Conclusion:  While this was a solid quarter for CAKE, the company keeping quiet on the impact of the small plate menu on the average check is telling; traffic and price alone will not keep this company on the right trajectory.


CAKE comparable store sales at both concepts, Cheesecake Factory and Grand Lux, came in ahead of the street’s expectations.  EPS of $0.37 was comfortably ahead of the consensus of $0.34 (although helped by a lower tax rate).  Looking at CAKE’s position on our SIGMA chart, which measures comparable sales growth against restaurant operating margin growth, the company remains in the optimal “Nirvana” quadrant with both metric showing year-over-year improvements.


CAKE: GOOD BUT NOT GREAT - cake sigma 1022


Looking at the top line, blended same-store sales growth of 2.8% handily beat the consensus estimate 1.6%.  Imbedded in the comp was 2.8% traffic and 1.3% of price.  This implies that the company experienced mix of -1.3%.  While management was averse to discussing the impact of small plates and snacks on average check during the earnings call, there is clearly an issue there.  The only instance where management touched on “check management” was in reference to a “sequential stabilization” in non-alcoholic beverage incidence rates.   Should this trend continue, as management rightly pointed out, it would enable the company to capture more of its menu price increases.  I will watch this space – one quarter does not a trend make.   The main takeaway is that – over several quarters now – CAKE has had an average check problem and it is not going away.


Unit growth guidance was certainly positive.  Management guided to six-to-nine new units for 2011, a sharp increase from three new units in 2010 (the last opening for 2010 was completed in 3Q). 


Turning to the bottom line, there were several factors that contributed to the impressive earnings growth in the third quarter.  As was the case in 2Q10, the company gained leverage on the following expense lines in the P&L: 10 bps of leverage on labor costs, 60 bps of leverage on other and operating costs, 40 bps on D&A, and 30 bps on G&A.  COGS were up as a percentage of sales by 50 bps. 


In terms of commodity cost guidance for 2010, the company adjusted its prior guidance of flat-to-1% to a new outlook of 1%-to-1.5%.  CAKE is vulnerable to price fluctuations (or moves straight up) in several commodities where the company is not locked in on a price but dairy was singled out as one example by management. 


All in all, a strong quarter from Cheesecake Factory and the concept has strong consumer position.  The decline in average check is definitely a red flag. 


Howard Penney

Managing Director


Our FQ4 and FY2011 estimates are below consensus but above the fear line 



The long-term fundamentals for the gaming supply sector are very compelling.  We believe we are at the beginning of a five year bull run in slot demand that could drive industry EPS up 20-25% CAGR over that period.  New markets and a simple normalization of replacement demand will be the drivers.  The over/under of the start of that cycle seems to be about 18 months.  We'll take the under. 


IGT is particularly compelling because sentiment is so poor surrounding this perennial market share loser.  However, we think June and September quarter market shares are unsustainably low.  Market share should pick up.  The buy side seems to be expecting around a $0.15 quarter and guidance in the $0.75-0.80 for fiscal 2011; too low in our opinion.  We think there are interested buyers who don't want to get in front of this quarter, which sets the stage for a relief rally.


We expect IGT to report $0.18 this quarter and assuming that IL shipments gets delayed until their F4Q2011, they can still produce $0.87 cents of EPS next year.


We’re not expecting a lot of cheerful news this quarter.  We know that there aren’t a lot of new openings in NA and that the new opening and expansion picture will be even worse through June 2011.  Replacements haven’t picked up yet, and we’re only expecting a Grand Total of 13,000 total shipments into NA this quarter.  Yes, the environment is ultra competitive: Konami is firing on all cyclinders; WMS is rumored to be unveiling a new poker product at G2E which we have also suspected since their Analyst Day – and if successful, will be another hit to IGT. 


So what is there to get excited about?  Well, EPS whisper expectations are too low as is IGT's current market share.  IGTs has been underearning its fair share, in our opinion, so share should begin to improve in December.  Its content has gotten a lot better.  Also, IGT can juice its EPS by about $0.10 by taking out its Convert. 


However, the big prize will be a pick up in replacement demand and there is some visibility there.  Large customers are getting "fit"; Harrah’s just got its balance sheet in “good” shape and is doing an IPO; STN is also in the clear; gaming operators have had enormous rallies this year; and the heighted M&A environment may just mean that some of the gaming assets that have been on their deathbed get a fresh infusion of capital - all of which point to an eventual sharp pickup in replacements.  As we've written about, recently introduced favorable tax depreciation laws should help, especially considering that the 2004 peak of the Ticket In/Ticket Out replacement cycle will be rolling off the 7 year tax depreciation schedule next year.


The following is our projections for the quarter:


F4Q2010 Detail

  • Product sales of $203MM at a 50% gross margin
    • We estimate that IGT will ship 3,550 units to North America at an ASP of $14,500
      • We estimate 2,700 replacement shipments and 700 new shipments and 150 deferred
      • IGT will recognize most of their Sugarhouse shipments this quarter but Cosmo shipments won’t get recognized until F1Q2011
    • We estimate 6,225 international shipments at an ASP of $10,300
    • North American non-box sales of $55MM and international non-box sales of $32MM
  • Gaming operations revenues of $273MM at a 60% gross margin
    • We expect a flat sequential install base and average win per unit of $50.3
  • Other stuff:
    • SG&A: $81MM, including $2.5MM provision for bad debt
    • D&A: $20MM
    • R&D: $53MM
    • Net interest expense: $25.5MM
    • 38% tax rate


TODAY’S S&P 500 SET-UP - October 22, 2010

As we look at today’s set up for the S&P 500, the range is 13 points or -0.53% downside to 1174 and 0.57% upside to 1187.  Equity futures are lower tracking European equities.  Little movement ahead of the outcome of the G20 meeting in South Korea.


No major economic data is expected today.

  • Align Technology (ALGN) 4Q EPS, rev. forecasts trailed est.
  • Inc. (AMZN) 4Q op. income forecast missed est.
  • American Express (AXP) 3Q EPS beat est.
  • Barnes & Noble (BKS) may face trial in lawsuit over bookstore buyout 
  • Boeing (BA) considering boosting 737 production rate to 40/month vs current 31.5 now
  • Cephalon (CEPH) xercised its options to acquire BioAssets Development for $12.5m
  • Cheesecake Factory (CAKE) 3Q EPS beat est.
  • Chipotle Mexican Grill (CMG) sees 2010 comp sales up in the high single digits 
  • Citrix Systems (CTXS) sees 4Q rev. ahead of estimates
  • H&R Block (HRB US): CDS traders paid more to protect H&R Block’s debt against near-term losses than for longer-dated contracts
  • Lattice Semiconductor (LSCC) 4Q rev. forecast below est.
  • Manpower(MAN) 3Q EPS beat est.
  • NCR (NCR) raised 2010 adj. EPS forecast
  • News Corp. (NWSA) will reassign employees working on Project Alesia after failing to attract enough interest from other news organizations, the Post Chronicle, citing a person familiar.
  • Playboy Enterprises (PLA) expects to record charge >$20 m charge in 3Q on writing down TV programming inventory
  • Polycom (PLCM) 3Q EPS beat est.
  • Riverbed Technology (RVBD) 3Q adj. EPS, rev. beat est.
  • SanDisk (SNDK) sees 4Q rev inline, gross margins lower


  • One day: Dow +0.35%, S&P +0.18%, Nasdaq +0.09%, Russell 2000 (0.57%)
  • Month/Quarter-to-date: Dow +3.32%, S&P +3.42%, Nasdaq +3.84%, Russell +3.25%
  • Year-to-date: Dow +6.89%, S&P +5.84%, Nasdaq +8.40%, Russell +11.63%
  • Sector Performance: Consumer Disc +0.58%, Industrials +0.81%, Consumer Spls +0.35%, Healthcare +0.26%, Tech +0.08%, Energy (0.03%), Financials (0.03%), Materials (0.03%), Utilities (0.43%)


  • ADVANCE/DECLINE LINE: -59 (-1625)
  • VOLUME: NYSE - 1055.91 (-4.09%)
  • MARKET LEADING/LAGGING STOCKS YESTERDAY: Flir +6.37%, Ebay +5.96% and Suntrust +4.48%/Janus Capital -5.90%, Tesoro -5.60% and E*Trade -4.14%.
  • VIX: - 19.27 -2.63% - YTD PERFORMANCE - (-11.12%)
  • SPX PUT/CALL RATIO: - 1.70 from 1.93 -11.57%


  • TED SPREAD - 16.88 0.203 (1.217%)
  • 3-MONTH T-BILL YIELD 0.13% -.01%  
  • YIELD CURVE - 2.20 from 2.16


  • CRB: 295.00 -1.15%
  • Oil: 82.56 -2.40% - BULLISH
  • COPPER: 378.15 -0.32% - OVERBOUGHT
  • GOLD: 1,324.35 -1.63%% - BULLISH


  • EURO: 1.3938 -0.16% - BULLISH
  • DOLLAR: 77.418 +0.32%  - BEARISH



European markets:

  • FTSE 100: (0.44%); DAX (0.13%); CAC 40 (0.14%)
  • European markets are lower in morning trade ahead however good earnings figures have limited the downside.
  • Ericsson is the standout gainer on the back of good Q3 figures. The numbers also boost the Technology sector.
  • Basic Resources is the worst performing sector tracking weak metals prices.
  • Construction sector crumbles after Investec downgrades all major UK house-building stocks.
  • Germany Oct IFO Business Climate index +107.6 vs consensus +106.5

Asian markets:

  • Nikkei +0.54%; Hang Seng (0.56%); Shanghai Composite (0.28%)
  • Asian markets ended the day mixed as investors remained on the sidelines and chose to wait and see what happens at today’s G20 meeting in South Korea.
  • Japan September supermarket sales (0.3%) y/y vs prior (0.8%) 
Howard Penney
Managing Director

THE DAILY OUTLOOK - levels and trends














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The Macau Metro Monitor, October 22nd 2010


Jacobs claimed LVS breached his employment contract and owes him millions of dollars in salary, bonuses, and stock options.  Mr. Jacobs' attorney, Don Campbell, wrote that Adelson told Jacobs to use "improper leverage against senior government officials of Macau" in order to obtain title to apartments.  Jacobs also alleges that Adelson told him to "threaten to withhold Sands China business from prominent Chinese banks unless they agreed to use influence with newly elected senior government officials of Macau in order to… obtain favorable treatment with regards to labor quotas and table limits."


The court papers also allege that Adelson ordered that "secret investigations be performed regarding the business and financial affairs of various high-ranking members of the Macau government so that any negative information obtained could be used to exert 'leverage' in order to thwart government regulations/initiatives viewed as adverse to LVSC's interests."


"While Las Vegas Sands normally does not comment on legal matters, we categorically deny these baseless and inflammatory allegations," said Sands spokesman Ron Reese. "From here on out, we will let the process work its way through the appropriate legal system."



The Macau Property Opportunities Fund announced that its ‘The Waterside’ project, in One Central, currently has an occupancy of 35%.  The fund said leasing activity at 'The Waterside' continue to be strong as market conditions strengthen.



 The Urban Redevelopment Authority (URA) showed that overall private residential prices in Q3 rose 2.9% QoQ from the second quarter, a sharp decline from the 5.3% growth in the previous three months. Estimates were for 3.1% growth.

Being a Lady

“Being powerful is like being a lady. If you have to tell people you are, you aren't.”

-Margaret Thatcher


America (she) is a great country and I’m proud to be an American!  When are we going to behave like the powerful nation we are?  


Sadly, of late, we need to keep reminding people how powerful we are.  We do have tremendous power and this is a great nation, but right now we lack the backbone and the political leadership to make the tough decisions to get us on the right track.  (And, no, I do not believe the Tea Party is the answer).   


Case in point #1 - Treasury Secretary Tim Geithner 


Mr. Geithner is in the hot seat today because he is representing the USA on the world stage in Seoul, South Korea at the G20 summit this weekend.  His quotes in the WSJ yesterday are a sign of weakness, not strength.  Just one example: “We would like countries to move toward a set of norms on exchange-rate policy."  Seriously, the Chinese are having a field day with that comment.  As issuers of the world reserve currency, it’s embarrassing that successive administrations have led us down this path.


Another embarrassing quote: "Right now, there is no established sense of what's fair".  What? C’mon, Mr. Geithner, what is not fair?  Given his record of paying taxes, some might find it amusing that Geithner is our guy in Seoul, making the moral case.  Some might say he lacks legitimacy in such a claim.  The same might be said by the international community: why is America pointing fingers when it is plainly obvious that failed economic policies and Washington DC dogma has rendered the U.S. economy and currency in their present states?  The Chinese march to the beat of their own drum and look out for their interests.  What part of that is not fair?


The countries with strong economic and fiscal policies are being forced to embrace capital controls to slow the inflows of speculative cash that is coming from the USA.  It’s not unfair, it’s embarrassing!  Nobody cares about the losing team complaining about the officiating or the lack of sportsmanship from the other team; at the end of the day, all that is remembered is who lifts the trophy.


Case in point #2 - Failed Washington policies - Stress Tests 2 is on the way


I could go in multiple directions with this one (TARP, Healthcare reform, etc….), but despite the Dodd-Frank financial regulatory act, the US financial banking system is still facing a high level of systemic risk.  The foreclosure fiasco is posing systemic risks to a number of financial intuitions, and I don’t believe the first round of bank stress tests contemplated a breach of contract in securitized mortgages.  This is a problem.  Who knows what other omissions the stress tests made from their “analysis”?


While today is the 103rd anniversary of the Panic of 1907, which led to a run on the Knickerbocker Trust Company, we are seeing another crisis emerge at a number of large financial institutions.  The 13% month-to-date decline in Bank of America is not a run on the bank, but it’s frightening nonetheless.  There is no immediate threat of Bank of America being insolvent, but the damage to the bank’s reputation is immeasurable and the financial liability is uncertain. 


If we have learned anything over the past two years, the downside scenario is that the losses are likely greater than the $47 billion that a few institutions want back.  Importantly, the latest round of uncertainty in our financial system is not helping consumer confidence and will make most financial institutions more cautious about extending new credit, further slowing the recovery.


It would seem that it’s just a matter of time before the Stability Oversight Council created by the Financial Regulatory Act orders Stress Tests 2.  


Case in point #3 - No credible plan


While Mr. Geithner can cry this weekend that things are not fair, nobody in Washington (Democrat nor Republican) has put forth a credible plan to fix the nation’s problems except for more QE.    


As my colleague Daryl Jones noted in a post yesterday on Canada, for the second time in the last 30 years, the Canadian Dollar is now worth more than the US Dollar.  In short, Canada cut spending and improved the corporate tax environment, which narrowed the deficit and reduced government borrowings. 


Austerity, not quantitative easing, will provide Mr. Geithner the respect he needs to be powerful on the world stage.  Leaders make brave decisions at difficult times; there is no evidence of strong leadership on either side of the aisle in Washington today.


The S&P 500 is up 3.4% so far this month, on the back of the FED printing more and more money.  The potential headwinds for the market are seemingly being ignored (for now) but won’t go away.  The headline risks from the mortgage mess, slowing GDP momentum, margin pressure from higher commodity costs and lingering worries about the backlash that could emanate from the divergent fundamentals at work in the foreign exchange market can’t be solved by the FED and QE.


Margaret Thatcher was a leader that was unafraid to take a stand.  She was a divisive figure in Britain, and around the world, and remains so today.  I believe that America’s leadership could learn much from her example.  She allowed the gales of creative destruction to blow through the nation’s economy and many fault her for the demise of the mining industry in Britain in the 1980s. 


On that same point, many applaud her confrontation of the unions and credit her with reestablishing Britain as a world power.  My point here is that she made difficult decisions, perhaps made mistakes at times, but showed the leadership that was needed to boost her country. 


Much like President Obama, Thatcher had a record-low approval rating during her tenure as Prime Minister.  On average, it was 40%.  History has been much kinder; a survey conducted by Yougov/Daily Telegraph in the United Kingdom in March 2008 rated Baroness Thatcher as the leader Britons regard as the greatest post-World War II prime minister, receiving 34% of the vote.  Sir Winston Churchill came in second, with less than half of Thatcher’s support, at 15% of the vote.  Politicians that make tough decisions are not always appreciated immediately. 


Doing the right thing is not always easy.  The administration needs to realize that instant gratification and pandering for votes is not going to set this country straight.


Function in distaster; finish in style,

Howard Penney


Being a Lady    - mt

China Sets the World Up for a CRASH

“In Macro, everything that matters happens on the margin.”

-Keith McCullough


Conclusion: China’s 3Q and September economic data tells us a lot of what we already knew about China and even more about what we “apparently” didn’t know about the global economy – growth is slowing; inflation is accelerating. Further, China vs. QE2 = a catch-22 that won’t end well for this current global rally.


Chinese 3Q10 GDP growth came in at +9.6% YoY, 10bps better than consensus expectations. Despite the “beat”, the Shanghai Composite Index fell (-0.7%) – the largest decline since September 16 – on the back of nasty inflation data: 

  • CPI quickened in September to the highest YoY growth rate in 23 months: +3.6% vs. +3.5% in August.
  • Food inflation accelerated +50bps MoM in September to +8% YoY vs. +7.5% in August. As we have shown previously, roughly 36% of China’s citizenry lives on less than $2 per day (PPP), with food being their largest expense. That’s roughly 480 MILLION Chinese citizens who are being starved on the margin by Bernanke’s QE policy (CRB Foodstuff Index has a (-0.86) inverse correlation to the U.S. dollar since the June 7th peak in the dollar).
  • Chinese CPI is still 110bps higher than the benchmark one-year deposit rate of 2.5%, despite Tuesday’s 25bps rate hike. As long as inflation continues erode savings, speculation will continue to be a thorn in China’s side. 

The ugly inflation data combined with a marginal deterioration in Industrial Production growth (+13.3% YoY in Sept. vs. +13.9% in Aug.) to overshadow sequential upticks in retail sales growth, rural wage growth, and business confidence. Simply put, it’s not good when growth is slowing and inflation is accelerating; the absolute levels of growth and inflation are less relevant to astute investors. Think about the last stock you remember working when topline growth was slowing and gross margins were contracting.


As the chart below shows, 3Q10 marks the second straight quarter of China’s marginal stagflation:


China Sets the World Up for a CRASH - 4


What IS currently working in China’s favor is the Fed-sponsored, dollar-debased, yield-chasing rally we’ve seen globally. As such, Chinese equities, using the Shanghai Composite as a proxy, have rallied ~27% off their July lows.


We know China has been the world’s engine of growth for much of the last 18-20 months and, as expected, the data confirms growth is slowing. Now, China (AND THE ENTIRE WORLD) is in a serious catch -22: 

  1. According to the yield chasers of the world, the U.S. (China’s largest customer at ~20% of exports) “needs” QE2 to grow demand for China’s products.
  2. QE2 crushes the U.S. dollar, which puts upward pressure on the prices of things Chinese citizens and businesses have to buy – the U.S. Dollar Index has an inverse correlation of (-0.95) to the CRB Commodities Index over the last 3 months.
  3. China gets smacked with more inflation, which leads to incremental tightening of Chinese monetary policy. On Tuesday, China reminded everyone how serious they are about fighting inflation with an “unexpected” 25bps hike in their benchmark one-year lending and deposit rates. 

China’s rate hike Tuesday reminded everyone across the globe the amount of correlation risk associated with yield chasing fueled by excess liquidity. Therein lies the rub – more QE and China (the world’s growth engine) is forced to tighten incrementally or less QE and the global Fed-sponsored, dollar-debased reflation rally we’ve seen across nearly asset class comes crashing back down to economic reality.


I believe they call this “damned if you do; damned if you don’t.”


Our CEO, Keith McCullough, has been aggressively reminding our clients that at a point, dollar down becomes a very BAD thing. While our Chaos Theory mantra suggest that you never know which incremental granule collapses the sand pyramid, we are going on record saying that Chinese monetary policy will certainly catch a few finger points when it’s all said and done.


Elsewhere in China’s economy, we circle back to Chinese property prices as adding incremental fuel to the fire. China’s Property Prices (70 Cities) rose in September by +0.5% MoM, marking the first sequential uptick on a monthly basis since May. While prices decelerated on a YoY basis in September (+9.1% vs. +9.3% in Aug.), the +56% MoM gain in property sales value and +52% MoM gain in property sales volume exacerbate the slight monthly increase in prices in September and overshadows the  marginal deceleration of YoY growth in September.


China Sets the World Up for a CRASH - 2


This latest reading may serve to speed up China’s implementation of a nationwide property tax trial and may also provide additional incentive for China to raise interest rates, should real estate prices continue to go the wrong way. As long as the spread between inflation (blame QE2) and one-year deposit rates is negative, China will find it difficult to fully oust speculation from its property market, all else being equal. That alone makes a compelling case for further rate hikes, which will crimp China’s growth on the margin (Gross Capital Formation is roughly 45-50% of GDP).


On the positive side of Chinese rate hikes, Todd Jordan, our Managing Director of GLL, has shown rate hikes to be positively correlated with Macau Mass Gaming Revenue (0.75). “Moreover, interest rates were statistically significant in explaining the changes in gaming revenues with the highest t-stat present in the Mass [Revenue] to Interest rate equation”, he remarks.


China Sets the World Up for a CRASH - 3


The takeaway here being that interest rate hikes provide upward pressure on the value of the currency (yuan), which ultimately filters into increased consumer spending and consumer confidence. Raising the value of your currency can actually be good for your citizenry? (shhhh… don’t tell Heli-Ben).


At the end of the day, incremental Chinese monetary policy tightening is bearish for Chinese growth, which itself is bearish for the speculative bid that has buoyed many emerging market equity markets and commodities YTD. This round of Keynesian Rallies is near its end. Don’t be caught holding the bag when China pokes a hole in it – that is to say if we haven’t popped it ourselves by standing up to the Fed’s weak monetary policy.


Darius Dale


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