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US CPI/PPI: Reflation's Rotation

Our Q3/Q4 2009 call on Reflation Rotation is much like the call that we made on US Housing Bottoming in Q2 of 2009. Back then, we weren’t calling for a booming housing market, nor are we calling for massive inflation readings now. We are simply calling the turn. We call this what’s happening on the margin. In our macro models, this is what matters most.

 

Now that we have both the September CPI and PPI reports in the rear-view, it’s easier to see the Reflation Rotation that we have been calling for. This means going from the lowest readings of deflation (which you can see happened in July of 2009 in the chart below) to lesser levels of year-over-year deflation.

 

The green arrow that Andrew Barber and I show in the chart below is our forecast. As we move ahead to the October and November CPI and PPI reports (reported in November and December), these deflation readings are going to continue to REFLATE.

 

We think the Street is starting to figure this out. New highs in the prices of both TIP and GLD confirm these expectations.

KM

 

Keith R. McCullough
Chief Executive Officer

 

US CPI/PPI: Reflation's Rotation - PPIKM


MCD – SEPTEMBER SALES PREVIEW

As I stated last week in my 3Q09 earnings preview (please see October 15 post titled “MCD – The Hamburglar Strikes” for more details), reported September sales trends should be the primary driver of the company's stock price performance.  That being said, I wanted to provide comparable sales ranges for each geographic segment as a benchmark of what I think would be GOOD, NEUTRAL, or BAD results based on 2-year average trends. 

 

For reference, I think September same-store sales growth could come in below expectations with the U.S. posting a +1% number (really BAD), which would point to continued deceleration in 2-year average monthly trends.  I am expecting September 2-year average trends in both Europe and APMEA to remain about even with August (NEUTRAL), which implies about 10% and 3.5% growth on a 1-year basis, respectively.

 

U.S. (facing an easy +2.8% comparison from last year):


GOOD: +3.3% or better would signal that the company is maintaining or improving its 2-year average trends on a sequential basis from August.  Although investors were not happy with the August number (stock traded down 2% that day), I don’t think people are expecting any improvement in September.

 

NEUTRAL: +2% to +3.2% would point to a slight deceleration in 2-year average trends but would not represent another month of significant deceleration like we saw in August when 2-year average trends declined 160 bps from the month prior.

 

BAD: below +2% would highlight a continued fall off in 2-year average trends in the U.S.  A reported 1% or worse would be really BAD as investors may have gotten over the shock of seeing these reported U.S. numbers in the 1.5%-1.8% range like we saw in June and August, but the company has not reported a number below +1.7% since March 2008 when comparable sales declined 0.8%.  A +1% number would imply a 120 bp sequential decline in 2-year average trends.

 

MCD – SEPTEMBER SALES PREVIEW - MCD US SSS

 

Europe (facing a relatively easy +5.0% comparison from last year):


GOOD: +11% or better would signal an acceleration in 2-year average trends.

 

NEUTRAL: +9% to +11% would point to 2-year average trends that are about even with what we saw in July and August.

 

BAD: below +9% would imply a slight slowdown in 2-year average trends and anything below 6% would be viewed as really BAD as it would signal a return in 2-year average trends to the low reported June levels.

 

MCD – SEPTEMBER SALES PREVIEW - MCD Europe SSS

 

APMEA (facing a relatively easy +5.9% comparison from last year):


GOOD: +5% or better would signal an acceleration in 2-year average trends.  A +8% or better would be really GOOD as it would imply a return to the 7%-plus 2-year average trend we saw earlier in the year.

 

NEUTRAL: +3% to +5% would point to 2-year average trends that are consistent with what we have seen in the last 3 months. 

 

BAD: below +3% would imply that 2-year average trends have slowed from recent levels and would represent a deceleration from June when the company posted its lowest 2-year average result since January 2007.

 

MCD – SEPTEMBER SALES PREVIEW - MCD APMEA SSS

 


PENN: A YOUTUBE PREVIEW

PENN reports Q3 tomorrow morning. It shouldn’t be that bad despite the regional softness.  We’re still worried about the duration of this downturn.

 

 

We’re projecting EBITDA of $160 million which is in-line with the Street, although our revenue projection of $629 million is a little below the Street at $641 million.  Our EPS estimate is $0.36, above the Street consensus of $0.34 due primarily to lower interest expense.

 

Q3 should not be a make-or-break quarter for PENN.  The stock is appropriately off its recent high of $33.67 (July 28th) due to sluggish regional revenues, despite the up move in the market.  Rather than focus on the Q3 results, we see two main catalysts:

  1. The duration of the downturn – we think well into 2010.  We’ve proven gas prices to be a statistically significant variable in explaining regional gaming revenues.  The easy gas comparison reverses in late November then is quite ugly through the first half of 2010.  Assuming the current price holds, YoY monthly gas prices will show a decline ranging from +50% in December down to +13% YoY in May 2010.
  2. Using their dry powder – PENN has over $1.5 billion in excess cash and credit availability that it could put to work.  Fontainebleau is obviously the odds on favorite.  The good news is that levering up this underleveraged balance sheet probably creates equity value over the near term.  The bad news is that acquisition multiples may be higher than the Street is anticipating and, in the case of Fontainebleau, realized cash flow may be a ways off.

For those of you interested in “YouTubing” management from Q2 please note the following:

 

 

PENN “YOUTUBE” FROM Q2

 

CURRENT TRENDS

  • “So, July is looking pretty nice and we feel comfortable with that, but who the heck knows what August is going to look like. We are in that kind of a mode. So, if we are a little mushy on that kind of question it is because that is all we can do.”
  • “I don’t think we are seeing any rebound on consumer spending anywhere. It is still the same kind of trends. Overall as you look at the first six months of 2009 there are ups and downs through that period and July is more of the same.”
  • “While the current economic environment continues to impact the overall gaming industry, regional market revenue trends remain largely stable…while visitation levels at our facilities remain similar to prior periods, spend-per-visit is lower, reflecting the challenges presented to consumers by current macro-economic conditions."
  • “We are very pleased with their [Lawrenceburg and Joliet] performance and look forward to a good third and fourth quarter there as the July results, as bill highlighted, continue to be online with our expectations.”
  • “It is going to take three or four quarters for Lawrenceburg to get fully ramped up and stabilized. We also have some additional work that we want to do to upgrade the amenities in the pavilion that is going to occur over the next three or four quarters as well. Nothing significant, but we certainly have some restaurants that need upgraded and that is going to be occurring over the next 12 to 15 months, but in terms of when we think Lawrenceburg will be running on all cylinders, it is going to take a few quarters out there for us to expose the new product to as many new consumers as we possibly can and then get all of our marketing programs in place that support the new facility.”
  • “To give you some color on Penn National, I do want to say it appears now, after about two months of operation, that we are not seeing any material impact from Bethlehem in the numbers there. When you add back the 1x catch up regulatory fees we are running at EBITDA margins that are around 20%. I think we can do a little bit better than that going forward as we continue to grow the business. The revenue growth there continues to be good; it is still showing double-digit growth.”
  • Peter Carlino [on the impact of oil in Zia’s market]:  “Last year… In Hobbs, New Mexico we saw the hotels there running 100% occupancies with ADRs above $100.00 because of all of the workers that were coming in there that were correlated to the oil industry. This has been a trend we saw late in the first quarter, continuing in the second quarter, where we are seeing the local market and our feeder markets not nearly as robust as it was a year ago. Things won’t get better until we see oil above $70.00 a barrel. That is an unusual circumstance, because in our other businesses we obviously want to see gasoline prices low and consumers not being faced with that hurdle to get in their car and come visit us, but when the oil industry and the price of a barrel of oil is high it does help us there.”

 

GUIDANCE

 

PENN: A YOUTUBE PREVIEW - penn guidance Q3

 

  • Excludes expected gain from insurance proceeds related to Empress Casino Hotel fire;
  • Excludes any future Ohio lobbying expense;
  • Depreciation and amortization charges in 2009 of $195.5 million, with $51.2 million projected to be incurred in the third quarter of 2009;
  • Estimated non-cash stock compensation expenses of $31.4 million for 2009, with $8.2 million of the cost incurred in the third quarter of 2009;
  • Excludes potential impact of Company modifying debt obligations;
  • A diluted share count of approximately 107.1 million shares; and,
  • There will be no material changes in applicable legislation or regulation, world events, weather, economic conditions, or other circumstances beyond our control that may adversely affect the Company’s results of operations.
  • “For the year we expect total maintenance CapEx to be roughly $90.5 million and project CapEx will be roughly $216.7 for a total of $307.4. [doesn’t include any spending in Kansas, Ohio, or Maryland.  Also it doesn’t include reimbursements from insurance related to the Joliet fire as we work through replacing the pavilion]
  • Tax rate should be in the 43% range and it shouldn’t pick up in 4Q vs 3Q – it should remain flat.

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TIP: Selling Some Inflation Protection

My cost basis in TIP dates back to buying it on 4/3/09 at $100.27. Since this summer I have been carrying a double digit percentage exposure to TIP (Treasury Inflation Protected bond ETF) in the Asset Allocation Model.

 

Today, with inflation expectations coming my way (see chart), I am selling that exposure to TIPs down to 3%.

 

Obviously the narrative fallacy shopped by the Depressionistas has been decimated, and so have perpetual expectations of deflation alongside that.

 

Expectations dominate these returns, not lagging CPI or PPI data. The two positions that I have taken to protect against inflation expectations are long Gold (GLD) and long TIP. I remain long of both… just less of both, as prices melt higher.

 

I’ll buy TIP back on pullbacks to the following TRADE and TREND lines in the chart below. TRADE line support = $102.89 and TREND line support (intermediate term) = $101.43.

KM

 

Keith R. McCullough
Chief Executive Officer

 

TIP: Selling Some Inflation Protection - a1

 


RESTAURANTS – WESTERN U.S. DEMAND HEADWINDS

On EAT’s 1Q conference call, management just stated that California continues to be weak.

 

Last week, CKR and CPKI reported worse than expected sales results, which suggested that sales trends in California are not getting any better.  The divergence in gas prices between the west coast and the national average, which is illustrated in the first two charts below, might help to explain the regional weakness.  Although there is a normal seasonal divergence in the price of gasoline geographically within the U.S., the current divergence is the most pronounced in more than 15 years. 

 

CKR’s CEO Andrew Puzder continues to attribute weakness in sales trends to the current unemployment rates in California and stated just last week that “In particular, record levels of California’s unemployment exceeding 12%, and 18% for the broader unofficial statistic, have negatively influenced consumers’ buying habits.”  Higher unemployment rates combined with this growing spread between regional gas prices, which has been accelerating since mid May, does not bode well for California-centric concepts, such as CPKI, CAKE, RRGB, MSSR, PFCB, JACK and CKR.  On a more favorable note, the third chart also highlights the regions of the country, which benefit from relatively lower gas prices, most notably Texas. 

 

Overall, gas prices have been extremely favorable on a YOY basis for restaurant companies this year.  During the first half of the year, national average gas prices were down 38% on average.  This YOY favorability continued into 3Q with gas prices down 33% on average.  Looking at the final chart below, this YOY cost benefit has already started to moderate and based on current prices should reverse come the end of October. 

 

RESTAURANTS – WESTERN U.S. DEMAND HEADWINDS - Gas price.west cost recent

 

RESTAURANTS – WESTERN U.S. DEMAND HEADWINDS - Gas price.west cost historical

 

RESTAURANTS – WESTERN U.S. DEMAND HEADWINDS - gas prices regional difference

 

RESTAURANTS – WESTERN U.S. DEMAND HEADWINDS - Gas Prices


TJX: Inside the Debate

Our internal process is one that openly encourages debate when we disagree. That’s when our hit ratio goes up… Here’s our take on TJX.  The bottom line is that big cap, liquid quality in a space that will be beating for the next 3-months is not a place to source shorts -- at least at this price.

 

 

Keith: Stock looking to be way overbought now fyi… on the news… I like shorting these for a TRADE.

 

Brian: Yes, TJX gets put in the ‘quality’ bucket in retail. But let’s not forget that margins are at peak, and we’re coming off an 18-month period that helped off-price retailers like TJX and ROST materially. The preannounced comp was a definite positive, but in looking at the 2 and 3-year trend, there is really no change in trend. If anything, it is slightly negative. The gross margin story here will be short-lived, with one more quarter before the financial profile looks less favorable. I’m not going to get too excited about the company’s announcement about an increase in long term unit growth to 4-5% as we’re already looking at a mature company with 2,700 big box stores.  There are other names I’d short before this one, but there will be a time over the next 1-2 quarters where this will make a lot of sense. If it is overbought on this news, then I won’t argue to stay away.

 

Levine: Recognizing that the incremental data points on TJX are likely to remain positive, I wanted to make a few points before putting the short TRADE on. 

 

Key factors to look out for over the next 3 months:  1) EPS guidance way too low, but the Street is obviously tuned in to this, 2) they took up the square footage growth rate for next year to 5% from 4%, which is fairly respectable for a company of this size.  I can’t knock them for investing into strength. And 3) the gross margin compares in Q4 are a joke (last year they got caught like the rest of retail with too much inventory).

 

On the flip side, the 2 year comp is holding steady but not accelerating.  With that said, this is still one of a few retailers with positive 2 year trends. 

 

Final note here, is that there may be support from other retail/apparel earnings as they begin to trickle out.  We’re now seeing a handful of positive pre-announcements as well which is likely to build momentum.  To the extent you view this is as a negative to being short, it is probably one of the biggest risk factors in the near-term.

 

 

Team Conclusion: Hold off at this price. Big cap, liquid quality in a space that will be beating for the next 3-months is not a place to source shorts.

 

TJX: Inside the Debate - TJX Comp Trends


Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.33%
  • SHORT SIGNALS 78.49%
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