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Showdown Brewing on the Korean Peninsula

Conclusion: Geopolitical risk in the region remains substantially higher than U.S. consensus is aware of and the threat of full-out military conflict continues to escalate as diplomacy has taken a backseat to posturing and bravado.


Position: We remain bearish on Korean equities for the intermediate term trend, primarily due to slowing economic growth which is being exacerbated by inflationary headwinds.


With the whole world seemingly focused on Trichet’s announcement this morning, we thought we’d have your back by keeping our Global Risk Management Eye on the Korean Peninsula (among other things) for you. Markets wait for no one and risk doesn’t abate because we fail to focus on it.


Considering, it’s important to highlight some of the latest military posturing and rhetoric by political leaders regarding the situation brewing in Korea.


Earlier this week, South Korean President Lee Myung Bak vowed to make Kim Jong Il’s regime pay for additional attacks, saying, “It’s become clear that more patience and tolerance only leads to bigger provocations… North Korea will be made to pay for further provocation no matter what”.


This latest shift in tone follows a survey that shows over 80% of South Koreans believe the government should have “displayed a stronger military response” to North Korea’s recent attack on the disputed island of Yeonpyeong . Moreover, 33% of respondents said they were willing to risk war to do so going forward.


Accordingly, South Korea has doubled its’ artillery strength on the island, which coincided with the North installing surface-to-air missiles in the area. Let the arms race begin…


International Involvement


The U.S. and Japan have initiated military exercises in the region to the tune of over 44,000 combined troops, and South Korea is planning to join in on the “fun” shortly. This step heightens the risk of further military conflict when taken in the context of the North’s latest aggressive commentary:


“North Korea will deal a merciless military counter-attack at any provocative act of intruding into its territorial waters.”


It’s important to keep in mind that the North doesn’t recognize the maritime border laid out after the 1 Korean War. Additionally, the North regime has urged its Southern counterparts to call off the exercises, yet anonymous South Korean officials said today that its military may carry out further artillery drills next week – similar to the drills that started this conflict last Tuesday.


At the very least, it appears the South has been emboldened by U.S. and Japanese support, which doesn’t bode well for peace in the region.


Another headwind for conflict resolution is U.S., Japanese and South Korean reluctance to enter six-party talks with China, North Korea and Russia. Originally proposed by China on Nov. 28th, the talks have been met with steep resistance, particularly from the U.S. and Japan: 

  • U.S. Admiral Michael Mullen yesterday: “Beijing’s call for consultations will not substitute for action. I do not believe we should continue to reward North Korea’s provocative and deeply destabilizing behavior with bargaining or new incentives.”
  • Japanese Foreign Minister yesterday: “Talks can’t be held only because North Korea has run amok.”
  • South Korea’s Ministry of Foreign Affairs and Trade said it would “consider China’s call for talks very cautiously”. 

The resistance to further negotiation is born out of two key factors: 

  1. North Korea has a history of rattling its saber to force diplomatic discussions whereby they wind up exchanging promises of good behavior for additional foreign aid (email us if you’d like to receive a podcast of our May call with Charles Hill regarding North Korean tactics, etc.); and
  2. The U.S. is concerned that North Korea poses a substantial nuclear proliferation threat. Last week it confirmed it has a uranium-enrichment facility and South America intel has concluded that North Korea recently shipped Iran 19 advanced missiles. The country is already under current UN sanctions for previous nuclear tests. 

Of course, it comes as no surprise that China, a long-time ally of North Korea, is criticizing the ongoing military exercises and rejections of diplomacy as both dangerous and unproductive. Today, Chinese Foreign Ministry spokeswoman Jian Yu said, “Brandishing of force cannot solve the issue. Some are playing with knives and guns while China is criticized for calling for dialogue – isn’t that fair?”


Further, Chinese opposition has stalled UN Security Council negotiations condemning the recent attack and North Korea’s expanding nuclear program. This is noteworthy, given that the council needs to reach consensus before making accusatory statements. Earlier this year, it took roughly four months to agree on a statement that only implicitly condemned North Korea for sinking the South Korean warship Cheonan.


China’s posturing has been met with more stringent international resistance this time around, as evidenced by U.K. Ambassodor Mark Lyall Grant’s recent comments: “We are not prepared to have a weak response by the council. These are serious violations on the nuclear side and the shelling should be condemned if we are to make any statement at all.”


At any rate, the situation on the Korean peninsula is increasingly shaping up as an international game of “Us vs. Them” and the rift could be far-reaching if the conflict isn’t resolved quickly. Unfortunately for sake of conflict resolution, neither side appears willing to back down at the current moment, leaving as situation of “high alert” as the best-case scenario for the region. Worst case, the conflict could heat up if certain lines (both physical and rhetorical) are crossed.


From a quantitative perspective, Korea’s KOSPI 100 remains broken from a TRADE perspective and bullish from a TREND perspective.


Darius Dale



Showdown Brewing on the Korean Peninsula - 1





The growth train kept on chugging in November despite tough hold and growth comparisons.  Total revenues grew 42% to $2.17 billion.  Table revenues grew 43% YoY, on top of a 63% growth rate in Nov 2009.  Mass market table revenue grew 29% while VIP revenues climbed 48%.  VIP revenues accounted for 77% of the total table revenues.  Direct play appears to have increased to 8.7% of VIP compared to 7.3% a year ago. Adjusted for direct play, market VIP hold appears to be about 3.04%, just slightly lower than last year's 3.09%.  December has an easier hold comparison, as our estimate of December 09 hold was only 2.74%.


Wynn was the big share gainer in the month of November while LVS was a big donor.  Lady luck was the primary driver of this divergence of fortune.  SJM also lost 1% of its market share while the other 3 concessionaires picked up some share with MPEL gaining 80bps and MGM climbing by another 50bps.  In terms of Mass share, LVS and WYNN lost share sequentially while MPEL, SJM, Galaxy, and MGM gained.



YoY Table Revenue Observations


LVS table revenues only grew 2% - 20% growth in Mass revenues offset by a 6.7% decrease in VIP revenues.  VIP suffered from the combination of low hold and difficult hold comparisons.

  • Sands decreased 7%, the second month of sequential declines and with growth of only 6% over the last 5 months despite the market growing 59%.  Part of the underperformance is due to difficult hold comparisons.
    • VIP revenues declined 17% despite a 10% increase in Junket RC volume
    • 16% increase in Mass revenues
    • Low hold was the culprit behind VIP revenue declines. Assuming 14% direct VIP play (same as 2Q & 3Q2010), we estimate that hold for November was 2.5% which compares to 3.3% hold last November, assuming 9% direct play (in-line with 4Q09).
  • Venetian was up 11%
    • VIP revenues only increased 5.5% on a 28% increase in Junket RC due to a difficult hold comparison
    • Mass revenues increased 21%
    • Assuming 23% direct VIP play volume, we estimate that hold for November was 2.7% compared to 3.5% last November if we assume that direct play was 17% (in-line with 4Q09 levels).
  • Four Seasons decreased 17%
    • Mass revenues grew 34%
    • VIP revenues decreased 28% on a 41% decrease in Junket VIP RC volume on very low hold despite easy comparisons
    • Assuming $525MM of direct VIP play or 50% in November, implied hold is 1.7% compared to 2.3% in November 2009 assuming direct play was 28% (consistent with 4Q09)

Wynn Macau/Encore table revenues were up 101%, driven by an 113% increase in VIP revenues and a 52% increase in Mass revenues

  • Junket RC volume increased 64%. Assuming 13% direct VIP play, November hold was 3.3% compared to an easy comparison of 2.5% hold experienced in November 2009 (assuming 12% direct play)

MPEL table revenues grew 57% with the growth driven by a 64% increase in VIP and Mass growth of 57%

  • Altira was up 63%, due to a 62% increase in VIP revenues and a 92% increase in Mass revenues
    • VIP revenue growth was partly driven by high hold as RC grew only 32%
    • We estimate that hold in November was 3.5% vs. 2.8% in November 2009
  • CoD table revenue increased 106.5% YoY, driven by 51% growth in Mass and 66% growth in VIP revenues
    • Junket VIP RC increased 46%
    • Hold benefited CoD's market share. Assuming 15% direct VIP play, hold was 3.3% compared to last November's hold of 2.9% assuming 18% direct play

SJM table revenues grew 38%

  • Mass was up 22% and VIP was up 47%
  • Junket RC volumes increased 59%
  • SJM's hold was 3%, compared to 3.25% in November 2009.  December will have an easier hold comparison since last December's hold rate was 2.8%.

Galaxy table revenue only increased 20%, driven by a 22% increase in VIP win and a 10% increase in Mass

  • Starworld's table revenue increased 22%, driven by 23% growth in VIP revenues and 18% growth in Mass
  • The Group RC volumes were up 28% while Starworld RC volumes increased 35%.  Despite hold being normal, the comparisons from November 2009 were difficult.  November hold for the Group and Starworld was 2.8%, respectively, compared to last November's hold of 3.0% and 3.1% last year. 

MGM reported the strongest growth in the month of November, with table rev growth of 81%

  • Mass revenue growth was 55%, while VIP revenues grew 88%
  • VIP RC grew 117%
  • Hold was high, at an estimated 3.2% but it was even higher last November at 3.6%


Table Market Share


LVS table share dropped 370bps sequentially to 14.8%, an all-time low for LVS since we've been tracking the data (March 2007)

  • LVS's share of VIP revenues dropped 4.3% to 11.9%, its lowest share since we've been getting data (March 2007).
  • RC share was flat sequentially at 11.6%.
  • Mass share fell 1.7% to 24.5%
  • Sands market share decreased by 50bps due to a 70bps loss in VIP share
  • Venetian lost 2% to 8.7% sequentially, driven mostly by losses in both VIP and Mass share which were impacted by difficult hold comparisons
  • FS share dropped 130bps to 1.2% due to a 160bps loss in VIP share

WYNN's table share increased 340bps to 17%

  • Mass market decreased 50bps to 10.9%
  • VIP revenue share increased 4.6% to 18.8% sequentially
  • Wynn's VIP share jumped to 2nd place behind SJM

MPEL's market share increased 70bps sequentially to 14.7% in November, driven by a 30bps increase in Mass and an 80bps increase in VIP share

  • CoD's share decreased 20bps
  • Altira's share increased 80%, driven by a 1% increase in VIP share

SJM's share decreased by 1.2% to 32.1%

  • SJM's share gain was driven by a 70bs gain in Mass share to 40.3% which was offset by 1.8% decrease in VIP share

Galaxy's inched up 20bps to to 10.3%

  • The Group's share gain was driven by a 90bps gain in Mass market share
  • Starworld's market share increased 40bps sequentially to 8.5%
  • Junket RC share was flat sequentially at 14%

MGM's share continued its climb to 11.2%, the property's highest share since July 2009

  • MGM's share gain can be attributed to a 70bps increase in VIP and a 40bps increase in Mass
  • RC share increased 60bps to 10.6%


November Slot Revenue Observations


Slot revenue grew 21% YoY in November reaching a total of $92MM and accounting for 4% of total revenues

  • MPEL experienced the largest growth of 69% to $20MM
  • MGM's slot revenue increased 43% to $12MM
  • Galaxy's slot revenue increased 43% to $3MM
  • LVS, having the largest base, barely grew - only 1.3% (YoY) to $26MM
  • Wynn's slot revenue increased 13% to $19MM
  • SJM's slot revenue grew 7% to $12MM








Conclusion:  We continue to be long SBUX in the Hedgeye portfolio.


It would be hard to dispute that fiscal 2010 was a strong and pivotal year for Starbucks.  In addition, with about 60% of analysts now recommending the stock as a buy versus a low of about 30% in mid-2009 and with only 2% short interest in the name, I doubt few would try.  That being said, with the stock now trading at 10.5x on a NTM EV/EBITDA basis, there has been some question about whether the company can maintain its current momentum.  Following SBUX management’s presentations yesterday, I am even more confident in the company’s long-term growth prospects than I was previously.


Fiscal 2010: The Year of VIA

Although the VIA brand was only net neutral to earnings in fiscal 2010, the success the company has enjoyed with the brand in such a short amount of time (generated about $135 million in global sales in the retail and CPG channels in its first year) has given the company a renewed confidence in its ability to pursue new avenues of growth.  The strong rollout of VIA has proven that the company can successfully leverage its retail store base to spur trial and awareness of a new brand in order to drive even more significant growth through the CPG channel (the basis for the company’s new “blueprint for profitable growth”). 


Starbucks employed the direct distribution model for the first time with the VIA rollout and the approach yielded such strong results that the company has decided to use a direct model, in addition to its already established license and JV partners, for the entire CPG channel, effective March 1, 2011.  SBUX has partnered with Acosta, a proven selling agent with nearly 100% coverage of the food, drug and mass channels in the U.S., to pursue this direct model approach and has ensured a smooth transition following the termination of the Kraft distribution agreement.  Through its new partnership with Acosta, Starbucks will be responsible for product development, manufacturing, distribution and marketing while Acosta will be responsible for the selling and merchandising of SBUX’s products within the grocery channel.  Although I am concerned about issues that may surface during the initial transition phase, over time, it should prove beneficial for Starbucks to be more vertically integrated and, as the company highlighted, to have one marketing voice across the entire CPG channel.  For reference, licensed sales of packaged coffee and tea mostly sold through the Kraft partnership accounted for 23% of specialty revenues in fiscal 2010 (or about 4% of total SBUX revenues).


The success of VIA, though still early days, has also proven that the company can develop and grow brands.  Outside of the $1 billion VIA brand potential, the company is significantly investing behind Seattle’s Best Coffee in both the retail store and grocery segments (SBC rebrand and relaunch), Frappuccino and Tazo Tea, among others.  These are all brands that the company thinks will drive tremendous upside over time, and again, leveraging trial within Starbucks’ retail stores will encourage growth.


Outside of developing brands organically and driving increased profitability of already established brands, Starbucks made it extremely clear that it would do an acquisition, either big or small, if it found a company that fit its business model.  Specifically, Starbucks is looking at all options and wants to be a leader in coffee, in all coffee categories.


Diversified Growth Engines

U.S. – Although Starbucks recently closed hundreds of stores in the U.S. and significantly reduced new unit growth, management highlighted that the U.S., which currently accounts for about 70% of total revenues and operating income, will continue to be an essential component of ongoing growth.  The company expects to add 100 net new stores in fiscal 2011 and accelerate unit growth in fiscal 2012 and beyond.  Growth in the U.S. will expand beyond unit growth, however, as the company remains focused on growing business within its existing store base through new store designs, increasing drive-thru business, new products, increasing capacity and expanding dayparts. 


U.S. margins are expected to increase 100-200 bps in fiscal 2011, on top of the nearly 640 bp increase in FY10 to 17.4%.  And, margins are expected to remain strong beyond 2011 with the company targeting long-term margins in the upper teens to approaching 20%.


International – This segment is expected to drive the next leg of growth for Starbucks as the company implements the lessons learned in the U.S.  This growth will come from an increased focus on operations and improving execution within the existing store base as well as accelerated new unit growth (primarily licensed store growth). 


On top of the expected 400 net new stores in fiscal 2011, the company specified that it is already investing now to build the real estate pipeline for 2012, 2013 and beyond.

  • Established markets: Canada and Japan – These markets are healthy and well poised for growth now.
  • Key European markets: UK, Ireland, France and Germany – These markets need work (apply U.S. learnings) before accelerating growth.
  • Emerging markets: China, Brazil, India and Russia – These markets provide tremendous growth opportunities but also require that Starbucks invest ahead of the growth curve.  The company continues to think that China will become the second largest market for the company outside of the U.S. (targeting 1,500 stores by 2015 from about 400 units now).

International margins are expected to increase 100-200 bps in FY11 as the company builds on the momentum of 2H10 and move into the mid-to-upper teens range over the next 3-5 years.


CPG – Following on the recent success of VIA, management seemed most excited about the potential of the CPG business.  The company currently only generates CPG revenues in 10 of the 54 countries in which it operates.  This, alone, is a huge opportunity for the company’s new direct model.  Once the company builds the internal capabilities, Starbucks will have the experience and knowledge to move into any market with its CPG business.  This, however, will take some time. 


The biggest near-term benefit for the CPG business comes from the VIA learnings and stems from the company’s ability to drive CPG growth by utilizing its retail store base.  The company can drive increased trial of already established brands (Frappuccino, Tazo Tea, Discoveries), newly developed brands or acquired brands in its stores before pushing them through the CPG channel.  Going forward, management is also convinced that as the CPG business growth accelerates, it will drive business back into its retail stores.  The company even mentioned the potential for a loyalty card that would allow cross-shopping and rewards for purchases of Starbucks products in both the grocery and retail store channels.


CPG margins are expected to be 30-35% in fiscal 2011 (35.3% in FY10).  Margins will remain under pressure in FY11 as Starbucks continues to invest behind VIA and the company is also expecting to incur some one-time costs associated with the termination of the Kraft distribution agreement.  That being said, the company expects the move to a direct model to be highly accretive in 2012 and beyond.


In sum, Starbucks is definitely well poised for growth.  This growth will continue to come from its core retail store base, in addition to new avenues of growth, which should become more important on a go forward basis.  To that end, I continue to be comfortable with our long position in the Hedgeye portfolio. 


Like anything else, however, there are some near-term challenges worth highlighting:

  • Expectations are high: The street is at $1.49 per share for FY11 relative to management’s $1.41-$1.47 guidance.
  • Coffee prices are high:  Management stated that coffee accounts for 15-20% of the company’s overall cost structure and that current prices are not sustainable.  If coffee prices move higher, however, margins will come under pressure and management may have to again raise prices.
  • The company is lapping its first quarter of positive comp growth in fiscal 1Q11.
  • Kraft transition disruptions: Management has said it will be a smooth transition, but there are likely to be some hiccups.
  • Consumption Cannonball: A weakened consumer environment would likely impact the company’s current comp sales momentum.



Howard Penney

Managing Director

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Shorting SPY Here: SP500 Levels, Refreshed



I shorted the SP500 (SPY) again at 1043AM EST today.


As a reminder, Hedgeye’s intermediate-term global macro outlook has 3 core components: 

  1. 1.       Global growth is slowing
  2. 2.       Global inflation is accelerating
  3. 3.       Interconnected risk is compounding 

My refreshed lines of immediate-term TRADE support and resistance lines are 1197 and 1217, respectively.



Keith R. McCullough
Chief Executive Officer


Shorting SPY Here: SP500 Levels, Refreshed - 2


In-line quarter; Florida helped results.



“Revenues in our markets were generally flat during the quarter...We are pleased to have achieved modestly increased results in Iowa, Missouri and Mississippi.  Management initiatives in Lake Charles to control costs and cut out unprofitable marketing efforts led to an increase in earnings despite decreased net revenues.  In Florida, we were able to take advantage of the gaming tax rates and modify our marketing efforts to achieve significant year over year improvement. In Black Hawk, we had a significant decrease in EBITDA due to a major competitive expansion in the market, which recently had its one year anniversary.  Our midweek revenues and hotel occupancy were impacted the most significantly.  We continue to refine our marketing programs and cost savings initiatives, and believe these changes will lead to more positive results in the coming periods. Including our recently acquired Vicksburg property, our operating costs decreased by $1.0 million, or 0.8%.  Excluding Vicksburg, we decreased our same-store operating cost structure by $5.3 million, or 4.0%, during the quarter.  Overall, we remain dedicated to keeping our costs tight and marketing to our most profitable customers until the economy improves."

- Virginia McDowell, President and COO of ISLE




  • "While we have recently seen positive signs in certain economic indicators and hope this positive news will continue, we believe that discretionary consumer spending could continue to lag these trends."
  • Corp & development expenses: $10.9MM ($12.3MM in F2Q 10)
  • Non-cash stock comp: $2.4MM ($2.6MM in F2Q 10)
  • $64.1MM in cash; $1.26BN in debt
  • Interest expense: $23.4MM ($17.9MM in F2Q 10) primarily as a result of increased borrowing costs and increased borrowings related to the acquisition of Rainbow Casino in Vicksburg.
  • Capex: $13MM--all maintenance
    • Capex for remainder of FY2011: $22MM
    • Cape Girardeau Capex: $10MM
  • PA license decision: Dec 16 or early January


  • Cape Girardeau: construction will start in summer of 2011; completion in 2012
  • Cautiously optimistic on consumer spending environment; rebound in jobs market is necessary for spending growth.
  • Other line in FQ2 2010: Pittsburgh Penguins receivable
  • EPS: -0.06 comparable with -0.18 last year
  • $1.26BN debt (85MM outstanding on revolver) $813MM in term loans; 357MM under the 7% bond indenture; 5MM other
    • Leverage ratio: 6.9x
    • Interest coverage: 2.3x
    • Available credit  facility: 106MM
  • Cape Girardeau funding: FCF and existing credit facility

Q & A

  • FY2011 maintenance capex: half of maintenance capex is slot-related (incl. conversion kits)
  • Pompano: still trying to find right marketing mix; good run rate going forward; big improvement in mid-week business
    • Competition: Coconut Creek expansion will include hotel; but still needs state approval
  • Colorado competition: had tough Q; had tough comps; weak mid-week business; benefited from increased retail play
  • Interested in Riviera Casino in Black Hawk if it becomes available? No.
  • Discontinued operations: income tax audits: favorable income tax from UK operations; could see a little more of this in the future.
  • Bettendorf: reopened highway helped the property; saw weekend business recover; had increase in mid-week convention business to better utilization of convention facilities.
  • Davenport: competitor pressured mid-tier  business. If offered $140-160MM for Davenport, then ISLE is interested. Agreement with operator runs to 2019.
  • Margin improvement: primarily due to tax decrease in FL and targeted marketing programs and cost containment measures.
  • Weather was not abnormal in October
  • Lake Charles market:
    • Upcoming competitor $450MM Mojito Pointe will have an impact
    • Sees pressure from Houston market and from competitors regarding mid-week promotions
  • $50MM Nemacolin project--funding through revolver and FCF
    • Each year will pay a $350K-500K all-in fee (base fee and % of revenue fee to the resort); rest of earnings will go to ISLE
  • Will amend senior credit facility (July 2012)
  • Not worried about January covenant 7.4x even with the two new projects
  • Biloxi: benefited from Alabama closures; still highly competitive; benefited from the double-digit declines in Pensacola market
  • Apples-apples quarter for Caruthersville would see 13% EBITDA growth YoY when one excludes the $950,000 tax effect  in FY2Q10
  • Q had Increase in retail play is a result of consumer confidence increasing; best example is Florida
  • More greenfield projects and property transactions possible
  • ROIC for the new projects: high teens; Cape G will be similar to Boonville
  • Operating costs down by $30MM; sees more flow-through once revenues recover

Gilly in WMT. Tough Fringe Competitor for CRI

Is it me? Or did GIL just say in Q&A that infant category was down meaningfully this year at its biggest customer, but have since made changes and now sales are up dd. Carter’s…are you listening to this??? Same product and same customer. And let's be real, the category is not growing by 30% inside Wal-Mart.

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