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German PPI on the Rise

The German Producer Price Index rose +0.5% in August month-over-month and improved on an annual basis to -6.9%, signaling an inflection point in PPI. We believe this inflection is another indication of rising inflation in Q4 for Europe’s largest economy, and expect to see an incremental rise in CPI sequentially in the intermediate term. 

 

It is worth noting that energy costs are a main component of PPI (contributing to some two-thirds in change of the index, according to the Federal Statistics Office) and that the plummet of energy prices off last summer’s highs will define annual compares going into Q4. With PPI peaking in September ’08, the annual reading in August still yielded a discount in energy of 14.3%. However on a sequential basis, PPI gained 1.1%.  

 

As changes on the margin matter for our analytical process, it’s worth noting the divergence between comparing components on an annual versus sequential basis: while heating oil, diesel, and gas fell 34.9%, 20.5% and 8.5% respectfully annually, sequentially the components rose 11.5%, 5%, and 4.6% versus the previous month.

 

We see Germany slowly moving out of a deflationary environment into Q4. We expect a steady rise in CPI, which currently stands at -0.1% in August (annually, Eurostat) and that as inflation moves out to 2010 the ECB will need to raise rates to stem inflation. The danger therein lies that the stronger economies of the Eurozone (ie. German and France) stand to benefit from a rate hike at the expense of the weaker ones (ie. Italy, Spain, Portugal, Ireland, to name a few). 

 

On balance we continue to be bullish on Germany but are not invested in Europe on the long side. Currently we’re short the UK via the etf EWU.

 

 

Matthew Hedrick
Analyst

 

German PPI on the Rise - a2


THE WEEK AHEAD

The Economic Data calendar for the week of the 21th through the 25th is relatively light. Attached below is a snapshot of some (though far from all) of the headline numbers that we will be focused on.  

 

 

Monday Sept. 21

 

North America

Leading Indicators for August will be released at 10 AM.

 

Europe

In the UK, Rightmove house prices for September will be released on Sunday evening while on Monday the DMO will be placing its new 2050 Index-linker issue (UK TIP equivalent).

 

Asia

Markets will be closed in Japan on Monday for a holiday.

 

 

Tuesday Sept. 22

 

North America

A FOMC 2 day meeting will commence on Tuesday and the Treasury will be auctioning 2 year notes at 1 PM. Weekly ICSC, Redbook and ABC Consumer Comfort index data will also be released at normal scheduled times. In Canada, Retail Sales figures for July will be released at 8:30 AM.

 

Europe

August trade balance data will be released in Switzerland on Tuesday morning.

 

Asia

August unemployment will be announced in Taiwan on Tuesday morning as will HK CPI for August.

 

 

Wednesday Sept. 23

 

North America

Weekly MBA Mortgage application data will be released on Wednesday morning along with EIA oil gas and distillate stock levels. At 1 PM the Treasury will auction 5 year Notes while the FOMC Policy Announcement is scheduled for 2:15 PM.

 

Europe

Reuters PMI for the Eurozone in aggregate, Germany and France (Composite, Services and Manufacturing) for September will be released on Wednesday morning as will Eurozone Industrial orders. French Consumer Spending figures for July, as well as Business Confidence and production Outlook sentiment index levels for September will also be published.  At 5:15 am Germany will issue a 5 year Bobl (note that last week’s auction saw orders exceed supply by a major margin). In the UK, BBA Mortgage and Consumer Credit data for August will be issued while the BOE minutes from the September 10th meeting will be published at 4:30 AM.

 

Asia

Taiwanese Export orders and Industrial Production figures for August will be issued on Wednesday morning, as will Singapore CPI.  Despite financial markets being closed for Autumn Equinox Japanese trade data for August will be released on Wednesday evening. 

 

 

Thursday Sept. 24

 

North America

August Existing Homes Sales will  be released at 10AM, while at 1 PM the Treasruy will auction 7 year Notes. Weekly Initial Claims, M2 and EIA Natural gas stocks data will be released at the normally scheduled times.

 

Europe

German IFO Business Sentiment measures for September are slated for release on Thursday while September Consumer Confidence figures will be issued in France. In Italy, July Trade data will be issued.

 

Asia

August Trade data will be announced in Hong Kong on Thursday morning. In Japan July All-Industry Index levels will be announced in the morning while in the evening August Corporate Service Prices will be issued. Indian weekly Wholesale Inflation levels are also scheduled for release.

 

 

Friday Sept. 25

 

North America

Durable Orders and Shipments for August will be released at 8:30 AM on Friday while the Michigan Sentiment Final for September will be issued at 9:55. At 10 AM New Home sales Figures for August will be announced.

 

Europe

Eurozone M3, French Q2 GDP (Final) and Italian Retail Sales for Italy are all on the calendar for Friday morning as is UK Q2 Business Investment data.

 

Asia

On Friday morning August Manufacturing data will be issued in Singapore as will Taiwanese August M2.


MONEY CALLS OF THE DAY

TECHNOLOGY: AAPL:  MOTHS TO THE FLAME…

By Rebecca Runkle and Team

 

“Thus hath the candle singd the moath”  William Shakespeare (Merchant of Venice) 

 

A sell-side shop upgraded Apple this morning.

 

Upgrading Apple after it’s doubled in 6 months and is over-bought reminds me of watching moths flutter around a night-time light as a young girl growing up in Colorado.  No one knows for sure why moths do what they do, but there are theories.  My favorite:  these creatures are irresistibly attracted to the bright light (Apple) due to an evolutionary short circuit of sorts (easier to upgrade at $180 than $90).   

   

Don’t get me wrong, Apple’s a great fundamental story and we are short it not because the franchise is going to hell in a hand-basket tomorrow.  We are short it in the virtual portfolio because it is over-bought, because Keith got his price and because if we did manage money we’d be selling some of our long position up here – not buying more.  Risk management, plain and simple.

 

Other names we like are MOT and YHOO, but price matters.

 

See Rebecca Runkle’s portal for more details 

 

 

HEALTHCARE: A DIFFERENT ANGLE ON FLU SEASON INVESTING 

By Tom Tobin and Team

 

H1N1 has boosted the performance of stocks we included in our Influenza screen.  In the last 2 weeks the trajectory of visits to physician offices has broken out to the upside.  When I went to compare the report for the same week last year, the report is not there because there is not typically a flu season in August to comment on.  Flu spreads when the weather gets cool and humidity drops because those conditions boost its survival out of the body and the chance to spread.  There is a raging flu season already in the US, even before the weather turns cool.  Starting from such a high concentration of flu cases means there are more chances for the virus to spread person to person; think exponential. 

 

What may be another way to look at flu is absenteeism in the workplace.  If flu gets out of hand, temp staffing will be catching a bid and suffering the same absenteeism which could spell pricing and volume.   While there is not complete overlap with nurse staffing (CCRN AHS and ASGN)  there may be some work to be done there on the long side.  Keith likes the quantitative set up telling me at least two of these stocks “look fantastic.”

 

AMGN, QGEN and UNH are our favorite names in Healthcare.

 

See Tom Tobin’s portal for more details 

 

 

RETAIL – RETAIL FIRST LOOK: SEPTEMBER 18, 2009

By Brian McGough and Team

 

A conversation with Dick’s Sporting Goods management suggested that Under Armour’s launch of running shoes in their stores was inline with plans and overall DKS was pleased with the product. This is particularly noteworthy because the general perception across the marketplace and the Street is that the launch did not live up to expectations. Clearly there were some disappointments. However, with DKS being one of UA’s largest partners we think the vote of confidence bodes well for future product proliferation.

 

See Brian McGough portal for the call outs of the day …  

 

UA continues to be our favorite long-term names…


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(Swine) Flu Season Already?

At the risk of being alarmist, we are pointing out the following graphics on (Swine) Flu with caution.  In no way is the Research Edge Retail team pretending to be CDC workers or doctors, but we would be foolish to ignore such eye opening trends.  The charts below tell the story, although we can say with certainty the media isn’t shying away from what may become the most talked about national topic in the coming weeks and months.   As evidence as to how consensus the concerns are, do a quick Google News search for “Flu” and you’ll find around 75mm hits, with about 39mm of them related to H1N1 specifically, and about symptoms, prevention, and the effectiveness of wearing surgical masks.

 

(Swine) Flu Season Already? - flu chart 1.1

 

We’ll leave it to you to decide if you want to stay home, avoid public places, and use Purell every five minutes.  However, we’re fairly sure if the Flu virus continues to permeate the rest of the U.S with the speed and breadth as we have observed in recent weeks in the South, then there will be implications for consumer spending in both quantity, category and channel.  

 

(Swine) Flu Season Already? - flu map 1.2

 

So, how should we think about the potential impact of Swine Flu fear and/or actual symptoms impacting a large portion of the U.S population?  The obvious answer is to think about which retailers may benefit from this pandemic, which include CVS, WAG, and RAD. For those thinking about which companies may suffer most, mall-based retailing could take the biggest hit as consumers look to avoid highly populated public areas.  For the extremists, Amazon.com, Drugstore.com, FedEx, and UPS all could benefit from cocooning.

 

We don’t have all the answers and we’re not into “playing” names at the expense of human suffering, but this is a trend worth watching.  For now we’re digging to see if any impact is materializing in the South as the brown states have reached “widespread” levels of Flu activity.  And for those who haven’t bookmarked http://www.cdc.gov/flu/ now is a good time.

 

 

Eric Levine

Director


SONC – FOLLOWING THE RESEARCH EDGE PROCESS

I don’t want to be out of consensus just to be out of consensus, but I like SONC.  Following the cash flow has always been a great way to make money in the restaurant sector and I have used ROIIC as a successful metric to see how cash is deployed and to look deeper into the company’s long-term strategy. 

 

For years SONC had a very enviable business model and to a certain degree, still does.  Complicating the company’s operational issues is the leveraged recap done a few years back, which has handicapped the company during this difficult time.  Given all that management is doing to improve operations, I see SONC as a company closer to seeing a shift on the margin toward better profitability.  Competitive issues are a risk, but it could be reason not to own any restaurant company.    

 

REFRANCHISING WILL ADD TO RETURNS - At the beginning of fiscal 2009, SONC set out to reduce the percentage of partnership drive-ins from 20% down to 12%- 14% of the total system.  There are two benefits from this (1) a refocus on improving the performance of the remaining partner drive-ins more effectively and (2) it reduces both the operational and financial risk from the business model, improving overall returns.  It will reduce volatility and provide a more consistent earnings stream over time.  At the end of the 3Q09, SONC had already reduced the percentage of partner drive-ins from 20% to about 14%. The 177 stores sold in the third quarter netted $50.0 million in cash, bringing the cash balance to more than $100.0 million at the end of 3Q09.

 

SLOWING CAPITAL SPENDING WILL ADD TO RETURNS – Between 2004 and 2007, SONC’s capital spending nearly doubled from approximately $57 million to $110 million.  In fiscal 2009, SONC will end up spending about $50.0 million and the company plans to take down that level of spending even further in fiscal 2010 to $30 to $40.0 million.  The increased focus on the current store base and limited spending on new stores will have a positive impact on a number of line items on the P&L, boosting profitability, margins and returns.

 

IMPROVED PROFITABILITY? – It’s likely that SONC will see improved restaurant level margins in fiscal 2010, which would be encouraging after five reported quarters of rather significant declines.   The underlying assumption for improved margins assumes flat partner drive-in same-store sales, which implies acceleration in sales trends on a 2-year average basis.  Although the company is relying on the full-year benefit of its 2009 refranchising activity and lower commodity costs to drive restaurant level margins higher, we have yet to see a recovery in SONC’s 2-year average partner drive-in comparable sales trends (though they are stabilizing).  And, if the value menu continues to grow as a percent of sales, it will continue to put pressure on average check and food costs as a percent of sales, offsetting some of the YOY commodity cost favorability.   Operating margins should turn positive as early as 4Q09 and stay positive in fiscal 2010 even if restaurant margins remain somewhat under pressure.

 

SONC – FOLLOWING THE RESEARCH EDGE PROCESS - soncroiic

 

There is much more to the SONC story, but clearly management is doing everything within its control to set the company down a better path.  Over time the path will reward shareholders, but in the short run the MACRO environment continues to be very challenging for every restaurant operator.  On the positive side, MCD’s same-store sales growth has slowed and traffic has turned negative, which implies that MCD is not taking market share anymore.  The downside risk associated with MCD’s slowing sales trends is that MCD will push harder to drive traffic, leading to an increased level of discounting from the company.

 

As a point of comparison I have included the same ROIIC calculation for JACK.

 

SONC – FOLLOWING THE RESEARCH EDGE PROCESS - jackroiic


MGM: TIME FOR AN EQUITY DEAL?

The MGM lion is roaring. Is it justified?  If I were management I’d issue a serious amount of stock and solve the balance sheet issues in one fell swoop.


 

The stock is up 72% in September alone.  Thankfully, we haven’t been negative on the name but we weren’t pushing it as a long either.  Shame on us.   So is it time to take a stand?

 

A weak upgrade yesterday helped push the stock up another 7% and pushed me over the edge.  I won’t dwell too much on the upgrade but 11x $1.5bn in 2010 in EBITDA gets me to about $8 per share, not $18.  I’ve covered this industry a long time and an 11x multiple for mostly LV assets is about 2 turns higher than the average multiple over the last 10-15 years, and that’s for companies that were leveraged on average 4-5x, not 8x.  I guess an 11x multiple makes sense if one assumes a sharp V-shaped recovery.  The days of cost of borrowing being 3%, 20%+ annual increases in home prices, and negative savings rates are long gone.  MGM won’t be approaching its peak EBITDA of $2.4bn in EBITDA for many, many years and there won’t be a v-shaped recovery.  Oh and I think $1.5bn in 2010 EBITDA is too high.

 

We were in Las Vegas this past week and it’s clear that business has picked up.  However, the improvement stems from:  1) seasonality and 2) easier comparisons.  Neither of these provides much comfort that the underlying metrics are improving.  Vegas seems to be bouncing along the bottom.  I would argue that we are not even in recovery mode, never mind a V-shaped recovery as implied by MGM’s valuation.

 

CityCenter is obviously a big potential catalyst, positive or negative.  We toured the construction site and I must admit that I was impressed.  The big issue is whether or not CityCenter can grow the market.  Does it have enough “special sauce” to drive visitation to the city to offset the huge capacity increase.  We calculate CityCenter’s 6k rooms will raise high end Strip room supply by over 30%.  Even if CityCenter does okay, cannibalization of MGM’s existing 32k Strip rooms is the big issue.  See our 07/17/2009 note, “PLENTY OF ROOMS AVAILABLE AT THE STRIP INN IN 2010”.

 

                                               MGM: TIME FOR AN EQUITY DEAL? - LV high end room inventory

 

It’s all about room rates and maybe that’s why we are negative on Las Vegas next year and skeptical of a v-shaped recovery.  We’ve written extensively on our view that Las Vegas was an exaggerated microcosm of the consumer bubble.  National housing prices was statistically the most significant economic driver of Strip room rates over the last 15 years and drove almost all of the huge margin expansion experienced over that time period (see our updated Strip margin analysis, “FRAT BOYS AND LAS VEGAS”  from 06/01/09).  With housing plummeting, the savings rate climbing, and gaming’s share of the discretionary wallet declining, we are hard-pressed to believe that:  a) a V-shaped recovery is forthcoming and b) room rates will approach their 2007/2008 peak any time soon.

 

                                                MGM: TIME FOR AN EQUITY DEAL? - LV PROFIT MARGINS

 

The new Las Vegas is looking awfully similar to the old Las Vegas:  low room rates keeping the gaming floor full.  This model works, just not as well as the one that focused on 20%+ annual room rate increases.

 

With this thesis in mind, I would be issuing equity, straight or a convertible note.  MGM is not out of the woods from a balance sheet perspective.  As of 6/30/09, MGM was levered almost 8x.  That’s high by any measure.  Why not take the leverage risk off the table? 


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