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Jobless Recovery in Europe?

Position: Long Germany (EWG)


In our post “Bear Cubs” on 10/1 we discussed rising unemployment as a headwind facing the Eurozone into year-end. On further reflection however, we think that it is worth considering that European economies may better weather a rise in unemployment than their global counterparts.


It’s a question worth qualifying and quantifying as a rise in joblessness has a potential to ripple through a country’s and a region’s economic performance. If you’ve been following our US strategist and food industry analyst Howard Penney’s research, you’d know we’ve struggled to make a case for resurgence in the US consumer, especially concerning discretionary spending like casual dining. Conversely our Retail team has become incrementally more bullish, highlighting in our call this morning that a slow and gradual recovery in underway, supported by better sales, tighter inventories, and favorable compares that led to several upside earnings revisions in the September numbers.  Could the outlook of the European Consumer differ in appearance?


Though we’ve cautioned against speaking about Europe in aggregate due to the divergence across countries on multiple factors, one aspect that much of the region shares collectively is a significantly stronger foundation of social services than those available to US citizens, and certainly greater than the safety net provided by governments in developing economies like China. One take away to note here is—without a job the fear of losing (for example) healthcare benefits and the inability to pay for comparable services is far greater in the US or in China (where all expenses are out of pocket), than in Europe due to government social programs, a comment astutely made by my colleague and Asia strategist Andrew Barber.


Secondly, it’s worth considering savings rates that may better pad one’s economic outlook.  As our European clients on the ground have so eloquently compared European to American spending: “Americans spend everything they have.” If this translates to on balance Americans having less cash reserves to fall back on in a weaker economy with tight access to capital, could it be that European sentiment, and therefore consumption, is more resilient in the face of adversity than that of Americans? Could a more cushy savings account and social network lead to increased optimism?  The chart below of unemployment levels in the US versus Eurozone over the last ten years speaks to the point that Europeans are more accustom to a higher jobless rate than Americans.  


As we measure the impact of rising unemployment in Europe, we keep in mind the vast divergence in joblessness among European countries—Spain is pushing 19% unemployment while Germany has hovered around the 8.2% level. While comparing the structural nature of Spain to Germany is far from comparing apples to apples on numerous counts, we do believe that the sequential rate of change in many of the fundamental metrics we follow in Europe will slow over the next months.


But the reality remains, a jobless recovery in Europe may actually be more bullish than in the United States.


Matthew Hedrick


Jobless Recovery in Europe? - a1



Chinese Auto Industry executives are worried about swelling capacity. They should be.


The CEO of China Auto Logistics was quoted yesterday saying that the 40% increase in auto sales in China this year, which has brought the total new cars sold to over 1 million per month, was a “one-time event”.  We agree with this assessment. The stimulus measure which drove these sales, particularly the tax incentives for rural buyers, created a lot of “replacement” sales: farmers and rural tradesmen trading up from ancient vehicles. The pace of those types of buyers coming to market should decline as we head into next year, but as the euphoria of the stimulus fades and “real” demand kicks in, we expect auto sales growth to continue at a healthy pace even if it looks weaker on a year-over-year basis compared with this year’s flood of purchases.




The critical question now is whether a moderation in the pace of sales growth will reveal excess capacity after a massive wave of investment by domestic and foreign JV producers.  Any supply glut could create a chain reaction through the industrial complex. Officially, the National Development and Reform Commission estimates domestic automotive industry capacity utilization at 80% with a drop to 70% projected by 2013 as more new plants come on line.


The Beijing plans outlined in Q1 called for consolidation that would alleviate some of these issues by creating a handful of dominant producers who control the entire manufacturing process internally rather than the present diverse network.  Any M&A cycle inside the Chinese automotive industry would be a welcome source of capacity reduction, but we see it as unlikely that new efficiencies through consolidation will be sufficient to offset the tide of diminished expectations as monthly sales figures comp to impossibly high 2009 levels. As such, the DBN 600 Automotive Sub Index current level appears likely to be unsustainable in the intermediate term after a 150% increase YTD and we are inclined to shift the group out of our industry focus group for Q4.




Land of Opportunity


The strategies adopted by US and European JVs pursuing market share in the Chinese market have produced  predictably mixed results to date, and recent developments suggest that some (primarily the US firms) will continue to flounder.


With under 3% of the total market Ford is playing catch up with the announcement of a third plant with partner Chonqing Changan to be on line by 2012 which will lift total annual capacity on the mainland to 600,000 units.  Given the macro factors  outlined above, and the fact that the focus segment –the compact market, is so heavily competitive,  this growth strategy appears to be too little too late. In contrast, French producer Peugeot Citroen has recently announced that its plan to construct a third facility citing looming excess capacity.


The luxury import segment has become lucrative enough for European manufacturers to start building domestic production facilities –with the Audi/FAW JV reportedly considering a plan to begin  complete A3 and A5 production on the mainland. Audi has had great success in China on the heels of Parent VW’s early and successful entry into the market there .


NOTE: Domestic Chinese Markets have been closed for the first 3 sessions of this week in observance of National Day and the Mid-Autumn celebration.



Andrew Barber




The quarter was very messy and riddled with charges as expected. However, it looks like clean EPS came in at $0.15, beating the street and company guidance as well as our $0.14 estimate.   Stronger leisure demand and solid cost controls contributed to the better than expected results.  Earlier this morning we put out a quick review.  Below are more details on the quarter.



RevPAR Details:

  • Full service room growth was lower than we expected, however, limited service growth more than made up for the difference. Limited service room growth actually accelerated in 3Q09 vs 1H09.
    • Total managed rooms were 1,200 light of our estimate while franchised rooms grew by 1.8% more than our estimated growth rate of 8.4%
  • ADR declines were a higher percentage of the RevPAR decline compared to our projections and chain scale results.
    • There was a notable sequential improvement in occupancy (declines), especially for the Ritz brand and the full-service brands
  • The FX drag on international RevPAR was 6.6%, highly correlating with the 6.2% y-o-y strengthening of the dollar vs Euro


Total Fee income:

  • Base management fees were exactly in line with our estimate but franchise fees were $5MM better, driven primarily by more room additions in the quarter
  • Incentive fees were also $7MM better than our estimate


Owned, leased and other:

  • Owned, leased and other revenues of  $226MM were $19MM above our estimate
    • $6MM of the beat was due to termination fees
    • $15MM was due to better F&B performance, which makes sense given that occupancy performed better than we expected for the full service hotels.   Food and beverage outperforms RevPAR over the next few quarters as occupancy flattens out
  • Assuming branding fees were in the same $19MM range as previous quarters, gross margins ex-termination fees and branding fees on “owned & leased” are about -$17MM.  Since there is a lot of other stuff in “Owned, leased & other”, we would caution investors on extrapolating too much from the margin changes of this bucket


Timeshare Details:

  • Contract sales declined 42%, coming in 6MM lower than our estimate.  Fractional sales were also weaker
  • Development revenues of $138MM declined 48%, missing our estimate of $172MM by $34MM, while finance revenues came in $3MM better
  • Timeshare results were 4MM below our estimate of $13MM due to lower JV equity earnings and lower timeshare sales & services, net results. Base fees were in line
  • As a reminder, in 2010 the adoption of FASB 166 & 167 will require MAR to consolidate its existing portfolio of non-recourse securitized loans.  This accounting change won’t change risk or cash flow from timeshare but will inflate liabilities & debt balance while benefitting pre-tax earnings by an estimated $30-40MM


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Natural Gas Consumption

We have a quick call out on natural gas as it relates to economic activity in the United States.  A primary end use of natural gas is in industrial production, as a result the Energy Information Administration (EIA) releases data on natural gas uses in industrial production on a monthly basis.   We have outlined this in the chart below and graphed it as a percentage change on a year-over-year basis.


No surprise, natural gas consumption has been in decline on a year-over-year basis since April 2008, which is in line with the broad decline in the U.S. economy that has occurred.  Surprisingly, we have seen no pick up on a year-over-year basis in consumption.  In fact, for the last four months we have seen declines year-over-year of greater than 5%.  This is surprising because comparables are presumably easy and, based on other leading indicators such as the stock market, one would expect some pick up in industrial use of natural gas – a sign that industrial production is increasing.


On another note, the EIA’s weekly natural gas report is due out today at 2pm.  We would expect to see much of the same in the way of continued inventory builds.  As of last week, inventory broadly in the U.S. was almost 15% above its five year range.  According to the EIA:


“At 3,589 Bcf, working gas in storage set a new record high for natural gas inventories. Current inventories exceed the previous 15-year-high reported on the Weekly Natural Gas Storage Report (WNGSR) of 3,545 Bcf, and the all-time high of 3,565 Bcf reported in the October 2007 Natural Gas Monthly. New record levels were established in the West and Producing regions, exceeding the previous records of 482 Bcf and 1,126 Bcf in the WNGSR, respectively”


The combination of soft end market demand, as emphasized in the chart below, with a domestic U.S. that is flush with natural gas supply, continue to paint a bearish picture for the commodity in the intermediate term.  The underlying data by end use also provides an interesting insight into economic activity in the industrial sector in the U.S.


Daryl G. Jones

Managing Director


Natural Gas Consumption - a3



I took the challenge and was not all that impressed, but VIA is a line extension for the brand that makes some sense.


Right about now, a successful new product in Starbucks stores would solidify the turn in fortunes at the company.  Given Starbucks’ massive retail distribution system in the United States it does not take much to move the needle on sales and profitability.   The instant coffee market is a $21 billion category at retail and is dominated by Nescafe and Sanka.  There is definitely room for SBUX to take some market share with a high margin product.  Obviously, the $21 billion in instant coffee sales are through other channels of distribution so the potential opportunity for SBUX beyond its own store base is big.


This past weekend it was media blitz with VIA ads everywhere, and for the first time in the company’s history, these ads were on TV. While it is way too early to call VIA a success or a failure, I was not overwhelmed and the bloggers are mixed on the product.  I am not yet convinced that the typical Starbucks consumer would want to buy instant coffee.  Instead, as I said before, I think VIA’s real potential lies in SBUX’s ability to steal market share from both Nescafe and Sanka in the grocery channel.


That being said, on an annual basis, a 1% improvement in SBUX’s U.S. same-store sales growth represents about $65 million in incremental sales.  For SBUX this means that each store needs to generate less than $30 a day in incremental sales from VIA (implies only about 10 units per day at $2.95) in order for the company to generate 1% in same-store sales on an annual basis.  I believe that the company’s goal is significantly higher than that.  That $30 of sales per day per store would add $0.02 to $0.04 in annualized EPS.  It is important to remember that VIA is a fiscal 2010 event as the product was just launched early in the first quarter of fiscal 2010.  That being said, we look forward to hearing how the product is faring thus far when the company holds its 4Q09 earnings call on November 5.


The table below shows the estimated sales and earnings potential for VIA, but again, we think the company’s targets are higher than what we are assuming.  We know there are millions of instant coffee drinkers in the United States, but the question is can SBUX convince them to drink VIA and will they go to Starbuck’s stores (or the web) to buy VIA. 




"Revenue per available room across our North American system declined less than expected during the third quarter as leisure travelers responded to attractive promotions and great values in our hotels. With solid cost controls, our hotels translated better than expected occupancy rates to stronger than expected fee revenue and earnings."



Outlook for 2010

  • Expect RevPAR to modestly decrease in 2010
    • ADR rates for group and government business will constrain and negatively impact ADR, as will the mix shift towards leisure
    • ADR will also be negatively impacted by supply increases
  • 25-30k new rooms expected to open
  • Applications from franchisees have slowed for their limited service hotels
  • Asia represented 40% of their full service pipeline, and virtually 100% is under construction
  • Think that there is a flight to quality for owners and franchisees
  • Haven't yet seen a pick up in conversions but expect to see a big pick up in 2010 as the number of workouts increases
  • System wide RevPAR flat to -5%
  • New managed hotels in Asia & ME will help incentive fees
  • Assume that international will be better than NA for 2010 (I'm sure the that FX will be part of this)
  • For timeshare, assume flat timeshare development profits and flat contract sales
    • Over 50% of costumers are paying for their timeshares with cash, so they are financing a smaller portion than before
    • Accounting change for FASB will add 5 to 8 cents to EPS in 2010
  • Timeshare expected to generate $75MM of FCF in 2009 and double that in 2010
  • Believe that a large portion of the savings they booked in G&A are permanent
  • 2010 should see large debt reduction
  • 1Q2010 is likely to continue to show meaningful RevPAR declines, driven by rate


Results for the quarter and 4Q09 outlook

  • Better profits were largely due to better RevPAR and cost controls
  • Corporate demand at MAR has been profoundly impacted by the economy
    • Room nights were down 11% compared to an 18% decline (y-o-y) in 2Q09. However some of the improvement is just easier comps
    • Room rates less encouraging.  Everyone wants a special deal.  Corporate room rates declined 19%. Expect them to continue to be weak until occupancy recovers
    • Corporate represent 25% of room nights and group represented 33%
    • Cancellations and attrition were better than 1H09, but last minute bookings in the quarter were very light
    • Occupancies in NY have moved up - a sign that corporates are dipping a toe in the water
  • Leisure accounted for 40% of room nights vs 30% last year
  • Weekend occupancy was 6 points higher than weekday occupancy
  • International
    • ME impacted by early Ramadan
    • European occupancies exceeded 70% despite big ADR drops
  • Domestic RevPAR is roughly at 2004 levels
  • Timeshare helped by customer incentives
    • Seeing stabilization in core 1 week sales
    • US delinquencies increased to 10.8% in Sept, however they were flat at 5.5% excluding loans already in default
    • Because of an improvement in cure rates they were able to get higher residual interest
    • New FASB rules require them to consolidate, debt & asset balances will increase while equity will decline. Revolver covenant calculations won't be impacted nor will the way rating agencies treat non-recourse debt.
    • Will try to monetize excess land in their timeshare division at favorable rates
      • Based on our estimates they have over 7 years of inventory at current sales velocity so selling land makes sense
  • Expect debt to decrease $600-650MM in 2009 with further reductions in 2010
  • Development front: opened 10k rooms and closed 500 rooms
    • Roughly 50% of the rooms in the pipeline are under construction and 7% are awaiting conversion
    • Added 8,000 rooms to the pipeline and cancelled 5,000
  • 4Q09 "outlook" not "guidance"
    • Much of the RevPAR decline will come from ADR and mix shift to lower rated and leisure business
    • Unit expansions will help fees but tougher cost comps will hurt them. 
    • House profit margin declines will be similar to what they experience in the 3Q09
    • Timeshare note sale in the 4Q09, and given the strong securitization market expect to book a $10-15MM gain
    • Expect G&A to decline 20%
  • Look forward to the upturn which they believe is "ever closer"




  • Expenses rising next year at corporate and property level?
    • There were basically slim no increases in 2009 and bonuses were also zero.  In 2010 they will probably need to give employees some wage growth and bonuses.  Healthcare and utility costs should increase slightly as well.
    • Need positive RevPAR to keep margins flat
  • Overwhelmingly their recovery will be levered to corporate and group recovery; ie GDP and economic recovery
  • Hope to cross over the zero line of occupancy hopefully in 1H2010, and at that point they can ease promotions
  • What more can they do at the property line to hold margins?
    • Procurement - managed to improve F&B margins
    • Labor productivity continues to improve
  • Timeshare Strategy change
    • Made a strategic decision concerning pricing especially at the luxury side of the business and at the new prices the NPV of the projects were materially lower, hence the impairment charge
    • Decided to accelerate sales in Europe and sell the remaining land inventory
    • Decided not to develop some land that they bought at the top of the market
    • Got ahead of themselves from an inventory standpoint, so now they are going to "right-size" the inventory to the current sales velocity
      • Most of the replenishment occurred in 2007 because the sales pace grew so much between 2005-2006, normal inventory should be 2-3 years not 7+ years
  • Could they be too conservative?
    • There aren't really any leading indicators for their business
    • Their business is heavily dependant on economic activity
  • One analyst claims that he is seeing stronger rates at hotels... I don't know what he is seeing but I travel very frequently and I'm seeing a tremendous amount of deals.  This week alone I saw
    • Wynn rates for $109
    • All inclusive Mexican resort for $59 per night per person
    • $419 7-night Caribbean cruise on Princess
    • 55% off on Accor hotels in Oct
  • Pay increases?
    • In the 3rd quarter the true run rate SG&A number was really $124MM (excluding $5MM of legal and $15MM deferred comp).  Can't continue to not pay people forever.  So assume SG&A will be up modestly in 2010.
  • Assumption that International will outperform NA in 2010?
    • Part of it is easier comparisons (like H1N1 and political instability in certain markets like Thailand)
    • Since they didn't book a lot of group business in the US for 2010, they need to dig themselves out of that hole in the US, while international has a lower % of group business
  • Cancellation and attrition in group is a less of an issue now than in 1H09, but booking pace is still very weak
  • 2010 will start with a meaningfully bad RevPAR number but will end a lot better... how things progress throughout the year will really determine what the final y-o-y RevPAR change is
  • Room growth:
    • Full service portion of their pipeline is primarily outside of the US. Its very difficult to develop full service in the US unless it's municipally financed or part of a mixed use project. There is no financing available for full service in the US.
    • Headwind in supply in US is in upscale not upper-upscale
  • Transaction volumes have not stepped up so far, but expect them to
    • Banks aren't forcing as many assets into foreclosure
    • They are interested in buying distressed assets for a short term hold and retaining management contracts
  • Timeshare, elaborate
    • In Europe they decided that they have plenty of inventory and it doesn't make sense to develop any more
    • For luxury residential, they are exiting that business -  at least what they develop, not what they license
    • Will continue to do fractionals though
  • FX tailwind?
    • 16-18% RevPAR declines in constant dollars for 4Q09, so they will be impacted by currency. They have some hedges in place too - so the bottom line impact won't be significantly material


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