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The Client's Trust

“The best way to find out if you can trust somebody is to trust them.”
-Ernest Hemingway
 
Hemingway was an American veteran of World War I. He was a writer and a journalist. He was well known for developing protagonists in his fictional writing who were, per Wikipedia, “stoical men who exhibit an ideal described as grace under pressure.”
 
President Obama, now that the Chinese have preemptively attacked your currency policy ahead of this week’s meetings, we all sincerely hope you are the non-fictional character who is up for the task. This is no time for prepared speeches. This is your time to face The Client and her investments in America.
 
Ahead of Tuesday’s meetings with China, here are two explicit shots across America’s bow:
 
1.       “The continuous depreciation in the dollar, and the U.S. government’s indication, that in order to resume growth and maintain public confidence, it basically won’t raise interest rates for the coming 12 to 18 months, has led to massive dollar arbitrage speculation”
- Liu Mingkang (Chairman of the China Banking Regulatory Commission)
 
2.       “I’m scared and leaders should look out… America is doing exactly what Japan did last time”
- Donald Tsang (Chief Executive of Hong Kong)
 
Memories on Wall Street may very well last as long as a crackberry minute, but the views of The Client (China) imply that she has not lost her historical perspective. One of the major contributors to the 1997 Asian Crisis was Japan’s ZERO percent policy. Asia remembers.
 
Do we remember? Do we care? Do we have a proactive plan to stay ahead of the predictable risks embedded in debt driven devaluation? Or are we simply going to react to the outcomes associated with our compromised monetary policy decisions, AFTER the fact?
 
Ben Bernanke probably won’t answer any of these questions tonight at the Economic Club of New York. The home crowd will be choke full of NYC bankers and carry trading financiers alike. Provided that he doesn’t take any of the aforementioned Chinese criticism to heart, Ben should be just fine. No one in the Levered Long or Piggy Banker room needs to be veering from the path of the willfully blind just yet - not into year-end bonus time.
 
Or do they? Re-read these Chinese comments! These are as aggressive as they get. Our Hedgeye agent in China is inching towards slipping an Indian proverb under Obama’s hotel room door ahead of these meetings: “listen or thy tongue will keep thee deaf.”
 
China has once again flat-out dismissed how “deeply” Obama’s Chief Squirrel Hunter feels about anything US Currency. There was no credibility in Timmy Geithner’s “strong dollar” policy rhetoric while speaking in Asia last week. As a result, there is once again no bid for Burning Bucks this morning.
 
Is the Buck Bombed Out or setting up to Burn again? This is THE question for the US stock market, and anything priced in US Dollars this week. There are 3 critical events that will determine the US Dollar’s direction from here:
 
1.      Bernanke’s ‘In De Club’ NYC banker speech tonight
2.      President Obama’s response to Chinese currency attacks
3.      The US Consumer Price Inflation report on Wednesday
 
If you follow the intermediate term TREND line of American political pandering, you’ll be betting on carry trading (Burning Buck) into and out of events 1 and 2. That’s what global markets are already doing this morning. The US Dollar is re-testing her YTD lows, trading down -0.35% to $75.07. Yes, these are all marked-to-market, real-time.
 
Event #3 will be very interesting to see play out. For now, I am not short the US Dollar into that print. When it comes to reported deflation, contrary to narrative fallacy belief, the lows of reported deflation here in the US came with the July 2009 CPI report of -2.1%.
 
I say narrative fallacy (Taleb) belief because that’s all the Great Depressionista storytelling was. It is both shocking and saddening all at once to see that American politicians have used Bernanke’s academic studies as a backstop to get the Debtors, Bankers, and Politicians paid.
 
A lot of people tell me that the Dollar Down call from here is consensus. After covering my short position in the US dollar last week, I implicitly agree with that – but only in the immediate term. In the intermediate to long term however, both my quantitative resistance levels and the politicized headwinds for the credibility of America’s currency remain bearish.
 
President Obama, now is your time to build The Client’s Trust. Shake those hands firmly, listen, and understand.
 
My immediate term TRADE lines of support/resistance for the SP500 are now 1074 and 1116.
 
Best of luck out there today,
KM

 

 

LONG ETFS


FXE – CurrencyShares Euro TrustWe bought the Euro on 11/12 on a down move against our short position in the British Pound. A bullish formation in the Euro remains and we think the ECB could hike before the Fed does.

EWT – iShares Taiwan
With the introduction of “Panda Diplomacy” Taiwan has found itself growing closer to mainland China. Although the politics remain awkward, the business opportunities are massive and the private sector, now almost fully emerged from state dominance, has rushed to both service “the client” and to make capital investments there.  With an export industry base heavily weighted towards technology and communications equipment, Taiwanese companies are in the right place at the right time to catch the wave of increased consumer spending spurred by Beijing’s massive stimulus package.

XLU – SPDR Utilities
We bought low beta Utilities on discount on 10/20. TRADE and TREND bullish.

GLD – SPDR Gold We bought back our long standing bullish position on gold on a down day on 9/14 with the threat of US centric stagflation heightening.   

CYB – WisdomTree Dreyfus Chinese Yuan The Yuan is a managed floating currency that trades inside a 0.5% band around the official PBOC mark versus a FX basket. Not quite pegged, not truly floating; the speculative interest in the Yuan/USD forward market has increased dramatically in recent years. We trade the ETN CYB to take exposure to this managed currency in a managed economy hoping to manage our risk as the stimulus led recovery in China dominates global trade.

TIP – iShares TIPS
The iShares etf, TIP, which is 90% invested in the inflation protected sector of the US Treasury Market currently offers a compelling yield. We believe that future inflation expectations are currently mispriced and that TIPS are a efficient way to own yield on an inflation protected basis, especially in the context of our re-flation thesis.

 
SHORT ETFS

EWY – iShares South Korea South Korea has joined Japan in the ominous position of broken TREND and TRADE. This is not China or Taiwan. This is an early cycle economy that we want to be short against China/Taiwan.

XLI – SPDR Industrials We shorted Industrials again on 11/9 on the up move as the US market made a lower-high.  This is the best way for us to be short the hope of a V-shaped recovery.   

EWU – iShares UK Despite areas of improvement, broader fundamentals remain shaky in the UK: government debt continues to expand, leadership in critical positions lacks, and the country’s leverage to the banking sector remains glaringly negative.  Q3 saw its GDP contract by -0.4%. Further bank stimulus and the BOE’s increase in its bond purchasing program suggest that this will not end well.

XLY – SPDR Consumer Discretionary We shorted Howard Penney’s view on Consumer Discretionary stocks on 10/30. TRADE and TREND bullish.  

FXB – CurrencyShares British Pound Sterling
The Pound is the only major currency that looks remotely as precarious as the US Dollar. We shorted the Pound into strength on 10/16.

SHY – iShares 1-3 Year Treasury Bonds  If you pull up a three year chart of 2-Year Treasuries you'll see the massive macro Trend of interest rates starting to move in the opposite direction. We call this chart the "Queen Mary" and its new-found positive slope means that America's cost of capital will start to go up, implying that access to capital will tighten. Yields are going to continue to make higher-highs and higher lows until consensus gets realistic.



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%

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 80.64%
  • SHORT SIGNALS 78.57%

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


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


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