Although heavy on content, McDonald’s Turnaround Plan was rather light on detail. Management announced several initiatives that should keep investors content over the next few months, but the lack of color surrounding operational initiatives was disappointing. CEO Steve Easterbook made it clear that there is more to come and held out a few carrots (potential for additional refranchising, leverage, and real estate scrutiny) for investors to nibble on. With that being said, it is abundantly clear that the road to recovery will be a long, bumpy one. We’re staying on the sidelines, for now, until management devises a strategic, actionable, and well-articulated plan to fix the operations of the business.
The Main Event
McDonald’s unveiled a reorganization of its business this morning in a video sent out by CEO Steve Easterbrook. The company will transition to a new organizational structure within the following market segments: U.S., International Lead Markets, High-Growth Markets, and Foundational Markets. The new structure will be supported by streamlined teams and fewer layers, which should allow for better focus within closely aligned markets. By restructuring the company, management hopes to eliminate its cumbersome and stagnant decision making process.
McDonald’s also announced it will accelerate its refranchising efforts, with the intention of bringing its franchise/company owned mix to 90%/10% by the end of 2018. The two initiatives combined should begin yielding $300 million in annual G&A savings by the end of 2017. In addition, the company will return $8-9 billion to shareholders in 2015 and plans to reach the top end of its 3-year $18-20 billion cash return range by end the end of 2016.
New Market Segments
- Accounts for more than 40% of operating income
- Will be led by current USA President Mike Andres
International Lead Markets
- Australia, Canada, France, Germany and the U.K.
- Accounts for approximately 40% of operating income
- Will be led by current Europe President Doug Goare
- China, Italy, Poland, Russia, South Korea, Spain, Switzerland and the Netherlands
- Will be led by current APMEA President Dave Hoffman
- Remaining markets in the system
- Will be led by current APMEA CFO Ian Borden
Takeaway: Value levers need to be pulled to offset the negative fundamental momentum. This was not a good quarter.
- Mayweather/Pacman fight: record REVPAR weekend. Tremendous gaming drop at MGM's properties.
- LV REVPAR 1Q: outperformed LVCVA reported Strip REVPAR of -1.5%
- MGM China increased its market share
- Lower volume and hold at Aria
- Vdara/Crystals: record EBITDA quarters
- Had expanded credit facility to $3bn - will continue to invest in Macau
- Arena 50/50 JV: MGM will invest $87m (equity contribution); during 1Q, secured Cola-Cola, Toshiba, and Snider Electric contracts. In negotiations with 8 other providers. Signed contracts for over 50% of the suites.
- Mandalay Bay expo convention space will open in Aug 2015 (already booked). Will renovate rooms in June 2015 and will be completed by March 2016.
- MGM Detroit: invested $800m in total (earning $150m/year)
- MGM National Harbor: moving towards Q4 2016 opening
- Springfield opening: Late 2017 - feels like MGM Detroit return profile
- MGM Cotai: remain on track for Q4 2016 opening. Mass-centric.
- Land & Buildings: suggested $2.6bn special dividends in MGM Macau. Pitch full of mistakes. Tabloid-like campaign.
- Concept of REIT is not a new one. Board have evaluated that option in prior year. But MGM business model is evolving.
- Non-luxury/regional properties were strong offset by luxury Strip resorts.
- LV REVPAR Q1: Jan (Double-digit growth), Feb (low-to-mid growth), but March very tough (excluding Conagg week, REVPAR would have been up 6%)
- But Q1 guidance had already accounted for difficult ConAgg comps
- Q2 LV REVPAR guidance: at least 5% REVPAR (helped by Mayweather/Pacquiao fight)
- Aria: 250bps decrease in table game hold YoY. Lower volumes from high-end Chinese business.
- Aria: 9% increase in convention room nights and 7% in ADR
- CityCenter: MGM received $200m dividend last Friday.
- Cash: $469m at MGM China. $1.1bn RC availabilty. $1.4bn of excess cash
- $1.5bn convertible notes converted into net 71.7m of MGM stock
- At end of 1Q: $950m in debt outstanding.
- CityCenter: $1.5bn debt outstanding, does not account for special dividend paid out last week
- Capex: $92m (domestic operations), $54m (Springfield/National Harbor). $19m Arena contribution. $14m MGM Macau. $132m at MGM Cotai.
- MGM China: targeted marketing efforts. Mix-shift (high-end premium floor): 50% of revs and 80% of EBITDA coming from mass. Additional 44 tables moved to mass vs prior year quarter (55% of total tables are mass). 80% of mgmt team are locals.
- Convention: lead volumes up 70% YoY. Corporates driving 60% of booked room nights.
Q & A
- LV Strip REVPAR guidance: better and better at forecasting it.
- LV REVPAR: +4% in April
- Chinese LV customers: <5% of total cash flow in LV. -30% collectively in Q1 or $15-20m in net gaming revenues.
- Japan/Korea/Taiwan customers doing well in LV
- March softness: particular in ConAgg week.
- May boxing weekend: benefited REVPAR by 1%
- Cost control: Costs up 2% in 1Q, FTEs flat in 1Q
- Very focused on margins in LV
- Still expect annual 50% flowthrough in Vegas
- Bellagio margins better than Wynn and LVS LV properties
- Luxury LV properties: more isolated from city-wide conventions
- Core LV properties: benefit from city-wide conventions.
- Core LV REVPAR in 1Q: up 4%
- Core REVPAR has outperformed luxury for last 3 quarters because they're farther away from peak.
- $8m wholly-owned 'bad luck': Bellagio, Mandalay, MGM Detroit - there wasn't any bad luck, however, as hold percentage was smack dab in the middle of the historical range
- % of room nights on the books for Q3 2015: booked a big business for August (in the year for the year). A little softness in international leisure travel but can be offset by domestic business.
- Q1 2015: some high-rollers delayed their trips to come visit for the Big Fight
- Crystals: a couple of years, explored sale. Had high level of interest. Being actively discussed at the board level.
- Only thing they agreed with Land&Buildings: MGM is undervalued
- Cash paid taxes in 2015: will be <$50m. Will be up a little bit in 2016.
- MGM China: very strong in premium mass. Focused on building out entertainment base and MICE business on Cotai.
- 3Q REVPAR/4Q REVPAR guidance: +2-3% comfortable target
- MGM China: Up to 35% of NI paid as regular dividends. Board will take a look at that.
- Leverage constraint: 5x for MGM China
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Takeaway: We are removing German Equities from Investing Ideas today.
Please be advised that we are removing German Equities (EWG) from Investing Ideas today.
Below is a brief note from Hedgeye CEO Keith McCullough on the decision.
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- Recent correlation sensitivity of DAX to Euro – widening FX risk ranges making me less confident
- Recent rollover in higher-frequency (monthly) European economic data
- Reducing the length of our Investing Ideas List (looking for a market correction to add it back again)
In case you missed it, Hedgeye's Internet & Media Sector Head Hesham Shaaban weighed in on Jim Cramer’s suggestion that Google ($GOOG) should purchase Twitter ($TWTR) live on Hedgeye TV earlier today.
CAT shares have outperformed since we removed CAT as a short from our Best Ideas List in late January 2015. However, we are interested in adding short CAT back to the list, and have focused on potential losses at Cat Financial as a downside catalyst. While we think CAT may beat and raise guidance again in the 2Q15 report, the second half of 2015 should bring much weaker results. We estimate that CAT’s 2H15 EPS will annualize to ≤$4.00 vs. 2016 consensus of $4.79. An increase in Mining past dues was a key takeaway from the 1Q15 release.
Losses at CAT’s captive finance subsidiary, a much lower EPS run rate, and uncertainty surrounding investigations/control issues may result in significant pressure on the shares later in 2015.
Cat Financial’s portfolio exposure to mining, coal, and upstream oil & gas producer defaults is hard to estimate given the current disclosures. While Cat Financial does not provide much detail on specific credit exposures, its marketing ‘pitch books’ do name some names. One important incremental piece of information is that Cat Financial does not appear to have any Export Import Bank (Exim) guarantees on these exposures. So Cat Financial would appear to be on its own should it retrieve collateral from Boseto, Kaunisvaara, and other troubled projects.
These deals may have made more sense in the 2007-2012 commodity price environment, but we wonder if Cat Financial was underwriting the equipment instead of the borrower. Remarketing repossessed mining equipment in the current equipment demand environment is unlikely to be easy, and repossessed equipment can compete with already depressed new equipment and parts sales. The recognition of these credit troubles seems likely to hit later in 2015. This should coincide with the step down in earnings as CAT's oil & gas backlog runs dry.
As for the 10-Q, there is quantification of the increase in past dues, an incremental subpoena, and a slight tailwind year-on-year from warranties:
Mining Past Dues: Management noted that past due receivables picked up in 1Q 2015, but the magnitude of the increase is noteworthy. Mining past dues were $39 million at year end 2014, but nearly tripled to $106 million during just the first quarter of 2015, and were up nearly 10x year-over-year. While the scale is still fairly small, we expect the ramp to continue during 2015. We also understand that some mining exposure is under the regional categories, as is Cat Financial’s upstream oil & gas exposure. The allowance for credit losses declined very slightly during the quarter.
Another Subpoena: Realistically, CAT can afford both the legal fees to keep these issues in court, and to pay whatever fines are needed to exit these investigations. It is a distraction for management, investors, and interested customers, however.
“The Company received an additional subpoena relating to this investigation requesting additional documents and information relating to, among other things, the purchase and resale of replacement parts by Caterpillar Inc. and non-U.S. Caterpillar subsidiaries. The Company is cooperating with this investigation. The Company is unable to predict the outcome or reasonably estimate any potential loss; however, we currently believe that this matter will not have a material adverse effect on the Company’s consolidated results of operations, financial position or liquidity.”
Warranty: Looking at CAT’s warranty accruals, it looks like a slight benefit year-on-year. This is partly a product of lower sales, and is offset by higher stock compensation in the 1Q15 results.
Upshot: While we think CAT may be able to post a favorable 2Q15, we expect significant pain later in 2015. By year-end, we see annualized EPS below 2016 estimates, mounting credit losses in the resources-exposed Cat Financial portfolio (mining, coal, oil & gas, etc), and renewed pressure on management/controls... perhaps (finally) precipitating a bottom in CAT's relative performance.
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