Dear Ben,


The President of the United States is in Asia this week and the two largest economies in that region are sending a clear message – STOP THE MADNESS.  Stop pandering and raise interest rates now!


If nothing else, this week the news flow out of Asia will provide some great GLOBAL MACRO theatre.


In very quiet trading the S&P 500 finished higher by 0.6% on Friday.  For the week the S&P 500 closed up 2.3%.  The market was supported by renewed dollar weakness, although the sectors that benefitted the most from the GLOBAL RECOVERY trade underperformed. The dollar sank by 0.5% and the VIX declined by 3.6% on the day.


The biggest area of concern seemed to be the MACRO calendar, as consumer sentiment fell for a second straight month in November. The University of Michigan’s Consumer Sentiment Index fell to 66 in the November from 70.6 in October, versus consensus expectations of 71.  Not surprisingly, expectations for personal finances and employment also deteriorated in November, as did the indexes measuring buying conditions for large household goods, houses and vehicles.


The Financials (XLF) sector was the worst performer declining 0.2% on Friday; the XLF was the only sector down on the day.  The banking finished lower for a second straight session, with the large-cap names such as Wells Fargo and JP Morgan were among the laggards.  It's notable that both the Financial and Materials (XLB) underperformed on Friday, as they are the two sectors of the market that have provided significant upside leadership since the March lows.


The three best performing sectors were Consumer Discretionary (XLY), Technology (XLK) and Utilities (XLU).  Despite the disappointing consumer sentiment data, the consumer discretionary sector was the best performer today as Retail was a bright spot.  Earnings helped lift some of the name and both DG and RUE rallied following their respective IPOs.


Today, the set up for the S&P 500 is: TRADE (1,074) and TREND is positive (1,039).   The Research Edge quantitative models have 9 of 9 sectors in the S&P 500 positive on TREND and 7 of 9 sectors are positive from the TRADE duration.  Two of the sectors that benefit the most from the lower dollar – Financials and Materials - are broken on the TRADE duration.   


The Research Edge Quant models have 2% upside and 2% downside in the S&P 500.  At the time of writing the major market futures are poised to open up small to the upside. 


The Research Edge MACRO Team







November 16, 2009





H&M sits near the top of my list of companies I track to keep a pulse on global discretionary spending. Many people underestimate how truly massive and relevant H&M is. But with sales of US$11bn, it compares to Gap, Inc at $15bn. While slightly smaller on the top line, its $2.6bn in EBIT dwarf’s Gap’s $1.6bn. Aside from being one of the largest, most profitable and highest-return apparel companies in the world, it is clearly the most diverse, as evidenced in the first exhibit below.  That’s why the headline comp delta improvement for October was interesting to me.  


The company highlighted Scandinavia, Central Europe, and Asia as geographic outperformers while France, Spain, and the US had another weak month. This ties in perfectly with what we’re hearing from Matt Hedrick (our Europe guru on our Macro team) in that consumption is picking up across the region, however we’ve yet to see substantial pick-up from the region’s largest economies. The UK reports October Retail Sales this Thursday, which is an important gauge from a Macro perspective. Based on H&M’s results, it does not sound like Western Europe is turning around meaningfully just yet…












Some Notable Call Outs


  • JC Penney provided some additional insights into its recent licensing partnership with Liz Claiborne. The namesake brand will be available in Penney stores for the Fall 2010 selling season. The brand is expected to span 30 product categories throughout the store. When surveyed, consumers indicated that Liz Claiborne was among their top three preferred brands, no matter where these customers chose to shop. Management was very enthusiastic for the potential growth of the brand, and indicated that they expect it to double in size over a five year period.


  • ANF management was quick to point out that they believe they may have swing the pendulum too far on tight inventory management. As a result, key product categories like denim have been negatively impacted by overly conservative inventory plans. Fashion items, which have sold well, are also unable to make a substantial impact on overall topline results given the low inventory commitments made to “trend” items.


  • Score one for Under Armour and the company’s endorsement of Milwaukee Buck rookie, Brandon Jennings. Jennings is the only NBA player currently endorsed by Under Armour and was the first player picked to wear the company’s prototype basketball shoes. While the rollout of the basketball line is still TBD, we can’t ignore the success of Jennings so far. While he was already the leading scorer on the Bucks and one of the leading rookies in the league so far this year, the attention on Jennings is sure to elevate with his 55 point performance on Friday night (just his 7th game ever in the NBA!). Jennings performance puts him in elite company becoming the first player to score 50 points in the fewest amount of games and also surpassing Lew Alcindor’s franchise record for scoring the most points as rookie. With this success, we wonder how long it will be before the UA hoops collection finally makes its way into retailers.




Obama to Seek Increased Trade in Asia - Speaking during his first trip to Asia since taking office, President Obama indicated over the weekend that the U.S. will seek to increase its engagement in trade in the region. Obama announced Saturday the U.S. will work with Vietnam, Singapore, Australia, Peru, Brunei Darussalam, New Zealand and Chile to shape a broader regional agreement out of the existing Trans Pacific Partnership (TPP) free trade area. Obama also indicated that the administration would engage South Korea in talks to work through outstanding issues keeping the stalled U.S.-Korea free trade agreement from moving forward, and pledged to continue working aggressively on the Doha Round of trade negotiations. “We’ve increased our exports to Asia at a healthy rate over the last decade, but not as much as other regions have — and we intend to change that,” Obama said. He delivered his remarks early in a weeklong trip that includes stopovers in Japan, Singapore, China and South Korea. <>


U.S. Demand May Take Until Next Year to ‘Regenerate,’ Li & Fung Says - U.S. consumer demand may take until the middle of 2010 to “regenerate,” and it’s unlikely China can fill the gap as the global economy recovers, said Victor Fung, chairman of Wal-Mart Stores Inc. supplier Li & Fung Ltd. “The slide in retail sales has been arrested, but I think it may take a little while before demand will regenerate,” Victor Fung said in an interview in Singapore Nov. 14. “We will look toward the middle of next year for that to come back up, before you can see a perceptible pick up in demand.” Sales at U.S. stores open at least a year rose 1.1 percent in September, the first increase in 13 months, as discounts drew shoppers back to shops. Li & Fung, founded in China in 1906 near the end of the Qing Dynasty, is accelerating efforts to buy makers of clothing, cosmetics, home products, accessories and shoes as retailers increase reordering. <>


Downside of U.S. Economic Recovery Is Swelling of Trade Gap - The U.S. economic expansion that began last quarter has a downside: the trade deficit will probably swell as imports jump. Purchases of goods made overseas climbed 5.8 percent in September to $168.4 billion, the Commerce Department reported today in Washington. The gain was the biggest since 1993 and reflected growing demand for crude oil, automobiles, metals, machines and even artwork. The figures illustrate the challenge faced by world leaders as they try to rebalance global growth away from American consumption and toward demand in emerging markets. President Barack Obama today began an eight-day trip focusing on trade that will take him from Singapore to Korea. <>


Walmart Extends AA Rating Benefits to Apparel Vendors - Wal-Mart Stores Inc., the world’s largest retailer, said it’s allowing more than 1,000 apparel companies to benefit from its high credit rating and arrange financing after CIT Group Inc. filed for bankruptcy. Walmart wrote a letter to its apparel makers on Nov. 2, a day after CIT’s bankruptcy filing, saying they can “take advantage of Walmart’s AA credit rating to secure financing to manufacture and deliver products for our stores,” John Simley, a company spokesman, said today by telephone. The retailer is working with Wells Fargo & Co. and Citigroup Inc. to have them pay vendors between 10 and 15 days from receipt of goods in Walmart stores, the letter said. The banks can provide the funding at attractive rates with the understanding that Walmart will pay them directly and on a timely basis, Walmart said. <>


China, Japan Say Fed’s Low Rates Fueling Speculation - Financial officials in Japan and China, Asia’s two largest economies, warned the Federal Reserve’s interest-rate policy risks spurring speculative capital that may inflate asset prices and derail the global economic recovery. Emerging economies “might overheat and experience financial turmoil,” Bank of Japan Governor Masaaki Shirakawa said in Tokyo today. Low rates and the dollar’s depreciation present “new, real and insurmountable risks to the recovery of the global economy,” Liu Mingkang, China’s top banking regulator, said yesterday. The comments reflect concern that the Fed’s pledge to keep rates near zero for an “extended period” may lead to a repeat of the financial crisis. MSCI’s emerging-markets stock index has risen 71 percent this year and Asian countries from Singapore to South Korea are trying to rein in surging real-estate prices. <>


China, Vietnam Gain as Imports Fall in Sept. - Textile and apparel imports to the U.S. from China and Vietnam increased in September, but shipments from the other top suppliers continued to decline. The Commerce Department’s Office of Textiles & Apparel said Friday that imports from China gained 3.2 percent to 2.2 billion square meter equivalents, driven by a rise in apparel shipments. Apparel imports from China grew 12.1 percent to 1.1 billion SME, and textile shipments fell 4.4 percent to 1.1 billion SME. Textile imports from Vietnam helped propel an increase in total textile and apparel shipments of 14.3 percent to 199 million SME. Textile shipments to the U.S. from Vietnam spiked 116.8 percent in September to 54 million SME; apparel imports dipped 3 percent to 144 million SME. Vietnam was also the only top textile and apparel supplier to increase shipments to the U.S. for the year-to-date period, rising 20.5 percent to 1.6 billion SME. <>


H&M's October sales drop but Jimmy Choo range is a success - H&M sales were worse than expected in October, down 3% on a like-for-like basis. The Swedish fashion giant said that sales in Scandinavia, Central Europe and Asia were satisfactory during October but that the performance in other markets including France, Spain and the US continued to be weaker. Total sales across the group grew 7% in October compared to the same month the previous year. The results came as H&M opened its doors to its latest designer collaboration, this time with Jimmy Choo which drew crowds across the country this weekend. H&M said it was “delighted” with the launch of the much-hyped range. There were long queues outside of the 19 stores in the UK and Ireland that carried the collection, which launched at 9am on Saturday morning. <>


Japan Q3 GDP Grows Faster Than Expected - Japan’s third-quarter gross domestic product grew at a faster-than-expected rate but longer-term concerns about the health of the economy and deflation persist. Japan’s real GDP rose 1.2 percent in the July to September period from the prior quarter, the Cabinet Office said Monday. That figure reflects 4.8 percent growth on an annualized basis for the world’s second-largest economy. Stimulus measures, both in Japan and other countries, are considered responsible for much of the jump. Japan officially emerged from recession in the second quarter of the year.  GDP for the April to June period rose 0.7 percent, revised downward from an original estimate of 0.9 percent growth. Still, concerns about Japan’s job market and overall economic health linger. The government is preparing to declare that the Japanese economy is in official deflation, according to a Cabinet Office spokeswoman. <>


European October Consumer Prices Fall for Fifth Month - European consumer prices declined for a fifth month in October as rising unemployment discouraged household spending. Prices in the 16-nation euro region declined 0.1 percent from a year earlier after falling 0.3 percent in September, the European Union statistics office in Luxembourg said today. That matched an initial estimate published on Oct. 30 and the median forecast of 35 economists in a Bloomberg survey. In the month, consumer prices rose 0.2 percent. European companies have been forced to cut prices and eliminate jobs to survive the worst global recession in more than six decades. While the region’s economy returned to growth in the third quarter, rising unemployment has undermined consumer spending. <>


Q&A With Jones Apparel Group: "We can't keep [enough] boots in stock" - “We really [have been] focused on getting the house in order and getting the core brands running well,” Card said in a recent interview. “The economy is still tough, and it’s a tough period to operate in, but we’re still doing as well as we can — and better than others. We’re well positioned for when the recovery really starts to take hold.” Meanwhile, as other companies have scaled back on new initiatives, Jones continues to invest in growth, this year launching Rachel Rachel Roy, an exclusive contemporary brand at Macy’s; a Vintage America collection within its Nine West brand; and the Shoe Woo retail concept, which offers a multibrand approach to footwear shopping. In the last few weeks, in particular, footwear has been a bright spot for the firm, thanks to brisk boot sales. “We can’t keep boots in stock,” Card said at last week’s Women’s Wear Daily CEO Summit. “[Shoppers] are buying boots like there’s no tomorrow. When consumers see an item they really want, [they’re buying it].” <>


GM to start repaying loans soon - General Motors Co. will announce on Monday it plans to start repaying a $6.7 billion loan to the U.S. Treasury by year-end due to modest operating improvements, a source knowledgeable about the situation said. GM, due to unveil its first post-bankruptcy earnings report on Monday, will begin making $1 billion quarterly installments on the loan on December 31. At the same time, the automaker also will start repaying a $1.4 billion loan to Canada at a rate of $200 million per quarter. GM was not required to make any payments on the U.S. loan before it matured in July 2015, but better-than-expected vehicle sales will let it start repayments much sooner than expected. <>


American Apparel to Supply US Navy Task Force Uniform Items - American Apparel in Selma, AL received a maximum $8.1 million firm-fixed-price with indefinite-quantity contract to supply items for the US Navy Task Force Uniform (TFU). The original Navy TFU contract was awarded to Wellstone Apparel in 2007; American Apparel purchased Wellstone in 2009. The Navy TFU was redesigned in 2006 to provide a single working uniform for all ranks… The BDU-style working uniform, designed to replace 7 different styles of working uniforms, is made of a permanent press 50/50 nylon and cotton blend. The working TFU includes several cold weather accessories, such as a unisex pullover sweater, a fleece jacket, and a parka. <>


Cherokee Heads to Retailer in China - RT Mart Stores, a division of Ruentex Industries Limited, has signed an exclusive international license deal with Cherokee. The multi-year agreement covers a complete range of categories, including men's, women's and children's clothing, footwear and accessories, as well as home textiles. "RT Mart, with its retail knowledge, merchandising and sourcing expertise, creates an ideal partnership for Cherokee in China," says Larry Sass, executive vice president of Cherokee. "By developing distribution in China, we have now achieved another significant goal in our 'world brand' strategy and are proud to have licensed Cherokee in more than 20 countries and five continents. Over the coming months, we plan to build upon our strategy throughout Asia, as well as Australia, Europe, Russia and Latin America." <>


TSA Hires Chief Marketing Officer and Chief Strategy Officer - The Sports Authority appointed industry veteran Jeffrey Schumacher to oversee all marketing, advertising, private brand strategy, digital/eCommerce, corporate and business development strategy. Schumacher, who currently serves as a Partner in McKinsey & Company's North American Marketing and Sales Practice, brings more than 15 years of industry experience in marketing, advertising, sales and brand/retail strategy. Schumacher's appointment to Executive Vice President, Chief Marketing Officer and Chief Strategy Officer is effective November 16, 2009. <>





COH: Michael Tucci, President-N. American Retail, sold 92,000 shares after exercising options to buy 75,000 shares for a net gain of $1.8mm.


BBY: Bradbury Anderson, Vice Chairman, sold 51,000 shares after exercising options to buy 30,000 shares for a net gain of $1.4mm.


TUES: Madison Dearborn Partners, 10% Owner, sold 10,300 shares for a gain of $31k.


SHOO: Peter Migliorini, Director, sold 7,500 shares after exercising options to buy 7,500 shares for a net gain of $188k.


FOSL: Jennifer Pritchard, Divisional President, sold 4,000 shares for a gain of $124k.


NFLX: Reed Hastings, CEO, sold 10,000 shares after exercising options to buy 4,500 shares for a net gain of $583k.


ANN: Gary Muto, President-LOFT, sold 6,500 shares for a gain of $91k.



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,




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.


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.

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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.





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. 


  • 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%


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