came in below expectations at $0.43 relative to the street’s $0.45 estimate.  Not only is JACK one of the few companies to miss from an earnings perspective in calendar 4Q09, but the quality of the earnings reported is low as the company benefited from a lower tax rate, a $1 million insurance recovery payment, a $2.5 million mark-to-market adjustments on investments supporting the company's non-qualified retirement plans and a $4.3 million decline in facility charges related to impairments (though the quarterly gains from the sale of company-operated units were lower in the quarter). 


Investors were obviously not happy with the magnitude of same-store sales decline expected during the first quarter as the stock traded down nearly 8% when JACK reported fiscal 4Q09 results and guided to a -10% comp at Jack in the Box company restaurants in fiscal 1Q10.  Unfortunately, management’s guidance proved not conservative enough as first quarter same-store sales declined 11.1%, implying a 130 bp decline in 2-year average trends from the prior quarter.  Based on same-store sales trends of -9% in the first four weeks of the quarter, management’s 2Q10 outlook assumes a -8% to -10% comp at Jack in the Box.  The company’s guidance also reflects the impact of the unfavorable weather it has experienced in many of both brands’ markets, particularly in Texas for Jack in the Box, which represents 30% of the concept’s company restaurants.  The low end of this 2Q10 guidance range implies another 10 bp sequential decline in 2-year average trends.




Comparable store sales at Qdoba declined 1.7% in the quarter, better than management’s guidance of -5%.  Specifically, same-store sales improved throughout the quarter and even turned positive in the second half of the first quarter. 




Management largely attributes the divergence in trends at Jack in the Box and Qdoba to the improvement in consumer confidence among higher income consumers relative to lower income consumers.  CEO Linda Lang stated that the issues at Jack in the Box are macro-related as the high rate of unemployment among its key demographics, particularly young males and Hispanics, continues to put pressure on sales, as does its significant geographic exposure to California and Texas.  She also pointed to continued aggressive industry discounting and lower grocery prices as detrimental to trends at Jack in the Box.  To that end, Jack in the Box has focused more on value offerings, causing average check to decline during the quarter for the first time since 2002.


In response to a question about whether the weakness at Jack in the Box is more brand-specific or macro driven, Lang stated, “We really believe that the challenges that we’ve had with regard to Jack in the Box is macro related and it’s related to the high unemployment among the core consumer, both the general market consumer, that younger, lower income consumer, as well as the Hispanic consumer.  From our research, we’re executing very well in terms of the guest experience.  From our attribute ratings and our new product research, they’re scoring very well. I can tell you the grilled sandwiches, the early indication is that the consumer is very positive with the launch and scored very high in terms of quality ratings as well as value ratings, so we know that from a consumer standpoint that value is very critical, not only for the bundled meal deals but also the premium products.  So we purposely re-recipe the grilled sandwiches so that we could launch them at a $3.99 price point and we think that’s really key to delivering a great product that’s differentiated, premium positioned but also a good value. So this isn’t -- we do not believe that this is a brand issue whatsoever.”


Although Jack in the Box is facing macro headwinds right now as its key demographics are clearly under pressure, as shown in the charts below, I think it is risky for a CEO to say none of the problems are concept-related as it does not leave investors feeling confident about a company’s ability to better navigate through a tough environment.




Despite the 11.1% decline in same-store sales at Jack in the Box, restaurant level margin only declined 30 bps in the quarter as the company benefited from a 7% decline in commodity costs.  Margin compares get more difficult as we trend through the balance of the year and the commodity favorability is expected to moderate in the second quarter and negatively impact margins in 2H10.  Increased discounting and bundling offerings will only add to this margin pressure.  For reference, management maintained its full-year 15% to 16% restaurant operating margin guidance despite lowering its same-store sales outlook at Jack in the Box to -5% to -8% from its prior -3% to -7% range.  Full-year commodity costs are now expected to decline 1% versus the company’s initial expectation for flat costs.


Other interesting takeaways:


Jack in the Box extended its value message to its breakfast menu, which has subsequently helped trends at breakfast.


Jack in the Box has experienced a steady improvement in traffic and sales trends since the end of November, which it attributes to a reallocation of media spend to communicate concurrent messages focusing on both value promotions and premium new products to drive traffic among a broader range of consumers.








Howard Penney

Managing Director

Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.46%
  • SHORT SIGNALS 78.35%

We See Inflation

In this morning's Early Look, I used a curling metaphor to describe the global macro markets news flow.  I'm not sure I can come up with a metaphor for the chart below, or that we need one.  Focus on the trend in PPI, which is used as a proxy for inflation.  As the comparisons get easier over the next couple of months, reported inflation is only going to accelerate.  As depicted in the chart below, inflation is already running well above the three year average at the 4.6% reported today.


He Who Sees No Bubbles or Inflation (Chairman Bernanke) has indicated recently that he will not keep interest rates or montary policy at emergency levels in perpetuity.  And that, thanks be to Volcker, is a prudent and rational thing.  The timing on when he takes action, of course, is the open ended question.  In contrast to the fair Chairman Bernanke, we look at the chart below and we see inflation. It is not interpretation, it is a fact.  What is also obvious is that inflation, on a reported basis, is only going to accelerate in the coming months.


A friend of the firm, who also happens to be the Treasurer of major resturant company, indicated to us a few months back that, "He didn't see a core inflation problem."  All I can say to that is to reiterate, we see inflation. And if you don't believe your friends at Hedgeye, believe the chart below.



Daryl G. Jones

Managing Director


We See Inflation - PPI








ANF: Denim, T’s, and Polarization

ANF: Denim, T’s, and Polarization


Over the years, Abercrombie has gone from loved to hated to loved and everywhere in between.  However, it’s hard to remember a time when investor interest and the company strategy have been more polarized.  The smoke has cleared after Tuesday’s EPS, expectations are reset, and the consensus EPS estimate is now $1.66 for 2010.


Over the years, Abercrombie has gone from loved to hated to loved and everywhere in between.  However, it’s hard to remember a time when investor interest and the company strategy have been more polarized. The smoke has cleared after Tuesday’s EPS, expectations are reset, and the consensus is now at $1.66 per share.  Aside from a slight beat vs. expectations, management provided some longer-term parameters or benchmarks for which they would like to Street to measure against.  First and foremost, the company set a goal to return to a 15% operating margin over the next three years.  Sounds reasonable when looking at the historical multi-year run of 19+% margins, but the company is now in the midst of more changes than we can remember.  If you’re a true optimist then you’re probably focused on CEO Mike Jeffries’ comments which suggested a return to 20% EBIT margins is also still within reach.


As analysts it’s our job to opine on the merits of such a goal and ultimately make a judgment on whether or not this seems reasonable, obtainable, and over what time frame can this realistically occur.  Unfortunately, the specifics of such a plan were not entirely quantified, although additional disclosure on underperforming stores (almost 25% of the entire base!) and the international operation was definitely a step in the right direction.  But, key questions in our view still remain.  Can domestic productivity rebound on store closures alone? Can gross margins return to peak levels while AUR’s continue to decline and macro headwinds (aka traffic) still exist?  Can management bring Gilly Hicks into the black while keeping the store base stable and relying on productivity gains? Can all this be accomplished while simultaneously doubling the international store base each year? Furthermore, is aggressive growth outside of the U.S really worth that much if the domestic business continues to shrink a measurable pace?


These questions are what makes Abercrombie so polarized, at least in our view.  Each of these factors is critical to realizing the 2012 margin goal of 15%+ ($3.30-$3.40 in EPS assuming flattish sales).  With margins finishing 2009 at 6.6%, a rebound of 840 bps is needed over the next 3 years to achieve this goal.  Keep in mind that management suggested trends may actually get worse in the near term. Gross margins are expected to remain under pressure as clearance activity and lower AUR’s persist.  Additionally, a back-half weighted store opening plan with a substantial international bias will also weigh on results as costs run through the P&L prior to opening.  Whether this is conservative positioning remains to be seen, but the reality is we’re now looking at holiday 2010 before we can make a reasonable judgment on the progress of the many initiatives underway.   For now, the bar has been set low, with little expected in the near-term as the company begins the three year journey towards a profitable recovery.  That keeps us smack of the middle of the debate for now.  On one hand it appears that management bought some time here, but on the other hand there are numerous unanswered questions that remain.  Before we can get on board and see through the polarization, we need to see more evidence that all these moving parts can in aggregate reverse a declining sales and profit trend that has been in place now for over two years.


Here are some more of our post-quarter thoughts.


 Domestic Productivity


  • There are 230 A&F, A&F Kids, and Hollister stores with a negative four-wall contribution in aggregate of $36 mm (about $0.27/share) in 2009. The negative contribution is skewed toward A&F and A&F Kids stores and is heavily concentrated in C malls. 95 of the 230 stores are more critically ill, which caused the company to take an impairment charge in the quarter.  Looking at the A&F store cannibalization, approximately 16% of the brand’s stores are located within a ½ mile distance from each other. 


ANF’s Plan: Cull the store base through natural lease expirations (half of the 230 stores have leases expiring before 2012), rent relief, and early closures where profitability is not achievable.  Additionally, management believes productivity (i.e. sales) improvements would boost some locations back to four-wall profitability, but the amount of such stores on the “cusp” is unknown


Hedgeye: Either way we look at it, almost 25% of the domestic store base is unprofitable and even with a same store sales rebound, total volume is likely to decrease as locations are shed.


  • Gross Margins have declined 280 bps since the 2007 peak of 67%, mostly due to increased promotional activity and higher markdown activity.  Headwinds will persist in 1H 2010 with lower AUR’s (still expected to be down 7-10%) in the Spring and an expected increase in freight costs.  Product costs in 2H 2010 have not been addressed, however many retailers and apparel companies are already planning for increases beyond mid-year.    


ANF’s Plan:  Management put gross margins first on the list of improvements needed to achieve the goal of 15% operating margin by 2012.  The intent to raise gross margins back to peak historical levels of 67% will likely be a difficult task in the near to intermediate term even as the higher-margin international business becomes a bigger part of the equation.  Clearly less clearance activity is both a function of better product and more customers walking over the lease line.  Both of which are still big unknowns.


Hedgeye: Management maintains that they are able to get back lost gross margins even with lower AUR’s (which have been offset by lower COGS) but this seems like a short sighted view based on a deflationary environment.  Additionally, lower volumes on a smaller store base does not suggest economies of scale are improving here.  Customer traffic, while barely mentioned on the call, remains a critical element to the “productivity” equation and a factor that will be dictated by the overall economy, merchandising improvements, and the price elasticity of lower prices.


  • The intimates concept Gilly Hicks, with 16 stores, remains unprofitable.  Management dispelled rumors that the brand would be shut down but noted that the store base will remain essentially unchanged until productivity is improved.   


ANF’s Plan: Management calls for Gilly Hicks to break-even or become profitable over the next few years through aggressive goals for increased productivity.  However, the steps needed to drive sales and ultimately profits were not articulated.  If a successful turnaround is made, the store base will ramp up in 2012.  In other words, management just bought three more years for the brand.


Hedgeye: While this is a smaller part of the story at the moment, it still represents the only potential domestic growth strategy for the company as of now. 


International Expansion


  • Flagships and international stores have considerably higher gross margins and sales volume than domestic stores, especially as the US store base finished the year with a mid-single digit operating margin.  The NYC 5th Ave. A&F flagship store contributes $100 mm in revenues a year while London, Milan, and newly opened Tokyo are expected to contribute $200 mm in aggregate to the topline in 2010.  Management suggests that close to 20% of the incremental sales added through international store openings will flow through to operating income, which is clearly the reason why store growth is ramping up overseas.  UK Hollister stores average 6x more volume than domestic stores, however newer stores are planned to be less productive on average than the malls they are currently in.  This sounds like the best locations were already opened. 


ANF Growth Plans: Copenhagen, Fukuoka (Japan), and NYC 5th Ave. Epic Hollister store are in the works for opening in Q3 and Q4 of 2010. Paris is in the works for 2011. The international store based will grow from 28 units to 60 with the addition of 30 new Hollister stores in Europe and 2 international A&F flagships.   As such capex is expected to grow by 40+% in 2010, to $250-$260 million.  That’s a big jump considering at least 100 stores will actually be closed over the same time frame.


Hedgeye:  There is no question that the best growth prospects for ANF at the moment are outside of the U.S and what better way to tap into this than opening highly visible, super productive flagship stores.  However, we wonder what happens when it comes time for these locations to finally comp against their initially high productivity.  Adding stores in a hub and spoke manner is also likely cannibalistic to the flagship, which can’t be good for leveraging high cost real estate. Over the next year or two however, we do believe that store closures can be somewhat offset by higher profile non-US growth. 



-Eric Levine & Zach Brown


ANF: Denim, T’s, and Polarization - 1


ANF: Denim, T’s, and Polarization - 2





"This has been a challenging but momentous year for MGM MIRAGE culminating with the opening of CityCenter in December. We generated significant cash flows and kept our buildings occupied at 90% even in a brutal economy because we are equipped with the highest quality resorts, the preeminent brands, and the finest employees in the industry. We have profoundly improved our cost structure and are actively building revenue to maximize operating leverage as the economy shifts into recovery mode. Our forward convention booking pace accelerated again in the fourth quarter with over 440,000 future room nights booked."

- Jim Murren, MGM MIRAGE Chairman and Chief Executive Officer



  • There has been aggressive price discounting among our competitors, we haven't been doing it though ...
    • Well LVS wasn't either ... so who was?
  • Claims that airlines have added seats to flights, and auto traffic has grown as well.. expect visitation to be up this year... still feel very comfortable that 38MM people will visit Vegas in 2010
  • MGM is the biggest Baccarat player - especially in the high end
  • The 440k room nights they booked in 4Q09 excludes Aria but isn't all for 2010, and its double what they booked in the 4Q07, and half of the bookings are from new customers
  • Group bookings in 2010 - mix was 11.3% (convention mix as a % of total portfolio) was 16% in 2007.  Expect that they will be back in the mid teens by 2011... that mix shift allows them to occupy rooms with more profitable customers
    • They aren't aggressively pricing this business - rather at rates competitive with leisure rates
    • Prices that they are getting are close to 04/05' and what they are booking for 2011 is close to 2007
  • Down to 16% attrition compared to 12-13% historically
  • International marketing was very successful - driven by their Asian visitation
  • Synergy between Aria and other properties has been very profitable so far, since they are now getting customers that were going elsewhere... that's their plan for growth too
  • How is Aria doing?
    • Reviews have been "outrageously great"
    • Volumes are ramping up
    • Opportunity going forward is almost "unlimited"
  • Bellagio is up in almost every metric and luxury portfolio is doing well.. no cannibalization from Aria. All properties had Baccarat increase ex- Aria
  • YTD occupancy is up y-o-y and room rates have been improving (I assume that means less negative?) They are up y-o-y right now.. because of CNY
  • We know we've gained market share 
  • The environment remains challenging and likely will remain so for sometime, but we see light at the end of the tunnel
    • Fundamentals improving and so is the balance sheet
  • 4Q results were impacted by impairment charges resulting from their decision to write off the AC "City Center East" development. They also adjusted thier accrual for the CityCenter guarantee to $150MM from $68MM previously
    • I assume this means that condo sales may be worse or capex to complete is higher?
  • Why do they say that things improved when the declines got less bad due to easier comps? It's not the same thing.. Improve means increase... not slowing declines
  • MGM Detroit continues to garner almost 40% market share
  • MGM Macau was impact by lower hold (EBITDA was only $46MM... I'd like to see them continue to argue that they can do $300MM of EBITDA in 2010 when they only did $161MM this year)
  • Aria benefited from high hold
  • New R/C would have a 20-25% paydown to extending lenders, LIBOR +500bps with 2% LIBOR floor still in place
  • Have $1.1BN of availability under the R/C which reflects the payoff of $293MM of bonds this past week that just matured
  • 2010 1Q Guidance
    • Total Stock comp: 10MM
    • Corporate expense: 30-35MM including 4MM of stock comp (this q included some severance and bonus accrual and hence came in 10MM above guidance)
    • Pre-opening should be minimal compared to 4Q2009
    • D&A: 160-170MM
    • Gross Interest expense: 265-275MM with no capitalized interest
    • Capex for 2010 will be a little higher than 200MM
    • RevPAR is expected to be decline less than what they saw in 4Q09
  • City Center update
    • About 1,000 contracts need to be closed out now that everything is open
    • Dec occupancy was 62% with an ADR of $236 for Aria
    • Booking trends in transient and leisure improving each week
    • Elvis set to have it's official opening next week
    • On residential - 30% price adjustment and mortgage finance assistance. Received 400 applications to date as a result.  Mandarin closings began and will take about 6 months
    • Crystals is continued to build out - opened with 41% tenants, will be 56% occupied by 1Q2010 end and 85% by 2010 YE (looks like they had some slippage in occupancy since last call)


  • Relaunching their marketing program next quarter- and expect it to be more effective than before and should help core properties and help them yield rooms more appropriately
  • Convention group used to be over 40% of its room mix historically, claim that the mix there is starting to improve
  • AC strategy
    • Already announced that they are looking to sell their 50% interest
  • Macau strategy 
    • Well we made "a lot of money" in January, and 4Q09 wasn't as good because of hold but volumes are improving (if they're so good why don't they disclose them?)
    • Luck was also on their side in January for more details see our January Macau note and the MGM IPO note. We estimate table win was $145MM in January
  • Contribution from Borgata was up slightly y-o-y but won't disclose the numbers
  • 100% of the rooms are open at Aria since about 5 weeks ago
  • $150-200MM reserve for City Center - what does that mean?
    • Yes there are roughly $150MM of cost over-runs
    • Entitled to use first $244MM towards construction - may have to put that out in 1Q2010
  • Gross casino receivables  - $261MM vs. $244MM in 4Q08 (predominantly LV)
  • Think that RevPAR will turn positive in the 3rd quarter, and should be no worse than flat if not up for the year.
    • I assume this includes Aria rooms which skews the number? Either way, with all the comps RevPAR is kind of meaningless since they can assign any rate they want to those rooms.  So bottom line will tell the story more so than "RevPAR"
    • Rates turn positive in April, and the rates they have on the books for 2011 are similar to 2008
  • What % of 2010 and 2011 books are net new to Las Vegas vs. stealing share from competitors or just rebooked cancelled conferences?
    • About 50% is new business to MGM Mirage in terms of convention business, of that maybe 50% of that is new to Las Vegas
    • Think that convention business will be low teens of their total business this year
  • How much secured debt basket they can issue?  $800-850MM range
  • Margins in MS & Detroit are better than competitors because these are market leading assets
    • One of the Detroit competitors has been aggressively buying business and they won't do that
    • Tunica is just doing great
    • They are cross marketing Detroit, Biloxi & Tunica more successfully than they have been able to do in the past
  • 2010 EBITDA expectations?
    • They don't give guidance but they expect cash flows to improve if RevPAR improves
  • Have 845 rooms at Vdara turned over to the hotel and the remaining are under contract.  In May, once the closing process is complete they can turn the remainder over to the hotel
  • Sources of liquidity over the next few years:
    • Cash flow from operations
    • Disposition of AC
    • IPO in Macau
    • Ramp up of CityCenter and as is underleveraged and as it matures they can recapitalize it
    • Opportunistic access to capital markets, right now more focused on secured because it's cheapest now
  • Who is City Center cannabilizing if its not them?
    • Won't know for a few months
    • Not Bellagio, it's benefited them, foot traffic at Bellagio has improved significantly and occupancy and ADR are up at Bellagio
  • Difference between transient and group rate?
    • Leisure and group differential is about $60

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