Europe by the Charts

Below we provide a number of charts we’ve been looking at recently in Europe. Taken together, we’ve been impressed with the fundamental data from Europe over recent weeks (especially compared to the US).  However, we caution that:

  1. August Data - we expect to see a sequential slowdown (month-over-month) in the fundamental data following the exuberance of the World Cup.
  2. Comparisons  - European markets will be pinned against significant macroeconomic headwinds in the back half of 2H10, including suppressed growth, consumer demand, and confidence as a result of government austerity measures.
  3. Housing - continued downward pressure on the housing market, in particular in Spain and the UK.
  4. Legacy - ongoing uncertainty about European bank exposure to sovereign debt, which were largely unaccounted for in the 91 bank stress test, and continued fiscal and political weakness throughout the region (more recently seen in Hungary).

On the margin, we maintain a bullish bias on German Equities (EWG) and the British Pound (FXB).


See our commentary below on the charts:

  • Eurozone (16) Confidence has improved over the last three months. Can this trend be sustained, especially post the World Cup?

Europe by the Charts - m1

  • The DAX and FTSE are trading above our intermediate term TREND lines, a bullish leading indicator. We’re still looking for the FTSE to confirm its move on a TRADE basis (3 weeks are less) before we act in the Hedgeye Virtual Portfolio.

Europe by the Charts - m2

  • PMI Services have largely declined for western European economies over recent months, especially in Italy and UK. Germany and France, on the other hand, have shown strength and we’ll be looking to the next two months of data to determine a trend. We continue to believe that should Western European economies slide, Eastern Europe will follow due to its trade dependence on its western neighbors.

Europe by the Charts - m3

  • While the Manufacturing sector contributes a much smaller share than the Services sector across European economies, the manufacturing PMI is nevertheless an important leading indicator that we follow. Here, Germany is leading its peers.  Overall, we’d expect manufacturing to slip before services in 2H10.

Europe by the Charts - m4

  • Germany is one economy in Europe that we have a bullish bias on. For now, business confidence (below) and consumer confidence surveys have been decidedly bullish since the beginning of 2009. The recent weakness in the EUR-USD (compared to recent years) has bolstered sentiment for Germany’s export oriented economy.

Europe by the Charts - m5

  • One number we focus on is factory orders. On an annual basis we continue to caution that the recent moon shot numbers need to be considered in light of the compare—rock bottom trough levels. This “easy” compare will fade in September. However, the most recent data on a month-over-month basis saw factory orders improve 3.2% in June.  

Europe by the Charts - m6

  • The cash for clunkers programs issued in 2009 throughout European countries boosted sales for German automakers. Reviewing Q2 earnings calls from European automakers, sales were largely mild or flat on the continent, with sales growth particular strong from China. Due to the headwinds we’ve presented, our fundamental outlook suggests that demand from Europe and the US should stay low or erode further.  

Europe by the Charts - m7

  • On the TAIL (3 years or less) this chart below will continue to be an important one to return to. We expect Asia (in particular China) to increase its market share of imports from Europe as exports to the US decline.

Europe by the Charts - m8


Matthew Hedrick


Hyatt's 2Q results beat the Street's EBITDA estimate due to a $6MM Rabbi trust benefit. While the results were still "good," they lacked the "wow" factor from their 1Q, and RevPAR didn't show the same sequential acceleration as those of other lodging companies.



Owned and Leased Hotel revenues of $483MM were materially lower than we estimated primarily due to weak F&B and other revenues. Owned and leased EBITDA also missed our mark.  Here are our takeaways:


The not so great:

  • ADR was lower than we estimated – given that Hyatt’s ADR was only down 40 bps for full service owned hotels, we expected slightly positive ADR this quarter.
  • Unlike Host and HOT, Hyatt didn’t experience strong growth in their F&B and other revenues.  We estimate that this category was up about 1% YoY
  • Pro-rata share of JV properties was flat YoY at $18MM compared to a 40% YoY lift last quarter

On the positive end:

  • CostPAR was down 5.9%, compared to  down 5.3% in 1Q09 on a much tougher comp.  In 1Q09, CostPAR was down 2.1% vs. being down 6% in 2Q09.
  • Put another way total implied costs increased only 3% YoY despite the large occupancy increase

Management, franchise, incentive & other revenues were $2MM below our estimate, but margins on the business were much better.  Thus, EBITDA contribution was $3MM higher than we expected.  If you take the difference between the $64MM of fee revenue and $59MM of EBITDA, the implied costs of the business were only $5MM.  This compares to $12MM of implied costs last quarter and $40MM of implied costs in 2009.


Other stuff

  • If not for the $6MM Rabbi Trust benefit, Adjusted EBITDA would have missed the street by $2MM. Well, at least now we know that 3Q09 was negatively impacted by $7MM of rabbi trust expenses – so the clean SG&A comp is $59MM.
  • D&A was $5MM below our estimate- not sure why it would have declined $4MM sequentially either
  • Interest expense was $3MM lower than our estimate


There are plenty of reasons for optimism and pessimism.  Optimism is winning for now


Looking at the price action yesterday, I had to scratch my head.  MSSR and MRT were up on big volume following their earnings releases the day prior.  Although McCormick and Schmick’s saw a 100 bp improvement in two-year average same-store sales, the 4% decline in comps was below expectations.  Furthermore, guidance for the year was lowered across the board; revenue guidance was lowered by $10 million and EPS guidance was lowered by 5 cents on both sides of the range.  Management said that the guidance revision was “based upon the impact of the Gulf oil spill on the second quarter and the uncertainty of the potential effect the publicity centered around the Gulf oil spill may have on our business for the second half of the year”.  Since the earnings call, there have been several positive news items emerge about the progress being made to “kill” the Macondo well in the Gulf of Mexico.  With certain areas of the Gulf of Mexico being given permission to resume commercial fishing, perhaps this incrementally positive news is being taken on board by investors.  However, public perception of Gulf sea food safety will likely take some time to recover, irrespective of FDA assurances. 


MRT saw a deceleration in two-year average top line trends when adjusted for the 2% Easter-related calendar shift.  The 7.1% headline number certainly was an upside surprise, and the 5.1% underlying comp was about in line with Street expectations.  In terms of the guidance management provided, however, it seems that they might have a difficult time meeting it.  3Q and fiscal year guidance assumes significant improvement in two-year average trends.  To accomplish a 4% same-store sales number in 3Q (the low end of the +4% to +6% guidance), two-year trends need to sequentially improve 310 bps from the 7.1% print (410 bps from the underlying 5.1%).  The low end of the full year +4% to +6% comp guidance target will require an additional 400 bps in two-year average trend improvement in 4Q. 


Despite the +7% to +8% same-store sales growth during the last two weeks of July, the recent choppy nature of sales at MRT (as described by management during the earnings call) is a reason for concern.  Based on management commentary during their recent earnings call, there is nothing specific that seems to support the notion that comps will level out at a strong level rather than the “soft” levels seen in late June and early July.  It is possible that there are initiatives or strategies that management did not disclose, but as yet the source of their confidence is unclear.  It is possible that the improvement in business travel reported by some lodging companies, and cited by Morton’s, has buoyed investor sentiment toward companies with exposure to this group.  The relative outperformance of PFCB yesterday lends credence to this view – about 30% of the Bistro’s tickets are driven by business spending.


In other news, an article on entitled “Consumer Rank Favorite Restaurant Chains” had some interesting data points on the consumer.  Specifically, the article says that the Market Force survey indicates that one in four consumers plan on eating out more in the coming months and they are driven to brands showcasing strong consumer service elements. 


 TALES OF THE TAPE - stocks 85


Howard Penney

Managing Director





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Jobs, Jobs, Jobs .... Still No Signs of Progress

Initial claims rose by 19k last week to 479k (rising 22k net of the revision).  Rolling claims came in at 458.5k, a rise of 5.25k over the previous week. This is the largest increase in the rolling series since early April, but it still remains in the range of 450-470k that it has occupied for all of 2010. Ultimately, we are still looking for initial claims in the 375-400k range before unemployment meaningfully improves. 


Our firm is of the strong view that US economic growth is going to slow markedly in the back half of this year and into 2011. We think this will keep a lid on new hiring activity and will keep cost rationalization paramount in the minds of C-suite executives. All of this raises the risks that a prospective slowdown in GDP will precipitate an incremental slowdown in hiring/pickup in firings, which will, in turn, further pressure growth. We continue to look to claims as the best indicator for the job market, as they are real time and inflections in the series have signaled important turning points in the market in the past.






As a reminder, May was the peak month of Census hiring, and it will remain a headwind through the September data as the Census continues to wind down.




Joshua Steiner, CFA


Allison Kaptur


As we look at today’s set up for the S&P 500, the range is 16 points or 1% (1,116) downside and 0.4% (1,132) upside.














Digging deeper into the incremental R&D



The vagaries of GAAP accounting force companies to expense Research and Development expenses as incurred.  In the slot industry, some R&D is indeed maintenance but much of it benefits future periods and could be considered investment spend.  WMS fell 3% yesterday – it was actually down more than 6% at one point – due in part to guidance for higher R&D reducing EPS by $0.10-0.12 in FY2011.


Would anyone care if R&D expenses were capitalized and WMS jacked them up by $10m?  Think about it.  Applying a 20x multiple on the $0.10 FY2011 hit yields $2 in value loss versus $0.17 ($10m divided by 58m shares) in stock value if R&D was accounted for as investment spend – and that would assume zero ROI.  So the real question is whether the incremental R&D is recurring, i.e. maintenance, or is it true investment?.  We think the latter.


While management was a little stingy with details of the incremental R&D spend, we’ve got some juice:


Incremental R&D

  • $10m step up has to do with networked gaming – WageNET
  • WMS has gotten a very favorable response to the WageNET products that are a few years out.  Customers want the products sooner rather than later. 
  • Essentially accelerating the commercialization of WageNET
  • Being opaque for competitive reasons (but some of it is what they’ve talked about like cashless account-based wagering)
  • Opening India too, so they can work around the clock
  • Won’t see a revenue benefit for 12-15 months

WMS has no debt and operating cash flow is finally ramping.  The beauty of the model is that they can grow and still generate positive cash flow.  The high class problem is where to spend it.  Share buyback?  Yes - $300 million worth.  Invest in the business?  Yes - $10m incremental in R&D and $40m in incremental Capex for Italy, leased games, and growing/refreshing the participation base.  Rather than detracting from value, these expenditures will generate future ROI and should be accounted for as such.

Early Look

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