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
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.
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.
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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.
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%
WTI Oil 76.43-80.51
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research
Client Talking Points
Day-3 of the Burning FX experiment looked like it was in trouble (in Nikkei terms) into the bell, then there was “chatter” of the “BOJ buying ETFs into the close”, and they managed to close the Nikkei up +0.4%. We couldn’t make this up if we tried. At 114.71 the Yen is crashing vs. USD and superimposing #Deflation onto everything and anything tied to Oil inflation expectations.
Today’s II Bull/Bear Spread is only +93% wider to the bullish side than it was on OCT 13th – no worries! If there was one sentiment reading that typifies the hope out there that we don’t revisit that mid-Oct fetal position, this one is it (Bulls at 54.7%, Bears re-testing all-time lows of 15.1% - spread = +3960bps wide, which is close to the end of SEP consensus bullishness).
In the Long Bond we trust. Don’t forget that the UST 10YR Yield is still in crash mode (-22% year-to-date) as U.S. growth and inflation expectations continue to fall – once we get through the mid-terms bounce today, next up is this jobs report (which was suspiciously strong ahead of the elections). A bad report should get your 2.21% on the UST 10YR, fast.
|FIXED INCOME||25%||INTL CURRENCIES||3%|
Top Long Ideas
The Vanguard Extended Duration Treasury (EDV) is an extended duration ETF (20-30yr). U.S. real GDP growth is unlikely to come in anywhere in the area code of consensus projections of 3-plus percent. And it is becoming clear to us that market participants are interpreting the Fed’s dovish shift as signaling cause for concern with respect to the growth outlook. We remain on other side of Consensus Macro positions (bearish on Oil, bullish on Treasuries, bearish on SPX) and still have high conviction in our biggest macro call of 2014 - that U.S. growth would slow and bond yields fall in kind.
We continue to think long-term interest rates are headed in the direction of both reported growth and growth expectations – i.e. lower. In light of that, we encourage you to remain long of the long bond. The performance divergence between Treasuries, stocks and commodities should continue to widen over the next two to three months. As it’s done for multiple generations, the 10Y Treasury Yield continues to track the slope of domestic economic growth like a glove. We certainly hope you had the Long Bond (TLT) on versus the Russell 2000 (short side) as the performance divergence in being long #GrowthSlowing hit its widest for 2014 YTD (ex-reinvesting interest).
Restoration Hardware remains our Retail Team’s highest-conviction long idea. We think that most parts of the thesis are at least acknowledged by the market (category growth, real estate expansion), but people are absolutely missing how all the pieces are coming together to drive such outsized earnings growth over an extremely long duration. The punchline of our real estate analysis is that a) RH stores could get far bigger than even the RH bulls seem to think, b) Aside from reconfiguring 66 existing markets, there’s another 19 markets we identified where the spending rate on home furnishings by people making over $100k in income suggests that RH should expand to these markets with Design Galleries, and c) the availability and economics on large properties for all these markets are far better than people think. The consensus is looking for long-term earnings growth of 28% -- we’re looking for 45%.
Three for the Road
TWEET OF THE DAY
#Quad4 Deflation is a very investable theme, on the short side of almost anything Energy/Oil
QUOTE OF THE DAY
To be prepared for war is one of the most effective means of preserving peace.
STAT OF THE DAY
According to an aggregation of polls from Real Clear Politics, Obama’s approval rating is 41.9% and his disapproval rating is 53.4%. For perspective, Obama’s current approval rating is very similar to that of President Bush prior to the 2006 mid-terms.
Takeaway: Our Macro Playbook is a daily 1-page summary of our investment themes, core ETF recommendations and proprietary quantitative market context.
Long Ideas/Overweight Recommendations
- iShares National AMT-Free Muni Bond ETF (MUB)
- iShares 20+ Year Treasury Bond ETF (TLT)
- Vanguard Extended Duration Treasury ETF (EDV)
- Health Care Select Sector SPDR Fund (XLV)
- Consumer Staples Select Sector SPDR Fund (XLP)
Short Ideas/Underweight Recommendations
- SPDR S&P Regional Banking ETF (KRE)
- iShares Russell 2000 ETF (IWM)
- iShares MSCI European Monetary Union ETF (EZU)
- iShares MSCI France ETF (EWQ)
- ADD: SPDR S&P Oil & Gas Exploration & Production ETF (XOP)
- REMOVE: iShares US Home Construction ETF (ITB)
QUANT SIGNALS & RESEARCH CONTEXT
- The U.S. Equity Market Will Never Go Down Ever Again… Right?: Incongruent with the consensus view that “globally coordinated monetary easing” has completely mitigated the risk of a correction (or crash) in the U.S. equity market is the performance of the asset classes, sectors and style factors most correlated to policy-induced asset price inflation. Specifically, 17 of the 20 ETFs exhibiting the greatest amount of negative momentum across the entire global macro complex as defined by our Tactical Asset Class Rotation Model (TACRM) are commodity producers and/or servicers (GDX, IEZ, FILL, XOP), individual commodity markets (USO, NIB, UGA, BNO, GLD, SLV, DBC, SGG), commodity currencies (FXC, CCX) and country indices with a significant degree of commodity price sensitivity (NGE, EWCS, EWC). Either recent price action has created the mother-of-all buying opportunities in these assets, or buy-side consensus will find itself dead wrong on the lazy thesis that the Fed/ECB/BoJ will “never let markets go down”. While the fear amongst hedge fund investors that “the stock market will never correct” is both pervasive and surreal, the real fear should be whether or not these exposures are discounting the eventual end to the market(s) actually responding positively to incremental Policies To Inflate.
- Commodity Price Tail Risks: Two tail risks emerging the commodity complex and all of the global CapEx (i.e. GDP) associated with commodity E&P include: perpetual debasement of the JPY (bullish for the USD) and the recent GOP mandate in Congress, which may portend a meaningful reduction in the Fed's ability to "CTRL+P". We wonder if the same investors buying the spoos here on the #GOPtakeover will be the same ones who sell the lows if the market crashes in realization of that last catalyst... At any rate, we're adding the SPDR S&P Oil & Gas Exploration & Production ETF (XOP) to our core investment recommendations on the short side in anticipation of further #Quad4 downside for commodity prices.
- Less Bearish on Housing: One of the questions we’ve been wrestling with internally is: “When do we make the turn from bearish to bullish on early-cycle sectors like housing?” Well, interestingly enough, our most recent deep dive into the state of the domestic housing market does indeed warrant reduction in our bearish bias (i.e. less negative). Housing, in ITB terms, continues to make a series of lower-highs so we do not yet think it’s appropriate to get bullish on housing at the current juncture. That being said, however, a failure to make a lower-low versus the intra-day low on 10/13 on the next meaningful pullback would be additional confirmation that our bearish bias is long in the tooth. As such, we are removing the ITB from our core investment recommendations on the short side. All told, a decline of -3.6% YTD for the ITB vs. +8.9% for the SPY is sizeable absolute and relative return for anyone who’s appropriately had our bearish housing thesis on all year.
***CLICK HERE to download the full TACRM presentation.***
TRACKING OUR ACTIVE MACRO THEMES
#Quad4 (introduced 10/2/14): Our models are forecasting a continued slowing in the pace of domestic economic growth, as well as a further deceleration in inflation here in Q4. The confluence of these two events is likely to perpetuate a rise in volatility across asset classes as broad-based expectations for a robust economic recovery and tighter monetary policy are met with bearish data that is counter to the consensus narrative.
#EuropeSlowing (introduced 10/2/14): Is ECB President Mario Draghi Europe's savior? Despite his ability to wield a QE fire hose, our view is that inflation via currency debasement does not produce sustainable economic growth. We believe select member states will struggle to implement appropriate structural reforms and fiscal management to induce real growth.
Early Look: All Boxed In (10/22)
#Bubbles (introduced 10/2/14): The current economic cycle is cresting and the confluence of policy-induced yield-chasing and late-cycle speculation is inflating spread risk across asset classes. The clock is ticking on the value proposition of the latest policy to inflate as the prices many investors are paying for financial assets is significantly higher than the value they are receiving in return.
Early Look: Deflated Disputants (10/30)
Best of luck out there,
Associate: Macro Team
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