With the news of a large activist buying into MCD, we find it prudent to ask, “Will shareholders be saved?”
We think it’s going to be a long road. The last activist that was involved in MCD was successful, but not because they had an impact on management thought process.
What did Pershing see in late 2005?
What did Pershing propose?
What was McDonald’s response?
In the end, the company never implemented any of Pershing's bold plans. Pershing's investment in MCD was successful, not because of the their ideas, but because the business was going in the right direction.
Here we are, ten years later, with another activist prepared to potentially knock on the door of MCD. In some ways, it’s a very different McDonald’s this time around. In others, it’s the same old story.
Last week, Jana Partners took a stake in MCD by accumulating 1.042 million shares, inclusive of calls. According to the investment manager’s website, “Jana typically applies a fundamental value discipline to identify undervalued companies that have one or more specific catalysts to unlock value. Jana can be the instrument for value creation by becoming an actively engaged shareholder.”
We understand why an activist would be attracted to MCD today:
The activist playbook in the restaurant space is generally confined to a couple of key moves. Get control of the board and do one, or all, of the following:
In the case of MCD, we believe it will be very difficult to achieve any of these moves.
First, we don’t think the board is ready to give up on CEO Don Thompson (for now, at least). Second, selling real-estate will never happen at MCD; there is a chance, however, that the company sells some McOpCo stores. All told, we believe the latter is too small of a change and would not move the needle on profitability. Third, McDonald’s doesn’t have any non-core assets. And, fourth, we believe it is unlikely management will increase leverage because they like their credit rating where it is. This would likely be a unwise move, to be frank, because increasing leverage in a declining sales and margin environment is unlikely to create shareholder value.
Now, either Jana’s investment is just the beginning of a bigger position or they are making the call on a short-term improvement in the operating performance of the company.
We’re not sure what the play is here.
What we are sure of is that McDonald’s is unlikely to see a notable, short-term improvement in trends and that Jana’s position is too small to agitate for change. The truth is, none of the typical moves in the activist playbook will generate much value in this environment.
The biggest upside in MCD will come from fixing the core operations. With no disrespect to Jana, there is likely little they can do in this regard. If they did come up with a silver bullet it would take 12-18 months for it to be approved and executed. Lastly, we doubt the franchisee base will look kindly upon a hedge fund telling them how to run their business.
For this reason, we still think there is risk to the numbers in 2015 and remain bearish on MCD. We normally side with activists in the restaurant space, but we don’t see how one can make money in MCD right now.
Feel free to call, or email, with questions.
This note was originally published at 8am on November 04, 2014 for Hedgeye subscribers.
“Write down, therefore, what you have seen, and what is happening, and what will happen afterwards.”
No, I’m not going all religious on you this morning. That’s the opening volley from Jim Rickards in his recent book, The Death of Money. For those of you who missed it, I had a Real Conversation @HedgeyeTV with Rickards earlier in the year that you can watch here.
Do you write it down? What is “it”? And what do you do when something macro is happening that hasn’t happened for a very long period of time (like #deflation)? Once market expectations go through a phase transition from inflation policies to deflation, what will happen afterwards?
I’ve been writing down real-time market quotes, data, research, etc. in my notebook for 15 years and I have only seen versions of what I have been writing down for the last 10 months 2x: October 2007 and October 2008. Neither were bullish historical reference points and neither were the same.
Back to the Global Macro Grind…
To review, what is #Quad4 Deflation? In our risk management process (rate of change) it’s when the second derivatives in both growth and inflation are slowing, at the same time. These signals are both non-linear, and dynamic.
“There has been no episode of persistent deflation in the United States since the period from 1927-1933; as a result, Americans have practically no living memory of deflation.” (The Death of Money, pg 9)
I was in LA yesterday (San Francisco today) and, to a degree, I think that’s why we’ve been getting so many moments of silence in one-on-one Institutional Investor meetings as of late. It’s really hard for objective risk managers to absorb a scenario they’ve really never had to deal with.
“Objective”? Yes, as in this is what the market told you about #Deflation expectations yesterday:
In other words, in stark contrast to the Dollar Up, Rates Up #Quad1 signal we gave you to be long of everything big beta US growth in 2013, this Dollar Up (going to cash), Down Rates, #Deflation move is nasty for most things that lose their pricing power.
Healthcare (XLV) and Utilities (XLU) are two of the sectors that don’t get decimated by #deflation as fast as a levered-long-crude-oil-hedgie-dude (or an upstream E&P MLP dude who depends on the “dividend” that is decided by the price of the other dude’s oil inflation expectations).
I know, #dude!
That’s why the objective investor who has been writing down the sector returns for the SP500 in 2014 has noted the following RELATIVE YTD performance:
Yep, if all you did was express either our early-cycle slowdown calls for #ConsumerSlowing and #HousingSlowdown from the beginning of the year and/or our #Quad4 deflation call, in your S&P Sector asset allocations, you’ve crushed it.
If all that mattered to the American Consumer was “gas prices” (it actually represents only 6.4% of the median consumer’s budget) all of these rosy “surveys” you’ve been reading would have been right. Instead, in relative and sector performance terms, those narrative fallacies got you killed.
But, but, the ISM number was great yesterday. Yep, just great, another survey!
In other news, Industrials (XLI) closed down on the day on that ISM manufacturing report. I wonder if that’s because the non-survey data (US Retail Sales, Consumer Spending, Durable Goods, Construction Spending, and New Home Sales), all recently SLOWED, in actual rate of change terms!
If only everyone who writes in this business was forced to actually write this stuff down, every single day, consensus might be as concerned about the big beta #bubble in levered-long-and-illiquid US equity inflation expectations as I am.
But what is your catalyst, Keith?
If everything that was in #crash mode on October 13-14th were to crash, literally, tomorrow… I’d write it down too – and “it” would be something that should not come as a surprise to anyone.
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 2.21-2.37%
Italy’s MIB Index 18912-20099
WTI Oil 76.41-80.94
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
Hedgeye CEO Keith McCullough handpicks the “best of the best” long and short ideas delivered to him by our team of over 30 research analysts across myriad sectors.
Takeaway: Lots of positive buzz on elements on Quantum, particularly the WiFi. But the 'Quantumizing' of the existing fleet will be costly.
Management commentary on board Quantum
Chairman Fain, CEO
Jason Liberty, CFO
Q & A
Editor's note: This complimentary research was originally published November 13, 2014 at 07:33 in Financials. For more information on our services click here.
After a two month slide, taxable bonds rebounded posting their first subscription in 8 weeks.
Investment Company Institute Mutual Fund Data and ETF Money Flow:
After an exciting month of October whereby over $36 billion alone spilled out from the taxable bond fund category, the latest ICI survey relayed some stability with a $5.0 billion inflow by investors, the first subscription since the week ending September 10th. A post-mortem of the beneficiaries of the October snap redemption shows that broadly bond ETFs hoovered up the most "money in motion," with several select Total Return Funds including the Metropolitan West Total Return Fund (a unit of TCW), BlackRock's flagship fund, and Jeff Gundlach's DoubleLine substantially improving assets-under-management in the month. Interestingly, but not a surprise to us, the Janus Uncontrained Bond Fund, had a very modest benefit and as a result we remain skeptical of the resulting market cap improvement of that company without the support of new assets-under-management (read our JNS research here).
In other survey data, U.S. equity mutual funds put up another worrisome $1.7 billion redemption making it 25 of the past 28 weeks with outflows. We continue to recommend underweight or short positions to those managers with outsized U.S. equities exposure (read our research here). Passive fund flows via ETFs continue to be substantial with a year-to-date high of $17.7 billion into total equity ETFs last week and another inflow into bond ETFs, the 6th straight week of fixed income subscriptions. The blood letting continued specifically in the Materials Sector SPDR with another 19% of assets-under-management alone coming out of that product over the past 5 days. Conversely there has been strength in Utilities (XLU) and the 20+ Treasury ETF (TLT) products with respective inflows improving AUM by 7% and 8% during the week.
In the most recent 5 day period ending November 5th, total equity mutual funds put up net outflows with $302 million coming out of the category according to the Investment Company Institute. The composition of the outflow was squarely the result of domestic stock fund redemptions as a $1.7 billion loss more than nullified the $1.4 billion which came into international stock funds. The two equity categories have been polar opposites all year with international stock funds having had inflow in 43 of the past 44 weeks, versus domestic trends which have been very soft with inflow in just 15 weeks of the 44 weeks thus far year-to-date. The running year-to-date weekly average for all equity fund flow continues to decline and now settles at a $1.1 billion inflow, now well below the $3.0 billion weekly average inflow from 2013.
Fixed income mutual funds napped their drawdown schedule of the past 5 weeks putting up inflows in both the taxable bond fund category and also in tax-free munis. Taxable fixed income netted a fresh $5.0 billion in investor money with municipal bond funds putting up a $399 million inflow, making it 42 of 44 weeks with positive subscriptions in tax-free bonds. The 2014 weekly average for fixed income mutual funds now stands at a $985 million weekly inflow, an improvement from 2013's weekly average outflow of $1.5 billion, but still a far cry from the $5.8 billion weekly average inflow from 2012 (our view of the blow off top in bond fund inflow).
ETF results were very strong during the week with substantial inflows in equity funds and decent subscriptions into passive fixed income products. Equity ETFs put up a 2014 year-to-date high subscription with a $17.7 billion inflow which made the $564 million inflow into passive bond products look very modest. The 2014 weekly averages are now a $2.1 billion weekly inflow for equity ETFs and a $1.1 billion weekly inflow for fixed income ETFs.
Mutual fund flow data is collected weekly from the Investment Company Institute (ICI) and represents a survey of 95% of the investment management industry's mutual fund assets. Mutual fund data largely reflects the actions of retail investors. Exchange traded fund (ETF) information is extracted from Bloomberg and is matched to the same weekly reporting schedule as the ICI mutual fund data. According to industry leader Blackrock (BLK), U.S. ETF participation is 60% institutional investors and 40% retail investors.
Most Recent 12 Week Flow in Millions by Mutual Fund Product: Chart data is the most recent 12 weeks from the ICI mutual fund survey and includes the running weekly year-to-date average for 2014 and the weekly quarter-to-date average for 4Q 2014:
Most Recent 12 Week Flow Within Equity and Fixed Income Exchange Traded Funds: Chart data is the most recent 12 weeks from Bloomberg's ETF database (matched to the Wednesday to Wednesday reporting format of the ICI) and the running weekly year-to-date average for 2014 and the weekly quarter-to-date average for 4Q 2014. The third table are the results of the weekly flows into and out of the major market and sector SPDRs:
Sector and Asset Class Weekly ETF and Year-to-Date Results: In specific callouts, the blood letting continued in the Materials Sector SPDR with another 19% of assets-under-management alone coming out of that product over the past 5 days. Conversely, the Utilities (XLU) and 20+ Treasury ETF (TLT) had respective inflows of 7% and 8% during the week.
The net of total equity mutual fund and ETF trends against total bond mutual fund and ETF flows totaled a positive $11.4 billion spread for the week ($17.4 billion of total equity inflow versus the $6.0 billion inflow within fixed income; positive numbers imply greater money flow to stocks; negative numbers imply greater money flow to bonds). The 52 week moving average has been $2.9 billion (more positive money flow to equities), with a 52 week high of $17.7 billion (more positive money flow to equities) and a 52 week low of -$37.5 billion (negative numbers imply more positive money flow to bonds for the week).
Exposures: The weekly data herein is important for the public asset managers with trends in mutual funds and ETFs impacting the companies with the following estimated revenue impact:
Jonathan Casteleyn, CFA, CMT
Joshua Steiner, CFA
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