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.”
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:
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:
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:
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%
Oil (WTI) 45.02-47.66
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
Takeaway: Vegas and Macau miss reduced EBITDA estimates. Still no signs of a recovery in Macau despite a better January for Wynn Macau
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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.
YUM remains on the Best Ideas list as a long.
“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.
“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.
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.
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