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**BABA: Our New Tracker (Revision)

Takeaway: Tmall GMV Mix Shift could make or break any quarter for BABA moving forward. Our new tracker suggests it's slowing even further into F4Q15.

Revision: we're correcting a grammatical error to clarify one of the Key Points.  We apologize for the confusion.

KEY POINTS

  1. WHY TMALL GMV MIX IS IMPORTANT: BABA only collects commissions on its Tmall platform, and growing Tmall GMV Mix has been propelling commission revenue growth well in excess of BABA's GMV growth throughout its reported history.  This has been masking the weakness in BABA's core Marketing segment (both reported in China Retail).  However, if this metric stalls, then all the weakness in its marketing segment bubbles to the top (similar to last quarter).
  2. OUR NEW TRACKER IS POINTING SOUTH: We have worked iResearch traffic metrics for BABA into an index, which has produced a .78 correlation with the y/y change in BABA's Tmall GMV Mix dating back to CY 1Q13.  Our index is pointing to a continued deceleration in Tmall GMV mix shift through February.  As it stands now, we're expecting Tmall GMV Mix will grow 1.5 percentage points y/y in F4Q15 (vs. 2.6 and 5.2 in F3Q15 and F2Q15, respectively).  In short, we expect the gap between the y/y growth in Commission Revenue and GMV will narrow further.

 

**BABA: Our New Tracker (Revision) - BABA   Tmall GMV Mix F3Q15

**BABA: Our New Tracker (Revision) - BABA   GMV vs. Commissions F3Q15

**BABA: Our New Tracker (Revision) - BABA   GMV Tracker solo

**BABA: Our New Tracker (Revision) - BABA   GMV tracker

 

 

Let us know if you have any questions, or would like to discuss in more detail.

 

Hesham Shaaban, CFA

@HedgeyeInternet

 


BABA: Our New Tracker

Takeaway: Tmall GMV Mix Shift could make or break any quarter for BABA moving forward. Our new tracker suggests it's slowing even further into F4Q15.

KEY POINTS

  1. WHY TMALL GMV MIX IS IMPORTANT: BABA only collects commissions on its Tmall platform, and growing Tmall GMV Mix has been propelling commission revenue growth well in excess of BABA's GMV growth throughout its reported history.  This has been masking the weakness in BABA's core Marketing segment (both reported in China Retail).  However, if this metric stalls, then all the weakness in its marketing segment bubbles to the top (similar to last quarter).
  2. OUR NEW TRACKER IS POINTING SOUTH: We have worked iResearch traffic metrics for BABA into an index, which has produced a .78 correlation with the y/y change in BABA's Tmall GMV Mix dating back to CY 1Q13.  Our index is pointing to a continued deceleration in Tmall GMV mix shift through February.  As it stands now, we're expecting Tmall GMV Mix will grow 1.5 percentage points y/y in F4Q15 (vs. 2.6 and 5.2 in F3Q15 and F2Q15, respectively).  In short, we expect the gap between the y/y growth in Commission Revenue and GMV will narrow further.

 

BABA: Our New Tracker - BABA   Tmall GMV Mix F3Q15

BABA: Our New Tracker - BABA   GMV vs. Commissions F3Q15

BABA: Our New Tracker - BABA   GMV Tracker solo

BABA: Our New Tracker - BABA   GMV tracker

 

 

Let us know if you have any questions, or would like to discuss in more detail.

 

Hesham Shaaban, CFA

@HedgeyeInternet

 


CCL F1Q 2015 CONFERENCE CALL NOTES

Takeaway: Booking strength and strong onboard spend drove the beat on yields and raised FY net yield guidance. Caribbean is the strength, not Europe.

CONF CALL

  • Excluding transactional/translation impact, net yield guidance raised from ~2.5% to 3.5% (midpoint)
  • Off to strong start in 2015
  • $0.28 drag from currency
  • 8% onboard yield growth (across the board strength)
  • Mid-single digit improvement in Carnival brand for 2015
  • Pleased with demand for Caribbean for reminder of year. Much of year booked at higher prices. Will strengthen pricing for remaining inventory.
  • 75% of addressable market in North America plan to cruise in next 5 years
  • Internet connectivity: 40% improvement in guest satisfaction, 30% increase in revenue
  • $70-80m cost savings in FY 2015
  • China: 4 ships
  • Expect a point in improvement in ROIC in 2015
  • Expect Low-mid single yield growth in long-term
  • Expect double-digit ROIC target in next 3-4 years
  • 1Q breakdown:  +0.06 cents from improvement in net onboard yields and +0.05 from timing of costs, -0.06 from FX/fuel
  • (CONSTANT DOLLAR BASIS) 1Q: 
    • Capacity: +2%; NAA: +3%, EAA: flat
    • Net ticket yield: flat , removing transactional impact, net ticket yield up 1%
  • Expect Caribbean yields to be up for reminder of year
  • Bookings from Wave season strong
  • For remainder of 3Q 2015, nicely ahead on bookings at slightly higher prices
  • NA Brand bookings: Caribbean/Alaska nicely ahead on pricing/occu; all other NA deployment brand (ahead on occu but on lower prices)
  • EAA brand bookings:  nicely ahead on price/occu (booking volume lower YoY but at higher prices)
  • Based on strength of bookings, increased revenue yields
  • Impact of fuel of 2015: +$0.63
  • Impact of transactional/translation currency : -$0.51
  • 2Q 2015: increased dry dock days disproportionally impacting costs
  • Marine accounting change: -$0.11 per share (2010-2014), a -$0.01 cent impact in 1Q.

 

Q & A

  • 1Q yield growth:  onboard/other yields.
  • 1% revenue yield raised guidance:  +0.17 impact on EPS
  • NA/Europe:  ahead on bookings (still on lower end on a historical basis). Very positive trend
  • 9 ship deal:  have not signed contracts with the yards yet. China will receive some of these new ships.
  • Marine account change:  one brand was using a different method. Wanted to make the accounting consistent across all the brands.
  • Constant currency explanation:  prices that the consumer in local currency (3-4% in yields)
  • 3-4% yield guidance vs December guidance:  in December, it was 2.5% yield in constant currency guidance. So it was raised to 3.5% (midpoint).
  • Transational impact:  Princess sailing in Australia. Revenues have to be converted back to US$; hence, negative impact given stronger dollar. 
  • For remaining 3 quarters: raised net ticket guidance (since more visibility), left onboard spend guidance the same
  • Not much significant change on 'real demand'
  • Expecting uptick in the Caribbean, stronger than Europe.  Particularly in Q3 where industry capacity down double digits in Caribbean.
  • Removed 4 ships from fleet in 2015 in North America/Europe. Expect they will remove more from North America/Europe in 2016/2017/2018. 
  • Bookings have been occurring closer and closer to time of sailing. Consumers have changed behavior to some extent.
  • Currency impact: -$0.28; net fuel positive: $0.02 (net of derivatives)
  • Brent fell more than their fuel grade
  • Transactional impact much smaller impact on firm in the past in terms of sourcing.  In past, constant dollar was fine. Now need to also consider transactional costs.
  • Europe/UK:  booking curve are farther out
  • Tunisia impact:  2% of port calls, not overly significant

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Keith's Macro Notebook 3/27: USD | Oil | Japan

 

Hedgeye Macro Analyst Ben Ryan shares the top three things in CEO Keith McCullough's macro notebook this morning.


INSTANT INSIGHT: Currency Wars, Strong Dollar & Oil

Editor's Note: This is an excerpt from CEO Keith McCullough's morning research today. Click here for more information on how you can become a subscriber.

*  *  *  *  *  *  *

 

INSTANT INSIGHT: Currency Wars, Strong Dollar & Oil - ben ryan oil

 

So, they tested the patience of the crowded Euro and Yen short positions... but all lines of @Hedgeye resistance for those majors in the #CurrencyWar held as the U.S. Dollar Index held all lines of support.

 

There's no support for the Euro to 1.05 and Yen 121.61 vs USD.

 

On a related note, Oil...

 

It doesn’t like #StrongDollar, but we like shorting Oil and levered E&P equity schemes on that (ping sales@hedgeye.com to see how our energy analyst Kevin Kaiser is positioning our customers on the long/short side of this).

 

WTI failed at the top-end of yesterday’s risk range and has no real support to $41.93.

 

(No, that’s not a typo.)


MCD: Putting the Activist Thesis to the Test

The basic premise of wanting to be long MCD is a good one; but for us, it comes down to a matter of timing.  From where we sit, with an abundance of unknowns, it’s still too early.

 

McDonald’s is a great company with strong margins, significant free cash flow, and unmatched global scale.  It’s an iconic brand, but its image is tarnished and in need of a major overhaul that can only be led by an overhaul of the menu and the food it serves.  This is precisely why the company is trading at $97 today.  Despite this, there is one shareholder that thinks the stock is worth $169.  We love the bold thinking, but it’s unlikely to happen anytime soon.

 

Three of the top fifteen shareholders that own MCD can be classified as activists.  Given that the new CEO has taken the initiative to classify himself as an internal activist, or a constructive agitator, will the company be better managed?

 

We’re working under the assumption that these shareholders are directing the company to pull some levers to create shareholder value.  This was confirmed by yesterday’s meet and greet with management in NYC.

 

Glenview Capital Management recently put forward a very aggressive case for what MCD can do to unlock value.  No matter what they put forward, turning this company around will ultimately come down to fixing its operations.  Importantly, this is the part of the story that cannot and should not be influenced by an activist.  It will also force the CEO to make difficult, strategic decisions that will be disruptive to how the company operates today.

 

The Glenview (and consensus) bull thesis goes something like this:

 

OPERATIONAL TURNAROUND

Glenview Capital Management: “McDonald’s same-store sales turned negative due to strategic misdirection, operational inefficiencies and disenfranchised franchisee.  We believe that each one of these is a solvable problem and our proprietary research in the channel and conversations with management suggest they are already being addressed, which should allow for a return to positive same-store sales.”

 

Hedgeye: We agree MCD can be fixed operationally.  The bigger question is how long it will take and what will it take to return to positive same-store sales?  How deep are the operational issues?  Will management address the health of its franchisees?  Our proprietary check into McDonald’s franchisees suggests that these issues are much deeper than most think.  The bigger issue revolves around how much blood management can extract from the proverbial stone.  At this point, the franchise system is not seeing “renewed enthusiasm” in the field and, in fact, franchisees are still very concerned about what the recovery will look like.  Consumer perception of the brand remains a huge issue.

 

Verdict: Glenview target price reduced by $11.  There is little evidence of a turnaround.  At the very least, it will not manifest into increased profitability until late 2016.

 

SG&A EXPENSE RATIONALIZATION

Glenview Capital Management: “The bull case says that MCD can cut $500 million of the $2.5 billion in SG&A spending.” 

 

Hedgeye: Once again, we agree that MCD is a bloated company relative to its peer group and there is a significant opportunity to cut costs.  Given the current management team and construct of the Board of Directors, MCD likely won’t come close to realizing the potential G&A cuts.  This type of change would require running the company with a significantly different mentality than anyone at McDonald’s is used to.  For this reason, we don’t believe this is in the cards anytime soon.  Additionally, a sizeable part of any G&A savings will need to be reinvested in the business to help improve assets and the quality of the food.

 

Verdict: Glenview target price reduced by $11.

 

REFRANCHISING

Glenview Capital Management: “Refranchising has a minimal impact on EPS when consummated in a rent-adjusted leverage neutral basis, but the improved quality of the less capital intensive and more stable earnings stream has been consistently and appropriately rewarded in the market via improved valuation. Multiple case studies point to both an immediate recognition upon announcement as well as overtime as the plan is executed, and McDonald’s stagnant franchise mix over the past five years has contributed to a valuation that was at the high end of its peers five years ago but now ranks as the cheapest in the group as others have capitalized on the opportunity while McDonalds has not.”

 

Hedgeye: Management has disclosed their intentions on refranchising, a position we believe they are unlikely to shift from.  The premise of the thesis here is that refranchising will lead to a higher multiple, given the more asset-light nature of the business.  For the most part, MCD U.S. is already an asset-light business model and, unfortunately, it’s not the right time for MCD to be refranchising its company-operated store base.  The company needs the store base right now, because it needs to prove to franchisees that the investments they are making to improve operations will result in the intended lift in sales and profitability.  It’s clear from our discussions with the McDonald’s franchise community that the system is very reluctant to incur incremental costs to fix the asset base until management proves the ROI.  Lastly, even the new CEO will have a difficult time getting the Board to approve this radical change in direction for the company.

 

Verdict: Glenview target price reduced by $14.

 

BALANCE SHEET OPTIMIZATION

Glenview Capital Management: “With accommodating credit markets providing access to generationally low interest rates, as evidenced by McDonald’s 30 year debt yielding slightly below 4% pre-tax or 2.6% after tax, we believe McDonald’s could return approximately 25% of the market cap to shareholders through the end of 2016 while still maintaining an investment grade rating and as much as 50% of the market cap if they choose to match the leverage levels of burger peers, QSR and WEN.”

 

Hedgeye: The potential for balance sheet optimization can be lumped into the same category as SG&A cuts and refranchising.  All three are real opportunities, but all three are highly unlikely given the current Board of Directors.  We don’t believe the new CEO and current Board will leverage the company to the degree that other asset-light companies have done.  That’s simply not the McDonald’s way.  It would represent a major shift in thinking at the company and there are no signs it will move in this direction.

 

Verdict: Glenview target price reduced by $12.

 

REAL ESTATE MONETIZATION

Glenview Capital Management: “Given that REITs are trading at almost 20x EBITDA, we do not believe this is reflected in McDonald’s current 12x EBITDA valuation, and we believe management efforts to monetize or illuminate this could unlock at least $20 billion of value.”

 

Hedgeye: We believe this entire topic of McDonald’s potential real estate opportunity is overblown and, on some level, flawed.  The Glenview letter is short on details and ignores some very important issues.  If those doing the analysis spent more time studying McDonald’s business model, they would better understand how the real estate and franchise sides of the business work together.

 

First, it appears that people believe McDonald’s is charging below market rents to franchisees.  This is simply not true – actual rent payments are far above market rates.  This would not be allowed under a publicly traded REIT.  If MCD gets a significant chunk of their revenues from rent paid by franchisees, how will a REIT further monetize real estate?  Raise the rent to franchisees?  They can’t.

 

Second, many properties are already encumbered by the franchise agreements in place at each and every location.  McDonald’s has no power to modify or force a renegotiation of these terms.  They can certainly sell the underlying properties into a REIT, but we fail to see how they can monetize this without charging higher rent.  And if they sell this underlying property, McDonald’s is still responsible to the franchisee for the remainder of the franchise term.  They can sell or assign their rights, but not their responsibilities.

 

The dirty little secret that no one talks about is ongoing rumors that there is a “secret MCREIT” that MCD set up with six of their suppliers 20 years ago.  According to industry insiders, the suppliers bought real estate and leased it back to MCD with zero transparency to shareholders.  How much of the leased land and buildings are already owned by this “secret MCREIT?”

 

Verdict: Glenview target price reduced by $25.

 

UPSHOT

Our target price is closer to $96, a far cry from the $169 target put forth by Glenview Capital Management.  We see downside/upside potential to $83/$112 per share, respectively.

 

MCD: Putting the Activist Thesis to the Test - 1


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