A REITailing Perspective


As the ensuing soap opera unfolds between Simon Properties, General Growth, and any other potential bidders, it’s worth taking a look at what a hypothetical combination of the two mall operators would look like from a retailers perspective.  A combined Simon/General Growth would own 1/3 of all mall space and virtually all ‘A-list’ properties.  Common logic says this is bad for retailers. We’re not so sure that’s the case – at least not for the good ones.  Here’s why…


A combination of the two would yield substantial control over U.S mall properties, with the combined entity owning 520+ centers and over 445 million square feet (not assuming any assets are sold as part of the deal).  To put that in perspective, the combined company would own approximately one-third of all mall-based/outlet store retailing in the U.S with a size approximately two-thirds of Wal-Mart’s domestic square footage.  So the obvious conclusion to make is that retailers will get squeezed on rents and will have one massive landlord to deal with.  However, one could argue that there is an efficiency to be had when dealing with one major landlord.


Historically, large companies such as The Limited or Gap have built large real estate teams to deal with multiple developers, regions, projects, brands, and geographies.  Even in the absence of true growth, there are hundreds of variables that need to be dealt with on the real estate front when it comes to retailing.  Whether it be lease renewals, store closures, or store remodels, the real estate component of retailing is 1) integral and 2) complex.  As such, even the most efficient retailers are dealing with numerous mall owners and landlords given the disparate ownership of the mall base and shopping center universe across the country.  Now along comes the mega-landlord.


All of sudden there actually may be a strategic benefit to dealing with the owner of one in three malls in the country, not to mention essentially every  A-list retail property.   Leverage certainly comes from both sides of the negotiating table, but the ability to plan and strategize a portfolio of say, Gap locations, from mall to mall with one owner could be meaningful.  Maybe Gap is looking to improve their position or downsize stores in a few malls, while looking to close stores in another mall. If this can be accomplished by dealing with one partner, there has to be some level of efficiency.  As it stands now, these discussions and planning sessions take place repeatedly with numerous landlords, over and over on a one-off basis. 


The game changer here is that the number of chess matches needed to manage a retailer’s store portfolio in theory should be reduced if a majority or large portion of their leases are held by one entity.  Partnering on such a grand scale is totally new to the retailer/mall-owner relationship and something that makes a ton of sense (in theory). Just ask most companies that do business with Wal-Mart. Is WMT evil just because it is so darn big? No. Margins might be tight, but they pay very quickly, and for an efficient vendor Wal-Mart tends to be among the highest return business partners. It’s the marginal vendors without a meaningful proposition (or Macro process) that end up getting pinched.


The risk of course is that the power of the mega-landlord leads to strong-arming on rent.  While this may seem obvious, the symbiotic relationship between a retailer and its landlord is really one of chicken and egg proportions.  This is especially true in the current environment, where growth in retail units and new concepts has slowed to a halt.  Landlords cannot afford to risk losing tenants at the expense of jacking up rents.  After all, what is mall really worth with numerous empty store fronts?  There are only so many movie theaters, kiosks, and food courts that can be positioned to mask vacancies.


Whether “the” deal or “a” deal goes through or not is really not up to us speculate on.  However, as the formation of a mega-landlord develops, it’s worth asking the questions about what this may mean down the road for those that make their living in the mall.  At first glance some may be skeptical of bigger is better in this case.  However, it appears that this may actually be a win from a strategic retail standpoint.  Yes, the weak economy and sluggish mall-traffic have swung the pendulum back to the retailer on lease costs for now, but the real opportunity lies ahead in the efficiencies of strategic planning and portfolio management, one-to-one. 


-Eric Levine



PFCB reported 4Q09 EPS of $0.52, blowing away both the street’s and my $0.40 per share estimate (and the company’s internal expectations).  Management attributed the better than expected earnings results to stronger than anticipated sales trends.  Same-store sales at the Bistro declined 5.2%, much better than the 8.5% decline in 3Q09; though trends still declined about 40 bps on a 2-year average basis.  Relative to industry market share, this sequential YOY improvement enabled the company to narrow its Gap to Knapp at the Bistro to -0.3% from -1.7% in 3Q09 (as shown in the chart below). 

Comparable store sales at Pei Wei increased 3% during the quarter, impressive in this environment and implied a 20 bp sequential improvement in trends on a 2-year average basis.  Management stated that traffic trends at both concepts were actually better than the comps indicated due to lower check averages.  To that end, Co-CEO Bert Vivian stated that comps should continue to get better as we trend through 2010 and he would expect average check to be less of a drag in 2010 than in 2009.


Outside of providing full-year 2010 EPS of $2.00 (relative to the street’s $1.92 estimate), management maintained its prior outlook of roughly flat revenues (slightly negative comps at the Bistro and slightly positive at Pei Wei) and flat restaurant level margins.  Some YOY favorability in preopening, interest and G&A expense should lead to slightly better pretax margins. 


PFCB may be experiencing some pressure today because despite this in line guidance, management cautioned investors that 1Q10 would be the low point of the year from an earnings standpoint with 2H10 expected to come in stronger than 1H10.  I also think investors would like to see the Bistro outperform the Knapp index, not just narrow the gap.  Looking at quarter-to-date trends, Mr. Vivian stated that weather is always an impact but that the company has gotten off to a slower start in the quarter due to weather.  In the first 6 weeks, when weather was not a factor, however, he said that PFCB saw a continuation of the improvement in trends seen throughout the fourth quarter.  The 53rd week in 2009, which was the week between Christmas and New Year’s Eve, is a high volume week for the company and produced average weekly sales of roughly $119,000 at the Bistro relative to the average of about $90,000 for all of 4Q09.  The benefit of this critical week in 4Q09 will be offset in 1Q10. 


Margins were helped in 2009, particularly at the Bistro, by the company’s operational initiatives, allowing the company to achieve near peak margins with comparable store sales down nearly 7% for the full year.  The company will continue to look for additional cost savings in 2010, but does not expect the same magnitude of savings as in 2009.  Comps are not expected to turn positive in 2010, but the Bistro will be well positioned to grow margins once demand returns.  A continuation of positive comps at Pei Wei will only further leverage the improvements the company has made at this concept.  Management attributed the higher average weekly sales at its Pei Wei class of 2009 openings to more disciplined real estate decisions.  In 2009, the company opened 7 Pei Wei units relative to 25 new units in 2008 and 37 units in 2007.  In 2010, I would expect to see another solid class of openings and improved unit returns as the company will continue to be selective as it is only planning to open 3-5 Pei Wei restaurants. 


PFCB’s cash flow story remains intact with the company expecting to generate about $90 in free cash flow in 2010 after about $40 million in capital spending.  Management plans to use this money, along with some cash on hand (ended the year with a cash balance of roughly $63 million), to pay down its $40 million credit facility and to repurchase about $40 million of shares.  Additionally, the company initiated a quarterly variable cash dividend, starting in 1Q10.  The amount of the cash dividend will be computed based on 45% of the Company's quarterly net income and is expected to total approximately $0.90 per share relating to fiscal 2010, or about $20 million of free cash flow, based on the company’s current EPS guidance of $2.00. 




Howard Penney

Managing Director

Risk Management Time: SP500 Levels, Refreshed...

Both our immediate and intermediate term risk management lines of resistance are starting to converge around the 1103 line. Most of the time when this occurs we are setting up for a period of increased volatility. Since there is plenty of immediate term upside in the VIX right now (up to 28.67), this is all starting to rhyme.


I am currently short the SP500 (SPY) right around today’s intraday price. So I’m positioned for what I think is going to be a test of the dotted green line in the chart below (the immediate term TRADE line of support = 1074).


The risk management question to ask is what happens if we breakdown through 1074 and close there? If it’s on accelerating volume and volatility studies, the answer (for the bulls) won’t be a pretty one. There is no other line of support in my macro model for the SP500 until 1048.


Immediate term macro calendar catalysts are hawkish. Both the PPI and CPI inflation reports for January are due out tomorrow and Friday morning, respectively.



Keith R. McCullough
Chief Executive Officer


Risk Management Time: SP500 Levels, Refreshed...  - spwas

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The calendar shift of Chinese New Year into Feb could be the last of the positive catalysts for now. Feb may disappoint, the variables are in place to pop the VIP bubble, and margins could be pressured.



We have been bullish on Macau and the Macau stocks for some time now.  Unfortunately, the long list of positive catalysts have come and gone (almost).  No one knows what the near and intermediate term will bring but we’re paid to project, estimate and opine.  In our projection, estimation, and opinion, the set up does not look favorable.


The generally known and positive:

  • Q4 was terrific in Macau
  • January was huge
    • table revenue was up 63%
    • both Mass and VIP was strong
    • on average, $54 million in revs per day
  • LVS, WYNN, and MGM should all report strong Q4 EBITDA beginning tonight with LVS and make positive comments about Q1 so far
  • On the surface Feb looks to be a good month with Chinese New Year falling in Feb vs. Jan last year


The issues:

  • The VIP bubble – China has tightened twice, GDP is slowing, and liquidity and credit are not flowing like they have been.  As we showed in our post “MACAU VIP AND CHINA MACRO VARIABLES”, China economic factors explain an overwhelming percentage of changes in the VIP business.  The calendar shift of Chinese New Year may be masking a slowdown in VIP already occurring in February.
  • Initial read on February is disappointing – Our sources indicate that Macau may generate only 10bn MOP ($1.2bn) in table gaming revenues in February, up “only” 35% YoY, but a sequential slowdown from January’s 63% gain despite the Chinese New Year shift.  Moreover, if that number holds, revenue per day will have fallen from $54m to $44m sequentially.
  • Commission cap probably isn’t applicable to revenue share – This is allowing SJM to be very aggressive with junket pricing because most of their arrangements are on revenue share and not on turnover commission.  LVS, WYNN, and MGM’s Macau properties maintain a greater percentage of commission based arrangements which could be bad for market share as we move forward.
  • SJM aggressiveness – We are told that SJM is aggressively pursuing VIP market share at the expense of margins.  A large junket operator is getting 55% of revenue with volume incentives up to 57% to operate inside Grand Lisboa and absorb property expenses.  This is the highest revenue share in the market and indications are that SJM is looking for more of these relationships.  Specifically, they are targeting a number of Venetian junkets to move over to SJM properties.  Previously, SJM had been franchising out at this rate but this is the first time to our knowledge that they are offering this structure in house.


The problem for Macau and the stocks is that the positive catalysts are in the past and present but not the near term future.  These risks are real and imminent and should not be ignored by the investment community.  LVS reports tonight and MGM tomorrow morning but we’re not sure we’ll get a lot of color on these issues just yet.  Stay tuned.

Exceptional Uncertainty

We’ve written on numerous occasions on the splintered leadership in the UK and the inability of the economy to show meaningful improvement over recent months. The most recent (lagging) data points suggest more of the same—high inflation and no improvement in unemployment while the economy drags off the bottom with a GDP reading of a mere + 0.1% in Q4 quarter-over-quarter.


UK CPI for January registered +3.5% year-over-year, up from 2.9% in December, and well above the target rate of 2%, with the components of transportation and energy as well as an increase in the VAT leading gains to the upside. (Note: PPI input prices rose 8.4% in January Y/Y). These inflationary levels can also be accounted for due to the deterioration of the Pound versus the USD and EURO a year ago.  Should the unemployment rate hold at this level, or even deteriorate, the set-up of increasing consumer and producer prices with meek growth is decidedly bearish.    


With the BOE voting to halt its 200 Billion Pound bond repurchasing program (ie quantitative easing through printing money), we’d expect macro fundamentals to pull back with the withdrawal of stimulus.   With the TREND line of the FTSE broken at 5284, the UK (via the etf EWU) will be one of the countries in Europe we’ll be considering on the short side. Stay tuned.


Matthew Hedrick


Exceptional Uncertainty - ukunempl

Death By A Thousand Paper Cuts

One of our key Macro TAIL (3 years or less) themes for Retail is the disintermediation of the West as it relates to its importance to global retail and sourcing. China unexpectedly handed us further validation for this game-changing theme.


‘Game changing’ theme? Don’t you think you’re being a little dramatic, McGough?   Hardly. Consider the facts. Here’s what we already knew…

  1. The consumer durable/non-durable brands and retailers in the US have come off of a 30-year cycle of scaling manufacturing out of the US, and into Asia, and to a lesser extent, Latin America. That’s hardly news to anyone. But an important consideration is that this offshoring/outsourcing was largely done with the US Dollar as the payment standard to foreign factories. With the US$ as the world’s reserve currency, this was the safest bet for all. But factories are beginning to accept payment in currencies that are not US$. That’s bad, really bad for companies that are not sophisticated enough to proactively manage this margin volatility – especially with the time lag between when an order is placed, and when the product ultimately arrives on a shelf for sale.
  2. Then, on January 1, we saw the implementation of AFTA, Asia’s equivalent of NAFTA where 4% import duties were eliminated between 16 nations to spur local consumption as a more profitable alternative than export to Western markets.
  3. Then yesterday, China pulled a surprise move and granted its first full factoring license to a London-based company called China Export Finance. Wy is this notable? Because it eliminates a step in the factoring process. Ordinarily, a Chinese factor working with a seller would have to collaborate with its counterpart in the West working for the buyer. Through China Export, the necessity for a Western Counterpart is mitigated. This would free up the Chinese vendor to sell its receivables to the trade finance firm, which would then make an advance payment to the vendor against the approval of a Western buyer. The buyer would then make payment directly to China Export when due.  Is this lone instance cause for alarm? No. But imagine if there were a thousand such licenses. Why can’t there be?


Our point here has not changed. In fact it is growing stronger as all this new evidence comes to the forefront. There are many different dynamics impacting the global supply chain. Any of these viewed in isolation is probably benign enough to slip right past the goalie without anyone noticing. But add ‘em all up and it definitely smells to me that generational shift we’ve seen in the manufacturing power base is at the end of its rope. The balance of power is swinging away from the West.


This is one of those themes that is probably irrelevant to near-term results. In fact, management teams won’t be talking about it, because I’d argue that over 90% of them don’t even know about it. This is something that will unfold over 1-2 years, and it will be clear who ‘gets it’ and who does not.


The longer-term winners are those that either have size, clout, pricing power AND a Macro process. NKE, UA, WMT, BBBY, RL, HBI an Li&Fung.

Losers will be those with no Macro process that are cruising by now on unsustainable margins due to lack of investment in content. JNY, DG, FDO, M, JCP, WRC, TRLG, and GIL.


Brian McGough

Early Look

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