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Mexican Headwinds

Position: Short Mexican equities via the etf EWW.


Conclusion: The outlook for Mexico’s macroeconomic health is tepid at best and incremental data points suggest there is more downside to come.


Last Thursday, Daryl Jones, our Managing Director of Macro, wrote a note outlining our short thesis on Mexico. In summary, the conviction is three-pronged: overreliance on oil, slowing growth in the U.S., and a drug war that by official estimates shaves a full percentage point off of GDP each year. In addition to these headwinds, additional bearish points on housing and government funding spell incremental trouble for the Mexican economy.




The first prong of our bearish outlook on the Mexican economy is an unhealthy reliance on oil will continue to be a headwind for the Mexican government’s budget, as oil production in the country continues to decline – down 29% in the last six years. The State-run oil conglomerate PEMEX funds an estimated ~35% of the federal budget, so as these funds continue to erode, the Mexican government will have to look elsewhere for support. While a substantial rise in the price of crude would be positive for the Mexican economy, we do not see that as a likely outcome for now. Oil is broken from an intermediate term TREND perspective ($78.50). We have been vocal in the past couple of months suggesting REFLATION based on U.S. dollar debasement will be less of a supportive factor this time around, as waning demand from tightening in China and economic slowing in the U.S. (the two largest consumers) continue to weigh on the price of crude oil (down 2.6% in the last month). As a point of note, the Mexico Bolsa Index has a 0.81 r-squared to the price of crude oil on a TREND duration.


 Mexican Headwinds - Mexico Crude Oil Production


The second prong of our bearish outlook for the Mexican economy concerns its leveraged exposure to the U.S. from a trade and investment perspective. Last year, 80% ($177 billion or 15% of Mexico’s GDP) of Mexico’s exports went to the U.S. A slowdown in U.S. consumption, of which we have a great deal of conviction (see Hedgeye Macro’s Q3 Themes: American Austerity & Housing Headwinds), is very negative to Mexican growth and job creation. This setup suggests Mexican retail sales will roll over hard from the 23-month high of 5% Y/Y in May of 2010.


The third prong of our bearish outlook for Mexico’s economy is the most obvious from a news flow perspective – drug wars. Weakness in May retail sales along the U.S. border (the most prominent area of violence) only tells part of the ominous story which has plagued Mexico for quite some time. Mexico has had upwards of 25,000 organized crime deaths related to the drug war since 2006 with 28% (7,048) of them occurring this year alone! The impact of violence is the single greatest threat to the Mexican economy, according to 57% of Mexican executives – up from 49% in March and 22% in December 2009. Furthermore, tourism, which accounts for 13% of Mexican GDP in aggregate, will continue to suffer as a result of the uncontained drug-related violence.




Mexico’s reliance on the U.S. for investment and aid is having an incremental negative effect on the Mexican government’s drug war efforts. According to a recent report from the U.S. Government Accountability Office, the U.S. has delivered only about 9% of the $1.6 billion in drug-war aid promised to Mexico and Central America, citing a lack of staff and funding. If the effects of American Austerity continue to gain steam, reprieve in the form of a U.S. hand-out may be unlikely in the near term.


Speaking of hand-outs, Mexico is seeking a $1 billion loan from a Chinese development bank and another $500 million from the World Bank to finance home lending. Sociedad Hipotecaria Federal (SHF) needs further funding to inject liquidity into Mexico’s mortgage market, even after receiving a $1 billion loan from the World bank in 2008 and installments of a $2.5 billion credit line from the Inter-American Development Bank. Rising delinquencies (delinquency rate +350bps Y/Y) brought on by the sharp increase in unemployment last year has SHF looking for further funding to finance an estimated 1 million mortgage loans this year. While the Chinese loan may be signed as soon as September, the delay or denial of either facility would be very bearish for the Mexican housing market – particularly if you factor in the employment headwinds brought on by a slowdown in the U.S. economy.


Darius Dale



Mexican Headwinds - Mexico Unemployment

THE MACRO MIXER - When LEADING is LAGGING or just meaningless

Things could be worse than they appear but it’s not a leading anything.


Today the Conference Board's Leading Economic Index declined by 0.2 and has now declined for two of the last three months.  Upon further review, things could actually be worse that they appear.  The movements of the sub-components of the index were very mixed, with four of the components declining, five rising and one flat.


The rising components during June (in order of positive contribution):


(1)    The yield curve

(2)    Building permits

(3)    Index of consumer expectations

(4)    Manufacturers’ new orders (consumer goods and materials)


At this point in the economic cycle, the yield curve is somewhat meaningless.  The yield curve has been sending a strong growth signal continuously since 2008, but there is no expansion in credit and low mortgage rates are not stimulating home sales.  A favorable yield curve is not providing the kind of stimulus that has occurred historically at similar interest rate levels.


The rising consumer expectations number is in sharp contrast to the Conference Board’s June 29th report on consumer confidence, which showed a sharp drop in confidence.  How can the same organization show consumer confidence rising and falling the same month?

In addition, a good part of the index is subject to changes and given the recent softness in the MACRO data, we are not likely to see upward revisions.  The press release from the conference board states, “the resulting indexes are therefore constructed using real and estimated data, and will be revised as the unavailable data during the time of publication become available.”

Today’s surging S&P is on the back of strong earnings from a number of companies.  At the time of writing, 40 of the 52 companies due to report today have reported (the others are reporting post-market) and only 2 missed in the earnings line and 10 missed on the revenue line.   For now, the negative news on jobs, housing and the supposed leading indicator are taking a back seat.


Howard Penney

Managing Director


THE MACRO MIXER - When LEADING is LAGGING or just meaningless - 1


Fiscal 3Q10 was a great quarter and after listening to the earnings call, I was left thinking that everything seems to be working well.  Starbucks continues to have sales momentum, is investing in the right areas of the business and most importantly, has the financial flexibility to continue to do so.   However, as I said yesterday, expectations have caught up with the company. 


I have been confident in Starbucks’ ability to continue to yield better results in fiscal 2010, but I never expected the level of same-store sales growth achieved year-to-date in the U.S., particularly the 9% growth in 3Q10.  To that end, I have underestimated the company, but expectations will remain high as the company’s FY11 same-store sales guidance of low-to-mid single digit growth assumes a fairly steady improvement in two-year trends.  For reference, +1% same-store sales growth in the U.S. in FY11 would imply a 350 bp improvement in two-year average trends from FY10 (assuming 6.5% growth for FY10).


I think same-store sales and margin growth will continue to materialize in FY11 but the rate of growth will slow and the company’s ability to continue to surprise to the upside from both top-line and bottom-line perspectives will likely diminish.  That being said, I think the stock still makes sense on a long-term basis as the company stands to benefit from continued leverage of its existing store base, international growth, its increased investment in marketing and its pursuit of additional platforms of growth (largely VIA and Seattle’s Best Coffee). 


Given current expectations and the stock’s recent performance, getting the right entry point matters most.  Below I provided Keith McCullough’s long-term buy TAIL and sell TRADE levels.




Relative to our restaurant sigma charts that look at same-store sales and restaurant-level margin growth, Starbucks is likely to remain in the “Nirvana” quadrant in fiscal 4Q10 with both positive same-store sales and YOY restaurant-level margin growth.  Management guided to mid single-digit comp growth in both the fourth quarter and for the full year.  A +5% number implies a 50 bp sequential improvement in two-year average trends.  For FY11, I am modeling positive same-store sales and restaurant level margin growth; though the company may dip out of “Nirvana” from quarter-to-quarter as a function of difficult comparisons.




Starbucks Read-Through:


We know now that Starbucks had a strong quarter, particularly from a top-line perspective in the U.S.  I do not think these strong results, however, should be interpreted to mean that we will see similarly strong demand for the remainder of the restaurant companies left to report calendar 2Q10 results.  To recall, we already know that casual dining trends on average, as reported by Malcolm Knapp, slowed about 50 bps in 2Q10 on a two-year average basis from the prior quarter.



Howard Penney

Managing Director

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No Pain, No Gain

Position: Long British Pound (FXB); Short US Dollar (UUP)


We’ve been vocal about the longer term benefit for economies that turn to austerity measures NOW to rein in bloated deficits. In making this call we’re by no means blind to the reality that over the intermediate term (1-3 years), austerity in forms such as higher consumption and income taxes, wage freezes, and job cuts (via trimming government positions and halting public works projects) should depress growth levels. This is the new reality!


Europe has already shown leadership in belt tightening, with the government of UK Prime Minister David Cameron holding the spotlight as lead horse. We believe the gains in both the British Pound versus the USD and the stabilization of the EUR versus the USD are the market’s bullish near-term reaction to Europe’s fiscal management.  While Europe’s sovereign debt issues are far from rear-view, the next question on our plate is the US’s response to its own debt and deficit imbalances, which we’ll be addressing in our next monthly theme call.


For now, we’re analyzing the fundamental macro data as it comes in and comparing movements in the market to the political and economic policy throughout the global economies we follow.  One notable data point released today was UK retail sales, which rose +0.7% month-over-month in June, and is showing an improving positive trend over the last three months. While we accredit this to the World Cup and promotional deals, the retail sales curve nevertheless looks very different in the US over the last three months (see chart below), a point worth highlighting.


Certainly, understanding the macro forces that influence economies is never an exact science. However, what stands out is that over the last months the jobless picture and consumer and presidential confidence have deteriorated in the US.   Conversely, across the pond in the UK a marginal level of optimism has paralleled the change in political leadership in May and the fiscal tightening measures announced since. We’re by no means bulled up on UK equities (or we’d have a position) and are cautious about economic fundamentals in the back half of 2H10. What’s clear, however, is that the current divergence between US and UK economic policy is flashing a clear signal to us from a currency standpoint, namely the divergence between a strengthening Pound and deteriorating USD.


We stand behind our short call on the USD via the etf UUP and long call on the British Pound (FXB), which we initiated in our virtual portfolio on 6/7/10 and 7/12/10, respectively. 


Matthew Hedrick



No Pain, No Gain - a1


No Pain, No Gain - a2


Not much to dislike for now. Here are our notes from the recently ended conference call.



“Starwood’s global footprint and strong brands drove the Company’s second quarter revenues and earnings above expectations. Average daily rates are back into positive territory as occupancy levels continue their steady ascent towards pre-crisis levels... While global lodging demand is solid, the economic outlook around the world remains unpredictable. We will continue to plan for a range of potential scenarios, but each entails a focus on driving top-line growth with strong discipline in our cost base. We remain cautiously confident in our near-term outlook and are bullish over the long-term given our growth prospects.”

- Frits van Paasschen, CEO



  • Longer term, they are bullish about getting more than their fair share of growth in emerging markets
  • Rebound in business travel is the story behind their growth - which makes up 75% of their revenues
  • Total group business on the books is actually not down. Business travel back to 2008 levels
  • Rebound in business travel will help in their corporate rate negotiations
  • Accruals for incentive comp have gone up due to better than expected results
  • So far, they haven't seen any slowdown from the global turmoil, but they wouldn't really see it until the fall anyway
  • 52% of their hotels are located outside the US. 85% of their pipeline will open outside the US
  • 2/3 of their hotels are either new or newly renovated (over the last 5 years)
  • They would consider splitting off a REIT but only under the right circumstances
  • Today, they are seeing an increased interest in lodging assets despite money being on the sidelines for now
  • 55% of owned EBITDA was generated outside the US. 2500 rooms are leased. 18,000 are wholly owned.
  • 18,000 rooms that are 100% owned:
    • 60% of those rooms don't need much capex
    • 2,500 rooms need renovations subject to sale
    • Transaction with partner hotels- big boxes that need renovations or repositionings - about 15% of their rooms
  • 3,000 rooms in unconsolidated JV hotels
  • Cash from timeshare expect to generate north of $500MM over the next few years from this business
  • Think that they can offset 50% of cost inflation and so far, they have not had to increase headcount despite the large increase in occupancy
  • SPG members account for 40% of their websites
  • Luxury brand RevPAR is up 15% YTD
  • Investor Day at the St. Regis NY on Dec 8th
  • Asia continued its sharp recovery - China led the charge with RevPAR up over 40%. Comparisons get tougher in 2H- so the rate of growth will slow down.  Accounts for 60% of their 80k room pipeline,
  • North America - RevPAR accelerated from 12.6% in April to 14.6% in June. NY, Chicago and Toronto were their strongest RevPAR cities.
  • Group room nights were up 16%, rate down 3%.  Transient rates were up 5%.
  • June owned hotel RevPAR grew 27%, with rates up 9%.
  • In the year, net room production is running at 3x 2009 levels.  Reducing less attractive leisure channels to manage yields.
  • YoY RevPAR growth will be lower in 2H given the more difficult comps
  • In Europe - London, Paris, Frankfurt and Vienna had strong occupancies- in the 90's in June. Trajectory of the recovery in Europe is slower than in the US.  Weak Euro will help them (volume wise) in 3Q, but timing of Ramandan will hurt ME travel demand.
  • Middle East - 3Q - Ramandan will impact August results
  • Latin America will lap H1N1 swine flu next quarter
  • Returning to peak margins is their #1 goal.  Expect margin improvement to continue into the back half.
  • SG&A growth had a funky comp, as in 2Q09, as they were reducing accruals for incentive comp
  • Vacation ownership business can best be described as sluggish.  With consumer confidence declining, they don't see any improvement in the back half.
  • Are aware and sensitive to some leading indicators turning negative.  However, at this point, there is no sign of a slowdown in their business.
  • Leverage ratio is now below 4x.  They are working on a securitization deal which should happen in 3Q.  Expect net debt of $2.5BN by year end.



  • Asia Pacific - 18% of their fee-based business, but a larger % of their pipeline (over 50%).
    • Right now RevPAR in Asia is approaching pre-crisis levels
    • Appreciation in the Yuan would help them
  • Their flat headcount commentary was referring to headcount at the corporate level.  At the property level, they continue to try to improve operating efficiencies and by doing so, they expect that they can keep expense growth to 50% of inflation. Productivity in NA hotels is up 7%.
  • Are seeing the impact of the Sheraton revitalization program. The Sheraton RevPAR is outperforming its peer group by 300 bps.
  • Selling hotels in 2010?
    • If the price is right and the agreement is right, they will consider it
    • If they get the point of considering a bigger transaction, they would consider a REIT spinoff vs. selling to an individual buyer
  • Looking for high single digit increases for corporate negotiated rates
  • Booking windows?
    • Corporate transient is always short and hasn't really changed
    • Sense is that group business is shorter given the pent up demand. Sense is that once they get to the back half of 2010 and 2011, that the pent up and catch up demand piece will go away and that the overall booking window here will return to a more normalized level.
  • Uses of FCF?
    • Past behavior should be a good indicator on what they would do... special dividend/ buybacks/ brand acquisitions.
  • How long can they keep selling timeshare without developing more?
    • A few years...


Operators’ hiring expectations are almost at pre-recession levels.


According to the People Report Workforce Index, 42% of respondents to a survey of restaurant operators said they expect to add hourly workers in the third quarter while a mere 5% plan to cut labor.  None of the respondents plan to fire managers while almost 50% plan to hire at the management level.  According to an article published by National Restaurant News, approximately 50 restaurant companies from quick service, fast casual, casual dining, and fine dining, responded to the survey.  From the results of the survey, it seems that quick service and fast casual are poised to do more of the hiring.  Hiring accelerated in the first half of 2010 with restaurants hiring 64,000 employees during the period.


Despite the slew of negative economic data emerging of late and the reported slowdown in casual dining trends as reported by Malcolm Knapp, reflected in the recent downturn in stock prices, it seems that restaurant operators are seeing a need for larger labor forces in their restaurants. This could be a leading indicator for an uptick in demand.  The possible pitfall of this thesis is that the People Report Workforce Index could be at “peak” levels, given business’ tendency to sometimes “hire at the top and fire at the bottom”.


RESTAURANT EMPLOYMENT - labor index restuarnts


Howard Penney

Managing Director

Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.48%
  • SHORT SIGNALS 78.35%