• run with the bulls

    get your first month

    of hedgeye free



The 2010 MGM outlook looks bleak and the valuation rich by historical standards. Does that mean it's a short right here?



We're not so sure.  We've written about the likely low CityCenter return on investment and more importantly, the potential for serious cannibalization (see CITYCENTER: A GROWTH OR DONNER PARTY FOR MGM?, 11/23/09).  The valuation at 11.5x 2010 EV/EBITDA looks high especially relative to the historical range of 7-11x.  Moreover, cost of capital is likely going higher as MGM will be forced into refinancing much of its debt in 2010.  We think some form of equity issuance (convertible or straight equity) is likely. 


That's a compelling short story, no?  The problem is that shorting MGM into the CityCenter opening this week is consensus.  Look at the following chart that measures sentiment and short interest among select gaming, lodging, and leisure stocks.  MGM sits farthest down the sentiment line, which measures average analyst rating along the vertical axis and overall short interest along the horizontal axis.  MGM maintains the highest short interest and one of the lowest average ratings in this universe.


MGM: THE CONSENSUS SHORT - sentiment and short interest


The sentiment surrounding MGM could hardly be worse.  Even after a big two day move, the stock is 20% off its recent high in an otherwise strong stock market and the short interest has been climbing.  Any encouraging data points surrounding Q1 2010 room rates or indicating a solid opening of CityCenter could spark a short squeeze.  Don't forget that MGM has extra incentive to spin the CityCenter opening and market absorption favorably.  After all, 2010 will be a year of financing and fundraising. 


So far, we don't have any positive data points to report.  Indeed, CityCenter is still pricing rooms at a discount to the peer group for January and MGM is offering attractive promotions for the Aria and now Bellagio (see below) for Q1.  However, shorter seller beware.


MGM: THE CONSENSUS SHORT - bellagio offer

Again! Higher Highs

“Success is how high you bounce when you hit the bottom.”

-General George S. Patton


In this game, there is no better measurement for success than the rate of return on an investment. Undoubtedly, people who live their lives making excuses and pointing fingers will take issue with that; particularly on Wall Street, where some people like to keep a relative score. In the arenas of professional sport however, the score is absolute. I think that professional accountability model has higher standards.


When considering investment opportunities, I tell my team that they can be one of three things: Bullish, Bearish, or Not Enough of one or the other. I, for one, have not remained Bullish Enough on US Equities into yesterday’s closing YTD high. That’s no one’s problem other than my own.


I made multiple sales at the YTD highs established between November 17th and December 3rd (multiple tests of SP), but was relegated to watching us make a higher-high yesterday from the cheap seats.


Higher-highs, in my macro model, are bullish until they aren’t. One day, we can all look back at the YTD high for what it was – an event in the rear view mirror. Tops are processes, not points. If you need a Wall Street/Washington economist, strategist, or academic to give you a replay of it all, we are choke full of those in this country. They are called revisionist historians.


My role as a global macro risk manager is to proactively call out probable outcomes, before they occur. Sometimes I am wrong. Sometimes I am right. We called the topping process in both Gold and Oil this year. We also called the bottoming process in short term Treasury yields. At the same time I feel shame for missing yesterday’s SP500 ringing the register at 1114.


Yesterday’s higher-high in the SP500 coincided with a higher-high in one other major global equity market – Brazil. That’s the only country we are currently long on the International Equity side of our Asset Allocation. It’s the only major country index, other than the USA, to hit a higher-YTD-high in the last few weeks. The rest of the world’s Great REFLATION trades have started to unwind.


Brazil’s stock market bottomed just inside of a week before the US stock market did back in March. Since, the EWZ (Brazilian ETF) is up +146%. Meanwhile, the SP500 has tacked on one of the most expedited 9 month moves ever (+64.5% since March the 9th). Yes, ever is a long time. And, yes, the absolute score here has been a monstrous success for those who didn’t buy into the Groupthink Inc. fear-mongering. “Success is how high you bounce when you hit bottom.”


Today, my risk management task isn’t to live in some of the mistakes I made yesterday. It’s to wake up, smell the coffee, and make moves based on the most probable outcomes for tomorrow. Today, is just another opportunity to play the game that’s in front of me.


My favorite scene in the movie Miracle is when Kurt Russell lines the boys up on the goal line and makes them skate until they puke. “Again” … “Again” … “Again”…


Over and over again, I have learned through the lessons of my own mistakes that chasing higher-highs doesn’t work; particularly when they are not confirmed by the rest of the market prices in my global macro model. Here are some risk management thoughts for you to consider before you hit the ice out there this morning:


1.       China’s A-Shares closed down -0.86% overnight, failing to make a higher-YTD-high

2.       Japan’s stock market was down -0.22% again overnight; it remains the worst performing major equity market in the world YTD

3.       Hong Kong’s H-shares were down another -1.2% overnight; they have recently broken their immediate term TRADE line, making lower-highs

4.       Greece, turned sharply lower again this morning after their PM’s assertions of budget cuts were voted on negatively by Mr. Macro Market

5.       UAE resumed selling its stock market down another -1.5% after 1 up day of hope that Dubai’s debts for 2010, 2011, 2012 don’t matter

6.       Russian stocks continue to lose price momentum, having recently broken their immediate term TRADE line, and now making lower-highs

7.       Oil is now broken from both an immediate term TRADE ($76.91) and an intermediate term TREND ($74.30) perspective

8.       Gold has broken her immediate term TRADE line of $1148/oz and looks ripe to continue making a series of lower-highs

9.       US Dollar Index is now breaking out of its intermediate term TREND line base ($76.31), making a 2-month high, and a series of higher-lows


“Again”… “Again” … “Again”…


Its 630AM right now and I’m just getting started here. This is a short list of risk management factors that my model has flashed to me in the first few hours of what we call the grind. I know my style and process is not for everyone, but you know that I know it has edge. Closet indexers don’t grind.


The only way to solve for making a mistake like I have in not being long the SP500 at the YTD high is to find a different way to win this morning. Real men and women of this gridiron know that this is all that matters. Not losing is always the highest probability position to be in if you want to start winning.


My immediate term line of TRADE support for the SP500 is -1.5% lower at 1098. I’ll buy and cover US stocks if we hold that line. A strong US Dollar is going to lead this country to higher real-rates of return on American fixed incomes. It’s also going to expedite the exit of losing players who we need to get off the ice. I look forward to that. “Again”!


Best of luck out there today,






VXX – iPath S&P500 Volatility For a TRADE we bought some protection at the market's YTD highs by buying volatility on 12/14.


EWZ – iShares Brazil As Greece and Dubai were blowing up, we took our Asset Allocation on International Equities to zero.  On 12/8 we started buying back exposure via our favorite country, Brazil, with the etf trading down on the day. We remain bullish on Brazil’s commodity complex and believe the country’s management of its interest rate policy has promoted stimulus.


XLK – SPDR Technology We bought back our position in Tech on 11/20. Rebecca Runkle has an innovation story in Mobility and Team Macro has an M&A story in our Q4 Theme, the “Banker Bonanza”. We’re bullish on XLK on TREND (3 Months or more).


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.





EWJ – iShares Japan While a sweeping victory for the Democratic Party of Japan has ended over 50 years of rule by the LDP bringing some hope to voters; the new leadership  appears, if anything, to have a less developed recovery plan than their predecessors. We view Japan as something of a Ponzi Economy -with a population maintaining very high savings rate whose nest eggs allow the government to borrow at ultra low interest levels in order to execute stimulus programs designed to encourage people to save less. This cycle of internal public debt accumulation (now hovering at close to 200% of GDP) is anchored to a vicious demographic curve that leaves the Japanese economy in the long-term position of a man treading water with a bowling ball in his hands.


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.   

XLY – SPDR Consumer DiscretionaryWe shorted Howard Penney’s view on Consumer Discretionary stocks on 10/30 and 12/2.


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.

Required Retail Reading: NKE: FX Context


December 15, 2009





With the USD putting in a near-term bottom, that might seem naturally bad for Nike. But the delta remains positive from Nike's last EPS report -- even though the stock has not moved and estimates have bottomed.



With a 4% move in the dollar since the recent November 24th low, how could we NOT acknowledge this as it relates to Nike? A 4% move might not seem like much in the grand scheme of things -- but lets not forget that we're talking a currency here, not a stock. 4% over 2 weeks is big.  With over half of its sales coming from outside the US, a stronger dollar is clearly bad for Nike over a shorter time period.  I stress 'near term' as a strong US Dollar is ultimately going to lead this country to higher real-rates of return on American fixed incomes. It's also going to expedite the exit of losing businesses who don't have much of a reason to exist, which is good for companies like Nike.


A very important near-term point to consider is that since Nike's last print, the currency delta is a net favorable one in spite of the fact that we've seen recent strength. The chart below shows what the FX outlook was three months back vs. today (our analysis weights forex based on every relevant country where Nike does business).  


Required Retail Reading: NKE: FX Context - NKE FX 12 15 09


On top of that, add the fact that this is the first real quarter where Nike has some SG&A runway due to its layoffs earlier this year (though much will be reinvested), downward earnings revisions have (justifiably) slowed materially, and we're now only 1-2 quarters away from when we think both futures and EBIT should improve substantially as Nike starts its next 'burst' of growth. Package all that together and its getting tougher to find a reason not to like this stock. This should be a winner in 2010.




  • In a survey based on the volume and number online posts, as well as the overall tone of the posts (positive/negative), Amazon.com, Target, Nike, and Wal-Mart were the retail brands included in the top 10 for 2009. The top 10 list compiled by Zeta Interactive, is often used as a measure of which brands or companies are utilizing social media to effectively generate positive “buzz” surrounding their brands.
  • This is the last week to take advantage of the broad-based free shipping offers in order to deliver gifts by December 25th. Many online retailers will end their free-shipping offers by December 18th, which is also the last day retailers will allow orders guaranteeing Christmas delivery for those using free shipping options. 62.3% of retailers will expire their holiday shipping offers exactly one week before Christmas.
  • While conventional wisdom may suggest that the premium denim trend has passed, the ability to sell privately owned premium denim brands may still be a possibility. West Coast based denim company, J Brand Denim is reportedly in the process of being sold. The rumored sales price is $90 million with the buyer rumored to be a private equity firm.




Barneys' Extended Temporary Lifeline as Abu Dhabi Bails Out Dubai World - As the retailer’s ultimate parent company, Dubai World, on Monday revealed a $10 billion lifeline from Abu Dhabi, speculation continues to swirl over Barneys’ future and whether it will be sold. While sources said a sale isn’t imminent, they’re not ruling it out down the road. There have been signs of a pickup at Barneys, with business up 7 percent in October, although sales slid back into the negative column in November, approximately in the high teens. Factors and vendors continue to show support and ship with extended payment terms. For now at least, all of this enables Barneys to put off a sale, a bankruptcy or some other restructuring, and hold off on announcing a strategy for the future until after the luxury chain digests its holiday business, according to sources. The state of limbo is heightened by the fact that Barneys has strangely operated without a chief executive officer since July 2008, and there is no one in line for the job. <wwd.com>


Kohl's Said Eyeing Broadway Site - Kohl’s Corp. is stepping up its search for its first Manhattan location. “They were in town last week,” said one real estate source familiar with the property search. The focus seems to be on 1775 Broadway, which is being fully renovated by Moinian Group, the landlord, and is located between 57th and 58th Streets and between Broadway and Eighth Avenue, just south of Columbus Circle. Comp USA was the last big-box retailer on the site. “The building has a pretty good size footprint. Most of the space is vacant. They could assemble a block of space over 100,000 square feet,” which would consist of three levels at around 33,000 square feet each, the real estate source said. Typical Kohl’s stores contain 80,000 to 90,000 gross square feet. WWD first reported in August that Kohl’s was scouting Manhattan and Broadway. Crain’s New York and The Real Deal reported last month that 1775 Broadway was the focus.  <wwd.com>


Timberland launches campaign to make people aware of climate change - Timberland has just launched a global campaign to get citizens mobilized. The slogan is "Don’t tell us it can’t be done!" The aim is to impact the 192 governments attending the UN Climate Change Conference taking place in Copenhagen. Timberland’s proposal is aimed at having the greatest number of governments sign an agreement outlining the norms for greenhouse gas emissions. The initiative also encourages citizens to become involved in this public debate via a Global Action Center and have an active presence in social networking sites such as Facebook, Twitter, YouTube and print media as well as in all its outlets throughout the world. <fashionnetasia.com>


Adidas names a head of global e-commerce to accelerate its online sales - Athletic footwear manufacturer Adidas Group is creating a new e-commerce team alongside its existing wholesale and retail units. To lead the new initiative, Germany-based Adidas has selected company veteran Christophe Bezu, who since 2003 has been the CEO of Adidas’ Reebok brand in the Asia-Pacific region. Bezu, who also was recently named the company’s managing director for Greater China, will head up a global project called Excellence in e-Commerce. He will report to Herbert Hainer, Adidas Group CEO and chairman, who will chair the steering committee for the new e-commerce group.  <internetretailer.com>


Israel Departs Sears - Sears, Roebuck & Co.’s top apparel executive, Craig Israel, has left the company. Israel was president of apparel and recently began reporting to John Goodman, who last month joined Sears Holding Corp., the parent of Sears and Kmart, as executive vice president of apparel and home, a new post. A spokesman for Sears said Monday that with Israel’s departure, Goodman will serve as interim leader of the Sears apparel business until a successor is found. Goodman is also serving as interim president of Kmart Apparel until a permanent officer is named to that post.  <wwd.com>


Saks Ends 'Poison Pill' Provision - Saks Inc. on Monday ended a “poison pill” provision in its shareholders’ rights plan that it had adopted last year to prevent a takeover. The luxury retailer enacted the condition, meant to kick in if a single investor held more than 20 percent of its shares, in November 2008, shortly after Mexican billionaire Carlos Slim Helú upped his stake in the firm to 18.3 percent. Chairman and chief executive officer Stephen I. Sadove said the rights plan had served its purpose and was no longer necessary because the firm increased a change-of-control threshold to 40 percent when it altered its revolving credit agreement on Nov. 23. In December 2008, Saks distributed a preferred share purchase right for each outstanding share of its common stock. The right would have only been redeemable if an investor acquired 20 percent or more of the firm’s shares and was designed to dilute such an acquirer’s stake. In a Securities and Exchange Commission filing at the time, the company said it had done so to “protect shareholders from coercive or otherwise unfair takeover tactics.”  <wwd.com>


Korean Retailer Who.A.U. to Open in N.Y. - One little-known youth-oriented foreign retailer trying to break into the U.S. market is taking over the retail space of another little-known youth-oriented foreign retailer that failed in its bid to enter the American market. Who.A.U. California Dream, a South Korean brand with two mall stores in the U.S., will open a 12,000-square-foot multilevel flagship at 22 West 34th Street between Fifth and Sixth Avenues. Kira Plastinina, the Russian brand designed by the teenager of the same name, was the last tenant to occupy the space. Kira Plastinina shuttered the location in December 2008.  <wwd.com>


Kahn Named Wet Seal Chairman - Foothill Ranch, Calif.–based The Wet Seal Inc. announced the retirement its chairman of the board, Alan Siegel on Dec. 14. Harold Kahn, another member of Wet Seal’s board, has been named as his replacement. Siegel served the young woman’s retailer for 20-years. He decided to resign because of his age. He will be 75 in January. He also will devote more of his time to working as the executor of the Wade F.B. Thompson Charitable Foundation based in Niantic, Conn. <apparelnews.net>


Online Shoppers Moving Away from Credit - The quest for fiscal fitness is leading online shoppers to increase their use of cash and debit cards even as issuers’ own policies and consumers’ desire to avoid debt have discouraged credit card use. According to a survey of more than 2,000 U.S. Internet users conducted in October by comScore Inc., 65 percent of respondents have changed the way they pay for items online because of concerns about the economy, down from 67 percent in the previous year. Of those who indicated they had altered their behavior, 42 percent said they are more likely to use cash, versus 50 percent in the 2008 study, and 40 percent said they are more likely to use a debit card, up from 34 percent. Twenty-three percent said they were more likely to use a credit card, up from 18 percent last year, and 13 percent said they had begun to consolidate spending to fewer credit cards, up from 12 percent. The percentage saying they had spread their spending among a greater number of cards advanced to 6 percent from 5 percent.  <wwd.com>


Online holiday spending is up 3.4% compared to a year ago - Shoppers have spent nearly $19.94 billion online this holiday shopping season, which began Nov. 1, a 3.4% percent jump from $19.28 billion a year ago, reports comScore Inc. Of the 10 largest shopping days on record, four have taken place this year (in $mm USD):

  • Monday, Nov. 30, $887
  • Tuesday, Dec. 1, $886
  • Thursday, Dec. 10, $852
  • Tuesday, Dec. 8, $828

Online sales shot up 4% last week when consumers spent more than $800 million on two separate days, says comScore. Since comScore began tracking e-commerce spending in 2001, it has recorded 13 spending days that have eclipsed $800 million. <internetretailer.com>


CIT Sweetens Small Business Loans - CIT Group Inc., back after fewer than six weeks in bankruptcy court, said it would waive a $1,000 packaging fee on loans approved under a Small Business Administration program. The lender, which last week emerged from bankruptcy as a public company, said it would waive the fee on the federal agency’s 7(a) loan applications through March 10. CIT previously committed $500 million to support government-guaranteed loan programs for the sector. “The small business sector remains a key driver of job creation in America,” said Chris Reilly, president of the lender’s small business unit. “These recent announcements reflect our commitment to bringing much needed credit to this sector, and to helping small businesses access the capital they need to weather this difficult economic environment.” CIT said small businesses employ nearly 59 million Americans. <wwd.com>

Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.


The Macau Metro Monitor.  December 15th, 2009




The People’s Bank of China yesterday relaxed restrictions on yuan transactions for Macau residents.  The central bank said Macau residents would soon be able to exchange the equivalent of 20,000 yuan (HK$22,704) per person per day, up from 6,000 yuan.  Macau residents will also be allowed to write yuan-denominated checks for purchases in Guangdong.  The PBOC announcement of the yuan business expansion comes as Beijing prepares to celebrate the 10th anniversary of Macau's handover to the mainland on December 20.




Hong Kong Chief Executive Donald Tsang Yam-kuen has said that the government will try to keep toll rates for the Hong Kong-Zhuhai-Macau Bridge as low as possible.  Tsang said the three governments would continue to work together to ensure the bridge was properly managed.


Across the board the market finished higher on Monday; the S&P 500 closed up 0.7% on the day.  The tone was set early with an energy M&A deal where XOM is buying XTO.  Also, news that Abu Dhabi will provide $10B to Dubai provided an easing to sovereign debt contagion concerns.  While the S&P 500 closed at a higher-high, the financials are still broken on both TRADE and TREND, while Energy is broken on TRADE.


For the balance of the week the MACRO calendar will dominate the news cycle.  We are looking forward to several key data points in the next two days, including inflation numbers (PPI on Tues, CPI on Wed), Housing Starts on Wed and the results from the FOMC meeting on Wednesday. 


Looking at the Producer Price Index (PPI), the most recent reports have been generally to the upside of expectations.  Currently, Bloomberg has a 0.8% MoM number versus 0.3% the month before.


On Wednesday, Consumer Price Index (CPI) for November 2009 will be reported.   The consensus estimates for the seasonally-adjusted November CPI is 0.4% according to Bloomberg versus 0.3% in October.  Given the implied relative strength of gasoline and food prices in the November retail sales data, an upside surprise to consensus is a better than average possibility.


This is what matters most.  A consensus report would boost year-to-year CPI inflation from minus 0.2% in October to roughly a positive 1.9% in November.  The November CPI data will officially end the recent period of formal DEFLATION.


The RECOVERY trade was in full force yesterday as the Materials (XLB), Industrials (XLI) and Energy (XLE) were the three top performing sectors.  The bottoms three were Financials (XLF), Utilities (XLU) and Consumer Staples (XLP).  It’s noted that every sector was up on the day and six sectors outperformed the S&P 500. 


Yesterday, the natural gas sector benefited from XOM’s acquisition of XTO.  Naturally the transaction increased speculation concerning further M&A activity in natural gas.  Materials (XLB) was the best performing sector, with Metals and Mining stocks leading the way. 


The Financials (XLF) continue to underperform, after being among the worst performers last week, but managed to end the day with a small gain. C and MBIA were the two worst performing stocks in the XLF. 


From a risk management standpoint, the ranges for the S&P 500, the Dollar Index and the VIX are seen in the charts below.  The range for the S&P 500 is 17 points or 0.5% upside and 1.5% downside.  At the time of writing the major market futures are trading slightly lower.


In early trading today, crude oil is trading lower as the dollar is moving higher.  The Research Edge Quant models have the following levels for OIL – buy Trade (68.78) and Sell Trade (74.30).


In London Gold is trading lower by 0.7% to $1,118.  The Research Edge Quant models have the following levels for GOLD – buy Trade ($1,089) and Sell Trade ($1,148). 


Copper in London is lower as the dollar strengthened.  The Research Edge Quant models have the following levels for COPPER – buy Trade (3.10) and Sell Trade (3.26).


In early trading today the US Dollar is up trading at +0.7% amid speculation improving economic data in the U.S. will require the Federal Reserve to signal an exit from easing policies intended to combat the recession.


Inflation is back!


Howard Penney

Managing Director















YUM used its annual analyst meeting to focus the investment community on where the growth is.  Pizza Hut and KFC in the US – forget-about-it. 


Last week, Yum Brands hosted its annual analyst meeting in New York City.  Prior to the meeting, the company put forth its 2010 EPS growth goal of at least 10%.  So, the focus of the meeting was on the company’s ability to get to 10%.


At the analyst meeting, YUM quantified its same-store sales assumptions underlying the earnings target.  In 2010, YUM sees 2% same-store sales growth world-wide.  Given the current environment and the pickle the US business is in, this target is aggressive.  To management’s credit, they even stated that they have no clue when comps will turn positive…


Looking at the three key business units, management’s outlook assumes 2% comparable sales growth in China, 3% at YRI and 2% for the US.  Let’s just say management is counting on a consumer recovery in 2H10 and the benefits of easy comparisons.  The current trends and outlook suggest that this will be very difficult to attain.


Global unit growth is the key driver to incremental profitability at YUM, especially in China.  In 2010, YUM expects at least 475 new restaurant openings in mainland China, or 13-14% growth.  Guidance is for 15% operating profit growth.  Currently, China generates about 33% of the company’s operating profits. 


Not to be to myopic but I was very interested to see how management handled the issue over sales trends in China.  I would note that they don’t talk about cannibalization anymore.  That being said, they have not changed their stance – it’s an economic issue.  As management sees it, the Chinese consumers have not recovered from two specific economic shocks.  The first one came in the middle of 2008 after the earthquake struck.  Prior to the earthquake, the company was posting double-digit same-store sales growth and 20% unit growth.


The second one came at the end of 2008 when the financial crisis struck and the consumer got even more cautious.  Same-store sales growth in China slowed rather significantly in 4Q08 on a 1-year basis and has remained weak for all of 2009.  The company was lapping difficult comparisons in the first half of 2009, but same-store sales were flat in Q3 and are expected to be -3% in Q4, despite the relatively easier comparisons in the back half of the year.   


Regardless of comparisons, 2-year average trends more accurately show where trends are headed.  Last year on YUM’s 4Q08 earnings call, CEO David Novak highlighted this fact when he said, “Given the strong results we were lapping in the second half of 2007, it makes sense to look at two-year growth rates to gain a greater understanding of China trends. When examining two-year trends for the China Division’s system-sales growth you will find that fourth quarter growth was 49%, just three points below the first half’s strong results, an improvement of four points over the third quarter.”  It is important to remember that Mr. Novak pointed us to look at 2-year trends when comparable sales growth in China came in at 1% in 4Q08 following 12% growth in 1Q08, 14% in 2Q08 and 5% in 3Q08.  On a 2-year basis, same-store sales trends improved in 4Q08 on a sequential basis from 3Q08 so Mr. Novak highlighted this improvement to justify the slowdown in 1-year numbers.  To that end, two-year average trends have gotten sequentially worse every quarter since then and will turn negative in 4Q09, assuming management’s outlook for -3% is correct. 




At its meeting last week, management said the continued softness is just a function of “lapping what we were running against.”  To that, I would respond that YUM is already lapping easier comparisons in 2H09 and more importantly, two-year average trends continue to come down.


Management also said the real test of current trends will come when they start to lap “the bad bad economy.”  We are already there.  As management stated in its presentation, the second “economic shock” came at the end of 2008.  Same-store sales in China were -1% in December 2008 so we are lapping the beginning of that impact in Q4 and comparable sales are expected to come in -3%. 


Importantly, management said “we still feel that there's no basic fundamental change in China,” which I viewed as justification for continued unit growth.  The extent at which management is bound and determined to keep the unit growth machine going was summed up when Mr. Novak said “We could drop our sales 20%-25% and open restaurants until the cows come home - So that's what we plan on doing.”    


My biggest take away from the meeting was that YUM management will do its best going forward to keep the investment community focused on China, YRI and Taco Bell.  Yum’s U.S. business accounts for 40% of the company’s global operating profits and Taco Bell accounts for 60% of the US.  With the US KFC and Pizza Hut businesses in secular decline, I would not be surprised if these businesses combined account for less than 20% of US operating profits in the coming years.  If it were not for the overseas potential of these brands, I see no need for the company to keep either brand.  For now, however, these businesses still matter.  Management may want to divert our attention to other areas of growth, but current trends at KFC and Pizza Hut are extremely concerning and need to be addressed.


Yum expects to focus much of its domestic efforts on refranchising KFC and Pizza Hut and expanding business at Taco Bell.  Thus, higher scrutiny on where Taco Bell is going is important.  According to management, Taco Bell’s success relies largely on its “branded value” perception and new products offering multiple proteins, a launch of balanced options (drive-thru diet) and day part expansion (breakfast).


I have a hard time believing that the latter two – the drive-thru diet and breakfast - will have any impact on sales any time soon.  Breakfast is so competitive and the real estate strategy for Taco Bell over the years did not contemplate offering breakfast (locations not conducive to morning rush hour traffic).  Therefore, the company will have a very difficult time building that day part.    The idea that YUM will be able to shift consumers’ mindsets to believe that they can lose weight at Taco Bell seems crazy to me and will not “change the category.” 


The Drive-Thru Diet will launch December 27 in order to take advantage of consumers making New Year's resolutions.  On January 1st Christine Dougherty will be to Taco Bell what Jared is to Subway.  According to YUM, Christine has lost 54 pounds over the last two years eating off the Drive-Thru Diet!  She has apparently been eating fast food between 12 to 15 times a month.  Some of those occasions were at Taco Bell, while others were at other brands.   


YUM is calling it the Drive-Thru Diet because they are trying to take on Subway directly while highlighting that Subway does not have drive-thrus.  The two key attributes of QSR are convenience and value.  With Taco Bell being the value leader in the category, management is trying to capture some “better for you” food customers.  Good luck with this one!


What will have in impact will be the new value product offering and new proteins being introduced in 2010.  Taco Bell will be generating a significant amount of new product news and three new proteins – (1) the Beefy 5-Layer Burrito (which could sell for 89 cents each), (2) Pacific Shrimp Tacos ($2.79 each), its new seafood entry and (3) Grilled Cantina Tacos (includes pork).  All of the new products will shift the concept away from the typical “spicy” Mexican flavor. 


All in all the investment community was very bullish on YUM and they do communicate a positive story.  The “growth till the cows come home” strategy is China will one day be a problem for YUM -- timing on this issue is critical.  Same-store sales trends in China are weak in 4Q09 despite easy comparisons. 


The trends in the US have put incremental pressure on management to keeping the China operations without issues.  For now management is getting a free pass on sales trends in China, but for how much longer?

investing ideas

Risk Managed Long Term Investing for Pros

Hedgeye CEO Keith McCullough handpicks the “best of the best” long and short ideas delivered to him by our team of over 30 research analysts across myriad sectors.