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"Bearish Enough On Spain?"

“Our debt is clean, we will not have to ask for help.”

-          Elena Salgado, Spanish Finance Minister, April 30th, 2010

 

We often say at our firm that as investors we can be bullish, bearish, or not enough of either.   As it relates to sovereign debt risk, the question remains, which are you? 

 

Currently, there is no shortage of bearish sentiment around global sovereign debt issues.  In recent weeks, Greece, Portugal, and Spain have all had their credit ratings downgraded, with Greece being downgraded to junk status.  Despite this flurry of negative news, I would submit that investors are still not bearish enough, particularly on Spain.

 

Historically, Greece is consistently an early and serial sovereign debt defaulter.  As a result, it is difficult to consider Greece anything but a leading indicator for sovereign debt issues.  While Iceland, Ireland, and Portugal all matter to a degree and will likely have accelerating debt issues, we view Spain as the key mispriced and misunderstood sovereign debt risk globally.

 

Spain has economy of size that matters.  According to the most recent estimates from the World Bank, Spain was the 9th largest economy in the world in 2009 with a GDP of $1.4 trillion. From a pure geography perspective, it is the second largest country by land size, after France, in the European Union.   It also has a government budget that is more than 4x that of Greece, and a commensurate debt balance.

 

We look at two primary facts to analyze sovereign debt default risk: the ratio of budget deficit-to-GDP and debt-to-GDP.

 

On the first point, the budget deficit-to-GDP, Spain is clearly in the danger zone.  As of the end of 2009, Spain’s ratio was 11.2% of GDP, and set to accelerate in 2010. Historically, anything beyond 10% is in the danger zone of potential for sovereign debt downgrades, and will lead to an acceleration of borrowing costs.  Based on that metric, Spain will need roughly 150 billion Euros in debt to fund its budget this fiscal year.

 

On the second metric, debt-to-GDP, Spain is more favorably positioned, with a ratio lower than the EU average of 54%.  While favorable at first glance, the reality is that this ratio has doubled in the last year. This ratio will continue to as the Spain’s budget is increasingly funded by debt. 

 

More importantly as it relates to outstanding debt, Spaniards have a substantial amount of debt that has to be rolled over this year.  Estimates suggest that figure could be as high as 225 billion Euros, of which almost 45% is held by foreigners.  Considering that the totality of the proposed Greek bailout is 146 billion Euros over three years, any potential bailout (and we are not there yet) would be of an exponentially larger scale than Greece.

 

Ironically, as recently as a few years ago, Spain’s leadership in growth and stability were a beacon with the European Union. The reality was, though, that Spain’s economic growth was predicated on the construction industry.  In essence, Spain was the poster child for the global housing and real estate boom, bubble, and subsequent bust.  In fact, home building and construction spending represented 20% of GDP and 12% of employment at the industry’s peak in Spain.  Due to an economy has limited exports to drive GDP, the evaporation of the construction sector as a major engine of growth and employment suggests the Spanish government’s estimates of 3% GDP growth in 2011 and beyond are likely optimistic.

 

Not surprisingly, as went the global construction market, so accelerated Spain’s unemployment.  Currently Spain’s unemployment is sitting at just north of 20%.  Just for the sake of anecdote, both the Sudan and West Bank are currently more employed than Spain.  There is good news, though, according to Spanish Finance Minister Elena Salgado only 290,000 jobs were destroyed in the first quarter of 2010. Good news is relative, it seems.

 

Another debt issue as it relates to Spain’s fiscal health is private indebtedness, currently at 178% of GDP, according to a recent S&P report that downgraded Spain’s long-term sovereign debt.   A substantial portion of this debt relates to mortgages and home financing.  While defaults have been increasing, doubling for the last three years in fact, we believe they are set to accelerate one again due to unemployment and the timing of benefits.

 

Spain has a very generous unemployment system that pays the unemployed 65% of the average national earnings for up to two years for those who have worked for the prior six years.  The risk, of course, is that as these benefits begin to run out, the ability of the unemployed to pay their mortgages diminishes substantially, which could lead to broad issues for the Spanish banking system.

 

As noted in the introductory quote, the Spanish leadership does not believe they have to ask for help.  In the short term that may be true.  In the longer term, they will have to show that they can help themselves.  Spain is not Greece, we agree with that. But if the Spaniards do not change their trajectory, they have the potential to be much more than Greece.  And that is not priced into the markets.

 

 

Daryl G. Jones
Managing Director

 

"Bearish Enough On Spain?" - Spain EU Unemployment


TXRH - EXPENSIVE AND IT'S NOT BUILT TO STAY THAT WAY

Reports spectacular EPS and margin improvement, but this too shall pass.

 

TXRH confirms that April was soft from a SSS stand point.  The company was quick to point out that the second half of April was better than the first.

 

At 8.8x EV/EBITDA, TXRH is one of the most expensive Full Service restaurants with a mediocre story.  SSS are punk with no real plan to drive traffic and the cost of construction does not justify new unit growth.

 

The company is also looking a developing another concept (Aspen Creek) to help drive incremental growth.  Why would TXRH need to develop a second concept?  The new concept and its ROI would need to be spectacular for this to overcome the obvious issues that can be inferred from this move - the original concept does not have the growth opportunity that was initially planned.

 

 

Notes from the call:

 

Food, labor, and utility costs were all favorable

  • Comparable restaurant sales growth of 0.4%
  • Margin expansion of 218 bps paved the way for better-than-expected earnings
  • Improved cash position and paid down debt
  • Being conservative until returns justify increased investment
  • Positioned well to take advantage of future opportunities

 

Financials

  • Revenues increased 6%
    • 5.4% increase in restaurant sales
    • 5% store week increase
    • 0.2% increase in AUVs
    • Opened 2 restaurants in 1Q
    • Comp store sales positive for first time in over two years
    • Guest traffic down 0.1% for quarter
    • Comps in January were down 1.6%, down slightly in February, and up 2.6% in March
    • 231 SSS restaurants averaged $75,100 in sales per week
    • 24 restaurants open 6-18 months that were in the AUV comp averaged  and averaged $73,100/wk
    • Others averaged $93,400/wk

 

Margins

  • Restaurant margin up 218 bps YoY
    • COS line down 185 bps
    • Food cost deflation
    • Labor down 18 bps
    • Low hourly turnover – below 80%
    • Preopening costs were down thanks to reduced openings
    • More assets becoming fully depreciated than they are adding

 

Other

  • Paid down 12m in debt
  • Net debt of $35m

 

Outlook

  • Tax rate for 10 will be ~33%
  • Continuing to generate excess cash flow and paying down debt
  • EPS now estimated up 14% to 18% (from $0.67) growth for 2010 (upward revision from previous 5%-10% growth estimate)
    • Flat to up 1% SSS growth
    • 14-15 openings
    • Food cost deflation of 2.5% to 3%
    • Capex of $50m
  • Food cost deflation will be less for the remainder of the year because of contracts
  • Spending on their conference will be $1-$1.2m more than last year
  • 2010 development is backend loaded
  • Confident necessary returns will be generated

 

Working on ways to enhance the guest experience

  • Refining processes
  • New menu rolling out
  • April gave back some sales momentum during the holiday season
  • 2H April was better
    • Sales environment will gradually improve
  • New kitchen design is decreasing development costs
    • Also looking at smaller units
    • Lower investment cost
  • 2010 investment cost could come down 200-400k from the 4m last year
    • If sales hold steady TXRH should hit the 1.1x sale : investment ratio
  • Looking at international markets carefully
  • Will be looking at two more aspen creek restaurants this year

 

 

 

 

Q&A

 

Q: Can you quantify the “improvement” in the second half of April? Menu impact on average check? More or less items?

 

A: Second half of April is consistent with what competitors have said.  There is no price increase in the menu.  Adding fried pickles, taking off one other item. Check neutral.

 

 

Q: Were you positive in the second half of April? Commodity deflation in 2Q?

 

A: Yes we were.

 

Commodity deflation in 2Q will be less.  Contracted for proteins through 2010.

 

 

Q: Any thought about extending contract on beef?

 

A: It’s early to talk about beef prices.  Will keep all doors open.

 

 

Q: 1Q comps, any negative impact from weather?

 

A: No, we don’t keep up with that. We don’t calculate bounce back from pent up demand either.

 

 

Q: Increase seating capacity initiative, how may units have been completed? Outlook for ’10?

 

A: Done 47.  Did 4 in 1Q.  Will do another 6 or 7 in the balance of the year.

 

 

Q: Comment on deflation?

 

A: In January beef costs were higher. Last year there were higher food costs in January but much lower in February and March.  This year then, there were substantial deflation in January but less so in February and March. That will continue into 2Q.

 

 

Q: When will you be considering expansion pace increasing?

 

A: Having those conversations now, have to be having them now.  We’re happy with the costs coming down and the performance of the recently opened stores.

 

 

Q: Does the 14 to 15 openings include the Aspen Creek locations?

 

A: Yes.  Store 15 may open after December 31st, they have to be built.

 

 

Q: Development – should we think about 2Q openings being similar to 1Q?

 

A: Fewer in 2Q. Late third quarter and beginning 4Q will have 75% of the remainder.

 

 

Q: No menu pricing going forward?

 

A: Lapped price at the beginning of April?

 

 

Q: Rate of deflation? Could 2Q food costs touch 33%?

 

A: Would expect them to be a little higher in 2Q as % of sales.

 

 

Q: In the long term is it a 35% concept?

 

A: Can’t predict what commodity markets are going to do or what pricing strategy is going to be.

 

 

Q: Clarify pricing versus ticket and traffic…was most improvement in the traffic line or did check pick up also?

 

A: Traffic was down .1% and check was up 0.4%.  Traffic was constant through the quarter, check improvement drove the quarter. No regional disparity – broad based.

 

 

Q: Marketing is getting more competitive, when you think about fighting for traffic since you’re not taking price and how are you managing the price versus marketing for that traffic?

 

A: If you compare historical performance through difficult times, TXRH does well through local store initiatives.  Looking at

how commodities behave will dictate future pricing.

 

 

Q: What are you doing to prepare for future price increases?

 

A: Not testing anything and have not made that decision yet.  I would guess that we will test it but have not made a decision yet.

 

 

Q: Development outlook.  Give some thoughts on why it makes sense to look at a second concept.

 

A: Texas Roadhouse will continue to be the focus but need to look at what will propel the brand  in 5 years.  Looking internationally.  The second concept is driven by the chairman and, starting from scratch, it could have future growth potential if the new concept works.

 

 

Q: International agreements…what is the number of near term units? What are the costs of development and negotiating/sourcing…negative G&A impact this quarter?

 

A: Franchise deal for 35 restaurants in 10 years.  Not a negative to G&A…no incremental G&A piece going forward. We’ve dedicated some resources to the international effort . 

 

 

Q: Capex outlook?

 

A: Lighter than last quarter…15m maintenance and remodel and the majority will be cost of new development.

 

 

Q: Other regions besides Middle East?

 

A: We are taking a targeted approach in Asia and Mexico also.

 

 

Q: Labor per operating week has fallen for 4 quarters in a row. Continuing?

 

A: Turnover is less – below 80%. Not sure it will continue to decrease.

 

 

Q: 2011 development, if ramped up, will it be spread across geographies?

 

A: Would like to spread it out as much as we can, similar to how it has been in the past.

 

 

Q: Competitive pressure in late night…alcohol is only 10% of your sales but have you seen pressure in late night?

 

A: We’re not a late night concept. Mix has continued to go down as a percentage of sales.  Not seeing anything different trend-wise. No impact from that…

 

 

Howard Penney

Managing Director


Even the bears aren't bearish enough on Spain's coming sovereign debt problem


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DEFERRED CAPEX NOT AS BIG AN ISSUE FOR PUBLIC COMPANIES

While deferred capex must certainly be accounted for when accounting for NAV’s, the math shows it’s not that material for the public hotel owners.

 

 

By the end of 2010, hotel owners in aggregate will have under spent for two consecutive years in terms of maintenance capital expenditures.  The following chart shows the trend as a percentage of revenues for the public hotel owners:

 

DEFERRED CAPEX NOT AS BIG AN ISSUE FOR PUBLIC COMPANIES - capex rev

 

The following chart shows maintenance CapEx per hotel room.  Under spending is clearly evident in this chart as well.  However, even if you assume that 2008 peak spending is the right number, the maximum amount of under spending would total only $9,500 ($4,750 multiplied by 2 years of under spending).  At best, deferred CapEx looks to be only $4,500 ($2,250 multiplied by two years) if we assume reversion to the trend line.

 

DEFERRED CAPEX NOT AS BIG AN ISSUE FOR PUBLIC COMPANIES - 12

 

While the public companies have certainly cut back spending, they have not fallen that far behind.  The situation for the private owners is quite different.  Most of the major transactions we've seen involve significant amounts of deferred CapEx.


HYATT "YOUTUBE"

In this note we've provided some forward looking commentary from Hyatt's Q4 earnings release and conference call in preparation for their Q1 earnings release on Thursday.

 

 

TRENDS & GUIDANCE:

  • "At present, there are mixed economic signals in the U.S. As to international operations, we are seeing some relative improvements in selected markets, especially in emerging markets such as China where economic stimulus from the government has created support for commercial activity. In general, occupancies on the transient side have shown some signs of improvement over the last  few months, but rates are still under pressure."
  • "On a year-over-year comparative basis, cancellations in group business have slowed and we saw a sequential reduction in the rate of decline in group bookings during the final months of 2009. These trends continued into 2010."
  • "Since any recovery in our industry is widely expected to be occupancy driven at first, and because we do expect to see some cost increases in 2010, including increased wages, we expect that margins will be under pressure in 2010 even as we focus on additional productivity gains."
  • "More recently the rate of decline in RevPAR for select-service properties has narrowed significantly compared to prior periods."
  • "We expect compensation expense to increase as we face some wage inflation in 2010."
  • "We plan to spend 270 to 290 million on CapEx in 2010, which is about 30% more than last year. This includes, roughly, four to 5% of owned hotel revenues on maintenance CapEx. We are starting major renovations projects at the Grand Hyatt New York and the Grand Hyatt San Francisco. Both of these projects will begin over the summer and continue into the third quarter of 2011. We anticipate that there will be disruption to business and estimate we’ll have about 400 rooms, on average, out of service per day in the second half of the year. We’ve got three other hotels, in essence largely the Park hotel in Chicago, the Hyatt Regency in Atlanta, and the Hyatt Regency in San Antonio, where we’re undertaking projects in 2010."
  • "We expect the tax rate on our U.S. income to be approximately 38% and the blended tax rate on our international income to be approximately 20%. In addition, we have certain fixed tax charges each year which we believe will approximate 2,911."
  • "One point of global RevPAR change equates to between 10 to 20 million of adjusted EBITDA for the company."
  • Potential acquisitions: "business transient hotels or hotels that principally serve business transients guests."
  • "The transaction volume for what I would say typical whole asset sales has not really been significant and not been growing significantly."
  • "While overall group revenue on the books for 2010 is below 2009, the decline has been lessening since about October of 2009. In the last four months we have booked something in the range of a third more group revenue for 2010 than the same period in the prior year."



German PMI and the Weight of Gravity

Position: Long Germany (EWG); Short Spain (EWP), Short Euro (FXE)

 

As a leading indicator, the Purchase Managers Index (PMI) is one critical data point we use in our fundamental analysis. While our bullish call on Germany remains (see our portal for recent analysis), we’re acutely aware that ‘gravity’ could prevent this number from improving over the coming months. 

 

Below we’ve pulled back a chart of German PMI over the last eight years and overlaid the DAX. There are two major call-outs:

 

(1.)  We’re now above the 60 level, a critical threshold for the Manufacturing PMI (the most current reading in April is 61.5 versus 60.2 in March).

(2.)  The change in the second derivative from March PMI to April slowed compared to previous months, an early sign that may suggest the expedited move since early 2009 could turn.

(3.)  If history is any gauge, and if April was the peak in PMI, we’re likely to see the DAX pull back.

 

As some of our subscribers have pointed out, the bailout of Greece and potentially other Euro member states could create downward contagion in Germany (the top loan sponsor), therefore threatening a long Germany position. While we wouldn’t disagree that contagion is a risk, over the intermediate term we see a weaker Euro as a bullish catalyst for the country’s export base and continue to believe that Germany’s fiscal health will help drive its equity market over its debt-laden peers.   To play this divergence, which is one of our Q2 2010 themes (Sovereign Debt Dichotomy), we’re long Germany, short Spain. Currently there is a 16.2% spread between the DAX and the Spain’s IBEX 35 year-to-date.

 

While we expect to see further slowing (and mild contraction) in PMI in the coming months from gravity as risks surrounding contagion from the sovereign debt bubble play out, we believe the data still supports our bullish call on Germany.  

 

Matthew Hedrick

Analyst

 

German PMI and the Weight of Gravity - pmii

 


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