Historical Perspective

“The charm of history and its enigmatic lesson consist in the fact that, from age to age, nothing changes and yet everything is completely different.”

-Aldous Huxley


On the days Keith writes the Early Look and provides historical context to the current period we are in, it’s always enlightening and helpful to have that context. Yesterday’s Early Look titled “Confirmation Bias” was one of those notes. 


The bottom line for me from yesterday’s Early Look was: stick with what you know and do not fight the tape.  Dollar down = Stocks up; stick with what works.  The dollar will continue to be subject to unprecedented budget deficits, near-zero interest rates and anemic economic growth.  That means capital will flow to hard assets and will find a rate of return that is greater than zero. 


There is no reason to think that President Obama is going to change his policies any time soon.   President Obama’s efforts to lead the world economic recovery by spending his way out of the recession will continue to undermine the dollar.  This will continue to trigger the REFLATION trade and is the reason why Materials (XLB) is the best performing sector year-to-date, up 41.6%.  Rounding out the top three performing sectors year-to-date are Technology (up 38%) and Consumer Discretionary (up 31%). The performance of technology is more understandable, due to growth and innovation, but consumer discretionary is puzzling.


I appreciate history as much as the next guy, but obviously, there are some significant differences between 1933 and today.  President Obama is not FDR, the unemployment rate is not 24%, and one quarter of the population in the U.S. is neither hungry nor starving.


In fact, the opposite is happening. Between 1933 and 1937, employment did not implode.   In 1933 the unemployment rate was 24.9% and by 1936 it was 16.9%.  It bottomed at 14.3% in 1937 before rising to 19% in 1938.  So although the absolute rate of unemployment was much higher then, the rate was coming down, not going up like it is today.


In September 2009, the unemployment rate stood at 9.8% versus 7.6% in January 2009.  In September alone, the economy lost 263,000 jobs, bringing the total number of Americans out of work to 15.1 million.  If you want to play with the number and include the 500,000 unemployed people who gave up looking for work in September, the unemployment rate would be 17%, the highest on record since 1994.


So how is the “Burning Buck” good for consumers, who account for 70% of the nation’s economy?  It’s NOT!  And the latest reading on consumer confidence has turned decisively negative. 


Yesterday, the ABC Consumer Confidence reading came in at (50) for the week of Oct 18th vs. (48) the prior week.  For a historical perspective - (54) is the worst reading ever.  Last week, The University of Michigan confidence index fell to 69.4 in early October from 73.5 in September.  In November 2008 the reading was 55.3.


The other big issue that more and more consumers are facing is housing.  While the government is trying its best to shore up the housing market, the efforts do not get at the heart of the problem –the rising unemployment is making it hard for consumers to make ends meet. 


The REFLATION trade is real and needs to be fully appreciated, but underneath the surface there are some real issues with the consumer that need more time to be worked out. Simply Burning the Buck is not the answer.  Yesterday could be a classic example of what will happen when the buck stops burning.  The S&P was down 0.6% and the two worst performing sectors were Materials and Consumer Discretionary, both down 1%.


I’m not trying to be bearish, just practical.  The S&P 500 is up 61% since the March 9th low and the Federal Reserve has spent TRILLIONS to fight the worst U.S. recession since the 1930s.  Operating stories like Yahoo can have a great quarter in this environment, as comparisons are easy across the board.  It’s staggering to see that 80% of the S&P 500 has beaten analysts’ estimates this earnings season.  That figure is not going to 90% or 100% next quarter. 


The most important headline today is that the Bank of England Governor Mervyn King is talking about higher interest rates.  I love the British because everything is so proper - “it would be wise to take account of the prospect of rising borrowing costs.”  Can Ben be far behind?  Rising borrowing costs are good for the dollar, bad for the consumer and bad for stocks.  It’s looking more and more like 2009 was the eye of the storm – the front wall hit in 2008 and the back side is coming in 2010.


1933 is in the past!


Function in disaster; finish in style.


Howard Penney 





XLU – SPDR UtilitiesWe bought low beta Utilities on discount (down 1%) on 10/20. Bullish formation for XLU across durations.  


FXC – CurrencyShares Canadian DollarWe bought the Canadian Dollar on a big pullback on 10/20. The currency ETF traded down -2%, but the TRADE and TREND lines are holding up next to Daryl Jones’ recent note on the Canadian economy.


EWG – iShares GermanyChancellor Angela Merkel won reelection with her pro-business coalition partners the Free Democrats. We expect to see continued leadership from her team with a focus on economic growth, including tax cuts. We believe that Germany’s powerful manufacturing capacity remains a primary structural advantage; with fundamentals improving in a low CPI/interest rate environment, we expect slow but steady economic improvement from Europe’s largest economy.


CAF – Morgan Stanley China Fund A closed-end fund providing exposure to the Shanghai A share market, we use CAF tactically to ride the more volatile domestic equity market instead of the shares listed in Hong Kong. To date the Chinese have shown leadership and a proactive response to the global recession, and now their number one priority is to offset contracting external demand with domestic growth. Although this process will inevitably come at a steep cost, we still see this as the best catalyst for economic growth globally and are long going into the celebration of the 60th Anniversary of the People’s Republic.


GLD – SPDR GoldWe bought back our long standing bullish position on gold on a down day on 9/14 with the threat of US centric stagflation heightening.  


XLV – SPDR Healthcare We’re finally getting the correction we’ve been calling for in Healthcare. We like defensible growth with an M&A tailwind. Our Healthcare sector head Tom Tobin remains bullish on fading the “public plan” at a price.


CYB – WisdomTree Dreyfus Chinese Yuan The Yuan is a managed floating currency that trades inside a 0.5% band around the official PBOC mark versus a FX basket. Not quite pegged, not truly floating; the speculative interest in the Yuan/USD forward market has increased dramatically in recent years. We trade the ETN CYB to take exposure to this managed currency in a managed economy hoping to manage our risk as the stimulus led recovery in China dominates global trade.


TIP – iShares TIPS The iShares etf, TIP, which is 90% invested in the inflation protected sector of the US Treasury Market currently offers a compelling yield. We believe that future inflation expectations are currently mispriced and that TIPS are a efficient way to own yield on an inflation protected basis, especially in the context of our re-flation thesis.




UUP – PowerShares US Dollar We re-shorted the US Dollar on strength on 10/20. It remains broken across all 3 investment durations and there is no government plan to support it.


FXB – CurrencyShares British Pound Sterling The Pound is the only major currency that looks remotely as precarious as the US Dollar. We shorted the Pound into strength on 10/16.


XLP – SPDR Consumer StaplesStrong day for Consumer Staples on 10/16, prompting a short versus our low beta long position in Utilities (XLU).


USO – US OIL Fund WTIC Oil traded just north of our overbought line on 10/12. With the US Dollar hitting another higher-low, we shorted more of oil’s curve.


EWJ – iShares Japan While a sweeping victory for the Democratic Party of Japan has ended over 50 years of rule by the LDP bringing some hope to voters; the new leadership  appears, if anything, to have a less developed recovery plan than their predecessors. We view Japan as something of a Ponzi Economy -with a population maintaining very high savings rate whose nest eggs allow the government to borrow at ultra low interest levels in order to execute stimulus programs designed to encourage people to save less. This cycle of internal public debt accumulation (now hovering at close to 200% of GDP) is anchored to a vicious demographic curve that leaves the Japanese economy in the long-term position of a man treading water with a bowling ball in his hands.


SHY – iShares 1-3 Year Treasury Bonds  If you pull up a three year chart of 2-Year Treasuries you'll see the massive macro Trend of interest rates starting to move in the opposite direction. We call this chart the "Queen Mary" and its new-found positive slope means that America's cost of capital will start to go up, implying that access to capital will tighten. Yields are going to continue to make higher-highs and higher lows until consensus gets realistic.


The bottom line – SONC continues to deliver on those initiatives that are within the company’s control.  The MACRO environment for QSR remains challenging.  The franchise model (SONC refranchised 205 partner drive-ins in fiscal 2009), margin improvement and continued unit growth will allow SONC to rise above the rest over time.  As I have said before, SONC’s return on incremental invested capital (ROIIC) has already turned and is becoming less negative.  The timing on the improvement in sales trends, however, will be a key driver to short-term sentiment.


Positive and Negative takeaways from the quarter/earnings call…




YOY operating margin improvement came in better than my expectations.


Traffic came in about flat (strong relative to peers).


New store openings in new markets are sustaining average unit volumes above the system average (always a strong indicator of future performance).


We should see continued improvement in restaurant margins in FY10 (turning positive despite continued pressure from promotional activity with COGS flat as a % of sales on a full-year basis). 


Restaurant –level and operating margins will be benefited by recent refranchising activity.


SONC will continue to generate free cash flow in fiscal 2010, which the company said it will use to generate shareholder value.




Management stated that weather has been a challenge, implying no improvement in sales trends in early fiscal first quarter.


Average check continued to decline in the quarter (so traffic improvement coming at the expense of average check).


Management said there were no changes to guidance provided on Sept 17 but when questioned specifically about flat same-store sales growth guidance, management said it would have to revisit this guidance following the first quarter results.


The current credit environment is delaying franchisee unit openings.  The company is offering deferred and reduced franchise fee and royalty requirements to spur new franchisee development, particularly multi-unit development.





Given that Street numbers have come down over 10% since the second quarter, we think this will be another quarter where Starwood beats and moderately lowers expectations.



Street expectations have come down more than 10% for 3Q09 since the last time we updated the consensus table in our model.  Therefore we won't be surprised if Starwood manages to eke out another small beat vs lower Street expectations. 


We are projecting Q3 Adjusted EBITDA of $182MM vs Street estimates of $175MM and company guidance of $165-$175MM.  We estimate that adjusted EPS will be $0.12 vs guidance of $0.06 to $0.10 and Street estimates of $0.10. Below are some of our assumptions for the quarter:

  • Branded Owned Hotels Worldwide: while our numbers aren't same store, our -24.5% RevPAR assumption compares to HOT's  guidance of  -24% to -26% (21% to 23% in constant dollars) for same store Branded Owned hotels worldwide
    • Since the dollar weakened against all currencies save the Argentinian Peso and Mexican Peso in Q3 vs Q2, we estimate less currency drag in the quarter than the first half of 2009
  • We estimate that total RevPAR (not SS) will decrease 21.4%, which compares somewhat to HOT's guidance of SS worldwide company operated hotels of -20% to -19% (-17% to -19% in constant dollars)
  • We are projecting that Owned, Leased and Consolidated JV hotel margins will decrease 970 bps and that total expenses for Owned, Leased and Consolidated JV hotels will decrease 22% y-o-y (vs 28% last quarter)


Last year in the 3Q08 release, HOT gave some "broad parameters" regarding how to think about 2009.  Given that Starwood has traditionally been more aggressive in providing its outlook than MAR, we expect them to give us a preview for 2010 expectations.


Going forward, a few things to keep in mind:

  • Starting 4Q09, FX will once again become a tailwind for Starwood. More than 50% of HOT's owned EBITDA comes from outside the US.  A weak dollar will strengthen reported RevPAR numbers but make cost comparisons more difficult as well.  We estimate that in 4Q09 FX will benefit international ADR's by as much as 7.5% at current FX rates for the owned portfolio.  For 2010, if FX rates stay constant, international ADR's will be aided by an estimated 5%
  • Starwood also has high international exposure in its managed and franchised business, so their system wide reported RevPAR statistics will also benefit from a weak dollar
    • 56% of HOT's managed and unconsolidated JV rooms are outside of North America (even higher when you exclude Canada)
    • Almost all of HOT's incentive fees are coming from international hotels at this point since international contracts typically don't have an owner's priority clause (where the brand doesn't get paid until the owner earnings a minimum return each year)
    • 26% of HOT's franchised hotels are located outside of North America
  • Aside from FX benefits, international RevPAR may recover faster than US RevPAR (barring more natural disasters, terror attacks and worsening swine flu outbreaks) given several unusual events in 2009:
    • H1N1, which heavily impacted travel starting April 2009
    • Supply overhang in China post Olympics
    • Mumbia attacks in India and bombings in Indonesia
    • Political instability in Thailand and Fiji
  • We've noticed that the number of new hotels opening in 2010 advertised on Starwood's website is roughly 50% less than what we counted opening in 2009.  However, these are gross hotels vs net, but nevertheless this is worth noting

Despite the likely favorable FX benefit, we think Street estimates remain too high due to unrealistic margin assumptions.  See our 10/15/09 post, "LODGING: HISTORY REPEATS", for details.



"YouTube" from 2Q09

"It appears to be a slow recovery so far. While the RevPAR decline is moderating in relative terms, it is still deep decline in absolute terms. The pace of improvement at this point is dependent on rate..."


Business conditions/ Outlook:

  • Occupancy stabilized in Q2 in North America and Europe... The fact that rate trails occupancy is fairly typical for [what] happens at this stage in the cycle. What is hard to pin down is the pace at which rates will stabilize. History would suggest it will be one or two quarters after occupancy does.
  • In North America, mix is skewing towards more price sensitive leisure business. Weakened demand, which is also more price-driven, is stronger than weekday, especially Monday through Wednesday demand.
  • Corporate room nights are down, leisure room nights are up, but there are early indications that corporate business is slowly coming back.
  • Group production in June was the best so far this year, and there are more leads coming in than we had earlier in the year. But so far, this feels more like a slow recovery than a sharp pickup from pent-up demand.
  • [Regarding group bookings] cancellation piece of this should abate and, at the same time, we are starting to see some pickup in activity that will certainly help as you get to the later part of 2010 and beyond.
  • RevPAR declines will be lower  than in Q2, but the absolute level of decline, at over 20%, is still deep by any historical measure. As such, we remain very focused on cost control. Our guidance implies that the rate of decline moderates even more in Q4, as we left the 15% decline last year. The situation is very similar in Europe with one major difference. Through the first three quarters, we face significant foreign exchange headwinds.
  • So if you look at it on a two-year basis, our expectations for the fourth quarter are really not that different from roughly where they are today. Clearly, the Forex in dollar reported terms dramatically changes. And in the second quarter, our entire international portfolio had a Forex headwind of around 800 basis points, and that becomes a tailwind of about 100 basis points. And if you say international is roughly half, that’s a 400 basis point benefit right there just from translation.
  • 4Q09 RevPAR thinking: close to high-single digit, double-digit decline in Q4.


Cost Commentary:

  • The contracted wage growth would probably be in the range of 3% to 4%



Pipeline commentary:  

  • Our reported pipeline now stands at 90,000 rooms. We pulled 25 deals from the pipeline based on financing issues experienced by our owners.


Asset sale commentary:  

  • We have some non-core assets that we are in discussions on. These include hotels we do not plan to retain our flag on, non-hotel businesses and land. Our preference would be to sell non-core assets at this point if we can realize good values.





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Sep same store rev increased 15% in Louisiana. However, the comp was easy (-23% last year) due to the hurricane and the Labor Day shift. The 2 Yr comp fell 12%.



On the surface, the Louisiana market looks very strong.  Same store revenue increased 15%, but off of a -23% comparison.  Hurricane Gustav hit in September of last year resulting in the closure of several properties including L'auberge du Lac, Boomtown New Orleans, Delta Downs, and Treasure Chest.  Moreover, as we wrote about in our 10/02/09 post, "APPLES TO APPLES", gaming markets were aided by Labor Day weekend falling in September of this year versus August of last year.



Looking at Louisiana over a two year perspective is more instructive.  The following delta chart shows gaming revenue growth over that period.  Not only was two year same store revenue down 12%, the delta line (3 month moving average) does not appear to be improving. 




PNK maintains the most exposure to Louisiana and Q3 numbers look pretty good.  However, for all of the regionals we continue to be concerned with the prospect of a more prolonged downturn.  As we've written about, gas prices will reverse to a significant headwind beginning in December - projected to be up as much as 50% nationally - and running through May 2010.  We previously determined that gas prices are statistically significant in predicting gaming revenues.



Going into the quarter, I stated that EAT needed to eliminate some questions around its long-term strategy changes at Chili’s.  Management did outline some of its plans around introducing menu enhancements which will come in stages and will work to remove some menu items while improving its core items.  Specifically, management said that the casual dining space has gotten crowded and the company needs to emerge from the “sea of sameness” by improving execution and providing better food, value and service. 


Based on the fact that the stock is trading down significantly today despite EAT’s reporting better than expected 1Q earnings and sales, my key takeaway from the earnings call is that management did not do a good job laying out its plans for the Chili’s brand.  Instead, most of management’s plans could be inserted into almost any casual dining company’s future plans, thereby only increasing the perception of industry “sameness.”  The fact that the company did not provide updated full-year guidance (and implied that prior EPS guidance is no longer a good number) is definitely weighing on the stock today as well, but the strategy changes at Chili’s will be important on a go-forward basis.


Focusing on execution, value and the core menu is very important and lies within the boundaries of what I think the company should be doing, but Brinker did not provide enough brand-specific initiatives.  It does not show them going for the jugular.  I know Brinker needs to be vague for competitive reasons, but in today’s tough economic environment, investors need more answers. 


We all know that the questions asked during a conference call often highlight investors’ primary concerns, and I was the sixth analyst to ask a question and the first to ask about Brinker’s specific plans for Chili’s.  So I just may be wrong.  People may not be too concerned with what management is saying about Chili’s because it will not matter until the changes yield actual results. 


Sales and margin performance will always drive stock price performance and although Brinker posted sequentially better sales in August and September, these sales numbers were only less bad and margins declined.  And, management hinted that restaurant margins would continue to decline in 2Q.  If Brinker is able to replicate MCD’s success by reenergizing its brand (as management referenced), then Chili’s sales are moving higher and will outperform its peers, but the company did not say anything today that leaves me convinced of this outcome in the near-term. 


Brinker has one of the best management teams in casual dining so it could surprise me, but I need to learn more and as they say, “the proof is in the pudding.”  To that end, Brinker was one of the first casual dining operators to really cut growth.  It was also one of the first to really create a leaner business model by implementing cost saving initiatives.  And, now, EAT is really focused on improving its core business and improving 4-wall execution.  This type of strategy often leads to better margins and returns (as we saw with MCD’s Plan to Win strategy and more recently, at Starbucks).  Although management’s comments did not leave me any more confident about near-term sales trends, EAT will be better positioned going forward based on this unit by unit in-store focus.


Can lawmakers in Washington justify extending the homebuyer tax credits with such obvious abuse from consumers?


While Keith covered the short on the XHB today, we continue to expect that the recent enthusiasm around the housing recovery and the homebuilders will continue to wane.  As such, we will look to an up day to re-short the XHB. 


The trend toward a stabilization of home prices and the improvement in new and existing home sales is self evident, and the consensus belief is that the bottom is in the rear view mirror.  The question at this point is the trajectory of the recovery in the housing market and what happens on the margin.  While there is significant reason to be optimistic about the recovery, the data flow over the next six months is likely to show a slowdown in the magnitude of improvement relative to what we have seen recently.   


The decline in mortgage rates and lower home prices has made housing more affordable than at any point over the past 2 decades. Additionally, the tax credit for first time home buyers has helped create significant incentive to jump start purchase activity.  


Today, it was reported that the National Association of Homebuilders housing market index dipped to 18 from 19 in September, falling below market expectations for a reading of 20.  Home builder sentiment is waning, as the November 30 expiration of the government's $8,000 tax credit for first-time buyer's approaches and there is no resolution for its future. 


The WSJ also notes today that the IRS is examining more than 100,000 suspicious claims for the first-time home-buyer tax break.  This is not a good sign and makes it less likely that the program will be extended. 


Also, construction of new homes rose 0.5% in September to a seasonally adjusted annual rate of 590,000 units; weaker than the 610,000 economists had thought.  The all important applications for building permits fell by the largest amount in five months. 


As an industry, the homebuilders are in the business of building new homes, which helps to support the nation’s economy.  Unfortunately, the bottom line is that we don’t need any more new homes.  Using data from the Mortgage Bankers Association, there are more than 7 million homes that are in some state of distress.  Given the pace of new homes being built, the current inventory of unsold homes and the potential number of homes that are in distress is likely to increase. Put simply: the housing overhang is here to stay. 


With the market now up 62% from the March 9 low, consumers may feel better, but it does not completely offset the fact that unemployment is approaching 10%+ and job security remains  an issue.  Today, most consumers need a substantial discount to motivate them to spend their hard earned paychecks.  Without government tax incentives, the housing market is on shaky ground.  Even if the government comes to the rescue with more aid, it does not fix the heart of the problem – most consumers are having a hard time making ends meet.


Howard Penney

Managing Director




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