History's People

This note was originally published at 8am on January 21, 2015 for Hedgeye subscribers.

“History isn’t really about events – it’s the people who really matter.”

-Glenn Beck


That’s from the intro of the latest US #history book I’ve been grinding through, Dreamers And Deceivers by Glenn Beck. And while I’m sure you have your own opinions about Beck, I personally think he’s a great storyteller.


No, Beck isn’t my political idol (here’s a shocker - I don’t have one!). Neither is President Obama. While sometimes fictional, both of these guys tell stories in a way that makes us feel something. That’s what gives birth to a healthy debate about the truth.


Ostensibly, in a free-market democracy it is The People who really matter. Do they believe in this Marxist #ClassWarfare argument of the “rich” vs. the “middle class”? Or does that insult them? I guess after last night’s State of The Union storytelling we’ll see…


Back to the Global Macro Grind


If you listen to just about anyone who loves Obama’s economic policies, they’ll tell you (as he trumpeted last night) that the “economy is back! growing 5%”. That’s obviously fiction, in year-over-year growth rate terms.


When someone throws that 5% number at you, they either A) don’t get that a quarter-over-quarter SAAR reading doesn’t equate to a year-over-year growth rate or B) are trying to obfuscate the number because the uninformed wouldn’t get it anyway.


Here’s the last 4 quarters of US GDP growth, on a year-over-year growth rate basis:


  1. Q413 = +3.1%
  2. Q114 = +1.9%
  3. Q214 = +2.6%
  4. Q314 = +2.7%


And since our macro model (GIP - Growth/Inflation/Policy Model that, using Bayesian Inference, has done as good a job as any research firm in predicting the rate of change in both growth and inflation for the last few years) was:


A)     Bullish on the y/y rate of change in US #GrowthAccelerating for all of 2013 until the growth rate peaked in Q413

B)      Bearish on the y/y rate of change in US growth starting at the beginning of 2014, as Q114 slowed…


I don’t have to make mediocre apologies for getting the rate of change in long-term bond yields right (bullish on #RatesRising in 2013, bearish on rates surprising to the downside in 2014) either.


Instead, being true to evolving the macro debate on Wall St., what I need to do after the #SOTU2015 speech is remind you that:


  1. The bond market (and economic data for December) signaled that the y/y US GDP growth rate slowed again in Q414
  2. Q414 US GDP growth will be reported much lower than “5% growth” within the coming weeks
  3. The annualized (year-over-year) US GDP growth rate for 2014 will be closer 2% than 4-5%


Obama won’t revise his storytelling about economic growth, after that. But #history will.


As you know, you can make a ton of money on the long side of asset prices tied to both A) Policies to Inflate (not to be confused with real economic growth – see 2011 for details) and B) #GrowthSlowing (buy Long Duration Bonds!). #TLT


What’s much more damning to asset prices than the rate of change in growth slowing is the rate of change in inflation #crashing. That’s mainly because asset #bubbles that were perpetuated by easy money Policies to Inflate get crushed by #deflation.


In hindsight, the #deflation risks to certain asset prices have been crystal clear:


  1. Commodities (CRB Commodities Index = 219, new lows, -30% since June 2014)
  2. Debt – and I mean high yield and junk bonds tied to cash flow streams that have implied inflation expectations


That’s why big debtor nations (and the companies who thrive on leverage to inflation in selling prices) try to avoid #deflation like the bubonic plague. #Deflation hammers debtors.


Japan (BOJ) and Europe (ECB) either convince the world that they can create inflation again – or they do not. After cutting his “inflation target” in ½ last night, the BOJ’s Kuroda looks about as confident about inflation as a chart of West Texas Crude Oil.


When this epic and unprecedented central planning experiment ends, it will be the people who signed off on it who are held responsible, not the politically conflicted speech events themselves.


Our immediate-term Global Macro Risk Ranges are now:


UST 10yr Yield 1.74-1.89%

SPX 1987-2036

Yen 116.12-120.23

Oil (WTI) 45.02-47.66
Gold 1242-1299

Copper 2.48-2.61


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


History's People - Chart of the Day


Takeaway: Vegas and Macau miss reduced EBITDA estimates. Still no signs of a recovery in Macau despite a better January for Wynn Macau



prepared commentary



  • January 2014: low hold. January 2015: high hold %
  • Q4 was tough; Golden Week in October was difficult (effects of changes in China have had a negative effect on top-end business)
  • January 2015:  no change in VIP business (volumes down hard).  Occupancy was high. Rolex/Louis Vuitton suffered. Made $80m in Jan 2015 (made $70m in Jan 2014).
  • Mass business in Jan 2015 was up 26%
  • Opening in a week or so a new area dedicated to VIP business
  • February should see an improvement of some sort
  • Thousands of Wynn Macau employees expecting promotions and better lifestyle
  • Wage Palace on budget and on time BUT builder last night said that because of a problem in timing of labor construction permits, it will not open before CNY 2016. So, Palace will open in the latter days of 1H 2016.
  • China remains a big question mark
  • Requested 1,000 additional laborers, got 700 laborers instead

Las Vegas

  • $515m in EBITDA in LV in 2014 encouraging   

Q & A 

  • Smoking ban will be extended to VIP. Will have unintended consequences. However, WYNN has some open terraces that will mitigate some of that no smoking impact.
  • Oct/Nov:  low hold in premium mass area ($15m/$20m EBITDA impact)
  • VIP hold was normal
  • Tables will increase by 40 tables (combination of junket tables/mass tables) and will be ready before CNY 2015.  Will be up to 485 tables in a couple of weeks.
  • LV promos:  nothing unusual
  • Mass improvement in January 2015:   Mainly mid to high end mass. Had been targeting 7,000 mid-mass players and the campaign has been very successful
  • Boston budget:  $1.7-$1.75bn
    • $50m/month in revenues for the state of MA
    • Another $50m/month for surrounding communities
    • Financed at LIBOR + 175bps non-recourse
  • Downturn is HK and Mainland China
  • Capital Allocation:  Always thought dividend would increase.  Lots of cash protecting the dividend and big property opening in 2016
  • No mass table reclassification 
  • Chinese people are cautious. There is uncertainty. Campaign against corruption has been a big wake up call.
  • Have eliminated weaker junkets. Only will deal with strongest junkets (SunCity and Guangdong new to the property).  Now do only with 9 junkets (12-13 junkets in the past).
  • Mass promotional spending as higher % of revenues:  not seeing in any major increase in promotional activity 
  • Wynn palace table count: 'common sense and integrity at end of day will be last word on subject'
  • 2 projects facing Wynn LV: Old Frontier hotel (purchased by James Packer). Old Stardust hotel (purchased by Genting).
    • Wynn sees these projects bringing more business to Vegas 
  • Raised Vegas pricing by 18% starting Labor Day
  • Mass margins have been very consistent.  Poor retail performance hurting mass margins since it has least income and highest margins.  
  • Overall EBITDA margins of low 30% target
  • They need 1,500 more laborers to build the Wynn Palace. They have put the request in. 

XLP: Removing Consumer Staples (ETF) from Investing Ideas

Takeaway: We are removing XLP from Investing Ideas.

Please be advised that we are removing Consumer Staples (XLP) from Investing Ideas today.


We added XLP on 9/26/14 for a 8.6% gain versus a 3.3% gain for the S&P 500.


According to Hedgeye CEO Keith McCullough:


This is more of a sell some beta move than anything else. I want to send you a sell signal on US equity exposure here so that I can signal buy, lower.


Fundamentally, International FX exposure to big cap Consumer Staples earnings is a new concern - one we don't get paid to ignore because the USD had a counter-TREND correction.


XLP: Removing Consumer Staples (ETF) from Investing Ideas - 55

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Cartoon of the Day: Snow Job

Cartoon of the Day: Snow Job - Earnings cartoon 02.03.2015

Investors aren't exactly digging the fourth quarter earnings season, which has been a disappointment so far.

WEN Leveraged Recap Puts Pressure on YUM

YUM remains on the Best Ideas list as a long.

Key Points

  • YUM’s balance sheet is significantly underleveraged, highlighted mostly recently by the WEN recapitalization.
  • Management must de-risk the business from its significant exposure to China.
  • YUM is significantly undervalued and has many levers to pull to enhance shareholder value.


YUM’s Underleveraged Balance Sheet

“We plan to take advantage of the current capital markets environment and low interest rates to recapitalize our balance sheet, targeting a leverage ratio of five to six times net debt to 2014 Adjusted EBITDA.”

–Wendy’s CEO, Emil Brolick


This morning, Wendy’s announced recapitalization and additional refranchising plans.  Through a leveraged recapitalization, management plans to take net debt to 2014 adj. EBITDA up to 5-6x in order to raise money and, in turn, allow them to return substantial cash to shareholders through share repurchases and, to a lesser extent, dividends.  Wendy’s shares are up more than 5% on the news.


In our view, this news exposes YUM’s underleveraged balance sheet in a very public manner.  A leveraged recap was a critical component of the long thesis we laid out in December in a Black Book.  The market is allowing restaurant companies to lever up to 5-6x “for free.”  BKW (now QSR) levered up to 7-8x and was rewarded handsomely for it.  In the case of YUM, all we are asking for is close to 5x, which would allow the company to repurchase ~40% of its equity value. 


The stock has been flat for the better part of the past three years, making it an ideal time to announce a transaction of this nature.  If management refuses to go this route, we find it highly likely that an outside force will step in to push for it. 


Opportunity to De-Risk the China Business

“We expect that the net result will be a reduction in Company-operated restaurant ownership to approximately 5 percent of the total system by the middle of 2016.  We believe this reduction in ownership will result in pretax cash proceeds of approximately $400 to $475 million and significantly reduce future capital expenditure requirements.”

-Wendy’s CEO, Emil Brolick


Wendy’s initiative to further evolve its system optimization initiative by reducing the percentage of company-operated restaurants from 15% to 5% is a stark reminder of the attractiveness of the franchise model. 


In particular, it reminded us of the opportunity for YUM to refranchise aggressively in China in order to de-risk the business from the recent and, likely, ongoing volatility.  Yum China represents a nasty mix for YUM – the business is under pressure and it is a significant part of the company’s overall financial performance. 


Not only are global asset light models are trading at a premium to the group, but it’s also an ideal time to be a seller of restaurant assets.  If you're sitting on the board, you must consider that now is the right time to pursue a transformational transaction of this nature.


SOTP Analysis Suggests Significant Upside

YUM is a great company, with great brands, that has dramatically underperformed its peers over the past one, three, and five years.  We believe both the external (sales trends are positive, multiples are at peak levels, strong demand for restaurant assets, strong demand for global brands) and internal (management changes, structural changes, underleveraged balance sheet) environment make for a perfect time to affect change at YUM. 


Despite significant global unit growth potential, high margins, significant FCF, and high returns, the company continues to trade at a significant discount to its intrinsic value – which may not last for long.  Management has a number of levers at its disposal to enhance shareholder value and must pull them – before they no longer have a choice.


WEN Leveraged Recap Puts Pressure on YUM - 1

WEN: Middling Q, But that's Not the Story Here

Wendy’s remains on the Investment Ideas list as a long.


Wendy’s reported 4Q14 results this morning, delivering a top line miss ($502mm vs $509 est.) and in-line EPS of $0.10.  Comps were a little light (1.9% vs 2.4% est.), but that’s not the story here.


In the release, management announced recapitalization plans and its intent to sell ~500 additional company restaurants to franchisees by the mid-2016, effectively bringing down the company-owned mix from 15% to 5%.  This extended system optimization is expected to raise $400-475 million in cash and considerably reduce future capital expenditures, while the leveraged recapitalization (up to 5-6x net debt/2014 adj. EBITDA) will allow the company to return substantial cash to shareholders primarily through share repurchases and, to a lesser extent, dividends.


In addition to the aforementioned, the company laid out 2020 goals for the system which include:

  • 1,000 new restaurants (excluding closures)
  • 20% restaurant margins
  • $2.0 million AUVs
  • 60% of restaurants reimaged


2020 is far out, but that's not the point.  The company is heading the right direction by investing in the appropriate strategic initiatives while becoming a leaner, more shareholder friendly company.  Asset-light models (PLKI, KKD, DIN, DNKN, etc.) are fetching premium valuations on the public market – and for good reason. 


Given the growing, steady stream of royalty income, along with lower G&A and capital expenditure requirements, Wendy’s expects to generate at least $200 million of free cash flow in 2017 and $250 million in 2015.  Considering the transformation underway, we believe Wendy’s presents one of the most attractive long-term investments in the restaurant.  


Financial highlights from the quarter include:

  • Company-operated same-store sales growth of +1.9%
  • Franchise same-store sales growth of +1.6%
  • N.A. company-operated margins of 16.8% (+50 bps y/y)
  • G&A expenses of $60.1 million (-22% y/y)
  • Adj. EBITDA of $107.1 million (+20.3% y/y)
  • Operating profit of $51.7 million (+78% y/y)
  • Net Income of $23.3 million, down from $33.1 million a year ago
  • EPS of $0.10, down from $0.11 a year ago


More to follow.

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