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GREAT CANADIAN ON A BEATING STREAK

As we discussed last week, GC reported EBITDA of $34MM and margins of 35.6%, beating Street estimates by 12% on EBITDA and margins by 450 bps and our estimates by $700k and 200bps, respectively.   Revenues came in light, primarly due to continued general economic malaise.

 

The three ongoing redevelopment projects - additional slots at View Royal and at Georgian Downs and the opening of the parcade and Canada Line station at River Rock - were completed on time and on budget.  Initial results from the Canada line opening and expansion at Georgian Downs were positive, while View Royal has yet to see a pick up in gaming volumes as a result of the expansion.  The British Columbia Lottery Commission (BCLC) is also in the process of refreshing many of GC's old and underperforming slots.  As a reminder, in BC the BCLC is responsible for buying slots which comes at no cost to GC.

 

Now that it looks like Great Canadian has gotten its (finally) cost structure under control, it's all about topline growth, which unfortunetely is highly leveraged to what the BC economy does.  We do expect a lift from the Winter Olympics, but management needs to keep its focus on existing operations rather than straying down the familiar expansion path.

 

 

PROPERTY LEVEL DETAIL:

 

River Rock

  • River Rock revenues declined by 12% y-o-y, driven by lower gaming and hospitality revenues.  Excluding table hold, which was comping against a high 24.8% hold in 3Q08, drop fell 4% and slot handle fell 5% (a relative improvement from the 16% y-o-y drop experienced in 2Q09).
  • Costs decreased by 26%, spread over promotional spend, HR, property, marketing, and administration; resulting in 10% y-o-y expansion in EBITDA margins to 48.4%.
  • River Rock should benefit from a slot refresh and expansion that will add roughly 150 slots. The product slots at River Rock haven't been updated in over five years. 

Boulevard

  • While table drop was flat y-o-y, slot handle fell 20% for the second sequential quarter, resulting in a 9% y-o-y decline in revenues at the property.  Hospitality revenues actually held up well at the property and were up 10% y-o-y.
  • Costs decreased 15%, resulting in 360 bps of EBITDA margin improvement to 48.4%.
  • The property looks to be losing some market share to its revamped nieghbor Grand Villa. Grand Villa's contribution to the Local Goverment Share of Provincial Casino and Community Gaming Centre Revenues grew 12% y-o-y in 3Q09 and 14% 2Q09 (y-o-y).   

Vancouver Island

  • While table drop declines were less bad this quarter, falling 13% (vs 25% in the 1H09), slot handle fell 10% y-o-y, showing no benefit from the incremental slots added at View Royal.  The increased FDC revenues softened the y-o-y decline to 6% at the Vancouver Island properties
  • The 17% decline in costs at the property helped grow EBITDA 5% and improve margins by 560 bps

Nova Scotia

  • Table drop only fell 2% y-o-y but there was a difficult hold comparison to 3Q08 resulting in an 8% table revenue decline.  Coin in was down 5%, showing no improvement over 2Q09
  • It appears that there were about 100 slots removed from the Nova Scotia properties
  • Costs declined another 200k sequentially, or 16% y-o-y, and look like they will remain at these levels barring another drop off in demand.
  • EBITDA decreased 7% but margins increased by 120 bps to 33.3%

BC Racinos (Hastings, Fraser, TBC)

  • Gaming revenues increased 2% due to the slot additions to Hastings and higher slot win, while racetrack revenues fell 12%
  • Revenue weakness was more than offset by an 18% reduction of costs which resulted in a 67% EBITDA increase and 10.4% expansion in margins

Georgian Downs

  • Gaming revenues increased 3.4% y-o-y compared to being flat y-o-y last quarter.  Seems too early to tell whether the slot addition will be accompanied by more demand.
  • Costs fell 18% y-o-y resulting in 24% EBITDA growth and 10.5% margin expansion to 50%

MCD – HIGHLIGHTS FROM THE MEETING

As I have said before, there is a lot to love about MCD.  After listening to management speak all day, it is hard to poke too many holes in the story (though being pumped full of MCD food all day left me feeling less than pleasant.  This is not meant to be an insult.  The food was good.  I particularly liked the Mac Snack Wrap, which the company is currently testing and I heard only positive reviews of the oatmeal at breakfast, but I did eat too much).

 

CEO Jim Skinner said he attributes some of MCD’s success every day, everywhere to “daily miracles.”  I will give MCD’s management more credit.  Management knows what it is doing and is running an efficient, strong-cash generating company.  It leaves little to miracles.

 

Things to love:

-Margins are moving higher across the board.

 

-International growth is impressive, particularly in Europe where reimages, drive-thrus and new products are driving share gains (even posting positive same-store sales growth in Germany with the rest of QSR negative).  MCD is increasing its unit growth outside of the U.S. in 2010 by 100 units and expects to allocate more capital spending dollars to reimages in Europe next year as well.

 

China continues to be the laggard in APMEA with comparable sales down 6.7% YTD through October.  Management attributed the weakness to economic challenges in the south where MCD has its most restaurants (represents 40% of China comp number).  Specifically, management said that visits to Western QSR is down 30%.  After paring back on unit development plans in China in 2009 to about 140 units as a result of the consumer pull back, MCD expects to open about 150-175 restaurants in 2010.  Management did highlight that despite the top-line weakness, restaurant level margins have moved higher in China.

 

-The cash flow story is still intact; though MCD is no longer providing targets around how much cash it will return to shareholders.  Management said there is no change to its capital allocation strategy and that it remains committed to paying out all of its free cash flow in the form of dividends and share purchases.  Management’s prior 3-year target was to return $15-$17 billion.  When asked why the company will no longer provide targets, management said that it deemed it necessary to provide targets to give some comfort to investors in the early stages of its revitalization process to show that “they would put their money where their mouth was.” 

 

-ROIIC remains high.  There was some concern over the fact that management’s current long-term ROIIC high teen target could suggest that returns are coming down as MCD reported consolidated ROIIC of 41% in 2007, 38% in 2008 and 39% YTD in 2009.  Based on all of the questions around the high teens target, even if management is just being conservative in an attempt to under promise and over deliver on this metric, despite the target, investors will continue to expect results that far exceed them.

 

-There are some definite near-term tailwinds: Commodity costs in both the U.S. and Europe are expected to be down about 3% YOY in Q4 after being up in the prior three quarters and expected to be flat in FY10 (so still favorable on a YOY basis in 1H10).  Management is also forecasting a $0.06 positive EPS FX benefit in Q4 after currency translation negatively impacted earnings by $0.22 per share in the prior 9 months.  And, based on current rates, MCD guided to a $0.10-$0.13 EPS benefit on a full-year basis in 2010.  G&A as percentage of sales is expected to continue to come down as well.

 

Problems in the U.S. remain.  When it comes to presenting, MCD’s management team again knows what it is doing.  The company showed a lot of charts that highlight MCD’s sequential improvements in annual U.S. operating income growth and margins.  It then included a slide that just said same-store sales in the US are up 3.1% YTD through October.  I could be wrong, but I don’t think management wanted to show a time series that would highlight the sequential decline in top-line trends.  Management did address the sales softness by saying that informal eating out category growth continues to be stagnant and MCD is gaining share of a shrinking pie.   That being said, I do not think the same-store sales chart was inadvertently left out of the presentation.

 

-Management did say that its new beverage platform, including McCafe, is exceeding its initial $125K in incremental sales per restaurant target in the test markets where it has been completely rolled out (including frappes and smoothies).  This $125K in incremental sales has been the source of some confusion since based on my recollection, management first provided the number at its meeting 2 years ago (at that time, MCD said the entire beverage roll out would be complete by 1Q09).  So to clarify, the $125K includes sales from McCafe, sweet tea, iced coffee, frappes, smoothies and a new bottled beverage lineup.  I was surprised to hear that this platform is proving successful in test markets, but I suspect MCD might have completed the roll out in the markets where initial McCafe results were performing best.  We should know more, however, once the entire platform is rolled out on a national basis, which is now not expected to be complete until mid-2010.

 

-YTD through October, coffee sales are up 28% (94% of that growth was driven by McCafe with the balance coming from continued growth in premium roast coffee sales).  The national Angus burger launch in August exceeded internal expectations by 25% and have remained strong (I don’t think management ever quantified those initial projections).  The Dollar Menu has not increased as a percentage of sales, remaining at about 10%-11% excluding the $1 double cheeseburger changes to the menu, so the Dollar Menu’s impact on average check should be holding relatively stable. 

 

This all sounds like good news, but looking at U.S. comparable sales growth on a 2-year average basis, there is a definite deceleration in trends.  So if McCafe and Angus sales are incremental, what do the core menu sales trends look like?

 

Like the chart we posted on CKR earlier this week, margins in the U.S. cannot keep moving higher with sales falling as shown in the chart below (margins have been helped by the company’s refranchising strategy which will continue).  Though as I already outlined, commodity cost tailwinds will help on this front in the next couple of quarters.  If MCD’s stock performance is driven largely by reported sales trends in the U.S., we could see continued weakness.  For reference, some pricing rolled off in October on a YOY basis which will continue to impact trends for the rest of the quarter and management said it will hold the line on pricing in this environment.

 

Some notable changes:

-MCD’s capital spending is expected to move higher in 2010 to $2.4 billion from the projected $2.1 billion in 2009.  Relative to the U.S., spending is expected to be flat YOY but management is allocating more dollars to reimages (spending roughly the same amount on reimages in 2010 as the company spent on the beverage initiative in 2009).  MCD’s President of McDonald’s USA Don Thompson said sales increases at remodeled restaurants are typically 6%-7% higher than the system average.  For reference, nearly 45% of the current U.S. system has been reimaged, rebuilt, relocated or newly built in the 2003-2008 timeframe. 

 

-Management said that more of its new openings will be skewed to freestanding restaurants with drive-thrus, which it says provides better returns.  Drive-thru business in the U.S. is up 4% YTD through October.

 

-Management is also expected to buy more real estate when and where it is possible (buying 20% more in the U.S. in 2010)

 

-MCD is committed to maintaining its current credit ratings but said it does have the flexibility to increase its leverage if deemed necessary.

 

-Management downplayed the media noise around going national in the U.S. with the Dollar Menu at breakfast, saying that it has been used in some markets for some time and is directionally consistent with overall Dollar Menu performance.   Management did say we will learn more about core breakfast initiatives in 2010.  And, we also learned that the company is expecting to allocate more advertising dollars to its Dollar Menu (to 15%-20% of resources from its current 10%-15% level).

 

MCD – HIGHLIGHTS FROM THE MEETING - MCD 3Q09 us margins vs. sss


Retail Chart of The Day

The intra-day tick chart of Dollar General vs. RUE21 says it all.

 

Retail Chart of The Day - 11 13 2009 2 45 25 PM


Daily Trading Ranges

20 Proprietary Risk Ranges

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The Week Ahead

The Economic Data calendar for the week of the 16th of November through the 20th is full of critical releases and events.  Attached below is a snapshot of some (though far from all) of the headline numbers that we will be focused on. 

 

The Week Ahead - snag11

The Week Ahead - snag22


Confidence Man?

Herman Melville’s last major novel was entitled, “The Confidence Man.”  According to Wikipedia:

 

“The novel's title refers to its central character, an ambiguous figure who sneaks aboard a Mississippi steamboat on April Fool's Day. This stranger attempts to test the confidence of the passengers, whose varied reactions constitute the bulk of the text. In this work Melville is at his best illustrating the human masquerade. Each person including the reader is forced to confront that in which he places his trust.”

 

The riverboat of the U.S. economy is having its own crisis of confidence in consumer land.

 

As our sage and savvy U.S. Strategist, Howard Penney, wrote in the Early Look this morning:

 

“Today we are going to get the preliminary November University of Michigan confidence numbers.  The consensus is expecting a slight improvement to a 71.0 reading.  A slowing to below the prior reading of 70.6 is more likely.”

 

Either Penney is clairvoyant or, which is more likely, the fact that he knows the restaurant sector better than most, and thus has an inside look on consumer spending, it came as no surprise that the preliminary Michigan Consumer Confidence reading this morning was a disappointing 66.0, which is a sequential decline from 70.6.

 

As we’ve outlined in the chart below, the trend in this measure of consumer confidence remains intact and certainly isn’t being helped by low saving rates and accelerating gas prices.  We’ve now seen another monthly sequential decline.  Confidence is waning, rather unambiguously.

 

Daryl G. Jones

Managing Director

 

Confidence Man? - Mich

 


Investment Theme: A Demographic Eye on Generation Y

“They’re the hottest commodity on the job market since Rosie the Riveter. They’re sociable, optimistic, talented, well-educated, collaborative, open-minded, influential, and achievement-oriented. They’ve always felt sought after, needed, indispensable. They are arriving in the workplace with higher expectations than any generation before them—and they’re so well connected that, if an employer doesn’t match those expectations, they can tell thousands of their cohorts with one click of the mouse. They’re the Millennial Generation.”

 

- Claire Raines, From her website – generationsatwork.com

 

Demographics are a popular topic at Research Edge.  Our Healthcare Sector Head, and all around boy genius, Tom Tobin does a lot of our demographic work.  Demographics is a topic that we will writing more and more on heading in 2010, and we will be developing core investment themes around these powerful trends.  In this note, I’m framing up one of the most important demographic groups domestically, the Millennials.  It is a demographic group characterized by an acceleration of live births, so is large, and one that will have an increasing impact on society and investable trends in the coming decades.

 

The Millennials are typically defined as those born between 1980 and 2000.  This demographic cohort goes by many names in addition to the Millennials, which include: the echo boom, generation y, boomlet, nexters, the Trophy Kids, the Nintendo generation, and the Internet Generation.  From a purely demographic perspective, the echo boom is actually defined as the five year span between 1989 and 1993 when, for the first time since 1964, the number of live births in the United States reached over four million.  Additionally, it took until 1985 for the live birth number to match that of 1965 at 3.76 million.

 

Understanding this group is important for a number of reasons.  First, many  of us are parents or aunts or uncles of this group.  Second, many of us own or are invested in business in which this a burgeoning client base, and a growing client base (retail, mobility, consumer products, etc).  Finally, as the baby boomers gradually retire and the Millennials come of age, this will be the dominant labor pool from which we will be hiring and/or working with. 

 

To understand Generation Y mindsets, we need to consider the time in which they were born, generally the  1980s and 1990s. Gen Y came of age during an unprecedented time of economic growth in the late 1990s.  Technology was rapidly growing driven by the dot com era (and bubble).  The environment in which they grew up expected more of them than in the environment in which Generation X-ers grew up, and thus how they interact with society is dramatically different from Gen X-ers.

 

Regardless of what we call them, and incidentally the Millennials is a name they themselves voted on based on an ABC Peter Jennings poll, this is a demographic group due to their size and characteristics that is going to have increasing impact on business and society.  Ironically, while the Millennials are sometimes refered to as generation Y, since they follow Generation X chronologically, they have characteristics that are much more in common with the Baby Boomers.  Specifically, this group tends to be more family oriented (studies have shown that when in college they contact their parents almost two times a day) and have more respect for conventional social norms. Specifically, this group has less teen pregnancies than Gen X, less use of heavy drugs, and more civic involvement.

 

From an international perspective, this echo boom, while prevalent in the United States, is actually not present in European and some Asian countries, specifically Japan.  This is obviously a much longer term investment theme that we will highlight in future posts.  That is, the differing aging trends of work forces globally will potentially create dramatic economic differences from country to country.  To quote a recent study:

 

“In many rich countries, the 1980s and 1990s were a period of rapidly falling birth rates. In Southern Europe and Japan, and less markedly in Northern and Eastern Europe, Generation Y is dramatically smaller than any of its predecessors, and its childhood years tended to be marked by small families, both immediate and extended, small classes at school and school closures.”

 

A few key characteristics of Generation Y that are unique versus Generation X include:

 

-       Technology Savvy – A 2007 survey of over 7,000 college students indicated that they are incredibly connected and adept at technology.  According to the survey, 97% owned a computer, 94% owned a cell phone, and 56% owned a MP3 player. 

 

-       Always Connected – According to the same survey, 76% of students used Instant Messaging, were logged on 35 hours per week and chatted an average of 80 minutes per day.  Almost 15% of IM users were logged on 24 hours / 7 days a week.  The vast majority also reported doing something else while IMing, including games and schoolwork as examples.

 

-       New Information Sources – In addition, 40% of students reported that the television was their primary source of obtaining news while 34% reported that websites were their primary source (newspapers were the primary source for 11% and radio for 8%). In addition, 28% reported owning a blog and 44% reported reading blogs.  Also, 70% of students reported having a Facebook account and logging on at least twice a day

 

-       Scheduled Lives - The Millennials are also the busiest generation of children we’ve ever seen in the U.S, growing up facing time pressures traditionally reserved for adults. Parents and teachers micromanaged their schedules, planning things out for them, leaving very little unstructured free time.

 

-       Multicultural Experiences - Kids growing up in the 90s and 00s with more daily interaction with other ethnicities and cultures than ever before. The most recent data from UCLA’s Higher Education Research Institute shows that interracial interaction among college freshmen has reached a record high.  In addition, being “amongst the first generations to be born and actively grow up in an American society desegregated by law (Brown v. Board of Education), imposing sexual equality by law (Title IX), and proactively defending the rights of various minority groups by law, in addition to the effects of '60s and '70s era influence on their generation, Millennials have been conditioned by the state, educational institutions, and by cultural influence to take a supportive outlook on multiculturalism.”

 

-       Terrorism Exposure - During their most formative years, Millennials witnessed the bombing of the federal building in Oklahoma City. They watched as two Columbine High School students killed and wounded their classmates, and as school shootings became somewhat of a trend. The catalyzing event for their generation was of course, the terrorist attacks on September 11, 2001. 

 

The emerging and powerful Millennials, will shape investable trends and important decision making for years to come.  Especially as certain classes of workers continue to age.  As Claire Raines also noted on her website:

 

“The average age for a nurse is 47. That means she—or he—will be moving on before long. Half of all certified school teachers plan to retire within five years. Sixty percent of all Federal workers are Baby Boomers who say they’re on the edge of retirement. There’s no getting around it. We’re going to need those Millennials.”

 

Indeed.

 

Daryl G. Jones
Managing Director

 


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 78.51%
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