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The End of Quantitative Easing, As We Know It

 “It’s the end of the world as we know it and I feel fine.”



R.E.M. is an iconic American rock band that was founded by Michael Stipe in 1980.  While the band is not known for its thoughts on monetary policy, the line quoted above from their song, “The End of the World Was We Know It”, provides a good metaphor for the Federal Reserve’s recent decision to halt quantitative easing.


While many market observers expected this planned ending of policy to lead to an increase in interest rates, particularly for mortgages, we have seen only a marginal change in rates.  In fact, over the last three weeks 30-year fixed mortgage rates have only increased marginally from 5.05% to 5.25%.  In essence, the quantitative easing world has ended, but those still borrowing via mortgages “feel fine”. 


To its credit, the Federal Reserve did an effective job at prepping the market for the end of this policy, so new buyers stepped in and the mortgage market has remained stable.


Backing up for a second, though, what exactly is quantitative easing? 


Central Banks have basically two key tools to implement monetary policy:  interest rates and reserve requirements.  By lowering interest rates, central banks can stimulate money supply by making borrowing rates more reasonable to borrowers and the margins from lending more compelling to lenders.  On the reserve front, the central bank can alter the reserve requirements, which is the ratio of cash a bank must hold compared to customer deposits. Any increase in reserve requirements will limit a bank’s ability to lend, or vice versa.


In the scenario where the interbank interest rate is zero and reserve ratios have been maxed out, central banks can initiate another form of policy: quantitative easing.  In simple terms, central banks will begin to purchase financial assets from banks through open market operations.   So the central banks print money to buy assets from banks, which increases the excess reserves on the balance sheet of banks. 


Quantitative easing was used by the Bank of Japan in the early 2000s in an attempt to offset deflation with limited results.  In November of 2008, the United States implemented their first ever policy of quantitative easing.  The policy had two aspects to it.  First, the Federal Reserve indicated they would purchase direct obligations of Fannie Mae, Freddie Mac, and the Federal Home Loan Banks.  Second, the Federal Reserve indicated they would purchase mortgage back securities.


The objective of this program according to the Federal Reserve was to, “reduce the cost and increase the availability of credit for the purchase of houses, which in turn should support housing markets and foster improved conditions in financial markets more generally.”  In effect, as credit markets ground to halt in late 2008, the Federal Reserve had to take the extraordinary and unprecedented measure of quantitative easing to offset the potential risk of deflation.


While the program started on a smaller scale with $500 billion of mortgage backed debt, the program was increased in March of 2009.  As the program ended on March 31, 2010, the Federal Reserve had purchased $1.2 trillion of mortgage-backed debt from banks and $200 billion of direct obligation debt of Fannie Mae and Freddie Mac, for total purchases of $1.4 trillion.  As a result of these actions, the Federal Reserve now owns almost 25% of the stock of mortgage-backed securities.


In the chart below, we have charted the increase of excess reserves on bank balance sheets.  The current amount of excess reserves is estimated to be around $1.2 trillion.  Assuming that these excess reserves were turned into loans at a 10:1 ratio, the increase in money supply into the system would be $12 trillion.  This is larger than the current amount of outstanding mortgages in the United States!


The reality is simply this: we have no idea what the consequences of this quantitative easing policy action will be.  It is an unprecedented move that, in time, will have to be unwound.  If the unwinding is natural, which would involve banks reducing their excess reserves to a more normal level, the inflationary impacts on the U.S. economy could be extraordinary.


At this point, I’m not going to predict the “end of the world as we know it” due to this massive increase in excess reserves, but this policy will have to be unwound at some point.  Either the Federal Reserve will have to pay competitive interest rates on these reserves so as to discourage loans, or the banks will begin to lend.  And lend.  And lend.


I can promise you this, if the $1.2 trillion in reserves starts to make its way into the economy, money supply will increase dramatically, and with it, inflation.  While there is increasing discussion of inflationary pressures, very few people are currently considering the unintended consequences of quantitative easing.


Daryl G. Jones

Managing Director


The End of Quantitative Easing, As We Know It - Excess Reserves


Following a spate of upgrades, restaurant stocks shot up yesterday on high volume in a down market.  We’ll see if today brings more of the same.


Volume on upmoves has been harder to come by in this space recently.  However, it is clear that some names continue to work well.  CBRL, PNRA, and (to a lesser extent) CMG and RUTH maintained their consistent performance on high volume.  KONA released preliminary  results this morning, exceeding topline expectations.  March comparable store sales were positive for the first time since early 2008.


While retail sales data have been strong for retailers such as Nordstrom, and the restaurant sector was upgraded yesterday, I am not convinced of the sustainability of this upward move.  While RT’s results showed stronger-than-preannounced trends and management described the commodity environment as “benign”, it is clear that restaurant companies have far less margin-boosting levers to pull relative to the retailers.  RT beat the numbers but momentum is clearly slowing.  We believe that momentum will slow further as we look towards the summer months.  RT opened down 3.3% following yesterday’s results.  See our note published this morning for further thoughts. 


Looking at the table below, it is notable that the full-service companies had a strong day yesterday.  The Street seems to believe that the restaurant recovery will continue for some time, but I’m not in that camp…


TALES OF THE TAPE - stock 4.7



TALES OF THE TAPE - commodity 4.7



Howard Penney

Managing Director



March was an odd month; a hot start, some head-fakes and misinformation, and ending in disappointment. VIP hold was lower than normal and the American companies continue to lose share.



VIP hold percentage was below normal which may have been partly responsible for the March misinformation in the press about revenues potentially being up 60% or more.  March's hold (quantified on just reported Junket RC) was 18 bps light of the TTM average,  20 bps below the average 3yr hold, and 55 bps below March 09 hold levels. Using a 3yr average hold would have resulted in 7% higher y-o-y growth. Alternatively, Junket RC increased 75% while VIP revenues only increased 47%.  Mass revenues grew 32% y-o-y, inline with a 6 month average 35%.


While some of this can be hold related, there is a clear trend of American companies continuing to lose share.  LVS lost 40bps of share from February and 680bps from March 2009.  Wynn lost 160bps and 280bps, respectively.  Despite the 42% increase for the market, LVS grew total revenues only 5% year over year while Wynn Macau increased only 17%.  Here is some detailed commentary.



Y-o-Y Table Revenue Observations:


LVS table revenues increased only 5% with all growth coming from a 16% increase in Mass revenues while VIP revenues were actually down 0.4%

  • Sands fell 3%, dragged down by a 6% decrease in VIP which was somewhat offset by a small 2% increase in Mass
    • The VIP decline was entire driven by weak hold coupled with a difficult hold comp.  Junket Rolling Chip (RC) was actually up a healthy 51%.  In March 2009, Sands benefited from very strong hold of roughly 4%, assuming 13% direct play.  If we assume 10% of total VIP play was direct in March '10, this implies hold of 2.6% 
  • Venetian was down 6%, driven by a 23% decline in VIP revenues which was only partly offset by 30% growth in Mass
    • Junket VIP RC only increased 60bps, so the decline in VIP revenues was hold related.  Assuming 19% direct play, we estimate that Venetian held at 2.6% compared to a hold of north of 4% last year assuming 17% direct VIP play.
  • Four Seasons was up 210% y-o-y entirely driven by 458% VIP growth with Mass declining 21% 
    • Junket VIP RC increased 189% to $727MM. 

Wynn Macau table revenues were up 17%, primarily driven by a 21% increase in VIP while Mass revenues were only up 4%

  • A massive 84% increase in Junket RC was dampened by what looks like very weak hold of roughly 2.3%
  • Wynn Macau was only able to grow Mass revenues in single digits in all three months of Q1 

Crown table revenues grew 133%, with the growth fueled by 653% growth in Mass and 101% growth in VIP

  • Altira was down 4%, with VIP down 4% while Mass increased 4%
    • VIP RC was down 1% and luck was bad - only 2.3%.  However, hold was also bad last year
  • CoD table revenue increased 2% sequentially, due to a 6% increase in VIP win which was partly offset by a 7% decrease in Mass
    • Mass was $33MM
    • Junket VIP RC increased 18.4% sequentially
    • If we assume 20% direct play at CoD (in line with what MPEL said on their earnings call), then total VIP RC would be $3.75BN.  However, hold in March was weak at only 2.4%.

SJM continued its hot streak, with table revenues up 67%

  • Mass was up 32% and VIP was up 90%
  • Junket RC volumes increased 122%
  • As we wrote about on several occasions, we believe SJM is being very aggressive on junket pricing

Galaxy table revenue was up 59%, mostly driven by a 67% increase in VIP win, while Mass increased 18%

  • Starworld's table revenue was up whopping 102%, driven mostly by 116% growth in VIP revenues, while Mass increased 14% y-o-y

MGM table revenue was up 17%

  • Mass revenue growth was 20%, while VIP grew 16%
  • VIP RC grew 33% y-o-y but hold comparisons were unfavorable. Assuming 15% direct VIP play, hold was 2.8% vs. 3.6% last year


Market Share:


LVS share dropped 40bps sequentially to 19.2%, with all the share loss coming from VIP. This is LVS's lowest share month since August 2007

  • All of the share loss was from VIP.  LVS's share of VIP revenues decreased to 16.4% from 17.2% in February'  However, LVS's share of Junket RC actually increased 20 bps to 13.5%
  • Mass share increased by 30 bps to 26.9%.
  • Sands lost 40bps, dropping to 6.4% sequentially.  This marks the properties' lowest share quarter since we've been tracking the data and likely its lowest share quarter since opening.  Sands lost share across both VIP and Mass.
  • Venetian lost 70bps to 10.2% sequentially.  Venetian's has only had one month (Sept 09) with worse share since opening.  
    • Venetian actually gained 70bps of market share in Mass sequentially to 17.1% but Mass gains were offset by a 140bps sequential drop in VIP share
  • FS share increased 70bps to 2.6%
  • After SJM, LVS commanded the second highest share of the Mass market with 26.6%, followed by Crown at 10%


WYNN's share fell to 12.9% from 14.5% in February

  • Wynn's loss was entirely driven by low VIP hold.  Wynn's share of the VIP revenues plunged from 16.5% in February to 14.1%.  Junket RC share only fell by 10 bps to 15.6% - still second only to SJM but Crown was a close 3rd.

Crown's market share fell by 70bps to 12.9% in February

  • All of the share loss came from Altira, whose share dropped to 5.3% from 6.1% in February. 
  • Altira's share drop was entirely due to a 1% decline in VIP share to 6.8% which was driven by the property's low hold
  • COD's share was flat at 7.5%.  Mass market share decreased by 1.2% to 7.6% and VIP share increased by 50bps to 7.5%

The American's loss was SJM's gain.  SJM's share climbed to 35.1% from 32.3% in February and 30.9% in January - its highest share month since Nov 2007

  • All the gains came from VIP share which increased 390bps to 32.6%
  • As we've been writing about, SJM has been aggressive on junket commissions to pursue market share at the expense of margins
  • More scrutiny on the American companies in regards to junket relationships may continue to erode their share of the VIP business
  • SJM Mass share declined by 1% to 41.6% sequentially

Aside from SJM, Galaxy was the only other concessionaire that gained share.  Galaxy's share increased to 11.9% from 11% last month

  • Starworld's market share was increased by 1.3% sequentially to 9.5%
  • Galaxy and it's flagship property gained share in both Mass and VIP in March

MGM's share decreased by 90bps to 8.1%

  • MGM's share loss can be attributed to a 1.2% sequential decrease in VIP share to 8.2%.  Mass share decreased 10 bps to 7.7%

Slot market commentary:

  • Slot win grew 32% y-o-y to $83MM
  • LVS's slot win grew across all 3 properties by 24% y-o-y to $27MM
  • Wynn slot revenues increased by 7% y-o-y to $16MM
  • Melco's slot win grew 109% y-o-y
  • MGM's slot win grew 48% y-o-y to $9MM
  • SJM's slot win grew 22% to $12MM
  • Galaxy was the only concessionaire that didn't see y-o-y grow in slot win.  Galaxy's slot was was down 20bps to $2MM







Claims data this morning worsened. Claims climbed 18k week over week to 460k on a seasonally adjusted basis (after last week’s number was revised up 3k to 442k).  The 4-week rolling average rose 2,250 to 450,250.  Consensus had expected just 442k initial claims.  The chart below shows the rolling average trend line. 




After approaching our 3 standard deviation channel for the last three weeks, this week’s data moved away from its upper bound.   A Labor Department official noted that seasonal factors relating to Easter (which is hard to correct for, since it moves on the calendar) likely had an impact on this week’s numbers. Looking forward, we continue to expect claims to move lower in the coming months as we see the tailwind associated with Census hiring kicking in. 




As a reminder, the following chart shows census hiring from the 2000 and 1990 census by month, which should be a reasonable proxy for hiring this spring. 




Joshua Steiner, CFA

Managing Director

Claims worsen, reversing five-week trend

Claims data this morning worsened. Claims climbed 18k week over week to 460k on a seasonally adjusted basis (after last week’s number was revised up 3k to 442k).  The 4-week rolling average rose 2,250 to 450,250.  Consensus had expected just 442k initial claims.  The chart below shows the rolling average trend line. 


Claims worsen, reversing five-week trend - claims rolling


After approaching our 3 standard deviation channel for the last three weeks, this week’s data moved away from its upper bound.   A Labor Department official noted that seasonal factors relating to Easter (which is hard to correct for, since it moves on the calendar) likely had an impact on this week’s numbers. Looking forward, we continue to expect claims to move lower in the coming months as we see the tailwind associated with Census hiring kicking in. 


Claims worsen, reversing five-week trend - claims raw


As a reminder, the following chart shows census hiring from the 2000 and 1990 census by month, which should be a reasonable proxy for hiring this spring. 


Claims worsen, reversing five-week trend - census chart


A strong quarter for Ruby Tuesday, trends may slow from here.


3Q SSS came in at -0.7%, slightly better than the preannounced range of -0.8% to -1%.  RT has outperformed Knapp now for 4 quarters, partly attributable to easier comps.  This was the first quarter RT outperformed Knapp on a two-year basis in over two years.  The two-year “Gap-to-Knapp” was 1%.  RT raised FY SSS guidance to -1% to -2% from -1% to -3% and raised FY EPS to $0.60-$0.65 from $0.50 to $0.60 (street was already at $0.63).


RT – HEDGEYE THOUGHTS - RT gap to knapp 1yr


RT – HEDGEYE THOUGHTS - RT gap to knapp 2yr



It was good quarter for RT, but it looks like this could be the last quarter of accelerating trends.  RT is partially benefiting from better overall industry trends and renewed focus on profitability.  In addition, it appears that RT is taking some market share from its larger rivals Chili’s and Applebee’s.




At 15x NTM EPS and 7.6x EV/EBITDA, RT has made a full recovery and the associated benefits to the company are now in the past.  Presently it seems that Q4 will likely be the first quarter in five where EBIT margins could be down year-over-year. With Brinker setting the stage to be more competitive the big market share gains for RT could be a thing of the past.


The industry outperformance yesterday has put the group in a precarious position. 



RT Earnings Call 3QFY10 - SUMMARY


3Q was the best sales quarters in three years.

  • Despite weather
  • Lapping difficult comps
  • Closed underperforming stores
  • SSS were down 0.7% in the quarter
  • Bad weather impacted that by 1.5% to 2%
  • SSS were slightly positive in January and February even with the weather impact which was significant in February
  • Sales outperformed Knapp on a 1 and 2 year basis



Focus on brand strategies has paid dividends despite lapping last year’s 3Q which was 4 points better than 2QFY10.

  • Getting people in to see the new RT and they are coming back
  • Introduced mid-year menu update in November:
  • Variety with a focus on quality and differentiation
  • Consumer’s responded well


Primary corporate goals were:

  • Increase SSS
  • Max cash flow reduce debt
  • Strengthen brand by providing guest with providing value
  • Long term strategies are helping create additional value


Price increase was 1-2%

  • Want to increase average check from $13.50 to $14.50
  • By managing promotions RT achieved good sales and good profits
  • Traded some check for profitability this past quarter






  • $0.28 vs. $0.09 last year
    • Last year included impairment charges of $0.17 vs.  closure and impairment charges of $0.02 this year
  • Restaurant margins were 19.5% for the quarter versus 18.8% last year
  • Food costs flat at 28.5%
  • Continue to experience favorable commodity costs
  • Labor costs declined to 32.7% from 33% as a percentage of sales
    • Store closings, initiatives outweighed higher payroll taxes


  • Depreciation was down 50 bps as a percentage of sales because of closures last year and assets becoming fully depreciated since the prior year
  • Higher G&A, up 70 bps, was due to bonus accrual and other minor factors


Interest expense declined

  • Lower interest rate
  • Lower spread to LIBOR
  • Less outstanding

Tax rate was 20.1% versus 5.3% last year


Balance Sheet

  • Book debt was $322 million, down $43 million in the quarter
  • YTD paid down 171 million of debt so far and $200m paid off in the last twelve months
  • Book debt to capital was 38% at end of quarter.  Book debt to EBITDA was 2.2x


Guidance on new stores openings

  • No company operated restaurants in 4Q. Closing one
  • Franchisees opening between 1 and 4, up to two of which are international
  • For the full year, intend on opening none and closing 14, franchisees are anticipating opening five to eight, including three to five international


Company operated SSS will be down 1-2% for the year - down 1.9% YTD.   4Q comparison represents the most difficult comparison of the year


ROP down slightly because of compelling value strategy

D&A will be 63-65m

SG&A down 12% yoy

Increase in marketing expense from last year’s low level

  • Newspaper
  • Internet

Bonuses are expense expected to be up

Interest expense - $16-$17m

EPS diluted - $0.60-$0.65c

CAPEX - $18-$20m

Pay down $20-$25m of additional debt this year, bringing down the total debt for the fiscal year to $190-$195m.


Excess liquidity of 175m after draw down of revolver to pay off 70m loan with an interest rate of 6.44%




Marketing strategy

  • Print
  • Internet
  • Media


The strategy has been effective, used in a way that supports high quality position.

  • Consumers cited the food over the promotion when asked about the advertising


New Dinner entrees, new brunch entrees, being introduced

  • Brunch is developing well


Liquor sales

  • $5 all day premium cocktail program
  • After 9pm, anyone getting a $3 drink gets a free mini


Offering or testing new products throughout this quarter

  • Increases guest frequency
  • More variety maintains traffic


Goal is to increase check from the $12 area where it is up to $13.50 to $14.50


Compelling value

  • Strengthening brand by increasing frequency, trial, average check
  • Improving guest experience
  • Surveys are doing well, intent to revisit/recommend all well over 90%
  • 70% of customers rate the experience as a 5 out of 5
    • Large sample size – 250k people


New management structure

  • Assistant managers are now either guest service specialists or culinary specialists
  • In March, all bartenders received second round of training to help increase bar sales
  • Guest satisfaction in the bar is a new survey
  • Scores are higher than overall which is encouraging


Turnover levels are in-line with objectives



Questions and Answers:



How are you thinking about reinvesting versus returning cash to shareholders?


Just got off the defensive and are now on the offensive. First objective is to invest in the business but no great demands right now.  In 12 months, give or take, we’ll have the extra cash and make that decision closer to the time



What’s driving the guest satisfaction? Something relative to what your competitors are doing? The bar? Freshness?


First quarter we’ve tracked bar guest satisfaction…encouraged with the scores.  Should be higher than the dining room – higher server to guest ratio.  Teams positioned as a premium bar product. Great food products at the bar.  Entertainment also, with the big screens etc. Innovation.



Considering how fast margins have turned, guidance implies that margins have to come back down. Is it initiatives that are going to drive that back down?


Whether it’s food costs, lobster, or extra labor on Saturday nights, during promotions, we will incur more costs.  We continue to invest in the brand.



How have franchisees done in managing costs?


We run better costs than they do



New company restaurant growth?


Way down the list of priorities.  No meaningful emphasis on that.  As far as franchising partners where it makes sense, you’ll see some of that but probably in line with the couple per year we’ve seen recently.



Is there a need for TV advertising to help franchisees?


This year we’ll invest in overmanaging them so they can adopt what we’re doing in the company stores.  We have them lag typically, when adopting new programs, to make sure they’re good.



Food cost experience year-over-year? What kind of deflation in your basket?


Flat on the basket. Our investment has been adding lobster to it.  Not seeing decreases.  Chicken could be up slightly but it’s a pretty benign market.



Traffic and check flipped this quarter. You’ve been very traffic focused, can you talk about that?


Tougher quarter with weather. Still beat Knapp Track, still one of the best performers out there.  On a two year basis, we continue to improve by 2 points on the second quarter. What we’re spending to drive traffic, and the return we’re getting, is satisfactory.



What’s the targeted impact on guest experience with new management structure?


Focusing on better food, better service. More focused assistant managers. We’ve gotten as much quality as possible out of the old structure. Now changing to a Capital Grille type structure and that will help us improve quality of food and service.

We’ll also have two managers in the building rather than one.  Offset the cost by focusing managers hours only when guests are in the building.



On the increase in marking dollars in 4Q, is that going to be split between OpEx and SG&A?


All in SG&A line



Increasing trial and frequency…is frequency up or is the increase just trial?


Frequency has to be up some, we are creating trial too but don’t know the exact numbers. 2.9 visits from those that came in during the 90 days.



Howard Penney

Managing Director

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