Monday’s political undertone was that the Volcker rules could be significantly watered down in the Senate if not just DOA. Today, Paul Volcker is scheduled to appear before a Senate hearing, with little expectations of presenting anything new. Today’s set up in the Senate is for party-line grandstanding, with the possibility of a few fireworks from some of the more vocal members of the Senate.
Yesterday, the S&P 500 finished higher by 1.43% on a 34% day-over-day decline is volume. The upward move was helped by the weakening RISK AVERSION trade, as both the Dollar index and the VIX declined. The VIX declined 7.9%, to 22.59 and is very close to the TRADE line of 22.51. The Hedgeye Risk Management models have the following levels for VIX – buy Trade (20.56) and Sell Trade (28.12).
On the MACRO front, upbeat manufacturing data out of the US and China helped to underpin the RECOVERY trade. Yesterday, the ISM manufacturing jumped to 58.4 in January from 54.9 in December, marking the highest level since mid-2004. The production component was a big contributor to the January increase, rising to 66.2 from 59.7. While the orders component only saw a slight improvement to 65.9 from 64.9, it remained firmly in expansionary territory. Importantly Employment continued to improve, moving up to 53.3 from 50.2 in December.
Nearly every up move in the S&P 500 in 2010 has been associated with very light volume and as I said earlier yesterday, was no exception. The best performing sectors yesterday were the sectors that have decline the most year-to-date - XLB, XLE and XLF.
Rebounding from an oversold condition, the Materials (XLB) was the best performing sector, rising 4%. The XLB benefited from its leverage to the ISM manufacturing data and the support provided by the RECOVERY trade.
The second best performing sector was Energy (XLE), up 3.3%. While all the major commodities were strong yesterday, natural gas prices led the way with t 5.9% increase. The integrated group snapped a four-day losing streak with help from the better-than-expected Q4 results out of XOM +2.7%. The coal stocks were also very strong following last week’s selloff.
The one sector that continues to underperform is Technology (XLK). While there was some upside leadership coming from the semi space, with the SOX +3.1%, the balance of the group can’t get out of its own way despite the continued trend of better-than-expected December quarter earnings.
As we look at today’s set up, the range for the S&P 500 is 36 points or 2.4% (1,062) downside and 0.8% (1,098) upside. Equity futures are trading mixed to fair value following yesterday's strong gains with concerns over potential tightening in China, the US housing numbers due out today offset by recent economic data and the fact that most 4Q10 earnings continue to beat estimates.
The Dollar Index decline 0.1% yesterday and the Hedgeye Risk Management models have the following levels for DXY – buy Trade (78.66) and Sell Trade (79.51).
Copper rose for a second day in London on speculation that a weaker dollar will spur demand. The Hedgeye Risk Management Quant models have the following levels for COPPER – buy Trade (2.99) and Sell Trade (3.13).
Gold remained almost unchanged over the past week, though a strong dollar is a negative for gold. The Hedgeye Risk Management models have the following levels for GOLD – buy Trade (1,077) and Sell Trade (1,113).
Crude oil climbed for a second day on speculation that recovering demand in the U.S. is causing fuel supplies to drop. The Hedgeye Risk Management models have the following levels for OIL – buy Trade (72.03) and Sell Trade (77.13).
ASCA reports Q4 EPS on Wednesday and we are below the Street at $0.11. Below we’ve got a recap of management’s forward looking comments from the Q3 earnings release and conference call.
We are projecting Q4 EBITDA and EPS of $72.3 million and $0.11 versus the Street at $74.1 million and $0.13. For 2010, we are only slightly behind the Street estimate, $1.02 versus $1.05. ASCA is the only regional gamer where our 2010 estimate is close to the Street.
While lacking a catalyst, ASCA is unique in that it carries a significant free cash flow yield on net free cash flow, not just cash flow before discretionary capex. This company is a cash cow. We calculate a 13% net FCF yield, even after today’s big 4% stock move. It is conceivable ASCA could grow it’s free cash flow by at least 3% over the next several years. Management’s cash flow outlook will be an important topic of discussion on the call.
YOUTUBE FROM Q3 RELEASE/CONF CALL
Property level commentary
- Blackhawk: “We've had a substantial improvement in net revenues during October and an even more substantial improvement on adjusted EBITDA.”
- “But at least during the month of October, the first month of the hotel being opening, the characteristics of the occupancy and the cash demand and cash ADRs are generally more of what we would see on a mature hotel instead of a brand-new one”
- “We're starting to see some signs of impact from an intensive management effort including in Vicksburg.”
- “Well, I think part of the issue with Vicksburg is the general economy. The Mississippi economy has never been the strongest that we operate in and with the current recession, there's been significant impact there. And there is additional competition, there's more gaming supply in the market which has affected our market share. I think we're seeing a little bit of light at the end of the tunnel in relationship to operating our new facility very efficiently and maximizing the customer satisfaction of coming to the new facility now…We're starting to see some margin improvement down there.”
- “The changes we're making at Vicksburg will actually be completed during the fourth quarter. I don't know how much benefit we're going to really see in the fourth quarter that's demonstrable from that. I think we'll hopefully see some focus on margins down there irrespective of the changes.”
General Trends & Outlook
- “We're seeing a little bit less spending per trip by patrons.”
- “I do think it's going to be a longer and slower trajectory in terms of recovery from that in consumer spending but I think it's going to happen.”
- “I think in East Chicago, we're looking a little bit more at the global issue with the economy and starting to see unemployment come back down. And I think in that particular market, unemployment is going to continue to go up for another quarter or two, no matter what your economist say.”
Balance Sheet/ Cash Flow and other
- “We obviously don't anticipate borrowing any money in the fourth quarter.”
- “We expect our leverage ratio will continue to improve. However, our fix charged coverage ratio is expected to decline slightly due to the increase in interest payments resulting from the unsecured notes offering.”
- 2010 Capex: “What we're looking at for the coming year is somewhere in the neighborhood of say $75 million to $80 million.”
- 2010 Capitalized Interest: “It's going to be very, very minimal. Nothing that you wouldn't want to take into account and booking at EPS.”
- 2010 tax rate: “Next year, it should still be 42%, 43% on an annual basis.”
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In our presentation of our Hedgeye Macro Themes for Q1 of 2010, we used this Chinese PMI chart to emphasize our point. Our call was quite simply that the PMI was elevated and setting up to roll over from its recent 2009 highs. This morning the data reported for January did just that.
China’s PMI report for January slowed sequentially to 55.8 versus 56.6 in December.
While the sequential slowdown wasn’t material, the point is that the PMI stopped accelerating to the upside. Everything that matters in our macro model happens on the margin. The change of the slope of this line is a good example of that.
Did it matter? With Chinese stocks closing down another -1.6% overnight, taking them to -10.3% for the YTD, apparently it did. We are not calling for a crash in China. Our Chinese Ox In A Box call is simply that inflation will accelerated sequentially as growth slows. This is obviously starting to be priced in.
Keith R. McCullough
Chief Executive Officer
This morning’s Prices Paid component of the ISM Manufacturing report for January was inflationary (see the chart below). Yes, unfortunately Ben, Main Street actually has to pay for things with marked to market prices. On a year-over-year basis, Prices Paid are up a staggering +133%!
I know, I know… the Federal Reserve claims to see none of this; 'tis the narrative fallacy of He Who Sees No Inflation (Bernanke). But the bond market sees it – that’s another reason why bonds are selling off today. For those who support this Bubble in US Politics, inflation is easy to ignore. Sadly, that doesn’t mean it goes away.
This Prices Paid reading of 70 (January) was a +13.8% sequential monthly acceleration from the December report. With headline Producer Prices (PPI) recently reported at +4.4% year-over-year, and Q4 GDP posted at +5.7%, this unsustainable and unreasonable policy of maintaining a ZERO percent “emergency” level for the Fed Fund rate is starting to really eat into the Times Man of the Year’s credibility.
Keith R. McCullough
Chief Executive Officer
YUM is scheduled to report 4Q09 earnings after the close on Wednesday with the earnings call to follow on Thursday morning. Given that the company updated its 4Q09 outlook and provided detailed FY10 guidance on December 4th prior to its annual investor meeting in New York, I am not expecting too many surprises. My EPS estimate of $0.50 is slightly better than the street’s $0.48 per share estimate, but again, an earnings beat from YUM would not come as a surprise. If YUM’s earnings do come in better than expectations, that will be the extent of any good news in the quarter. Management guided to 4Q09 same-store sales growth of -3% in China, -1% in YRI and -8% in the U.S., which implies a further sequential slowdown in 2-year average trends in the U.S. and China, YUM’s two biggest segments from an operating profit perspective. A -1% at YRI in 4Q09 yields a +2.0% 2-year average trend, which is flat sequentially from 3Q09, but down from the 5%-plus level that the company posted in 1Q09 and throughout all of 2008.
YUM’s stock has underperformed its QSR peers over the last year and more recently, in the last 6 months, slumped -3.1% versus the group’s average 10.3% move higher. This sequential slowing of top-line trends across each of the company’s segments is largely to blame, and management’s full-year 2010 comparable store sales guidance assumes more of the same. YUM’s same-store sales guidance of +2% in the U.S. implies flat 2-year average trends in 2010, but this is flat with what have been consistently weak results. YUM’s 2% comparable store sales target for China in 2010 assumes a 250 bp decline in 2-year average trends, after declining more than 600 bps in 2009. And, the 3% target for YRI also points to continued declines in 2-year average trends.
Management maintained its 10% EPS growth goal for 2010. The company will benefit from continued commodity deflation in the first half of the year, particularly during the first quarter and should be helped by foreign currency favorability, also in the first half of the year (the company guided to a full-year foreign currency translation benefit of $25-50 million). The solid cash flow story remains intact with YUM set to generate about $900 million in free cash in FY09 and I am modeling a number north of that in FY10. That being said, I think investors need to a see shift in trends in China, most importantly, and in the U.S. before becoming more comfortable with owning this name.
Despite all of the slides that YUM management has put up over the years showing the size of the U.S. relative to the growing size of China and YRI in terms of operating profit, currently, the U.S. remains the biggest segment at 38% of operating profit. Although the U.S. is still the biggest standalone segment, the company’s ongoing EPS growth model relies more on growth driven by Financial Strategies than from the U.S. business (as seen in the company’s slide attached below). This is not new as the company has successfully achieved its annual 10% EPS growth goal while consistently missing its ongoing U.S. operating profit growth target of 5%. If the company is unable to hit this 5% goal in 2009 (my model has the company just falling short), it will only become increasingly harder to do. Yes, YUM is currently operating in a difficult environment from a top-line perspective but the company has been benefiting from significant commodity favorability, particularly in the second half of the year, on top of the recently implemented G&A savings (yielded over $50 million of the targeted $60 million in savings through 3Q09). It is important to remember that YUM’s initial 2009 guidance included 15% operating profit growth in the U.S. This was then revised down to high single digit growth, which again, I think could prove aggressive.
During the fourth quarter, YUM will reverse its prior four quarters of operating profit growth in the U.S. Same-store sales growth deteriorated further as indicated by management’s -8% guidance (could come in worse as we have heard from YUM’s peers that weather in December was a factor), commodity deflation will still benefit the company during the quarter but to a lesser degree than in 3Q09 (only about $9 million vs. $16 million in 3Q09, according to guidance provided in the 3Q09 earnings release) and G&A savings could be partially offset by “certain G&A expenses that are a bit back loaded this year.”
Going forward, management has said that YUM’s profits will increasingly be driven by Mainland China, YRI and Taco Bell (estimated to make up 90% of profits by 2012 versus close to 85% now). In the meantime, the company continues to maintain its 5% operating profit goal in the U.S. In 2010, YUM will be lapping positive operating profit growth in the U.S., which in and of itself, puts the company’s 5% operating growth at risk once again. YUM will also be lapping the $60 million in cost savings. Not to mention, we do not know when trends will stop getting worse.
So that leaves China and YRI to buoy future growth, but based on recent trends and the uncertainty around when demand will return to prior levels, some investors may not be convinced.
As I said earlier, same-store sales trends in China continue to get worse. And, easy comparisons no longer seem meaningful as the company’s 4Q09 guidance of -3% is lapping only 1% growth from the prior year (which is an easy comparison relative to the 12%-14% compares from 1H08). In 3Q09, YUM was able to deliver 32% operating profit growth despite the slowdown in top-line trends as commodity deflation helped to the tune of $21 million. Although the company is expecting a similar level of commodity favorability during the fourth quarter, the continued fall off in same-store sales will lead to increased sales deleveraging. I am modeling single digit operating profit growth in the quarter, which is a far cry from the 20%-plus growth to which investors have become accustomed. Commodity deflation should continue to benefit margins in the first quarter, but remember the company’s same-store sales guidance implies a continued fall off in 2-year average trends for the full year. Management will do its best to offset any bottom line weakness with continued development growth (6% of the company’s EPS growth target is driven by new unit growth), but it is important to note that the company lowered its targets for China within it ongoing earnings growth model to 15% operating profit growth (from +20%).
Same-store sales trends fell off during the second quarter on a 2-year average basis, but have remained fairly steady since then. Full-year guidance, however, implies a slight slowdown in 2010. Both commodity costs and foreign currency translation worked against YRI for most of 2009, but that should reverse on both fronts in the fourth quarter. Through the third quarter, YUM’s earnings included a negative $53 million impact from currency. In its December 4th 2009 guidance, the company stated that its full-year guidance assumed a negative foreign currency translation impact of about $45 million, which implies an $8 million benefit in 4Q09, largely at YRI. Those two factors should help to offset the expected 1% same-store sales decline during the quarter and lead to operating profit growth in the quarter, reversing the prior four quarters of decline. Commodity cost and F/X favorability should continue to benefit this segment in early 2010 but slowing top-line trends could weigh on results.
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