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Greece’s Hockey Stick Risk Curve

We’ll spare you the words and let the chart below do the talking – risk is heightening (again) via sovereign CDS spreads across Europe, especially in Greece, after abating in the months of September and October. We're managing around risk in Europe--we’re currently not invested across the continent on the long side, but continue to like Germany (via the etf EWG) at a price. Germany printed another month of solid employment data today, with the October unemployment rate unchanged at 7.5%, and the number of unemployed persons falling below the 3 Million mark, an important hurdle that has not been crossed in over 18 years, and coincides with the first anniversary of Chancellor Merkel’s center-right coalition.

 

Matthew Hedrick

Analyst

 

Greece’s Hockey Stick Risk Curve - mh


PNK 3Q2010 CONF CALL NOTES

Another very strong, margin driven quarter for PNK. Numbers need to go higher.

 

"Pinnacle's growth in third quarter revenues and Adjusted EBITDA, together with improvements in Adjusted EBITDA margins, reflect further progress in creating sustainable operating efficiencies across the entire organization while remaining focused on delivering best-in-market guest experiences.  With revenue increases in four of our six markets and improved operating execution across our property portfolio, we are benefiting from our disciplined approach to operational excellence and have a focused team that can drive further improvements."

 

-Anthony Sanfilippo, president and chief executive officer of Pinnacle Entertainment

 

 

HIGHLIGHTS FROM THE RELEASE

  • "Adjusted EBITDA margins increased from prior-year levels in every market except St. Louis, which is affected by the continued ramp-up of operations at River City after its opening earlier this year."
    • Consolidated Adjusted EBITDA margin rose to 20.9%, compared with 16.4% in 3Q 09
  • St. Louis market share was 31.2% in 3Q compared with 19.3% in the prior-year period. 
  • $228MM cash; an estimated $70 million of which is used in day-to-day operations. $375MM undrawn credit facility with $9.6 million of outstanding letters of credit.
  • Gross interest expense ex cap interest: $28MM vs $22.5 MM in 3Q 09; Virtually no cap interest vs $3.8MM in '09
  • Loss of $2.3MM due to discontinued operations
  • Income tax benefit of $5.34MM
  • $357MM Baton Rouge property to open in Dec 2011 with 1,500 slot machines and 51 table games
  • Ginny Sharks appointed to Chief Marketing Officer

CONF CALL NOTES

  • Operational excellence continues to be the key
  • Still in the midst of a relatively static revenue environment
  • L'Auberge team did a good job by yield managing the hotel
  • Did a good job at River City managing flow-through. Also did a good job optimizing labor and joint property initiatives across St. Louis.
  • Belterra's adjusted EBITDA still improved substantially despite heightened competition, largely as a result of marketing efforts
  • Bossier City - targeted labor and marketing efficiencies which helped the bottom line
  • Reno property took a real shift - turned last year's loss into a $1.5MM gain - which was a great result in the absence of a top line lift. Evaluating possible scenarios about selling their land in Reno.
  • Corporate expense decrease was due to office consolidation, aircraft sales, and some downsizing. Still looking for room to cut there.
  • Have $500MM of liquidity and Baton Rouge is fully funded.
  • Capex spend was $30MM including some amount for Baton Rouge
  • Marketers at PNK are a good "intuitive team" but will be helped by analytic tools
  • Efforts underway:
    • Think about how to market in St Louis where they share customers
    • How to reward their good customers
    • Installation of revenue management systems at hotels
  • Will think and act like shareholders
  • L'Auberge prospects:
    • Proud of their 3Q results but still have a lot of work to do

Q&A

  • Return assumption at Baton Rouge given the bump up in capex?
    • Think that on the $100MM add on they will get a good return
    • Add on rooms are not as expensive as initial rooms
    • Parking lot is also important
  • How much of the improvement this quarter is due to better slot product?
    • They are operating more on facts than on gut (like before)
    • They already had fairly fresh slot product
    • Want make sure all the cuts and changes sustainable
  • Purchasing an Ohio track?
    • Won't comment.  They are looking at all markets though
    • They are a growth company and are looking for ways to grow and diversify their portfolio
  • River City parking deck
    • They hired a new manager
    • They need a new parking structure but don't expect it in the next 9-10 months
    • They are thinking about what the next appropriate capital spend is at that property
  • Shared services in St. Louis?
    • Worst outcome would be to compete against each other
    • Moved a corporate guy down to St Louis to manage the finances of both properties
  • Is this quarter's margin at Belterra sustainable?
    • Focusing on identifying who their profitable customers are
    • It's a very competitive market and will be even more competitive when Ohio opens
    • The new margins are sustainable
  • Thoughts on 3 applicants in Louisiana?
    • Applicants have been very vague, but in Dec, they will see presentations on the proposed projects
  • Are they in a dispute with the port of Lake Charles over the land?
    • Entered into a lease with them, but can't comment on whether there is a dispute - generally they have a good relationship there
  • They are in the early stages of using their newly installed yield management system and they have over 900 rooms at L'Auberge.  They are also looking at yielding their slot floor more appropriately.  More than likely, the margins should continue to improve as they replace unprofitable revenues with profitable revenues.
  • Haven't even started appropriately marketing River City - so they think that there is lots of room there
  • Hotel yield system was just installed last month in St. Louis
  • Could seasonality explain why consensus for FY is so low?
    • Have 4 properties subject to difficult weather conditions in the 4th and 1st quarters
  • AC - any change in their view there?
    • They have done a lot to clean up the balance sheet.  AC has been very painful. They will not exit that market at a giveaway price. In the meantime they are trying to minimize the carrying cost.
    • It is possible that if they can't sell the land that they would consider a boutique hotel there
  • They are at the "top of the 3rd inning" in terms of marketing
  • Impairment charge was $4MM for this current quarter in relation to Baton Rouge design write-offs. Going forward the only other potential impairments can come from AC (book is $38MM). Book value and shareholder value aren't necessarily the same.
  • Tax credit was included in the G&A line
  • There is so much volatility in income taxes because of their reserve NOL's
  • Are they going to try to go the way of Harrah's with a national loyalty plan with a key destination?
    • They are focused on growth and building a loyalty culture
    • Their focus is to encourage cross play
    • They do want MyChoice to be their linking brand - they want their customers to know that they own multiple properties. They won't be changing their names.
  • Texas?
    • Continuing to monitor the situation. If something happens there, they will see if and how they can participate.

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


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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


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


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