Takeaway: Mass and VIP volume well below expectations. Premium Mass table conversions to Direct VIP only partly to blame for the Mass disappointment.
October numbers look much worse than previously thought.
Please see our note: http://docs.hedgeye.com/HE_Macau_OctDetail_11.5.14.pdf
There are more than five reasons, but we will start with these.
S.E.C. Subpoena: In a Halloween 10-Q filing, CAT disclosed an S.E.C. subpoena from September 10, 2014 saying “…SEC issued to Caterpillar a subpoena seeking information concerning the Company’s accounting for the goodwill relating to its acquisition of Bucyrus International Inc. in 2011 and related matters. The Company is cooperating with the SEC regarding this subpoena and its ongoing investigation. We currently believe that this matter will not have a material adverse effect on the Company's consolidated results of operation, financial position or liquidity.” We reviewed this accounting issue in the summer of 2013 CAT Short Review: Short Thesis, Long Tail: Replay: CLICK HERE, Materials: CLICK HERE. Investors love S.E.C. subpoenas and potential restatements.
Oil Price Decline: Oil & Gas is a large, high margin end-market for CAT. After the collapse in mining equipment demand, CAT management directed attention away from Resource Industries and toward Energy & Transportation. We continue to think that will prove an error. On their earnings call, CAT commented that “the feedback we've been getting that say, mid-$80s - say $80 to $90, somewhere in there on a sustained basis, certainly will take the really agitated top off of it. …. I think if you'd see low $70s on a sustained basis there would be a chill across the market. Markets are closer to the “chill” level now and time will tell if it is on a “sustained basis”. Still, it sets up what are likely to be tough comps for E&T in 2015, which already had tough comps elsewhere. Our recent call on tight oil suggests the chill may not thaw soon.
Mining Can Get Worse: Mining capital spending may be at or near a bottom, but results from Resource Industries can get worse. We expect pricing pressure, which was mentioned in the 3Q 2014 earnings press release, to persist. Orders in revenue likely reflect better pricing than those backlogged in today’s weaker market. With mined commodity prices continuing to see pressure (e.g seaborne iron ore under $80/t) and MATS rules set to impact coal in 2015, idled equipment may well be parted out or resold/repurposed. CAT Financial may be impacted if used equipment prices decline, potentially exposing the receivables portfolio to losses. As we understand it, not all of CAT’s mining exposure is categorized under the “Mining” section of CAT Financials disclosures, as much of it is presented by geographic region.
Tier IV Pre-Buy: While the locomotive pre-buy ahead of new emissions regulations was largely telegraphed and quantified at “less than 2% impact on Energy and Transportation” next year, the rest of the Tier IV impact was not. We expect to see an impact on larger gensets and other very large engines in 2015.
Inflated 2015 Estimates: CAT hasn’t guided revenues conservatively in recent years, with the 2014 top line mid-point staying constant since last October. Given the evaporation of Resource Industries, likely pressure on Energy & Transportation (Tier IV, Lower Oil), and tough comps in Construction Industries (dealer inventory build, record margins), flat revenue growth seems reasonable, and perhaps aggressive, in 1H 2015. The street lowered 2015 sales estimates a bit following the guidance, but remains above guidance (consensus at ~$56.9 bil vs. guide of ~$55 bil). EPS are expected to grow to an adjusted $7.00 from an estimated $6.50 in 2014. By our initial estimates, CAT would have to buy in a huge amount of stock to get there.
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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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