A Pounded Pound Breeds Inflation

Research Edge Position: Short UK (EWU), Short British Pound (FXB)


When we speak of “imported” inflation we’re talking about the relationship between the strength of a country’s currency versus the price of goods and services it imports. With respect to the UK, an import and service based economy, the depreciation of the British Pound since mid ‘08—which we’ve named The Pounded Pound—has bred inflation (for both Producers and Consumers) as the depreciation in the currency has not only diminished purchasing power for its citizenry at home (as more money is needed to chase goods and services), but it has also reduced purchasing power versus its primary import partners. Finally, the global appreciation in the price of oil, denominated in US dollars and therefore boosted by the inverse correlation of depreciating USD (without consideration of supply and demand dynamics), has inflated energy costs for importing nations like the UK.


Therefore, with the depreciation of the Pound and the rise in oil prices (a major cost component for Producers), it comes as no great surprise to see a sequential and annual rise in the UK Producer Price Index.  In fact, Input Prices, the materials and fuels manufacturers buy, rose 2.6% in October versus the previous month, while Output Prices, or what manufacturers sell, increased 0.2% sequentially or 1.7% Y/Y. The take-away here is (see chart below) that cost inputs are trending positive and upward in the UK, while outputs have remained positive, but stable over the last year. This price inflation should compress margins for Producers, costs that will eventually be passed on to the consumer.


If the above rhymes, we must also mention that UK Consumer Price Index, in aggregate, has declined over the last months, from 1.6% in August Y/Y to 1.1% in September.   This decline can be attributed to a sluggish economy, still searching for growth with Q3 GDP registered at -0.4% Q/Q, annual declines in energy costs, and rising unemployment, all of which should put pressure on broader fundamentals. Further we hold that with the Treasury continuing to print money, including issuing a second wave of bailouts to RBS and Lloyds to the tune of 40 Billion Pounds this week, and the BOE expanding its bond purchasing program while keeping rates steady at a historic low of 0.5% will sustain a weak Pound, which should encourage inflation.   


In our virtual portfolio we remain short the UK via the etf EWU and short the Pound via FXB.  We expect to see continued underperformance in UK fundamentals. With the economy looking to return to moderate growth by the end of the year, Producer Inflation may remain a major headwind over the intermediate term. 


Matthew Hedrick



A Pounded Pound Breeds Inflation  - UK PPI OCT



A look at good, neutral, or bad numbers…


MCD is scheduled to report October same-store sales numbers before the market opens on Monday.  Management provided the following outlook for October sales trends on its 3Q09 earnings call:


“As we move through October, consolidated comparable sales remain positive with Europe and APMEA contributing strong results. In the U.S., despite continued gains in market share and advancement in our industry-leading position, we're expecting flat to slightly negative October comps. This is due in part to the current economic environment and strong results a year ago. We do not believe, however, that this is a change in the overall trend in performance in the U.S.”


Taking those comments into consideration, 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 largely on 2-year average trends. 


U.S. (facing a relatively difficult +5.3% comparison from last year):

GOOD: Any number better than flat would signal that the company’s trends came in better than management’s guidance.  The company needs to report at least +0.6% to just maintain its 2-year average trends from August and September.  So this month, even a GOOD result will most likely point to a continued deceleration in 2-year average trends.


NEUTRAL: -1% to flat would signal that full month trends were in line with management’s guidance.  So this range of results, though neutral from an investor sentiment perspective as it relates to expectations, is not a favorable sign for current trends.  MCD has not reported a decline in U.S. same-store sales growth since March 2008.  This neutral range also implies a continued deceleration in 2-year average trends.


BAD: below -1% would be worse than expectations as set by management.  A -1% number points to an 85 bp sequential decline in 2-year average trends.  A -1.5% or below would be very BAD as it implies a 2-year average trend of less than 2%.  MCD has not posted 2-year average trends below that level since early 2003.


Europe (facing a relatively tough +9.8% comparison from last year):


GOOD: +4.5% or better would signal an acceleration in 2-year average trends from September levels and a return to the 7%-plus levels MCD has experienced for the greater part of the year.


NEUTRAL: +2% to +4.5% would point to 2-year average trends that are about even with to slightly better than what we saw in September.  Investors are most likely expecting some sequential improvement as management said Europe and APMEA are “contributing strong results” in October.


BAD: below +2% would imply a slight slowdown in 2-year average trends and anything below 1% would be viewed as really BAD as it would signal a return in 2-year average trends to the low reported June levels.


APMEA (facing a relatively difficult +11.5% comparison from last year):


GOOD: +2.0% or better would signal an acceleration in 2-year average trends.  A +2.5% 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: flat to +2% would point to 2-year average trends that are consistent with to slightly better than what we saw in September.  Like Europe, based on management comments, investors are most likely expecting some sequential improvement in APMEA. 


BAD: any number below a flat result would imply that 2-year average trends have slowed somewhat.  Although MCD reported a negative comp in August, I think the sticker shock associated with seeing this segment go negative again would be bad.  Any number below -2% would be really BAD as it would imply a return to the softened 2-year average levels we saw in June, July and August.





CPKI – California dreaming of better times

On a relative basis, 3Q09 was not a bad quarter for CPKI with same-store sales down 8%, which came in only 0.5% below management’s initial guidance.   During the quarter, price was up 2.6% and traffic was down 10.6%.  Management’s comment about current trends that “easy comparisons have yet to restore momentum to the industry” was interesting and only reinforces my belief that Q4 estimates across the industry are relying too much on a sales recovery based on easy comparisons.  California continues to be a problem for CPKI.


The company reported $0.24 per share, in line with October guidance.  CPKI reported that total revenue declined 5.3%.  Lower food costs (offset by higher labor costs), lower pre-opening costs and a lower tax rate enabled CPKI to grow net income by 17% and EPS by 20%.


CPKI’s off-premise sales had grown to 18% of restaurant sales, of which takeout was 14% and delivery was 4%.  In 3Q09, however, off-premise sales fell to 16% as delivery declined to 2%.  Part of the decline can be attributed to high unemployment and office vacancy rates in California.  Food service comps for the third quarter were only down 7% and off-premise contributed a negative 1%. 


On a monthly basis, July same-store sales declined 9% (-1.3% last year), August was down 7.2% (-2.2% last year) and September was down 7.3% (-4% last year).  System wide, CPK restaurants delivered AWS of $60,945, down 8.7% year-over-year.


Kraft royalties were up 35.2% in the quarter and management expects Kraft to spend a significant amount promoting the CPK brand this year.   CPKI is working cooperatively with Kraft on several initiatives to increase brand awareness for both its frozen product line and full service restaurants. 


According to management, real estate opportunities in 2010 are among the best it has seen in years.  Available space is providing attractive locations and terms.  CPKI is targeting 8 new locations in 2010; all outside California.


Some new Initiatives in the restaurant to help fight declining sales trends:

  • New fall menu with 8 new items and no price increase
  • additions are “value orientated”
  • Sales productivity report to help increase check averages by “Suggestive” at-table strategy… (I would find this annoying!)
  • Call center for takeout. More efficient and allows for better results. Supplements online ordering at


4Q09 GUIDANCE - 4Q09 EPS guidance of $0.16 to $0.18 assumes a same-store sales decline of -5.5% to -6.5%.  For the month of October, same-store sales were down 6.1% versus 7.3% last year.  We can add CPKI to the list of casual dining companies that is seeing sequentially better trends in October.




US Employment: A Perverse Relationship

Suffice to say, this morning’s US Employment report for the month of October was not good.


So why is the stock market up? Answer: The US Dollar. The US Dollar is down for the 4th week out of the last 5. The Buck continues to Burn.


What’s negative for the US economy is negative for the US Dollar. What’s negative for the US Dollar is positive for most things priced in dollars. If you didn’t know about this perverse relationship between the price of the US Dollars and everything else, now you know.


Put another way, if the Federal Reserve’s Pander Program hinges on “the data”:

  1. Bad economic data = Fed stays at ZERO
  2. Good economic data = Fed signals their 1st hike

That’s why we are so focused on this dynamic relationship between the Fed and the Dollar. The politicization  of the Fed perpetuates US Dollar weakness.


In the charts below, Matt Hedrick and I show both the size and context of this morning’s jump in the unemployment rate. The most important takeaway, as always, is what we observed on the margin. On the margin, the rate of US unemployment accelerated sequentially. You can see this in the bar chart below (the red arrows are accelerations; the green ones are decelerations).


The unemployment rate accelerated its recent monthly pace of gains to +40 basis points month-over-month (from 9.8% in September to 10.2% in October).  You have to go all the way back to May of 2009 to find a monthly acceleration in the employment rate that surpasses October’s.


In Q1 our call was that the unemployment rate would decelerate in Q2. It did.


In Q4 our call is that unemployment will remain pinned up in no man’s land. We don’t think we’ll see another 40 basis point acceleration in November’s unemployment rate, yet. We need more data on November jobless claims to make that call just yet.


The Fed will use this data point to justify their pandering to a perpetual policy of ZERO return on the American citizenry’s savings. The only thing worse than being unemployed in this country, is being unemployed with a savings account.



Keith R. McCullough
Chief Executive Officer


US Employment: A Perverse Relationship - US Unempl Oct


US Employment: A Perverse Relationship - Oct Unempl Seq



Low quality beat and lower guidance for 4Q09




  • Despite the most challenging lodging environment they have been able to grow their footprint
  • The operating environment for hotels continues to be challenging.  CHH RevPAR performance was 50 bps better than their chain segment comps
  • Pace of RevPAR decline in the 3Q was comparable to what they saw in the 2Q but things are starting to stabilize. Occupancy, rate and RevPAR declines on the weekends have been noticeably less severe than week nights (so high single digit for weekends vs high teens during week days)
  • December results will be in the their 1Q2010
  • Expect pace of RevPAR declines to continue to ease into 4Q09, Guidance of -12% in 4Q
  • Focusing on brand awareness - loyalty programs are seeing very nice member growth - will have over 9MM members and account for more than 24% of their revenues (vs 22% in '08)
  • Continuing their commitment to returning FCF to shareholders through dividends and share repurchase
  • Offset some percentage of their RevPAR declines with royalty rate increases and room growth.  Royalty fees are expected to grow 5 bps next year
  • Executed 79 new domestic franchise contracts in the quarter and applications for conversions were flat y-o-y. New construction franchise sales declined by 82% in the quarter.  22 re-licensing transactions.
  • Adjusted SG&A declined 8% y-o-y and expect to manage to a high single digit decline for the full year
  • Leverage = 1.8x Adjusted 2009E EBITDA
  • Goal is to generate the highest ROI for franchisees
  • They remain committed to returning FCF to shareholders




  • Looks like unit growth guidance has increase from July.
    • Gross openings are inline, but there have been less terminations than they anticipated
  • Conversion trends?
    • Holding up better than everything else.  New build market has become extraordinarily difficult. They have no seen that big uptick in conversions that they usually occurs when lots of hotels trade hands.  Bid and ask for hotels is starting to sync. Think that all the action in hotels will be all about conversions and that should benefit them as they are the "premier conversion company in the space"
    • Seeing some owners want to upgrade brands
  • Out of the 550 companies in the pipeline, what is under construction?
    • Low-to-mid teens area. Conversions have traditionally been (2/3rds?) of gross openings which aren't in the pipeline for very long. A lot of their pipeline will not start given the lack of construction.  The first financing that does come back will be in smaller hotels so they will benefit first
  • Cambria suites, no new contracts this quarter?
    • Victim of current financing environment.  Loans above $10MM simply aren't available. So until the financing market recovers that brand will grow very slowly
  • Potential acquisitions?
    • Some brands are in play, like Extended Stay, but haven't really seen a lot of others
    • Looking at everything and scanning the environment for opportunitites and hoping that brands will trade at better prices than in the past
  • Any change in other brands providing incentives on new build?
    • Have seen aggressive incentives but doesn't really move the needle in an environment with no financing
    • They have not changed their incentives... there aren't really many other companies that do any kind real conversion volume - they are really new builds
  • November 2008 was the first really bad month for them so comps get 600 bps easier over Sept/Oct last year
  • They have pretty good visibility into their guidance since more than two thirds of the "quarter" is over for them
  • Continue to think they are getting the benefit from trade downs although they would call it share gain from their value proposition
  • Are they getting more corporate contract business?
    • Yes - up 30+%
  • OTA's are not a big part of their business, EXPE is their largest OTA channel at 3% of their bookings.  Thinks that OTA's are an expensive channel, but anywhere you can get revenues today is worth dealing with
  • Why is the EBITDA coming down so much since they shouldn't be as sensitive to RevPAR?
    • Slight reduction on the royalty revenues
    • Lower initial and re-licensing fees
    • Re-licensing fees are really driven my turnover in asset base - they really can't stimulate that
  • Have a very high retention rate of properties in their system.  Haven't seen any real benefit from discounting franchising fees aside from the normal "ramp in fees" that they get (i.e. initial discount)
  • Primary priority for FCF is returning cash to shareholders, whenever they think their stock is cheap they will opportunistically buyback stock.  They are one of the only companies that increased their dividend this past year.  Lastly they are exploring ways to grow their business (brands, acquisitions, etc) - but returns need to be very high on those opportunities
  • 50% of conversions is from repeat business (when current franchisees buy new hotels)
  • Not seeing strength in leisure translating into more week night travel
  • The fact that RevPAR is starting to look better is just easier comps not from any fundamental improvement
  • Typical cost for a travel agent is 10%
  • Were the lower terminations just deferrals?
    • Some were but some were not.  The franchisee actually made the improvements they needed to make to keep the flag
  • Assume no gain or loss on investment on retirement funds in the 4Q.  If the market is up in 4Q than there could be a gain and vice-versa but there is an offset to higher SG&A on a portion of any gain or loss

US STRATEGY – For Your Eyes Only

Continuing with Keith’s theme from the Early Look, we’ve titled the U.S. Sector Strategy piece this morning after the 12th film in the James Bond Series.  In total, there were 22 films in the James Bond Series, with the 22nd having been released in the U.K. on Halloween of this year.  


On an inflation adjusted basis, the James Bond film series brought in $11.7BN in revenue versus costs of production of $1.1BN. Now that is a margin you can take to the bank. (Maybe even a government subsidized bank!)  Although, as we have seen recently in the U.S., government subsidized financial institutions actually do quite well.   This morning AIG continued that trend with it second quarter of positive earnings, though with the stock up 6x since March, it is trading down in the pre-market on earnings.


The S&P 500 has been up for four days in a row, rising 1.9% yesterday.  Yesterday’s rally was on the back of upbeat earnings and guidance in the Technology sector and favorable MACRO data points.  In addition, retailers saw the biggest increase in same-store sales since July 2008, but the rate of growth is still anemic.  Also helping was the passage of stimulus legislation, including and extension (and expansion) of homebuyer tax credit and unemployment benefits.  The homebuyer tax credit as extended to April 30th for signed contracts.


In addition, the VIX fell 8.3% yesterday, now falling for the fourth straight session after spiking nearly 38% last week.


On the MACRO calendar productivity was the mantra of the day, as Q3 nonfarm productivity jumped 9.5%, well ahead of the 6.5% consensus and the biggest quarterly increase in six years. With output up and unit labor costs declining the numbers highlight the attractive corporate profitability trends.  In addition, initial jobless claims fell to 512,000 (from 532,000) in the week-ended October 31st.  The four-week-moving average fell to 524,000 from 527,000, the ninth consecutive weekly decline. Continuing claims fell for a sixth straight week.  This morning the focus is the government’s monthly employment report.


All the sectors with leverage to the global RECOVERY theme outperformed the S&P 500 across the board yesterday. The move came despite some strength in the dollar and pullback in the CRB; the CRB declined 1% yesterday.  The three best performing sectors were Consumer Discretionary (XLY), Industrials (XLI) and Financials (XLF), while the safety trade – Utilities (XLU), Healthcare (XLV) and Consumer Staples (XLP) - were relative underperformers.  All nine sectors were positive on the day. 


The two stocks causing the underperformance of the Consumer Staples (XLP) yesterday were CVS down 20% and WFMI down 15%.  CVS announced the loss of $3.7B in PBM contracts and disclosed that antitrust regulators were probing some business practices.  Also, the margin guidance for the PBM business in 2010 appeared to be disappointing.  WFMI was taken out behind the wood shed issuing below-consensus 2010 EPS guidance. 


Today, the set up for the S&P 500 is: TRADE (1,064) and TREND is positive (1,029).   The Research Edge quantitative models have 9 of 9 sectors in the S&P 500 positive on TREND and 6 of 9 sectors are positive from the TRADE duration.  Consumer Staples is the only sector positive on both durations and the Financials broke TREND. 


The Research Edge Quant models have 1% upside and 3% downside in the S&P 500.  At the time of writing the major market futures are poised to open down. 


The Research Edge MACRO Team.


US STRATEGY – For Your Eyes Only - S P500

US STRATEGY – For Your Eyes Only - s pperf



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