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The Macau Metro Monitor, June 16th and 17th, 2010



The latest version of the tobacco ban bill draft declares that smoking will be allowed in "venues for adults"--i.e. casinos, bars, terraces and business open areas, massage lounges and dance halls--for a three-year period.  According to Chan Chak Mo, who heads the Second Standing Committee of the Legislative Assembly, pressure from several industries led to this decision. “  After two years, the government says that a revision of the law should be done in order to decide if the suspension continues in the third year or not,” added Chan.



Galaxy has closed its six-year HK$9 billion club loan from a consortium of Asia’s banks.  The loan was upsized to HK $9 billion from HK $8.8 billion.  The lending consortium agreed to undertake a “take and hold” on the loan with no sell down requirement.  The interest rate is HIBOR + 4.5%, substantially below the previous bond rate of 9.875%.

Lui Che Woo, chairman of GEG said: “I am delighted to say that we are in a very strong financial position and that 2010 is shaping up to be a fantastic year for GEG. This club loan, combined with the outstanding credentials of the banks involved, is a clear endorsement of both our future plans and the strength of the Macau market."



Zhu Kuan Mansion was sold to Cheng Long for HK$701 million in the biggest office transaction in Macau since the global financial crisis began in late 2008. The original owner, Capitalsino Properties, bought the property for more than HK$700 million in 2007.  The transaction price of HK$701 million equates to a price of HK$1,443 per square foot, reflecting an initial yield of 3.5%.


Franco Liu Pui-lam, a consultant at Savills, which brokered the deal, said that the Macau office market and investor sentiment had picked up after a subdued period last year. According to a Savills report, office demand from gaming and related industries will return and office prices and rents will be supported by extremely limited supply as no new projects have been approved by the government recently.

The Fiat Empire

“A greedy father has thieves for children.”

-Serbian proverb


Not unlike those of the Roman Empire, the political fathers of the modern day Fiat Empire purge their citizenry’s hard earned capital in order to attempt to maintain short term popularity. When they run out of funds, they simply borrow more. Then they spend that too.


I’m in the midst of reading “Rubicon  - The Last Years of the Roman Republic.” I’ve written about this before, but it’s worth mentioning again. The behavioral parallels between professional politicians circa 100BC was eerily similar to what you see in Western Europe and America today.


Sulla (138BC-78BC) was the poster child of what became an untenable Roman dictatorship. Once he captured control, he swept away the ideals that galvanized the Roman Empire’s longstanding pride. The meritocracy that allowed common citizens to rise up against the political aristocracy and lead their country was quashed. The greed and lust for political power in the Republic became disgusting. Tom Holland captures life in the Sulla moment effectively:


“As dictator he had thrown the largest parties in Rome’s history. Everyone in the city had been invited. Spit roasts had sizzled in the streets, vintage wines had flowed from public fountains. The citizens had gorged themselves.” (Rubicon, pg 104).


This, of course, didn’t end well. Leveraging yourself to the habit of overspending never does. European governments are finally coming to grips with this new reality. While their political resolve continues to be borrow-borrow-borrow, then spend what they borrow, unlike America, at least they are implementing some form of austerity on the spending side of this dysfunctional equation.


This morning, markets around the world remain confused. This is mainly a function of professional investors being confused, not the people whose money they are managing. To the citizenry of all nations who are over-geared, the output of austerity is crystal clear – slowing growth and less to gorge.


Here are some interesting thoughts from influential Europeans in this morning’s news:


1. UK – George Osborne (the new Chancellor of the Exchequer): “At the heart of the crisis was a rapid and unsustainable increase in debt that our macroeconomic and regulatory system utterly failed to identify, let alone prevent.”


2. Russia – Igor Shuvalov (First Deputy Prime Minister): “I’d be very cautious about stock investments in this country. I would welcome real investors who can build factories, something new in this country.”


3. Italy – Claudio Artusi (CEO of City Life – Milan’s $2.6B real estate project that’s built the tallest building in Italy): “Our investors are more concerned about long term value than short term returns. The project is aimed at the top end of the market and won’t be affected by the economic cycle.”


Confusion from the Italian sitting on his perch at Club Myopia and, at the same time, admission of the new Age of Austerity that has been voted into the UK’s political system. All the while Spanish and French governments are trying to convince the Russians to buy their broken promissory notes (more sovereign debt auctions this morning) as the Russians look to start taxing their almighty petrodollars (considering a tax on oil exports from tax-exempt Siberian oil fields).


The only way that this unsustainable Piling Debt Upon Debt plan changes is if we change the governments who plan to keep spending. Germany has a much better fiscal position than the US at this stage of the game and has already implemented austerity measures on the order of 2.7% of GDP. Part in parcel with Osborne’s comments in the UK this morning is David Cameron getting rid of the FSA (Financial Services Authority). Why? Because it doesn’t work.


You can’t solve problems with politicians who perpetuated the problems. Change is good and it seems to me that those countries who have the political backbone to make changes first will win this race to the bottom in the end (you need to hit bottom before you bounce).


Levered markets, politicians, and financiers alike need to take a good, hard, and long look at the bottom before they change their ways. Artusi’s fanciful expectations are a metaphor for an era that’s passing us by. The score for Italy’s latest version of an opulent “City Life” is on the board – only 90 of 390 luxury apartments sold. The Fiat Empire may not be burning yet, but the smell is becoming awfully familiar…


We covered our short position in the SP500 (SPY) yesterday on market weakness. That doesn’t mean I’m not bearish. It simply means I think I can re-short the market higher. We will see if I’m right about that. My immediate term support and resistance lines are now 1101 and 1127, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


The Fiat Empire - V bottom in the Deficit


A key Hedgeye phrase is that “everything that matters happens on the margin.”  On the margin, the news in Europe is getting better (the Euro is rallying) and the news in the US is getting worse (the dollar is getting weaker) - this has been bullish for stocks so far this week.  Soon the news from the US will dominate the headlines and that will likely be bearish.  Yesterday, there was little follow through from Tuesday’s big rally, as the S&P 500 finished down slightly on Wednesday.  


Stocks were down as the EURO declined slightly, as another round of speculation emerged that Spain will have to tap the EU's new bailout facility.  The continued concerns surrounding Spain dampened some of the momentum behind the risk trade, but the demand for Spanish bonds in today’s auction is helping the Euro rally in early trading.  The EURO is currently trading up to 1.2388, up 0.6%.  The Hedgeye Risk Management models have the following levels for the EURO – Buy Trade ($1.21) and Sell Trade ($1.23).


Treasuries were stronger with the increased aversion for risk, as the VIX rose by 0.2%.  The Hedgeye Risk Management models have the following levels for the VIX – Buy Trade (23.32) and Sell Trade (32.33). The DXY rallied slightly and the Hedgeye Risk Management models have the following levels for the USD – Buy Trade (85.55) and Sell Trade (86.51). 


On the MACRO front in the US, weaker-than-expected housing data was another headwind for the market.   Housing starts posted a larger-than-expected 10% month-to-month decline to an annualized rate of 593,000 in May. The decline was entirely driven by single-family starts, which fell 17.2% to 468,000. Permits were down 5.9% in May and have now fallen 16% since the last peak in March.  In addition, single-family permits were down nearly 10%.


The Hedgeye Risk Management Financials team, led by Josh Steiner, hosts our next Black Book release and Conference Call, “Housing Double Dip a Game Changer for Financials in 2011” on Friday June 25th at 11 a.m. EDT.  The call is open to qualified institutional subscribers of Hedgeye's Financials vertical -- and for qualified prospective institutional subscribers. Email if you are interested in learning more about Josh Steiner’s Financials institutional research product.


The disappointing housing data contributed to Consumer Discretionary (XLY) being the worst performing sector on the day; followed by Consumer Staples (XLP) and Industrials (XLI).  The S&P homebuilding Index declined by 1.5%, lead by PHM down 1.8%.  The XLY was also hurt by the retail group underperforming the broader market again yesterday, with the S&P Retail Index (0.8%).   The Johnson/Redbook 2-week same-store sales were reported down 0.5% from May.  In addition, earlier in the week, BBY reported weaker-than-expected May quarter results along with continued cautious commentary surrounding consumer spending trends.


The three best performing sectors were Technology (XLK) +0.3%, Healthcare (XLV) +0.4% and Utilities +0.6%.   The XLK topped the list of best performing sectors on the back of the AAPL and iPhone sales trends and was able to shrug off a sharp selloff in NOK (10.7%) after the company cut its Q2 outlook.  For the second day in a row, memory names MU +2.2% and SNDK +1.4% helped the SOX +0.4% extend its rally another day. 


Oil rallied to $77.67 and the Reuters/Jefferies CRB Index of Commodities posted a sixth straight gain.  The Hedgeye Risk Management models have the following levels for OIL – Buy Trade ($75.46) and Sell Trade ($79.60).


Copper continues to flash a bearish signal for US/Global growth; selling off this morning to $2.96, well below our long term TAIL line of 3.05.  The Hedgeye Risk Management Quant models have the following levels for COPPER – Buy Trade (2.89) and Sell Trade (3.05). 


Gold remains in a bullish formation and we are long.  The Hedgeye Risk Management models have the following levels for GOLD – Buy Trade (1,218) and Sell Trade (1,244).   


As we look at today’s set up for the S&P 500, the range is 26 points or 1.2% (1,101) downside and 1.1% (1,127) upside.  Equity futures are trading mixed-to-fair value having finished lower yesterday.  On the docket for today is May's CPI and initial jobless claims.   


Howard Penney













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.


QSR EBIT margin trends continued to improve YOY in 1Q10, but compares get more difficult for the balance of the year.


Two weeks ago, I wrote about current casual dining margin trends (please refer to the June 2 post titled “CASUAL DINING – THE SQUATTERS’ INCOME IMPACT”) and QSR trends look rather similar from a YOY comparison perspective with 1Q10 having been the easiest compare of the year from an EBIT margin standpoint. 




One major difference is that the QSR industry’s comps (as measured by our QSR index shown below) get easier for the rest of the year whereas the casual dining industry’s comps get easier for 2Q and 3Q and then get more difficult in Q4, as reported by Malcolm Knapp.  According to our Hedgeye Risk Management QSR index, comps turned positive in calendar 1Q10 for the first time since calendar 4Q08, and that improvement included the significant negative impact of harsh weather in February. 


Although many QSR companies stated on their most recent earnings calls that April trends were in line with March or slightly better, more recent comments from a handful of companies point to decelerating trends in May, at least on a 2-year average basis. 


This morning Sonic preannounced its fiscal 3Q10 (quarter ended May 31) system same-store sales trends, reporting a 6% to 6.5% decline YOY.  At the low end, this 3Q10 result implies a nearly 250 bp sequential improvement in 2-year average trends from the prior quarter, but it is important to remember that SONC management attributed about two-thirds of the reported 2Q10 decline in same-store sales to inclement weather.  Excluding the weather impact, a 6.5% decline in 3Q10 implies a nearly 200 bp sequential deceleration in 2-year average trends.  SONC’s preannounced 3Q10 trends combined with its 4Q10 same-store sales guidance of -4% to -8% point to a 5% to 7% decline in the back half of the year, 200 bps worse at the low end than the flat to -5% guidance management provided three months ago.  Specifically, SONC’s press release stated, “The consumer environment continued to pose a challenge for same-store sales in the quarter, with same-store sales estimates for the system expected to decline between 6.0% and 6.5%. Though negative, same-store sales improved from March to April, but deteriorated in May.” 


MCD trends did not deteriorate in May, but the company’s U.S. trends, though still strong on an absolute basis, have slowed on a 2-year basis in both April and May when you adjust for calendar shifts.  CKR has also reported its monthly trends through May 17 and blended same-store sales decelerated slightly on a 2-year average basis in the most recent period.  Carl’s Jr., however, which has greatly underperformed Hardee’s recently, posted slightly better numbers in the most recent period on both a 1-year and 2-year basis.  That being said, same-store sales were still down 5.2%. 


Reuters reported Monday that SBUX CEO Howard Schultz said "With 10 percent unemployment continuing in America, I think this is a time for continued thoughtfulness and discipline, but we have not seen a downturn from quarters in the past. So it has been relatively the same and consistent."  This comment does provide too much insight into current trends, but it implies that trends remain at least in line with the company’s prior full-year guidance of mid-single-digit same-store sales growth as the company posted 4% and 7% growth in fiscal 1Q10 and 2Q10, respectively.


Based on this limited glimpse of current QSR top-line trends, I am not expecting trends to get better on a 2-year average basis in the second quarter as they did in 1Q; though easier comparisons will help trends on a 1-year basis. 




Food cost trends

Like the casual dining names, QSR margins were helped by declining commodity costs for most of 2009, largely in the second half of the year.  Although most companies continued to reap the benefit of lower food costs YOY in calendar 1Q10, most guided to higher costs for the balance of the year, particularly in 2H10.  Beef costs, which make up the largest food ticket item for most of the QSR names, have increased 9.6% YOY (as measured by the S&P GSCI Live Cattle Commodity Index), and the CRB Foodstuffs Index is up 6.2% YOY.


SONC:  Just this morning, SONC reported that it is expecting a 150 to 250 bp decline in 4Q10 restaurant level margin as a result of deleveraging and higher-than-expected beef costs.


MCD:  Reported a 5% decrease in its U.S. basket of goods in 1Q10 and guided to a 2% to 3% decrease in the U.S. for the full-year, which implies increased pressure for the balance of the year. During a June 2 investor presentation, CEO Jim Skinner said commodities would be flat-to-slightly down.


BKC:  Guided to a 4% YOY increase in its U.S. food costs in fiscal 4Q10 after beef costs increased 9% on a sequential basis in fiscal 3Q10.


WEN:  1Q benefited from lower YOY food costs, but the company is expecting a 2% to 3% increase in commodity costs for the full year, which will hurt margins for the balance of the year.  “Although commodities were favorable in the first quarter, they are beginning to increase earlier than we had anticipated, especially beef.”


CKR:  Management called commodity costs the “one wild card” on its last earnings call.  For fiscal 1Q11, the company guided to a 100 to 110 bp increase in food and packaging costs as a percentage of company-operated sales.  Food and packaging costs as a percentage of sales have decreased YOY for the last 6 reported quarters.


JACK: Guided to a 1% decrease in full-year commodity costs after costs declined 4.5% in the first two quarters of the year.  Specifically, management stated, “Commodity costs are expected to increase by approximately 2% in the third quarter and 3% in the fourth quarter as compared to prior year.  The increase in the third and fourth quarters is being driven by higher beef costs, which accounts for approximately 20% of our spend.”


YUM:   1Q10 U.S. operating income benefited from $5 million in commodity deflation; this benefit is expected to go away and turn inflationary as we trend through the year.  Management is expecting costs to be relatively flat for the full year. 


CMG: Food costs decreased in the first quarter but management expects food costs to increase slightly for the year, primarily in 2H, “due to modest commodity inflation enabled by increased consumer demand.”


Companies will be slow to offset these higher food costs with pricing as consumers continue to be under pressure in this economic environment and have not yet proven a willingness to spend more money.  QSR demand trends are highly tied to unemployment levels and as MCD‘s CEO Jim Skinner stated at a recent investor presentation, “We don’t have a lot of price elasticity right now.”  If MCD can’t raise prices, it leaves little room for the smaller players to do so.  On the other end, higher food costs will put increased pressure on margins as companies continue to rely on value initiatives and promotions to drive traffic.  The QSR companies on average posted higher YOY EBIT margin each quarter in FY09 even with same-store sales negative and with an increased focus on value.  These trends will not be sustainable for the remainder of FY10 if commodity costs move higher, on a YOY basis, as expected.




Labor cost trends

On average, labor costs increased as a percentage of sales for the QSR companies for most of 2009.  Based on the deleveraging of negative same-store sales and recent minimum wage increases, this is not surprising.  The tough sales environment actually caused most QSR companies to focus on increasing the efficiency of its labor and this will likely continue for some time.  To that end, management can’t cut labor costs forever without impacting the customer experience so the big cuts, even if sustainable, have already been made on a YOY basis. 


As I stated in the casual dining post two weeks ago, if the jobs picture improves, it’s only a matter of time before we hear about higher labor costs.  In an economy that is creating jobs, there is an increased incentive to quit and walk away from a lower-paying job (think restaurant server/cooks), and the restaurant industry will pay the price.   QSR Web reported on this topic on Monday, saying that QSR operators are well aware they will have to work harder to retain employees in the coming months.  Specifically, the article cited a recent Harris Interactive poll, which showed that one in five employees say they will look for a new job once the economy improves.  Employees ages 18 to 34 say they are even more likely — 26 percent — to look for new employment or expect a promotion.  A better economy will be good for top-line trends, but it will also put increased pressure on the labor cost line.




Howard Penney

Managing Director


Sentiment remains strong around the Chipotle brand.  We expect continued strength in comps but are watching for any signs of margin contraction.


CMG delivered a strong 1Q and all indications suggest that another strong quarter is possible in 2Q.  1Q comps were 4.3%, almost entirely driven by traffic, and no price has been taken in the past 12 months.  From a topline perspective, the comparisons do not get much more difficult for the remainder of the year; 2Q, 3Q, and 4Q comparisons are 1.7%, 2.7%, and 2% respectively.  Given that marketing spend in 1Q was 1.1% of sales, and management guided to marketing spend of 1.8% for the full year, traffic should remain strong for CMG in 2Q.  However, the company will feel increased pressure on the other operating cost line as it invests in its new marketing campaign.  Any pickup in other drivers of traffic will be incremental but management has stated that they will not be taking price.  The only possibility for that would come in 2H10 when some additional food with integrity will be rolled out in certain markets with “either no or very modest price increases”.  Management did point out, however, that should inflation become more of headwind than expected (guided to a low single digit increase for the full year, primarily in 2H) that they do have the ability to raise prices, but will be patient before rushing into a menu price increase.


CMG: WATCH MARGINS - cmg detail


In terms of efficiency, 1Q results were partly attributable to progress made on throughput.  On the last earnings call, management stated that they had previously taken their “eye off the ball over the last couple of years” with respect to throughput.  Assuming that the initiatives addressing these issues remain in place, store productivity should remain high.


CMG: WATCH MARGINS - EBIT Margins.xlsx 1q10


The favorable commodity cost environment enabled CMG to attain higher margins from 1Q09 onward.  The company is not locked into many of its ingredients and could see margin pressure should inflation begin to impact their commodity basket.   The few items that management has locked in include rice, soy oil, corn, and tortillas.  Traditionally, Chipotle has also kept cheese locked in but decided that the spot market was more attractive and that this enabled them to move towards more pasture-raised dairy.  Holding current cheese prices constant, the Bureau of Labor Statistics’ PPI database is showing average inflation of 7.6% for the first 5 months of 2010. Moving to the spot market, while undoubtedly beneficial during the deflationary period of 2009, could cause more volatility and uncertainty for CMG management if inflation takes hold on their cost line in 2H10 (as they expect).  During the 1Q10 earnings call, management said that the inflation outlook seemed “manageable” but having such a proportion of their basket on the spot market means that their outlook is subject to the volatility of the commodity markets.


During the first quarter, CMG posted an EBIT margin of 15.3%, up over 300 bps YOY.  This YOY growth was impressive given the fact the company was lapping a nearly 300 bp improvement from 1Q09.  Going forward, margin comparisons get increasingly more difficult on a YOY basis, particularly in the second half of the year, as the company laps the extremely favorable food costs from last year.



Howard Penney

Managing Director

Calendar Catalyst: UK Emergency Budget Meeting

Position: Short France (EWQ); Short Italy (EWI)


UK unemployment fell 10bps to 7.9% according to the latest reading from the International Labour Organization (ILO). While directionally the number is positive, the chart below points out that the rate has trended sideways for most of this year. Now PM Cameron and Co. must deliver on campaign promises to return growth to the UK economy, including greater improvements in employment. Already Cameron proposed 6 Billion Pounds in spending cuts for this year. Mark your calendar for next Tuesday, June 22nd, when the new Chancellor of the Exchequer George Osborne outlines the go-forward spending cuts in an emergency budget meeting. 


Today, the Nationwide Building Society published its UK Consumer Confidence Index .  Notably, May’s survey saw significant deterioration (below) which mirrors the slide in German consumer confidence that we saw yesterday in the ZEW survey. We believe this inflection is representative of heightened fears of the next European country to face sovereign debt default risk.


UK Consumer Confidence Index-

Index of Sentiment: 65 in May versus 75 in April

Expectations (6 months ahead): 93 in May versus 105 in April

Current Perception: 23 in May versus 29 in April

Propensity to Spend: held steady at 98


Matthew Hedrick



Calendar Catalyst: UK Emergency Budget Meeting - uk ILO

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