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Bernanke Primes the Pump for a CRASH

Conclusion: While some strategists consider QE2 (or Quantitative Guessing as we’ve termed it) a bullish factor, we believe it won’t end well.  We outline below the market risk that Bernanke has been brewing which may potentially come to the forefront in the very near term.

 

Position: Short U.S. equities (SPY)

 

We don’t quite yet have a quantified way of measuring this, but we feel reasonably comfortable saying that, lately, Deflationistas have been awfully quiet of late. Perhaps watching nearly every commodity (outside of natural gas) make either a YTD or all-time high takes the wind out of their sails (on the margin, of course).

 

Fear not, supporters of Krugman’s Kryptonite; soon you may have plenty of deflation to fear monger about – particularly in equities and commodities. Both the S&P 500 and the CRB Commodity Index have inverse correlations to the U.S. Dollar Index north of 0.90 on a two-month basis (coincidentally, Bernanke got everyone excited about QE2 in Jackson Hole roughly two months ago). The chart below tells the story much better than my prose:

 

Bernanke Primes the Pump for a CRASH - 1 

 

If you don’t know, now you know. Equities weren’t going up globally on the strength of great earnings – and if they were, shame on those Year-End Bonus Peddlers for cheering on more stimulus and talking up bullish fundamentals at the same time.

 

The largest risk in today’s market (as it was the entire way up) is the interconnectedness of global risk, as evidenced by some of the lofty inverse correlations many equity markets globally have versus the U.S. Dollar over the last two months: 

  • Hong Kong: 0.96
  • South Africa: 0.95
  • Brazil, Mexico: 0.94
  • S. Korea, Singapore, Poland: 0.93
  • U.K., India: 0.87 

South Africa?? Poland?? Well, you get the point…

 

As Keith has been calling out on our Morning Macro Call seemingly every day for the past 3 months, at a point, dollar down becomes a very bad thing. Particularly, if the dollar catches a bid from a round of short covering, a lot of assets globally will come under pressure. Interestingly enough, we’ve had a measurable shift on the margin towards more hawkish monetary policy globally. In the last ten days alone, we’ve had: 

  • CHINA raised interest rates and called out inflationary U.S. monetary policy for accelerating price gains within their country
  • SWEDEN raised interest rates
  • AUSTRALIA’s Central Bank set the tone for a near-term rate hike
  • GERMANY’s Axel Weber (Bundesbank President) called for the ECB to phase out its bond purchase program
  • BRAZIL’s Finance Minister raised taxes again on foreign capital inflows; calls out against inflationary U.S. monetary policy for fueling “bubbles in emerging economies”
  • SOUTH KOREA is preparing measures to curb inflationary inflows of capital
  • GERMAN and CANADIAN Finance Ministers spoke out against U.S. dollar debasement
  • U.S.: Kansas City Federal Reserve President Tom Hoenig delivered a speech warning against the ill-effects of “pumping excessive liquidity into the banking system”
  • U.S.: Philly Fed Charles Plosser and former OMB Director Peter Orszag said flat out QE2 won’t help and it fails to address America’s real issues; risks Federal Reserve credibility
  • U.S.: PIMCO’s Bill Gross called out QE for what it is – inflationary and bad for both bonds and equities 

Not that we need Bill Gross or Peter Orszag to validate our conclusions, we do, however, appreciate the recent Plague of Sobriety that is spreading thorough the market. This week’s (-0.55%) TIPS auction yield explains just how worried investors are becoming of inflation – and rightfully so. If we’ve learned anything from the 1970’s it’s that nothing works from an investment perspective in periods of stagflation. The chart below gives you a prelude of what might become if QE2 is as heavy as some would like:

 

Bernanke Primes the Pump for a CRASH - 2 

 

Now, we’re mired in a slowing growth environment (email us if you’d like to see our presentations on why) and Heli-Ben seems heli-bent on creating inflation to the tune of a sustained +2% YoY in Core CPI. In our models, QE2 = Quantitative Guessing = Inflation; AND Inflation + Slowing Growth = Jobless Stagflation.

 

From a more immediate term perspective, the confluence of hawkish global monetary policy, hawkish fiscal rhetoric (see: Republican’s new plan to cut discretionary spending by ~$100bn as early as January), and the likelihood that the QE2 announcement will disappoint lofty expectations of $500 billion-$1 trillion is providing a bid for the dollar. We measure the spread of 30-year Treasury yields and 10-year Treasury yields as one gauge of the bond market’s expectations of QE2. That spread has started to come in recently, as 10-year yields have backed up meaningfully over the past 2 weeks. Today, however, on the news that the New York Fed is surveying its banker cronies to gauge market expectations for the size of the program and its impact on yields, the spread has inflected meaningfully. Today’s move might be a sign that the next week’s announcement is more likely meet consensus’ lofty expectations.

 

Bernanke Primes the Pump for a CRASH - 3 

 

As we’ve said before, Ben Bernanke, Charles Evans, and Bill Dudley have officially primed the pump for QE2, and in doing so, have fueled the two-month dollar-debasement rally we’ve seen across asset classes globally. If the size of the asset purchase program in next Wednesday’s announcement doesn’t meet market expectations, look out below. If the market crashes, which we think is in the realm of noteworthy probability, there will be no one to blame but these three amigos. If their announcement satisfies expectations, then the “look out below” simply gets extended in duration, as Jobless Stagflation begins to show up in the reported numbers in 2011 (unless, of course, they change the CPI calculation again).

 

Bernanke Primes the Pump for a CRASH - 4 

 

Should the QE2 announcement miss expectations there’s no meaningful downside support to 1,113 on the S&P 500.

 

Bernanke Primes the Pump for a CRASH - 5 

 

Should QE2 fail to have the desired impact of stimulating growth, what will the next bullish catalyst be? QE3? We have to look no further than Japan to see how this game of failed monetary policy will end. I believe they are on QE86 after 20 years of economic malaise.

 

Darius Dale

Analyst

 

Bernanke Primes the Pump for a CRASH - 6


HOT 3Q2010 CONF CALL NOTES

In line quarter but Q4 guidance below.  2011 guidance looked strong but similar to MAR, is there enough visibility for high single digit RevPAR guidance?


“We were able to beat expectations thanks to our top-line growth initiatives that powered third quarter REVPAR results. Our distinctive and compelling brands are gaining share, and our strong presence in the key global cities positions us well to benefit from the return of the business traveler.”

- Frits van Paasschen, CEO

 

HIGHLIGHTS FROM THE RELEASE

  • WW System-wide REVPAR (SS): +10.0% (11.1% in constant dollars)
  • System-wide REVPAR (SS) in North America: +10.6% (10.0% in constant dollars)
  • Worldwide SS company-operated gross operating profit margins: +140bps
  • Worldwide REVPAR for branded SS Owned Hotels: +10.8% (12.5% in constant dollars)
  • REVPAR for Starwood branded SS Owned Hotels in NA: +12.5% (11.2% in constant dollars)
  • Margins at Starwood branded SS Owned Hotels Worldwide: +110bps
  • 3Q 2010 included a "pretax charge of $55 million ($52 million after tax or $0.28 per share) and were primarily related to the loss on the sale of one hotel. Special items in the third quarter of 2009 included an $11 million after tax benefit or $0.06 per share primarily related to a tax benefit on a hotel sale."
  • "In North America, supply growth in the Upper Upscale and Luxury segments is expected to fall below 0.5% in 2011, and remain at these low levels for a few years to come."
  • "During the third quarter of 2010, the Company signed 20 hotel management and franchise contracts, representing approximately 4,500 rooms, of which 15 are new builds and five are conversions from other brands. At September 30, 2010, the Company had approximately 350 hotels in the active pipeline representing approximately 85,000 rooms."
  • There was almost no room attrition in the quarter with 3,300 rooms entering the systems and only 300 rooms exiting.
  • "Originated contract sales of vacation ownership intervals decreased 4.8% primarily due to lower tour flow and a lower average price. The number of contracts signed decreased 3.6%...and the average price per vacation ownership unit sold decreased 2.5% to approximately $14,000, driven by price reductions and inventory mix."
  • "On September 29, 2010, the Company completed the sale of one hotel for gross proceeds of $70 million. This hotel was sold subject to a long-term management contract." (Aspen St. Regis)
  • In 3Q2010, HOT "completed the securitization of approximately $300 million of vacation ownership notes receivable. Approximately $93 million of proceeds from this transaction were used to terminate the privately placed securitization completed in June 2009. The net cash proceeds from the securitization were approximately $180 million."
  • "The Company expects to receive a tax refund of over $200 million during the fourth quarter of 2010."
  • 4Q2010 Guidance:
    • Adjusted EBITDA of $230-235MM -which is unchanged from HOT's guidance and consensus of $245MM
    • SS company operated WW RevPAR: 7-9% in constant dollars
    • RevPAR for Branded SS owned hotels WW: 7-9% in constant dollars
    • EPS: $0.36-$0.38 vs. consensus of $0.38
  • 2011 Guidance:
    • Assume continuation of current trends
    • SS company operated WW RevPAR: 7-9% in constant dollars
    • RevPAR for Branded SS owned hotels WW: 7-9% in constant dollars
    • Adjusted EBITDA of $950-$990MM (consensus at $965MM)
    • EPS: $1.44-1.55 (vs. consensus at $1.50)

CONF CALL NOTES:

  • Asia Pacific accounts for 22% of their fee income and over 60% of their pipeline
  • The lodging recovery continues despite the economic malaise. Both business and leisure travel continue to show improvement.
  • Strength in gateway cities is spreading to secondary markets
  • Corporate rate negotiations - like what they are seeing so far
  • In Sept, booking for 2010 were up 19%, and revenues for 2011 were up 30%
  • 2011 group pace is now flat with last year.  Think that 2011 group bookings can match 2008 levels.
  • Close rates in VOI are steadily improving
  • Will generate $220MM of cash in timeshare this year
  • Headcount is flat over 2009 and expect it to remain flat in 2011
  • Plan to open 86 hotels in Asia Pacific in the years ahead - with the greatest number in China
  • RevPAR growth in China was up 33% 
  • EMEA division President:
    • Europe: Will have 22 openings in Central Europe over the next few years
    • Plan to open 20 hotels in the next 3 years in the Middle East. Saw rates turn positive in September
    • Africa has experienced substantial growth: 30% unit growth.  RevPAR increase 5% this past quarter (ADR increase offset by occupancy declines)
  • Latin America:
    • Mexico saw RevPAR growth of 4% in the 3rd quarter
    • There was a 2 point increase in margin
  • Goal is to hold cost growth at half the rate of inflation
  • Think that they can exceed past peak levels
  • India update: 29 hotels open and 18 under construction. They are the largest hotel chain in India.

Q&A

  • They expect a double digit increase in RevPAR for 2011 in China
  • Incentive fees are currently driven by international fees and will grow more in-line with international RevPAR
  • Unit growth assumptions for 2011?
    • Looking to open 80 hotels in 2010 and a little less in 2011
  • Expense growth: European RevPAR growth was weak and there was more incentive comp...
    • Greff actually asked some good questions and they answered none of them.. hmmm
  • Last year they got business interruption insurance for H1N1 in 3Q09
  • Mgmt and franchise fees are low for next year
  • Rates in secondary citites in China are about 33% lower than in primary cities but yields are still attractive to owners. 
  • Use of cash: They will step up investment in their owned hotels... aside from that, they will update the Street on that during the Dec 8th analyst day. They will also continue to focus on debt reduction to become investment grade.
  • Why is their luxury RevPAR growth lagging?
    • Bulk of their collection is in Europe and they had a nasty FX impact
  • Would like to do a larger M&A sale but there are a lack of buyers right now


PNK: MARGINS, MARGINS, MARGINS

PNK beat our Street high EBITDA estimate pretty handily.  Margins were better at every property – and they’re not done yet.

 

 

The PNK thesis is a secular margin story.  EBITDA improvements are likely, even in a soft regional gaming environment.  We like that PNK is 18 months behind the industry in terms of cost cutting.  We like that previous management thought that three corporate headquarters and a couple of corporate jets were appropriate, that marketing was like a government agency that needed money thrown at it but didn’t need to produce results, that a fabulous high cost development pipeline was what mattered, and that they really didn’t care about margins.  The new management is a beneficiary of previous management’s mismanagement, if you will.

 

It’s not like the margin story isn’t well known.  Consensus EBITDA projection was higher than last year despite sluggish revenues.  However, we were a lot more bullish on the size of the margin improvement which drove our Q3 EBITDA estimate to $56.1 million versus the Street at $51.5 million.  So where did they come in?  $60.2 million.  This management team is doing a great job.  Forward estimates look too low.

 

PNK beat us in EBITDA at every property.  While revenues were slightly better overall, margins were the story.  Here are the numbers relative to our expectations:

 

PNK: MARGINS, MARGINS, MARGINS - PNK


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INITIAL JOBLESS CLAIMS DROP 21K APPROACHING LOWS OF THE YEAR

Initial Claims Fall 21K to Levels Near Lows of the Year

We won't split hairs. The claims number this morning is solid. It pushes both reported claims and rolling claims to levels near the lows seen YTD. Clealry this is a big step in the right direction. The question is, we've been here before - now multiple times this year - will they go lower or is this as good as it gets? We'll keep a close eye on claims. Remember, claims in the 375-400k range are low enough to start making a dent in the unemployment rate.

 

The headline initial claims number fell 21k last week to 434k (18k before the revision of last week's print).  Rolling claims came in at 453.25, a decline of 5.5k over the previous week.

 

INITIAL JOBLESS CLAIMS DROP 21K APPROACHING LOWS OF THE YEAR - A

 

INITIAL JOBLESS CLAIMS DROP 21K APPROACHING LOWS OF THE YEAR - B

 

In the table below, we chart US equity correlations with Initial Claims, the Dollar Index, and US 10Y Treasury yields on a weekly basis going back 3 months, 1 year, and 3 years.

 

INITIAL JOBLESS CLAIMS DROP 21K APPROACHING LOWS OF THE YEAR - AA

 

Joshua Steiner, CFA

 

Allison Kaptur


INITIAL JOBLESS CLAIMS DROP 21K APPROACHING LOWS OF THE YEAR

*** Our Updated Earnings Scorecard for Financials is Included Below ***

 

Initial Claims Fall 21K to Levels Near Lows of the Year

We won't split hairs. The claims number this morning is solid. It pushes both reported claims and rolling claims to levels near the lows seen YTD. Clealry this is a big step in the right direction. The question is, we've been here before - now multiple times this year - will they go lower or is this as good as it gets? We'll keep a close eye on claims. Remember, claims in the 375-400k range are low enough to start making a dent in the unemployment rate.

 

The headline initial claims number fell 21k last week to 434k (18k before the revision of last week's print).  Rolling claims came in at 453.25, a decline of 5.5k over the previous week.

 

INITIAL JOBLESS CLAIMS DROP 21K APPROACHING LOWS OF THE YEAR - rolling

 

INITIAL JOBLESS CLAIMS DROP 21K APPROACHING LOWS OF THE YEAR - raw claims

 

Yield Curve Moves Wider

The following chart shows 2-10 spread by quarter while the chart below that shows the sequential change. The 2-10 spread (a proxy for NIM) has been collapsing in the past two quarters.  Yesterday’s closing value of 231 bps is up from 218 bps last week.

 

INITIAL JOBLESS CLAIMS DROP 21K APPROACHING LOWS OF THE YEAR - spreads

 

INITIAL JOBLESS CLAIMS DROP 21K APPROACHING LOWS OF THE YEAR - speads QoQ

 

The table below shows the stock performance of each Financial subsector over four durations. 

 

INITIAL JOBLESS CLAIMS DROP 21K APPROACHING LOWS OF THE YEAR - subsector perf

 

Hedgeye Earnings Scorecard

Below we show our rolling earnings scorecard which includes all financials that have reported thus far in the earnings season, along with subsector averages and our proprietary Hedgeye Earnings Score. The score evaluates company performance across ten measures, looking for either sequential improvement or decline and performance relative to expectations. A "perfect" score would be 10 while the worst possible score is negative 10.

 

INITIAL JOBLESS CLAIMS DROP 21K APPROACHING LOWS OF THE YEAR - earnings scorecard

 

 

Joshua Steiner, CFA

 

Allison Kaptur


LVS: AND WE HAD THE HIGHEST ESTIMATES

Favorable mix in Macau, higher gaming volumes in Singapore, and better cost controls drove revenue and EBITDA higher than our Street high estimates.

 

 

Not much to say other than Steve Wynn must be kicking himself again for not bidding on Singapore.  Macau wasn’t too shabby either.  Las Vegas was a disappointment but who really cares other than MGM shareholders? 

 

 

Venetian Macau revenues were $15MM above our estimate and EBITDA was $16MM better

  • The revenue beat vs. our numbers came from
    • Mass revenues coming in $9MM better
    • Retail and other was $5MM better
    • F&B was $2MM
  • EBITDA was boosted by better fixed cost controls.
    • We estimate fixed costs were $91MM down $1MM from 2Q and 11% YoY. We assumed that Venetian has lapped their ability to cut costs and that fixed costs would increase to $95MM.
    • $5MM of lower commission payments to junkets due to a higher direct play mix which were completely offset by $6MM in higher taxes on better revenues
    • Bottom line variable expenses were in-line with our estimate despite better revenues
  • Direct play was 23% vs. our estimate of 21%
  • High Mass hold benefited property revenues by $21MM and higher than normal hold benefited VIP gross revenues by $17MM and we estimate that the impact on EBITDA was about $19MM

Not much to add on Sands Macau as revenue and EBITDA were exactly in-line with our estimates

  • Direct play was 14%, a few points above our estimate
  • High hold on VIP helped revenues and EBITDA by $9MM and $4MM, respectively
  • Slightly higher gross gaming revenues were offset by higher rebates which were 1% of RC
    • Could be partly due to higher direct play
  • Slightly higher non-gaming revenues were offset by higher promotional expenses
  • Implied fixed costs increased 2% YoY to $47MM

Four Seasons revenues were $22MM above our estimate and EBITDA was double our estimate

  • Why was our revenue number so off?
    • Net VIP revenues were $15MM higher than we estimated due to a rebate rate of only 83bps vs. a rebate rate that was 101bps last quarter on hold of 3.07% and a rebate rate of 94bps in 1Q2010 on a hold of only 2.5%.  The low rebate rate accounted for $10MM of the revenue difference while VIP gross revenues were also $5MM higher
    • Retail & other revenue was $7MM above our estimate; basically doubling QoQ
  • Why was EBITDA so off?
    • Variable expenses were only $2MM higher than we estimated on a revenue beat of $22MMM since the lower rebate brought down the total commission rate
    • Non-gaming margins are very high and non-gaming revenues were $6MM higher
    • Fixed expenses were only $20MM vs our estimate of $25MM
    • Put another way, last quarter, FS printed a $33MM EBITDA quarter with gross gaming win of $181MM and this quarter on $182MM of gross gaming win, they printed $49MM
  • Direct play was only 42% vs. our estimate of 50%, and therefore hold was actually not low as we had estimated but high at 3.08%
    • High hold boosted revenues by $11MM and EBITDA by $2MM
  • Mass play was $2MM higher than we projected but hold was also off the charts at almost 30%
    • High hold helped revenues by $4MM and EBITDA by $2MM

MBS reported revenues were $22MM higher and EBITDA was $6MM better

  • Bottom line – handle and drop were stronger than we estimated and beat our numbers despite low hold
  • Low hold depressed VIP gross revenues by $15MM and EBITDA by $6MM
  • Rebates were 1.34% this quarter or $135MM (basically difference between calculated gross gaming revenues and reported net casino revenues)
  • Fixed expenses were $145MM

Las Vegas net revenues were $19MM higher than we estimated but EBITDA was $10MM below our estimate

  • Casino revenues were $7MM below our estimate and rooms revenues were $4MM below our estimate, but F&B, retail and other were $30MM better, while promotional was exactly in-line
  • Operating expenses increased 20% YoY (Revenues- EBITDA)
  • Rebates were 3.6% of gaming revenues  and promotional expenses were 31% of gross gaming revenues
  • Added over 200 slots sequentially at Venetian

LVS: AND WE HAD THE HIGHEST ESTIMATES - LVS


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