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CHART OF THE DAY: A Middle Finger Salute North of the Border

Editor's Note: Below is a chart and brief excerpt from this morning's Early Look written by Hedgeye Director of Research Daryl Jones. Click here if you'd like more information on how you can subscribe.


CHART OF THE DAY: A Middle Finger Salute North of the Border - zzz COD 10.20.15 chart


"For those of you not familiar with Canadian political history, the "Trudeau salute" was a middle-fingered gesture former Canadian Prime Minister Pierre Trudeau gave to protestors in Western Canada in the early 1980s.  To Western Canadians at the time, it was symbolic of years of policy that undermined their commodity laden economies. 


...it is difficult to see in the short run how Trudeau will have a positive impact on the Canadian dollar or economy.   In part, of course, the Canadian dollar has front run this and is down about 11% over the last year, but with a deficit that is likely to expand, the floor has probably not been established for the Loonie.

The Trudeau Salute

“The essential ingredient of politics is timing.”

-Pierre Trudeau


For those of you not familiar with Canadian political history, the "Trudeau salute" was a middle-fingered gesture former Canadian Prime Minister Pierre Trudeau gave to protestors in Western Canada in the early 1980s.  To Western Canadians at the time, it was symbolic of years of policy that undermined their commodity laden economies. 


Yesterday, Canadians elected Justin Trudeau, the 43-year old former son of Prime Minister Pierre Trudeau, as their next Prime Minister.  This was as much an election that rejected Prime Minister Stephen Harper as one that voted in the relative neophyte, Trudeau. 


Trudeau’s victory marks the biggest political rebound in Canadian history. The Liberals become the first third-place party to win an election, and the party’s seat gain from the prior election of around 150 is the largest ever.  In fact, the Liberals, who had governed for about two-thirds of the 100 years before Harper came to power, won just 34 districts in the 2011 election, the worst result in their history.


After almost 10 years of Conservative rule, the Canadians wanted change.   And change they have elected, in an epic way.  Some would even argue with an emphatic middle finger to the departing Prime Minister.


Prime Minister-elect Trudeau has basically indicated that his economic policies will be built around two key points: raising taxes on those making over $200,000 and increasing government spending on infrastructure.  (Incidentally, he also intends to legalize marijuana quickly, which is clearly a priority for a nation in recession.)   By and large, Trudeau will be taking a page right out of the Keynesian playbooks of many European countries. 


The Trudeau Salute - zzz trudeau


Back to the Global Macro Grind...


From our purview, it is difficult to see in the short run how Trudeau will have a positive impact on the Canadian dollar or economy.   In part, of course, the Canadian dollar has front run this and is down about 11% over the last year, but with a deficit that is likely to expand, the floor has probably not been established for the Loonie.


There is a more significant issue facing Canada than a collapsing currency, which is the state of the Canadian banking system.  Our financials team introduced their call to short the Canadian Banks this summer and in an update note in late September wrote the following:


“You would think that with the Canadian economy in recession, energy prices tumbling, Oil & Gas loan impairments skyrocketing, and the whole Canadian housing market sitting atop an historic bubble, the Canadian banks would be at Defcon 4: building reserves, speaking cautiously, slowing loan growth. Instead, however, management(s) couldn't be more unconcerned, disinterested, and generally indignant at the mere suggestion that risk is rising.


Over the last two weeks the big six Canadian banks (BMO, RY, NA, CM, TD, BNS) and CWB reported their fiscal 3Q15 earnings. Generally speaking the results were not terrible. There were four beats, two misses and one in-line print.


Part of the reason the results weren't terrible is that the banks continue to avoid taking reserves against future losses. There's no better example than in the Oil & Gas patch. A major focus of Canadian bank earnings conference calls over the past two weeks was the effect (or supposed lack thereof) of low oil prices on the Canadian economy and on bank earnings. The consensus from management teams is that it’s no big deal, and their lack of concern concerns us. We can't help but be reminded of Aesop's The Ant and the Grasshopper fable. In a word, the Canadian banks are Grasshoppers, all.”


In light of yesterday’s election results, we’d recommend you email to review our work on the Canadian banking system and set up a call with our financials research team.  The short thesis is timely this morning.


Canada isn’t the only sovereign we have concerns about in the current environment of political change.  In fact, tomorrow we will be doing a call on Spain, which has been a perpetual weak economic link in the Eurozone.  Similar to Canada, Spain has an important election scheduled on December 20th.  On the call, Hedgeye contributor Daniel Lacalle, a former buy-side PM at PIMCO and Citadel, will talk through his scenario analysis on Spain.


In contrast to Canada, Spain has been under Conservative rule for the last four years.  In that time period, the Conservative Party (PP) unwound years of deficit spending from the previous administration. In fact, the PSOE had left a deficit of 9% of GDP after promising a maximum of 7%.  


As Lacalle has written, when the socialist government left office, Spain had more than 40 billion euro in unpaid invoices from the public administrations to the private sector, the public savings banks presented a capital requirement of 100 billion euro and the regions and municipalities faced a bailout of 125 billion euro. To many, this was seemingly an insurmountable situation.


However, after a large austerity plan that was split 50% in tax increases and 50% in spending cuts, and a very substantial set of reforms, including the financial sector, labor market, entrepreneurship programs and early payment schemes, Spain recovered.


Between 2014 and 2015 Spain started to grow well above the EU average. It led job creation in the Eurozone, with more than one million jobs, and brought unemployment rates back to September 2010 levels. It went from a massive trade deficit to a balance by 2015.


In summary, Spain undertook the largest adjustment seen in an OECD economy, 15 points of GDP, and managed to do so growing and creating jobs.  But as austerity is prone to do, it does make some folks unhappy.  As a result, much like in Canada, the December 20th election in Spain will be referendum on the Conservatives.   And with political change, comes investment opportunity.  After all, the great thing about being stock market operators is that we can go both ways.


Our immediate-term Global Macro Risk Ranges are now:


UST 10yr Yield 1.98-2.08%


VIX 14.94-20.69
Oil (WTI) 45.08-47.99

Gold 1144-1195


Keep your head up and stick on the ice,


Daryl G. Jones

Director of Research


The Trudeau Salute - zzz COD 10.20.15 chart


McDonald’s (MCD) is on our Hedgeye Restaurants Best Ideas list as a LONG.




Our long standing view has been that the inflection point for the MCD turnaround will be 3Q15.  We are now two days away from that event and the confidence in our call remains very strong.  McDonald’s is a resilient company and its new leadership team is making some significant changes to how the company is being run.


The company will also be hosting an analyst meeting in NYC on 11/10/15.  On the earnings call, I believe the company will defer questions about the long-term strategy to the analyst meeting.  Importantly, at the analyst meeting the company will outline the decision on what to do with the company’s real estate holdings.  I now believe that there is a greater than 50% chance the company will likely create a more efficient tax structure with its rental revenue stream.        






Optimize the menu to offer customers their favorite food & drinks more effectively

  • Shrink the menu, improve existing products, develop new products, adjust pricing, create more excitement about the food
  • All Day Breakfast
  • Improve the value message: At the analyst meeting the company will discuss a national value platform in the U.S.


Transformation of the customer service experience

  • Modernizing the interaction between MCD and the customer to create a memorable experience. Self-ordering kiosks are a great experience for the customer, and they allow the kitchen to operate more efficiently.


Refranchise and close stores

  • Eliminate underperforming stores to cut costs and improve profitability, leading to improved industry metrics.


Manage complexity of restaurant operations

  • With everything management has added to the restaurants, it was getting too complex, keep it simple.
  • New training programs for employees to improve accuracy and experience for the customer and employee.
  • The company has completed the installation of smaller drive-thru menu’s


Financial strings to pull

  • Refranchising and store closures must lead to sizeable SG&A savings at corporate
  • Financial engineering, potential to lever up and buy back more shares or increase the dividend
  • Reduce capital spending to improve ROIIC.  (We should begin to see the impact of this in 3Q15)



MCD EPS peaked at $5.55 in FY13, and will earn $4.75 in FY15, down 15% from the peak.  Street estimates have MCD earning $5.15 in FY16.  As it stands today, our estimates are for MCD to post a near record tying EPS in FY16 of $5.40-$5.60 with $6.00 being a real possibility. The potential for $6.00 is dependent on how aggressive the company gets with any additional G&A cost cutting to be announced at the upcoming analyst meeting.   




I expect the mood at the analyst day in NYC will be very upbeat (following the better than expected 3Q15 performance) and the momentum being experienced internally given the major changes that are taking place at MCD.  In addition, the tone of how CEO, Steve Easterbrook will manage the business going forward was set in his first 100 days as CEO of MCD:

  • “everything is in play”
  • "constructive agitator"
  • “internal activist”
  • “I’m honest and fair and don’t dispense forced kindness”
  • “We will try new things, move fast with what works and even faster from what doesn’t”
  • “We’re making the business more responsive to market conditions by using our scale advantage more effectively, we cannot afford to carry legacy attitudes and legacy thinking, and we won’t”


Some of the themes we expect to hear at the NYC Analyst day

AWARENESS – The new corporate structure is changing the way McDonald’s does business around the world for the better.  What to look for:

  • We are expecting MCD to make additional SG&A cuts.  There are significant opportunities to cut from the estimated FY15 $2.3 billion spent in this line item.
  • The new structure is accelerating the innovation pipeline. Leaders are more in touch with their regions than ever before, giving them greater ability to share best practices across like markets.


RATIONALIZATION/SIMPLIFICATION – There are parts of this that MCD has already talked about but there is so much more to focus on. 

  • Stores – store closings (already announced)
  • McCafé – Please no espresso drinks (should be addressed)
  • Cost Cutting – as per above there will be more G&A cuts
  • Changes to the Menu – In addition to McCafé, management will talk about regional simplification to its menu


SUSTAINABILITY – Will McDonald’s compete effectively in the consumer centric world of sustainable food?

  • We think so, McDonald’s is improving their food, from the source to how it is prepared. They have committed to using cage free eggs by 2025 and they pledged to move towards antibiotic free chicken within two years.


REAL ESTATE – Could this be the year!

The big news coming from this year’s analyst meeting will be what the company has decided to do with the company’s massive real estate holdings. 


If the current pattern of behavior holds true the company will be looking to alter its real estate holdings.  For over 50 years many people including myself said MCD can’t sell breakfast all day.  I have also said they will never do anything with their real estate.  I was wrong about and breakfast and chances are I will be wrong about the real estate too. 


I imagine there are others who are working overtime to help the company see the value that can be created by changing the structure of the real estate.  According to FactSet, there are two large shareholders of McDonald’s who are classified as “activism threat level is high.”  I assume both of them want MCD to think differently about the real estate.


I also found it out of character that a McDonald’s Board member would give a quote to the WSJ about the review process.  McDonald’s Board member Miles D. White said on Thursday, “McDonald’s board and management haven’t made a decision yet, but we have had a lot of review and a lot of debate.”   Mr. White is chief executive of Abbott Laboratories and head of the corporate-governance committee for the McDonald’s board.  Why was he speaking on behalf of the company one week before they report earnings?


Between 2008 and 2011 there has never been a need for the company to do anything with the real estate, because the business was strong. Since the business began to decelerate in 2012, the real estate rumors have become more pronounced. The CEO at the time, Don Thompson, did not have the internal mandate to make those types of changes.  Under CEO Steve “everything is in play” Easterbrook, the odds of the company changing the structure of the real estate have gone up significantly. 


The issue at hand is the company’s ability to re-arrange royalty rates with franchisees.  The company generates over $6.0 billion a year in rental income with operating margins running north of 75%.  This is all taxable at the effective tax rate of 32%.  If the company can structure an internal REIT to own the rental stream the company could save billions in taxes, creating substantial shareholder value.  As a general rule, for every $500 million the company can save in taxes (at 22x) it creates an $11 increase per share in shareholder value.


Objections to altering the real estate structure in the past have centered on giving up control of the real estate and preservation of its credit rating.  If the company can establish a REIT to shelter its rental income, while controlling the real estate and maintaining its credit profile everybody wins!


Please call or e-mail with any questions.


Howard Penney

Managing Director


Shayne Laidlaw




Early Look

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Relied upon by big institutional and individual investors across the world, this granular morning newsletter distills the latest and most vital market developments and insures that you are always in the know.


Takeaway: Please join us for our call TODAY, Oct 20th at 1:00pm EDT. Dialing instructions below

We will be hosting our quarterly INTERNET BEST IDEAS Update Call today.  We will be reviewing the major themes and incremental developments to our Best Idea Short theses (YELP, P), our Best Idea Long thesis on LNKD, as well as our Short thesis on TWTR.  The emphasis of this call will be to outline our view over various durations (particularly 2016) as well as the upcoming catalyst calendar; identifying the major risks and catalysts to each position over the near-to-intermediate term. 


Join us for our call TODAY, Oct 20th at 1:00pm EDT.  




  • LNKD: Sheepish guidance ≠ deteriorating fundamentals; why LNKD is poised to breakout from major 1H15 investments (not Lynda).
  • P: Model can’t handle much more than a best case scenario under Web IV; why the worst-case is more likely.
  • YELP: Model is broken, but street now understands that; what we’ll be monitoring to assess the short from here.  
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Hesham Shaaban, CFA


The Macro Show Replay | October 20, 2015


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