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MCD – Coffee conversion math!

Here are is what we know so far:
4Q07 – No comment from the company when asked on the conference call about the number of stores selling specialty coffee, but they did not expect to see critical mass until later in 2009.
1Q08 – “We are currently in about 1300 restaurants and expect the rollout to accelerate and pick up pace later in the year.”
2Q08 – “Specialty coffees is just one element of the combined beverage business and it’s currently in more than 1600 restaurants.”
3Q08E - ???

If we assume the company accelerates the conversion process in 2H08 and converts 1,200 stores, the total number of McDonald’s stores with the ability to sell specialty coffee in the US would be 2,800. This represents only 25% of the McDonald’s system! McDonald’s senior management has set expectations for a national launch for the specialty coffee program in mid-2009. If it has not started already, the 2009 budgeting process needs to incorporate the national launch of the specialty coffee program. If only 25% of the store base has the ability to sell specialty coffee, how can the company justify spending the marketing dollars in 2009? More importantly, will the franchise system embrace the move?

Right or wrong management is committed to the specialty coffee program, I believe they need to reset expectations.

The US Dollar Remains THE Factor...

The governing factor that will beget further immediate term strength in the US stock market, that is...

The US Dollar Index is defying the skeptics (including myself), continuing its rally in the face of an easy money US Federal Reserve. I am data dependent, and respecting this factor above all reasonable doubts. As the facts change, I will.

Today the US Dollar is up another 60 basis points to 77.16, taking its 1 month moon shot rally to +7.3%! This has led to a meltdown in everything commodities related, and provided the impetus for a bullish US stock market "Trade".

The "Trade" higher in the US$ is undeniably bullish, but will run out of momentum at the 77.55 level. I have attached the long term chart. All Bernanke has to do to extend this currency strength above my level, is step up to the plate and raise interest rates.

KM
  • Next level of resistance in the US$ is 77.55
(chart courtesy of stockcharts.com)

Yes, Asia Has Slowed!

Hong Kong reported the most important economic data point of the day, with a GDP report that slowed to +4.2% for Q2 of 2008, down sharply from Q1's year over year growth rate of +7.3%.

I have attached a chart of the meltdown in the Hang Seng Index, which has dropped -33% now from its October 2007 highs.

Today the Hang Seng led Asian equity markets lower, closing down another -1.1% at 21,160. Next level of support is 20,857.

Until this picture improves, fundamentally or quantitatively, there is absolutely no reason to buy into the notion that the worst of the global growth slowdown is behind us. This remains a fluid situation that I am monitoring very closely.
KM
  • Hang Sang's Collapse
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Chart courtesy of StockCharts.com

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PENN: BULLISH TRADE AND TREND

It seems that most of my gaming research and analysis has reached negative conclusions recently. At the same time, that same research keeps leading me back to PENN on the long side. Gaming operators have a liquidity problem. PENN has a liquidity bonanza. Gamers need to sell assets and de-lever. PENN is a buyer with no competition in a buyer’s market. Las Vegas is in serious trouble. PENN has no Vegas exposure but could buy into the market at the bottom. MGM, WYNN, LVS are still expensive. PENN is cheap and a valuation resistance discussion can’t be had until the stock has at least a 4 in front of it. Industry return on investment is dropping like swimming world records at the Olympics. Budgets are being busted and cash flows are declining. PENN’s capex is limited and what they spend on an acquisition (asset or company) will likely be at a discount. Unlike Colony/Station, Columbia Sussex/Aztar, ASCA/East Chicago, MGM/CityCenter, BYD/Echelon, etc., PENN won’t be buying at the top.

In my opinion, the two big themes surrounding this industry are liquidity and ROIC. PENN shines on both. Oh and by the way, PENN also shines on my partner Keith McCullough’s quantitative model.



LVS: UPDATE FROM THE GROUND IN SINGAPORE

Our man on the ground in Singapore reported back some interesting tidbits following meetings with government officials, academics, resort and construction companies, and local reporters. There seems to be some concern that LVS will not be able to open Marina Bay Sands by the end of 2009. As of this past week, 55% of the concrete has been poured and the facility is built up to floor 10 of 56. However, construction costs have exploded over the past year in Singapore and labor is tighter than it’s ever been. Marina Bay Sands may or may not open on time. It’s probably too early to tell, but with these conditions I would expect the budget to escalate from the current $4.5bn.

Typical chart of a new casino budget

Winning

Three more American gold medals were won in the pool last night, with Michael Phelps adding his 6th, pushing Team USA ahead of the Chinese in total medals by a score of 44 to 37. The Canadians have no medals.

My fellow Canadians and I can stay awake well into the night hoping for a bronze in synchronized diving or whatever it is that has less global competition, but our hopes are just that - hopes. Hope is neither an investment process nor a winning strategy when competing in a global grudge match. Confidence in a repeatable and disciplined daily research regimen is however, and that’s primarily why I come across overly proud of ours every morning.

As you might imagine, my morning thoughts elicit plenty of responses. Usually, the highest octane criticisms I receive land in my inbox within 3 minutes of the note’s distribution. Yesterday, I had one that said “good research, but hard to read”. On many counts, I think that view is fair. I am very aware that my writing style is overly confident.

We’re not in this game to appease personalities. We are in it to win it. If we score, we want you to, alongside us. My teammates are much more humble than I. Thank God for that! That gives us balance. The only way I know how to play is on the edge – that’s why our firm bears the name. I feel “smart” every morning because my teammates are. The underpinnings of the knowledge transfer mechanism in Wall Street Research are changing. Our highest conviction “idea” today, is that we know what this paradigm shift will look like tomorrow.

This morning’s pre market news is looking as light as yesterday’s trading volume did. What remains of the bullish “Trade” formation we are in should play out quietly as we move to the high end of my range. The most impressive moves remain in the deflating inflation “Trade”. The US Dollar’s positive correlation with the US stock market remains the most relevant macro factor to watch. The US$ Index is trading higher again this morning at 77.12, +7.3% since July 14th. Currencies in Asia and Europe continue their decline alongside commodity prices. I am going to bump up the high end of my S&P 500 range to 1316, from 1312 prior. Deflating commodity inflation is undoubtedly bullish in the immediate term. If we test the aforementioned 1316 line, the question will be what matters more from there, global growth or inflation slowing?

On the growth front, Asian markets were weak again on both an absolute and relative basis to global equities because Hong Kong joined Singapore and Japan as the latest Asian economy to report a major slowdown in GDP growth. Hong Kong reported a +4.3% growth rate for Q2, down sharply from +7.3% in Q1 of this year, and well below consensus expectations of a number closer to +6%. Singapore and Japan told us they are both running negative export growth this week, and now the lead article in the Wall Street Journal this morning goes something like ‘US Economic Slowdown Spreading Globally’. Gee, thanks for the proactive prediction ahead of time.

I have been penning my thoughts and themes about Asian growth slowing since Q4 of last year. This was in the face of Wall Street misleading Main Street and then ultimately itself. It was supposed to be “global this time” and the world economies were supposed to “decouple”… remember? In an investment community where I have sat at the most relevant tables of debate, am I proud to have raised my hand on the other side of this macro trade? You bet. If its “hard to read” good research, that’s better than having an easy time reading what was plain bad research back then.

Einstein said, “great spirits have always encountered violent opposition from mediocre minds”, and it’s hard to disagree with that. Ask Michael Phelps how much adversity he has faced in his life. Gold is minted in it.

Have a great weekend,
KM



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