R3: An Update from the Master’s Champ


April 16, 2010





Coming off of Calloway’s big win at the Masters, the company pre-announced its first quarter last night.  At first glance, the results appear to be largely in line with the consensus, although it’s quite possible that expectations were running even higher given more recent, positive commentary on the category in general. 


In looking below the headline results however, there are a few interesting comments:


- Management cited unfavorable weather conditions which had a negative impact on the start to the golf season in many of the company’s key markets as reflected in the 20% decline in rounds played through February according to National Golf Foundation data.  Given the strong sales of seasonal apparel and general merchandise in March across the board, we wonder if this wasn’t a case where the quarter started out sluggish and ended with some renewed strength.  Management did not comment on the monthly trend and did not suggest sales have really picked up.  A more general statement was made saying, “we believe that golf spending will increase as weather conditions improve and the golf season opens.” 


- Perhaps more important than the weather report is management’s commentary on the promotional environment.  Further confirmation was given that inventory levels across retail are healthy and aggressive discounting is now in the past.  This is consistent with early signs of a recovery for the space we saw when DKS reported its 4Q results in early March. 


- Finally, management suggested that the ELY product cycle is favorable, in part buoyed by the success of its pro’s on the Tour.  Thanks again Phil!  However, this optimism was left hanging, with management reiterating that it’s 2Q results will be critical to making full year targets.


- All in, the overall announcement reads like a mixed bag.  Sales momentum appears to have been slightly tempered by weather only to now be helped by recent marketing wins at the pro level.  Clearly business is OK, not great for ELY.  We do wonder with the weather being such a big tailwind to other seasonal categories recently, why it’s not giving management more confidence?   


Eric Levine






- Saks CEO noted that the opportunity to monetize the company’s real estate holdings (i.e NYC flagship store) still exists and but is not something that company is actively looking at. He went on to note that while anything is possible, the monetization of real estate assets or a sale-leaseback is not top of mind or high on the company’s priority list.


- Add Gymboree to the list of companies citing potential negative impact on cost of goods from recent and dramatic increases in cotton prices. While the company has made its commitments to fabrics a long way into the future, it did not that is beginning to see upward pressure from cotton prices in a couple of areas.


- Ann Taylor LOFT threw a party at Manhattan’s hot spot the Bowery Hotel last night to showcase its latest collection/collaboration called LOFT Style Studio. The fall capsule collection is a collaboration with four well known stylists. And while I wasn’t there firsthand to see the goods, I can’t resist sharing this random comment from someone who was interviewed on the scene. “It’s like they want to be J.Crew, but J.Crew is so inspired by other more high fashion things, so by the time you’re inspired by something else inspired, it has this weird watered down effect.”





R3: An Update from the Master’s Champ - Calendar





Sport Supply Group Buyout - Sport Supply Group Inc. is going ahead with the buyout offer from Canada's ONCAP Management Partners LP, the mid-market private equity business of Onex Corp. after failing to win any other binding bids. <>


UPS` U.S. Package Volume Grew for the First Time in Two Years - UPS reported that its U.S. domestic daily package volume grew less than 1%. The slight rise was the first year-over-year domestic daily package growth in more than two years. <>


India Introduces Levy on Raw Cotton Exports - Indian government has been pressured by the domestic textile industry and has recently imposed a punitive duty on raw cotton and cotton waste exports for a period of six months. The decision came after the fact that raw cotton and cotton yarn prices had been hiked by 35% in the last few months, which has impacted the downstream consumers. Exports of raw cotton have been slapped an export duty of Rs 2,500 per ton and shipments of cotton waste attract a levy of 3% of the free-on-board value, while cotton yarn exports are required to be compulsorily registered with Textile Commissioners Office. <>


ITC Establishes Punitive Tariffs on Plastic Retail Bags from Vietnam, Indonesia, and Taiwan - The International Trade Commission cleared the way Thursday for punitive tariffs to be imposed on plastic retail bags from Vietnam, Indonesia and Taiwan in a trade remedy case that could impact industries such as textiles. The ITC, in a 5-to-1 vote, ruled that the domestic industry is being injured by imported plastic bags from Vietnam that are sold in the U.S. for less than fair value and subsidized by the Vietnamese government. According to the ITC, last year, an estimated $43 mm worth of bags were imported from Vietnam, Indonesia shipped an estimated $13.5 mm worth and about $19 mm worth was imported from Taiwan. <>


Chinese Sports and Recreation Sales Rise 13.3% - China’s gross domestic product rose 11.9% in the first quarter, the country’s National Bureau of Statistics reported. The value of production by textile companies rose 21.6%, while retail sales of sports and recreation articles rose 13.3%. <>


Store Owners Seeking Premium U.S. Real Estate Wait for `Retailers to Die' - Retailers planning to open stores this year may have difficulty finding space in the most desirable malls and shopping centers, industry executives said. <>


Luxury Industry Set for Mergers, Acquisitions, Stock Listings, Bain Says - The luxury-goods industry may be set for a new wave of mergers, acquisitions and initial public offerings as it recovers from its worst year on record, according to consulting firm Bain & Co.  <>


Skechers Rolls Out First Animated Series at MipTV and More - "Zevo 3," Skechers Entertainment's first animated series for kids ages 6 to 11, was previewed at MipTV in Cannes. Meanwhile, Day 3 saw more presales roll in for Atlantyca, Nickelodeon, Kelencontent and others. Skechers Entertainment's "Zevo 3," 26x22, is scheduled to air this fall on Nicktoons in the U.S. Moonscoop is handling international sales and distribution. The series follows three young teens, who gain super powers when exposed to a compound called Zevo. A licensing program is in the works and master licensees will be named soon, according to Kristen Van Cott, co-executive producer and senior vice president of creative development for Skechers Entertainment.  <>


Callaway Preannounces 11% Sales Growth - Callaway Golf Company said first quarter sales are estimated to rise 11% to $303 million from $272 million for the first quarter of 2009. Earnings per share are estimated to be approximately 24 cents, well ahead of 11 cents earned a year ago. <>


Kodiak Footwear Expands More in the US - Iconic Canadian work and outdoor resource Kodiak Group Holdings Co. is celebrating its 100th anniversary this year with an eye toward growing the U.S. business. While the company’s Kodiak brand has been available in the States since the ’80s, according to EVP David McCarthy, a U.S. office was only established in Portland, Tenn. to distribute both the Kodiak and Terra brands in the mid-2000s. As a result of the increased U.S. focus, the company recently expanded its sales force from seven to 20, said McCarthy. And, while he declined to reveal sales figures for business in the U.S., McCarthy said the Cambridge, Ontario-based company plans continued growth here. Fall ’10 will see the launch of Kodiak’s first lifestyle collection under the Heritage name. The series of men’s and women’s styles have a vintage look and is set to retail for $125 to $175. <>


Saucony Sprinter Endorsement - Saucony announced Thursday that it signed sprinter Lauryn Williams to a multi-year deal. Williams, 26, is a three-time IAAF World Champion gold medalist in the 100-meter sprint and 4x100-meter relay. Williams competed in the 2004 Athens Olympic games (where she took a silver in the 100-meter) and in the 2008 Beijing games. Under the terms of the deal, a biannual grant in Williams’ name will be awarded to support track-and-field programs for girls as part of Saucony’s Run for Good Foundation, which targets childhood obesity. Lexington, Mass.-based Saucony is a division of Topeka, Kansas-based Collective Brands Inc. <>


Airwalk’s First Endorsement - Englewood, Colo.-based Collective Licensing (also a division of Collective Brands Inc.) announced Thursday an addition to its roster, signing freestyle motocross athlete Ronnie Renner as the Airwalk brand’s first athlete in the field. Renner, 32, took gold in last year’s X-Games Step-Up and has appeared in shows on MTV and Fuel TV. <>


All-American Running Back Drafted by Adidas - In anticipation of the 2010 NFL Draft, Portland, Ore.-based Adidas said it signed a multi-year agreement with C.J. Spiller, an All-American running back from Clemson University. Spiller was widely expected to be a top prospect in the draft. Under terms of the deal, Spiller will be involved in product development for the football and training footwear and apparel programs, and will appear as a face of the Adidas football program in marketing efforts. Spiller, also a three-time All-American in track, is one of only two college players in history to notch 3,000 rushing yards, 1,500 kickoff return yards, 1,000 receiving yards and 500 punt returns yards (the other is Adidas labelmate Reggie Bush). Spiller set more than 30 school and conference records. <>


Mattel Posts Surprise First-Quarter Profit as Sales Beat Analyst Estimates - Mattel Inc., the world’s largest toymaker, posted an unexpected profit in the first quarter on sales of Toy Story and World Wrestling Entertainment action figures and games. <>


MasterCard Launches A Payments Lab that Could Boost Its Online Offerings - MasterCard Worldwide today said it has established a research and development arm. The unit could boost the payment card network’s offerings for online retail payments. <>


Jamba Juice Debuts Branded Apparel - Licensee Headline Entertainment has rolled out the first line of Jamba Juice-branded apparel at mass and specialty retailers, as well as online. A separate launch will follow this summer at Jamba Juice stores. The apparel line ($12 to $22) includes T-shirts, a hooded sweatshirt, canvas tote bag and two different style hats for men, women and kids. <>


Prosperity's Volcano

"The first panacea for a mismanaged nation is inflation of the currency; the second is war.  Both bring a temporary prosperity; both bring a permanent ruin.  But both are the refuge of political and economic opportunists."
-Ernest Hemingway


As the wanna be Maestro Ministers of European finance descend on the capital of Spain today, remember one thing: European politicians take long lunches and long naps. These guys are in it for their own temporary prosperity. Their proactively predictable plan coming out of Madrid will be to Pile Debt Upon Debt Upon Debt. That is going to bring a permanent ruin to the already high-low society that they perpetuate.


From Argentina to Greece this morning, countries who have lived their lives in serial default are going to tell you “it’s different this time.” That’s what liars and/or people who don’t know what they don’t know about history do. Always remember: markets don’t lie; politicians do.


Reinhart & Rogoff’s latest compilation of 8 centuries of inflation and currency data would agree – “This Time Is Different” – in only that this time we are going to light up this global bonfire of fiat currencies from Athens to Bangkok. That volcano in Iceland is nothing compared to what’s coming down this financial system’s pike.


While some might choose to forget that Argentina defaulted on a cool $95 Billion in 2001… and some may choose to ignore that stocks in Thailand have dropped -9.4% since April the 7th … and some may claim these aren’t facts that will affect the collective geopolitical risk that we Hedgeyes call interconnectedness… that doesn’t mean these realities cease to exist. The hot magma of global sovereign debt risk is beginning to bubble.


Like the Bear Stearns story of May 2008, when soothsayers named Blankfein, Bernanke, and Fuld said the storms of debt obligations hath passed, Greece is a metaphor that risk managers in May of 2010 better not choose to ignore.


Funding long term liabilities with short term marked-to-model government paper didn’t work then, and it won’t work now. Borrowing short allows the gasses of inflation that lie below the belts of political crust smell like what they are. Everyone in this risk management room knows the stench.


On that cheery Friday note, allow me to introduce the Return of the Hedgeye and our Q2 Macro Themes for 2010 (we will be hosting a conference call for our subscribers at 11AM EST):

  1. Sovereign Debt Dichotomy – As sovereign debt issues accelerate, we expect to see a dichotomy develop between the winners and losers.  The equity and currencies markets of these countries will react accordingly, with a number of investment opportunities on both the long and short side.
  2. Inflation’s V-Bottom – We continue to see a reacceleration in inflation that is currently not priced into interest rates, or broad prices.  We will be also introducing our proprietary Hedgeye Inflation Index on our conference call this morning.
  3. April Flowers / May Showers – In an inverse of the cute expression, we are expecting the spike in the U.S. stock market from April to come back down to earth.  We are not calling for a crash, but a proactively manageable correction. We will outline 15 reasons as to why we think the SP500 is a short going into May.

As is customary for our Macro team’s presentations, we have inside of 3 dozen glossy slides that would make Fed doves like Janet Yellen and Bill Dudley cry. Our goal is not to be alarmists, but to continue to protect you and your families from the sinews of our conflicted and compromised government forecasting processes like we did in 2008.


My immediate term support and resistance levels for the SP500 are 1195 and 2014, respectively. We shorted the SP500 yesterday and bought volatility. If you’d like to participate in our conference call, please email . We will have a full Q&A session that doesn’t have the shackles of sell side compliance people who need to protect their conflicted investment banking and brokerage business machines. This is all about real-time research, all of the time.


Best of luck out there today and have a great weekend,



Prosperity's Volcano - Thai SET




The Macau Metro Monitor, April 16th, 2010


Wynn Encore's opening day is April 21. The MOP1.5 billion project includes 61 gaming tables, 400 suites and four luxury villas. The president of Wynn Macau, Ian Coughlan, said that the Macau government's recent decision to cap the number of gambling tables is suitable and bears in mind Macau’s own characteristics.



Domestic bank loans to the private sector expanded 1.9% in February to MOP104.6 billion, according to statistics released by the Monetary Authority of Macau. Meanwhile, external loans grew 6.2% to MOP101.2 billion.Total deposits with the banking sector dropped 0.5% from the previous month to MOP293.2 billion. Due to the decline in resident deposits and increase in domestic loans to the private sector, the loan-to-deposit ratio for the resident sector grew 2.0% in a month to 47.5% at end-February 2010.

get free cartoon of the day!

Start receiving Hedgeye's Cartoon of the Day, an exclusive and humourous take on the market and the economy, delivered every morning to your inbox

By joining our email marketing list you agree to receive marketing emails from Hedgeye. You may unsubscribe at any time by clicking the unsubscribe link in one of the emails.


The US equities indices finished mostly higher on Thursday and the Dow, S&P, NASDAQ and Russell all recorded their sixth straight day of gains.  But underneath the hood it was not so green.  Five of the nine sectors were actually down on and Healthcare looks to be breaking down.  Every day this week, Volume has accelerated day-over-day as the advance/decline line is breaking down.   


On the MACRO front, the earnings season is a tailwind so far, with much of the good news yesterday coming out of the early-cycle Industrial (XLI) names.  The big disappointment came from initial claims, which unexpectedly jumped 24,000 to 484,000, the highest level since late February (but the government gave us the Easter caveat).


Also on the MACRO front the Empire Manufacturing Index, improved to 31.9 in April from 22.9 in March and the Philadelphia Fed Index improved to a better-than-expected 20.2 in April from 18.9 in March.  While industrial production raised just 0.1% m/m in March vs. consensus expectations for a 0.7% gain. 


Internationally, sovereign concerns surrounding Greece remained above the fold and adverse liquidity developments out of China are working against the RECOVERY trade.


The Industrials (XLI) was the best performing sector on the back of the transportation names.  The sector benefited from a positive pre-announcement from UPS which traded up 5.3% yesterday.  The company pointed to a significant acceleration in its international package and supply chain businesses, along with improved operating margins across all three segments.  Consolidation speculation continued to provide some support with Continental and United in merger talks. 


The Technology (XLK) outperformed, with the SOX +0.3% - PC-leveraged names such as INTC +3% and AMD +2.7% were among the best performers.  GOOG reported after the close, missing some estimates.   


After a big up day on Wednesday, the Financials (XLF) was the worst performing sector yesterday.  The banking group declined with the BKX down nearly 1.0% on the day.  The regional names, which have come under some heightened scrutiny from a valuation perspective, were among the laggards in the group.


For the second day in a row the Energy (XLE) and Materials (XLB) just slightly underperformed the Market.


Crude is looking to have only one up day this week due to below expectation MACRO economic data.  The Hedgeye Risk Management models have the following levels for OIL – Buy TRADE (83.35) and Sell TRADE (87.61). 


The commodity complex was hurt by a stronger dollar yesterday.  The Dollar Index was up 0.36% yesterday.  The Hedgeye Risk Management models have levels for the Dollar Index (DXY) at:  buy TRADE (79.57) and sell TRADE (80.80).


Yesterday we bought the VXX and shorted the SPX.  The VIX rallied 1.9% yesterday; the Hedgeye Risk Management models have levels for the VIX at: buy TRADE (15.30) and sell TRADE (17.07).


In early trading, gold is trading higher as a hedge against inflation.  The Hedgeye Risk Management models have the following levels for GOLD – Buy TRADE (1,123) and Sell TRADE (1,169).


Copper prices are trading lower as the Chinese continue to signal that their white-hot economy needs to cool down.  The Hedgeye Risk Management Quant models have the following levels for COPPER – Buy TRADE (3.48) and Sell TRADE (3.64).


In early trading, equity futures are trading slightly below fair value on disappointing reaction from Google's earnings.  This is also creating weakness in the Asian markets overnight, which has spilled into European trade. Today’s highlight will be March housing starts, earnings from BAC and GE, plus any further developments regarding Greece.  As we look at today’s set up the range for the S&P 500 is 19 points or 1.4% (1,195) downside and 0.2% (1,214) upside. 


On the MACRO calendar today:


  • March Housing Starts
  • Building Permits
  • April U. of Michigan Confidence


Howard Penney

Managing Director














Here is our Q1 2010 earnings preview and a "YouTube" from Q4.



MAR is scheduled to report its 1Q2010 results next Thursday and numbers should be good but that is probably expected. Our estimates for the quarter are in line with the Street and ahead of management guidance.  Everyone knows that RevPAR is tracking way ahead of expectations and the occupancy recovery has been exceptionally strong.  We think it will be interesting to see the flow through of better RevPAR to EBITDA on the owned side of the business, since occupancy does bring more cost with it.


For FY 2010 we’re at $974MM of adjusted EBITDA which is 3% ahead of the Street and just above the top end of guidance. 

While there are no bargains in lodging right now, we do like the MAR model and believe that it is less expensive than the real-estate leveraged companies.  Investors seem overleveraged to the earlier cycle hotel owners.  That relative trade may have already played itself out.  Buying MAR at 12x 2011 isn’t crazy in light of upcoming multiple year up cycle if you want to have exposure to the space.






  • “While relative, corporate demand is picking up, cancellations are running again at normal levels and our 2010 group bookings continue to build. In December, new group bookings for any time in the future were both higher than the prior year and ahead of our expectations. We saw meaningful improvement in occupancy in December and January, businesses getting back to work. Adding it all together, we believe U.S. RevPAR growth should turn positive sometime in the second half of 2010. Outside the U.S., RevPAR will likely turn positive faster and yield a higher RevPAR in 2010 than in 2009.”
  • “Of course, pricing will recover slowly.”
  • “For the domestic Marriott Hotels and Resorts brand, group room nights on the books for 2010 are down 2% adjusted for last year’s cancellations and attrition and room rates for that business are down 3% year-over-year. Outside North America, group room nights on the books are also down 2% but room rates are down a bit more. Still, with pent up demand and easy comparables, we expect our in the year for the year group business to improve from these levels.”
  • “Our special corporate rate negotiations are nearly complete and special corporate rates for 2010 are running down modestly from 2009 levels.”
  • “For the Marriott brand … by the fourth quarter, occupancy was roughly flat and by period 13, occupancy increased roughly 1 to 2 percentage points.”  
  • “For most of 2009, we saw weak corporate room demand, but that is changing. Comparable room nights for corporate rated business in the Marriott brand declined 13% in the full year 2009, were flat in the fourth quarter, but rose 10% in period 13. On the other hand… room rates remain weak. For the Marriott brand, room rates at domestic company operated comparable hotels declined 12% in 2009, 11% in the fourth quarter, and declined 8% in period 13”
  • “In the fourth quarter, international occupancies increased slightly and in December occupancies increased 4 percentage points year-over-year. Demand in Europe and the UK strengthened with the improving transient and group demand. In the first quarter, we expect London and Paris occupancies to increase at double-digit rates. In Asia, occupancy rates rose over four percentage points in the fourth quarter, dramatically exceeding our expectation. Occupancy in our hotels in China increased over five percentage points in the fourth quarter, with better than expected domestic corporate demand.”
  • “Costs are likely to rise in 2010 and margins will be under more pressure from room rate  weakness, but we continue to work to identify more efficient ways of doing business.”
  • “Property level cost cutting is largely behind us, so incrementally weaker RevPAR will be more difficult to mitigate”
  • “We do try and hedge our currencies, particularly in the liquid currencies like the euro and the pound, I think we’re probably 60 to 70% hedged for 2010.”
  • “I think on balance we would expect incentive fees full year when 2010 closes out to be very modestly lower than those of 2009 as all those factors sort of go through.”
  • “View that ballpark we ought to be opening the same number of rooms in the next few years in each year, but obviously we’ll have to see how the economy develops and a little bit on how the financing market develops to know that for sure.”
  • “I think the comparisons that make it hard to extrapolate too much from what we’re seeing now is what we talked about before, which is the incredible pessimism that we were dealing with in the marketplace a year ago and as a consequence I think we are seeing a significant increase in volumes. So whether it’s our data from December and January, whether it’s the Smith Travel data that you look at, you see occupancy growth in virtually every segment….And I think as a consequence they’ve [luxury hotels] got a good number of months ahead of them where they’re going to post occupancy growth.”
  • “I think on margins and on owner returns, you’re going to see this year continued albeit modest hourly wage growth. I think we’ll see a continued growth in healthcare costs, management wages because they were really devastated in 2009, are likely to be up in 2010. There will be less benefit from a reduction in the number of managers because we’ve cut that already very deeply. And there will need to be and the management team deserves to be compensated with some bonus potential that really has not flowed through to them in 2008 or 2009. All of those are going to put some pressure on margins, and as a consequence in an environment in which particularly occupancy is moving first and rate is starting the year continuing to be down, we’ll see continued  pressure on house profit margins and owner returns.”
  • “The likelihood that timeshare even in a strong consumer environment and decent recovery there would ever get back to the same percentage contribution to company, I think is very, very slight. And it will end up being a smaller part of our business than it was at the peak”



  • “In 2010, we expect new timeshare inventory spending to be both lower than 2009 spending and over 100 million lower than our expected cost of goods sold… With lower investment spending in 2010, we expect 2010 timeshare net cash flow should increase to about 175 million to $200 million.”
  • “For those of you with different RevPAR outlooks, we believe that one point of worldwide systemwide RevPAR is worth about $10 million to $15 million in total fee revenue and about 3 to $4 million of profits on the owned leased, corporate housing and other line.”
  • [Timeshare] “We’re working under the assumption that contract sales in 2010 will be just slightly better than the 2009 level. All in all, in 2010 we believe our timeshare business could generate 170 to $180 million on the timeshare sales and services net line and 145 to 155 million in segment earnings.”
  • “We anticipate that Marriott’s adjusted general administrative and other expenses will increase 2 to 4% to 635 to 645 million in 2010 as we resume investing in our business and our people for the future. We expect wages will rise modestly in the second half and management bonuses will be reinstated in 2010. While changes in our deferred compensation program will reduce deferred comp expense on the G&A line by about $15 million in 2010, we’ve cautiously assumed roughly $15 million of additional performance related charges for a few hotels in that year as well.”


We have been short YUM, which has been the wrong call, particularly into first quarter numbers, which came in better than both sales and earnings expectations.  That being said, I continue to have my concerns, largely related to what I recognize

as overly aggressive unit growth in China and profitability issues in the U.S. 




The most surprising upside came in China with same-store sales up 4% in the quarter, accelerating 400 bps sequentially from the fourth quarter on a 2-year average basis.  Management commented that it benefited from a very strong Chinese New Year during the first quarter on top of trends that point to an improving consumer; though it would not yet call it a recovery.  The company guided to a similar magnitude of same-store sales growth in 2Q10 as reported in 1Q10.  Relative to YUM’s full year +2% same-store sales outlook issued in December, this implied +3% to +4% 2Q guidance points to upside in the full-year numbers as the company’s same-store sales comparisons get easier for the remainder of the year (management did not revise its full-year guidance).  


This 2Q guidance, though it may be conservative, also implies a sequential slowdown in 2-year average trends as YUM is lapping its easiest comparison from 2009.  A +4% number in 2Q10 would represent a 300 bp sequential deceleration from the first quarter on a 2-year average basis.  Maybe management is concerned that the strong holiday drove a lot of the momentum during the first quarter, which is obviously not sustainable for the remainder of the year, in addition to its concern that the consumer has not yet fully recovered.


Despite the strong first quarter performance, the +14% new unit growth, combined with 4% same-store sales growth, should add up to approximately 18% system sales growth.  YUM China reported 15% system sales growth which highlights a decline in new unit AUVs.  In response to a question during the earnings call, management stated that there is a $300K gap between new unit AUVs and the rest of the system, which it attributes to the fact that the company is opening in smaller cities which generate lower sales but also require a lower cost structure.  This will be an important trend, although not new, to monitor because lower new unit AUVs is typically a sign of growing too fast and cannibalized sales.





U.S. same-store sales of -1% showed marked improvement from the -8% in the fourth quarter.  Pizza Hut led the charge with same-store sales up 5%. Management attributed the strong sequential recovery at Pizza Hut to its “$10 Any Way You Want It” pizza promotion.  This promotion hurt average check, which was down 10%, but more than offset it with increased transaction growth, according to management. 


Although we knew trends had improved at Pizza Hut, as reported earlier by NPD, the 750 bp sequential improvement in the 2-year average trend was impressive.  Despite this better top-line performance and $5 million in commodity deflation, operating profit declined 9% in the quarter.  Although same-store sales comparisons get easier in the back half of the year after lapping the Kentucky Grilled Chicken launch from 2Q09, the commodity benefit is expected to go away and turn inflationary as we trend through the year as management is expecting costs to be relatively flat for the full year.  In addition, the operating profit growth compares get more difficult for the next two quarters as the company benefited last year from implementing a $65 million reduction in its U.S. G&A cost structure.


It is also concerning that more consumers at Taco Bell, YUM’s most profitable U.S. concept, are buying from the “Why Pay More” menu.  This, combined with the need for promotions at Pizza Hut that drive average check lower by 10%, will put increased pressure on U.S. profitability.  Despite easier same-store sales comparisons in 2H10, I do not find much comfort in management’s comment that it is comfortable with its full-year 5% U.S. operating profit growth outlook as the company consistently misses its U.S. operating profit targets.  To recall, YUM’s initial 2009 U.S. operating profit target was 15% and it came in at +1%.


All in, the first quarter was a strong start to the year for YUM.  To that end, I think it will be difficult for the company to maintain this momentum for the following reasons:

  • China’s margin performance of 1Q won’t continue - Expect moderate year-over-year improvement over China’s 21% margins in Mainland China last year
    • Commodity inflation is expected in the back half of the year (reported commodity deflation of $15 million in 1Q10)
    • YUM is facing increased wage inflation in 2H10 after facing lower than usual wage growth rates in 1Q10
  • YUM is facing its most difficult U.S. SSS comparison in 2Q10 as it laps the Kentucky Grilled Chicken launch, which drove KFC comps positive for one quarter
  • U.S. operating profit growth comparisons get more difficult for the next 2 quarters and commodity deflation with likely turn inflationary
  • After tax results will be challenged in the second quarter as the company laps the favorable 16.4% effective tax rate from 2Q09




On the way to achieving 9th straight year of double-digit EPS growth

  • Worldwide 1Q operating profit grew 17%, EPS grew
  • China division’s profit grew 37%
    • SSS growth and unit growth
  • U.S. sales improved also, particularly PH
    • U.S. profits down 9%, SSS declined 1%
  • YRI system sales increased 1% and profits increased 2% prior to FX
    • Driven by new unit development

Overall, pleased with the start to 2010.




Continue to build leading brands

  • SSS grew by 4%
  • Units grew by 14%
  • Rest margins at 27%
  • Profit growth of 37%
  • Lapping 30% profit growth in 1Q09


New Unit development is the major driver of growth

  • 96 units opened in 1Q
  • Surpassed 3,500 units
    • Leading position in China


  • 1.4m dollars AUV per year
  • Delivery is now available in over 110 cities
  • Developing sales layer now over 3% of sales
  • Breakfast represents 7% of transactions and continues to grow
    • Nearly 3,000 KFC units in over 650 Chinese cities


Pizza Hut

  • Leading western casual dining concept in China
  • Double-digit SSS growth
  • Menu appeals to Chinese consumers
    • Updating 25% of menu every six months
    • PH has 467 units in 122 Chinese cities

Other minor brands also gaining traction




Strategy is to aggressively expand

  • New unit development is a key driver
    • 109 openings in more than 40 countries during 1Q
  • Network of 1,000 franchisees
  • Goal of 900 for year
  • SSS declined 1%
  • 2% op profit growth excl FX



  • Expanding value menu to more markets using proven strategies
  • Incremental sales layers
    • KFC breakfast – KFC AM continues to grow


Pizza Hut

  • Everyday affordable prices
  • Weaker transaction trends due to check but menu is being changed


France, India and Russia delivered 14% system sales growth prior to FX in 1Q10

  • KFC expanding aggressively in these markets
  • Provincial cities
  • In Russia, 150 KFC units in 22 cities
  • In India there are 74 KFCs in 14 cities and 159 Pizza Huts in 33 cities
    • KFC is leveraging television advertising to build brand awareness


Two new Taco Bells opening in London





Strategy is to improve brand and returns

  • Pleased with improvement from 4Q09


Pizza Hut

  • Promotion has helped bring people back
  • Check was too high
  • Going from Pizza to Pizza, Pasta, and Wings
  • Turned corner on sales trends


Taco Bell

  • Disappointed with -2% decline in SSS as people increasingly traded down
  • Pipeline of products is strong for the rest of the year


KFC’s performance improved sequentially

  • Balanced options – fried and grilled chicken
  • Portable options – double down
  • Improved operations
  • Performance has improved from 4Q and company expects this to continue


Took a non-cash charge that basically reflects the beginning of refranchising KFC to 5% company ownership.  That is also our goal for Pizza Hut, where we’ve already begun the journey and are well on our way.



Chief Financial Officer


1Q results

  • Strong Chinese holiday
  • SSS of 4%, system sales growth of 15%
  • Consumer confidence in China has improved yoy the past three months
  • Benefitted significantly from chicken cost inflation vs prior year and lower-than-usual wage inflation


  • Sales results weak in developed markets like Japan and Canada
    • Dampened overall results for YRI’s quarter
  • Only 2% profit growth prior FX
    • Post FX growth was 13%


United States

  • Unemployment and discounting environment is difficult
  • Taco Bell experienced higher Why Pay More mix and had lower drink incidence
  • Reduced G&A by 6m dollars


Outlook for 2010

  • Expect moderate SSS growth in China in the second quarter
  • For the U.S. expected that positive sales growth will come in 2H10
    • Comps easier in 2H
  • China’s margin performance of 1Q won’t continue
    • Commodity inflation in back half and a bigger impact from wage inflation
  • Expect moderate year-over-year improvement over China’s 21% margins in Mainland China last year
  • After tax results will be challenged in the second quarter as a favorable 16.4% effective tax rate before special items is rolled over
  • Confident that 10% EPS objective will be met


Strategy for emerging markets

  • Significant growth opportunity


Emerging markets – China, Indonesia, Malaysia, India, Brazil… collectively there markets are growing at a fast rate.  Long runway for restaurant growth in those countries.  Further, in top ten emerging markets, YUM has 1.5 units per 1m people.

  • 10,000 units in emerging markets.  55% of YRI + China units.  Larger than peers in these markets and growing fastest. 
  • 2x MCD’s emerging markets presence.  Most of YUM’s competitors aren’t even opening in emerging markets. 


In upcoming calls and investor meetings, YUM will provide more color on these emerging market strategies.








Pizza Hut value…what is the impact on mix from the $10 promotion. How are you thinking about sustaining value there going forward?



Posted strong sales in 1Q of 5%.  Addressed the biggest problem, which was value.  Comparable margins have held steady.  Flow through has offset the drop in price.  Brand is improving as a result of the initiative.  Working hard with franchisees on sustaining compelling value. 


Check was down about 10% but transactions increased at a much faster rate.




How are you responding to the consumer’s reaction to shrimp taco?



People like it. We have some product supply issues because the shrimp tacos flew off the shelves. Made a lot of sense to have it during lent.




Detail on consumer environment in China…your results were strong, what is giving you pause in calling for the recovery in the Chinese consumer?



Consumer confidence has gone up the last three months but still below where it was a year, year-and-a-half ago….(but they are up year-over-year?).  Other metrics are positive.  We are focusing more development on the stronger regions (coastal regions are not recovering as fast).




Seen anything from 1Q to suggest that low-to-mid single digit comp is unsustainable for the rest of year?



No significant change from 1Q levels as yet.




The profit for 1Q was down domestically, food costs aren’t going to help going forward, how do you feel about the U.S. business, profit-wise for the year?



Overlaps get easier in the second half of the year. Not assuming a great economic recovery for domestic business to get better.  Things are better than they were in 3Q, 4Q last year.  On the commodity side, there was some deflation in 1Q. Current guess is that it will be flat for the full year. Value, product, and managing costs are the three key focuses at our domestic brands. 


Still comfortable with 5% growth in U.S. outlook




Pizza category in the U.S., who are you taking share from? Is it sustainable?



More competitive on the pricing front. Usually when YUM grows like it is right now, it comes from overall category and the “mom and pops”.




You have been running without menu pricing in China for at least six months, what’s the new opportunity in coming quarters, especially if there is inflation in 2H10?



Labor and costs were unusually low but we’re studying what we want to do now for the back half in terms of costs. 




Update on KFC U.S. business. Last quarter some of the franchisees were behind in royalty payments – has there been improvement there? 



Bad debt did a little better in 1Q. Hopefully we get in to a better seasonal time now.


Regarding refranchising, we’re on a three year refranchising program that really started in ’08.  In the first two years of that,

Long John Silver was fully refranchised.


KFC continues to be the biggest challenge in the US. Likely will be negative in 2Q as grilled chicken is lapped.


More innovation around “balanced” and “high-end” opportunities.




YRI, why have sales remained soft in key markets like Australia and the U.K.?



Australia has had a strong run of consistency. Pipeline and innovation has fallen behind.  Expect that business to perform better. The brand is strong there.  In the U.K., pleased with the progress of KFC which had a great year in 2009.  Pizza Hut is big challenge there, not affordable.  In the early days of making a substantial change there. 




What kind of comp do you need to offset coming increases in fixed costs?



In 2H09 the government didn’t take up minimum wages. In 1H10 Yum is benefitting from that. In 2H the company will be impacted by that.  For the full year there will be a moderate increase.  A modest comp is required to offset that. 

Normally wages in China are in the 8% to 10% level.  Rates were lower than that in the first half of the year but will be higher for the balance.  Should average 10% for the full year. 




All of the publicly traded pizza players saw big improvement in comps. Is there any other place you can get market growth from? One of your competitors said that market has been declining but it now ticking up?



There’s nothing like the power of having the leading brand.  When you’re value competitive, your odds are better.  We’re trying to have a two-fold strategy. One is to compete better in the pizza market value-wise.  The other is to leverage variety – pasta and wings being added into the equation and marketing them primarily during the week. 




China, new unit volumes.  Are we still looking at 200k difference in new unit volumes? What is the ramp for new units?



AUVs are 1.4m and new units come in at 1 or 1.1m.  That trend has been intact for a while.  As you get to the smaller cities, margins are similar despite lower sales because cost structures are lower there. 




U.S. Taco Bell business.  Can you talk about the -2% comp and the lower level of drink incidence? 



Lower average guest check. Less drinks and combo meals.  Most media spend was on the value side.  The “why pay more” usage was a higher portion of mix.  More and more people are at the low end.  We did have positive transactions and we can build off that strength. 


Biggest challenge is to get SSS going. Easier to build off positive transactions.  Also extremely enthusiastic about results from longer term initiatives. Optimistic about the future of the brand and TB can get modest SSS growth for the balance of the year.  Sales layers being added will help TB become a net new unit developer. 




SBUX, MCD, DPZ results seem much better internationally.  If there’s anything that’s going to change from a management perspective, remodels…can you give color on that? Can you also comment on company store margins in the YRI division?



No question that YRI has problems that need to be addressed.  Focused on value.  Looking at value menus that have been successful in South Africa and expanding into U.K.


Rolling out incremental sales layers.  Frozen beverages….


Hoping for a better second half in 2010.




Any benefit from New Year being in February as opposed to January?



No dramatic shift between Jan and Feb.  Was check flat and transaction up 4?




Internet coupon deal that went awry in China?



Couponing error caused some concern among customers, short term issue.




Cost for YUM in terms of healthcare? Any push back in refranchising?



Small impact this year but the major impact of the legislation will be in 2014. We’re going to 5% ownership of KFC and PH. Lots of legislative details to be ironed out. Will cost $15k per store starting in 2014.  Plenty of time to deal with the issue.




With comps up 4% in the first quarter that was versus a +2%.  In 2Q last year it was down…can you drill down deeper and tell us why the trends won’t accelerate. Anything in 1Q that isn’t flowing through? 



Looking at it in terms of 3, 2, or 1 years is not the point.  We expect moderate growth from 2Q last year.




Corporate expenses were down this quarter…is this $30m per quarter run rate to be expected going forward or was it unusual?



U.S. saw a reduction in G&A.  Goal is to offset refranchising costs with G&A savings. 




Is the $10 price point important to keep for PH? Even with a change in toppings…or is the variability of getting whatever you want more important?  Separate occasions for pasta and chicken or bundling?



Relative value is the real key here. More into separate occasions than bundling. 


YUM - ENTER THE DRAGON? - mainland china









Howard Penney

Managing Director

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.