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IGT POST DIGESTION

After what was looking like a day of indigestion for IGT bulls, the stock closed flat. The good in the quarter outweighed the bad and guidance looks conservative.

 

 

We don’t want to regurgitate the quarter, we will leave that to the sell side historians.  We’d rather focus on the future.  Hopefully, you’ll find our takeaways interesting and forward looking. 

 

While others are focused on the slow acceleration of replacement demand, we think the big negative issue for IGT is in the participation segment.  It’s going to be very difficult for the company to grow this business.  For IGT, we view participation similar to a casino.  The problem is unlike a casino with no growth that spends 6% of revenues on maintenance CapEx, IGT spends around 17%.  That eats into ROI big time.  At least for WMS and BYI, their participation segments are growing.

 

Potentially outweighing the participation drag, at least for the near and intermediate term, is the impressive margin gains.  IGT’s top line missed big due in small part to the participation segment but mostly due to international sales.  However, not only did the margins more than offset that, the improvement looks sustainable – enough so that guidance looks conservative for once.  We expect that better margins will carry IGT until replacements inevitably takes off and new markets begin to provide growth.  We will be focused on the declining ROI in the participation segment down the road.

 

Here are some of our specific forward-looking takeaways:

  • In North America, IGT finally met our expectations.  For the first time in 6 years, IGT shipped more replacement units in its F1Q than its F4Q.  For most operators, December is a seasonally better replacement quarter than September, but since IGT’s fiscal year is in September (which is usually companies’ most promotional quarter) that hasn’t held true for them.  We suspect that this reversal of trend means that replacements in December were much stronger than our estimated 9,300 replacements shipped in September.
  • So much for annual price increases being a given.  For as many years as we've covered this space, annual price hikes were a given.  These last few quarters have demonstrated that this isn’t the case anymore… whether you blame it on mix or selling what would normally be ‘discontinued’ product lines or deeper discounts –the numbers don’t lie.  While we still don’t believe that price is the main determinant for operators when buying games, it’s clearly become a factor and with the heightened competition, suppliers need to play the price game.
  • Despite Patti’s assurances that international product sales were strong this quarter, the numbers tell a different story.  This is the lowest unit ship quarter for international in over a decade (excluding Japan).  The company still maintains that they expect international unit shipments to be up YoY with little rationale as to why aside from guidance from their customers that the second half of the year should be better and roughly 1,500 for sale units to Italy.
  • Margins were very good considering the low number of shipments.  Systems and software sales must have been good this quarter because they carry margins of north of 70% which coupled with the higher mix of non-box sales clearly helped this quarter.  The 1,000 Mexican units also had very high margins despite lower ASPs since they were fully depreciated.  Going forward, the company expects that game sale margins will be 200-300bps lower than F1Q11 – partly due to another promotion ala– Dynamix that they plan on introducing shortly.

Gaming Operations:

  • Well, at least IGT finally admits that “the installed base isn’t expected to grow meaningfully this year” or at all if we excludes the Italian units.  On the bright side, yields finally stopped declining – although one can say that the removal of the incremental Alabama units from Victoryland helped here.
  • Some of the increase in margin is also due to the consolidation and simplification of platforms which materially decreases the installation and refresh cost.  The company expects margins to be 150bps lower for the next few quarters – which is still above prior guidance of 58-60%.

THE M3: HO TRANSFERS SJM SHARES; LAND AUCTIONS; S'PORE INFLATION; MGM JET

The Macau Metro Monitor, January 24, 2011

 

STANLEY HO GIVES UP SJM STAKES SJM, WSJ

Dr. Stanley Ho has transferred all but 100 shares of his 31.655% stake in SJM's parent company, Sociedade de Turismo e Diversoes de Macau, SA, to Lanceford Company Limited.  Lanceford Co. is controlled by Dr. Ho's 3rd wife, Chan Un-chan, who owns 50.55% of the company and by Dr. Ho's 2nd wife, Lucina Ho, who owns the remaining 49.45% of Lanceford.  Lucina Ho's children--Pansy Ho, Daisy Ho, Maisy Ho, Josie Ho and Lawrence Ho--each hold 20% of her stake.

 

The move may complicate the question of succession given the families of three of the tycoon's companions now each have significant stakes in SJM.  The Company states that there will be no change in management or strategic direction as a result of the share transfer.

 

GOV'T TO LAUNCH NEW LAND AUCTIONS Macau Daily TImes
Secretary for Transport and Public Works, Lau Si Io, said that one or two new land plots will be auctioned this year.  He stressed the Government is trying to make the land granting process more transparent.  The government had delayed the auction of the 3,400 square meters land parcel in Fai Chi Kei for the construction of no less than 500 small- and medium-sized residential units.

 

 

VISITOR ARRIVALS FOR DECEMBER 2010 DSEC

Total visitor arrivals rose by 11.6% YoY to 2,271,301.  Mainland China visitors increased by 18.8% YoY to 1,200,324 (52.8% of total), with 494,567 traveling under the Individual Visit Scheme.  Visitors from Hong Kong (667,595) and Republic of Korea (33,775) increased by 10.9% and 49.0% respectively; however, those from Taiwan (105,747), Malaysia (41,256), Japan (36,052), and Singapore (34,839) decreased by 7.4%, 10.2%, 5.8% and 11.9% respectively.  Total visitor arrivals reached 24,965,411 for the whole year of 2010, up by 14.8% YoY.

 

THE M3: HO TRANSFERS SJM SHARES; LAND AUCTIONS; S'PORE INFLATION; MGM JET - visitor


INFLATION IN S'PORE CONTINUED RISE IN DECEMBER Channel News Asia

Singapore CPI rose by 4.6% YoY in December.  For 2010, CPI rose by 2.8% YoY.

 

MGM MACAU LAUNCHES "GOLDEN LION JET" macaubusiness.com

MGM Macau has refurbished a TurboJet vessel as the “Golden Lion Jet”, which will sail between Hong Kong and Macau.  The refurbished jet made its debut on January 21.


WEEKLY RISK MONITOR FOR FINANCIALS: STILL POSITIVE SHORT & INTERMEDIATE TERM OUTLOOK

Financial Risk Monitor Summary (Across 3 Durations):

  • Short-term (WoW): Positive / 4 of 10 improved / 2 out of 10 worsened / 5 of 10 unchanged
  • Intermediate-term (MoM): Positive / 7 of 10 improved / 2 of 10 worsened / 2 of 10 unchanged
  • Long-term (150 DMA): Positive / 4 of 10 improved / 3 of 10 worsened / 3 of 10 unchanged / 1 of 10 n/a

WEEKLY RISK MONITOR FOR FINANCIALS: STILL POSITIVE SHORT & INTERMEDIATE TERM OUTLOOK - summary

 

1. US Financials CDS Monitor – Swaps were mixed across domestic financials, tightening for 15 of the 28 reference entities and widening for 13.  The moneycenters saw the greatest tightening of the group, while widening was concentrated in mortgage insurers. 

Widened the most vs last week: PMI, MTG, RDN

Tightened the most vs last week: BAC, C, WFC

Widened the most vs last month: MTG, ACE, CB

Tightened the most vs last month: LNC, MET, MBI

 

WEEKLY RISK MONITOR FOR FINANCIALS: STILL POSITIVE SHORT & INTERMEDIATE TERM OUTLOOK - us cds

 

2. European Financials CDS Monitor – Banks swaps in Europe tightened across the board last week.  Swaps tightened for 38 of the 39 reference entities.

 

WEEKLY RISK MONITOR FOR FINANCIALS: STILL POSITIVE SHORT & INTERMEDIATE TERM OUTLOOK - euro cds

 

3. Sovereign CDS – Sovereign CDS continued to fall last week, retracing to their levels of late November. 

 

WEEKLY RISK MONITOR FOR FINANCIALS: STILL POSITIVE SHORT & INTERMEDIATE TERM OUTLOOK - sov cds

 

4. High Yield (YTM) Monitor – High Yield rates rose 7 bps last week, closing at 7.98 on Friday.  

 

WEEKLY RISK MONITOR FOR FINANCIALS: STILL POSITIVE SHORT & INTERMEDIATE TERM OUTLOOK - high yield

 

5. Leveraged Loan Index Monitor – The Leveraged Loan Index continued to rise, closing at 1605, 6.5 points higher than the previous week.   

 

WEEKLY RISK MONITOR FOR FINANCIALS: STILL POSITIVE SHORT & INTERMEDIATE TERM OUTLOOK - LLI

 

6. TED Spread Monitor – The TED spread held nearly flat, ending the week at 15.3 versus 15.8 the prior week.

 

WEEKLY RISK MONITOR FOR FINANCIALS: STILL POSITIVE SHORT & INTERMEDIATE TERM OUTLOOK - ted

 

7. Journal of Commerce Commodity Price Index – Last week, the index fell 3 points, closing at 32.6 on Friday.

 

WEEKLY RISK MONITOR FOR FINANCIALS: STILL POSITIVE SHORT & INTERMEDIATE TERM OUTLOOK - JOC

 

8. Greek Bond Yields Monitor – We chart the 10-year yield on Greek bonds.  Last week yields rose 19 bps.

 

WEEKLY RISK MONITOR FOR FINANCIALS: STILL POSITIVE SHORT & INTERMEDIATE TERM OUTLOOK - greek bonds

 

9. Markit MCDX Index Monitor – The Markit MCDX is a measure of municipal credit default swaps.  We believe this index is a useful indicator of pressure in state and local governments.  Markit publishes index values daily on four 5-year tenor baskets including 50 reference entities each. Each basket includes a diversified pool of revenue and GO bonds from a broad array of states. Our index is the average of their four indices.  Spreads fell last week, dropping 21 bps to 198.  

 

WEEKLY RISK MONITOR FOR FINANCIALS: STILL POSITIVE SHORT & INTERMEDIATE TERM OUTLOOK - markit

 

10. Baltic Dry Index – The Baltic Dry Index measures international shipping rates of dry bulk cargo, mostly commodities used for industrial production.  Higher demand for such goods, as manifested in higher shipping rates, indicates economic expansion.  The index fell to a new low of 1370 as flooded coal mines in Australia continued to pressure demand. 

 

WEEKLY RISK MONITOR FOR FINANCIALS: STILL POSITIVE SHORT & INTERMEDIATE TERM OUTLOOK - BDI

 

11. 2-10 Spread – We track the 2-10 spread as a proxy for bank margins.  Last week the 2-10 spread widened slightly to 278 bps. 

 

WEEKLY RISK MONITOR FOR FINANCIALS: STILL POSITIVE SHORT & INTERMEDIATE TERM OUTLOOK - 2 10 spread

 

12. XLF Macro Quantitative Setup – Our Macro team sees the setup in the XLF as follows: 1.9% upside to TRADE resistance, 2.3% downside to TRADE support. 

 

WEEKLY RISK MONITOR FOR FINANCIALS: STILL POSITIVE SHORT & INTERMEDIATE TERM OUTLOOK - xlf

 

 

Joshua Steiner, CFA

 

Allison Kaptur


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Governing The Government

This note was originally published at 8am on January 19, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“The Constitution was designed to govern the government, not the people.”

-Steve Hanke

 

In a concisely written piece of Complex Simplicity, Steve Hanke penned this quote in a paper I was reading yesterday titled “Reagonomics Goes Global.” Hanke is a professor of applied economics at Johns Hopkins University and a Senior Fellow at the Cato Institute. I interviewed him while I was running a radio show for Bloomberg Radio last year and have been reading his work ever since. He gets government math.

 

The white paper featured different opinions from different authors and I think Hanke’s chapter, titled “Lessons from America’s Founding Fathers and US Experience” is well worth taking the time to read. Hanke takes a crack at differentiating the definitions of American style democracy and liberty. He also highlights Alexander Hamilton’s original US fiscal convictions:

 

“The United States was born in a sea of debt. A majority of the public favored a debt default . Alexander Hamilton, acting as Washington’s Secretary of the Treasury, was firmly against default. As a matter of principle, he argued that the sanctity of contracts was the foundation of all morality. And as a practical matter, Hamilton argued that good government depended on its ability to fulfill its promises.” (Reagonomics Goes Global, page 8)

 

I call this to your attention this morning because it draws a historical bridge between THE most important US Economic question that’s on my mind right now (can the US Dollar Index hold its newfound intermediate term TREND line of support at $78.66?) and what I am going to talk about on our Q1 Macro Theme call this morning under the umbrella of a theme called American Sacrifice (email sales@hedgeye.com if you’d like access to the call and/or the slide presentation).

 

Duration matters. That’s why I try my best to make sure my team is Duration Agnostic when considering risk, probability, and uncertainty. That’s why we have developed our TRADE, TREND, and TAIL model. It’s not perfect, but at least it’s an evolution of legacy Wall Street research and risk management processes gone bad. What the US stock market is doing in the immediate-term is not the most important long-term US Economic factor that’s on my mind.

 

Seeing the stock market going up every day isn’t the solution to this structural mess (stock market fans should remember that 1/3 of this country (102 MILLION Americans) have ZERO moneys in a retirement account and 1/2 of Americans have $2,000 or less). Neither is inflation – that’s a policy. What I think we ultimately need is a strong currency, balance sheet, and handshake that the world can trust again. If we have those, the jobs will come.

 

We can hope and pray that the new Republican leadership can be depended upon to “fulfill its promises” of spending cuts, but we must remember that hope is not an investment process and trusting a conflicted and compromised politician better have some serious prayer attached to the exercise. The foundations of morality matter (repaying your debts) to a lot of people in this country. So does protecting whatever integrity remains of her currency.

 

It’s time.

 

So, let’s roll with that this morning and figure out whether the intermediate-term strengthening of America’s currency (US Dollar Index is up for 8 out of the last 11 weeks since the midterms) is a leading indicator to a long-term TREND of American Sacrifice and fiscal sobriety.

 

Governing the Government on Global Macroeconomic risk management matters sounds like both a painful and herculean task – but I think it’s achievable.

 

Here’s what we need to execute:

  1. A Real-Time Accountability Mechanism (Twitter – check)
  2. An Analytically Competent and Independent Research Firm With Real American Clients Who Care (Hedgeye and The Buy Side – check)
  3. Freedom of Speech and email forwarding (iPhones, Crackberries, etc – check)

The messaging is out there folks. The People have already voted. Americans want spending, deficit, and debt cuts – and this is our last chance to Govern the Government so that we get all three of those things no matter what the intermediate-term American Sacrifice.

 

By “last chance”, I’m not trying to be dramatic either. With the upcoming debt ceiling and deficit/debt commission debates, this is it - for the US Dollar, America’s balance sheet, and her handshake with the world as its fiduciary of the world’s reserve currency that is…

 

I am a Canadian-American, so I have no allegiances to any person, politician, or party on this matter. If the US Dollar starts to break down again, sustainably, below my $78.66 TREND line, I will sell it faster than you can say Thunder Bay Bear.

 

Another debauchery of the US Dollar will equate to $120 oil, global food inflation riots, and plenty of other unintended consequences that I, for one, have no patience seeing my firm and family endure under the willfully blind veil of no one could have seen this coming.

 

My immediate-term support and resistance lines for the SP500 are now 1280 and 1298, respectively.

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Governing The Government - 7


Golden Silence

“Silence may be golden, but can you think of a better way to entertain someone than to listen to him?”

-Brigham Young

 

We’re looking forward to the listening to the President of the United States at tomorrow night’s State of The Union address. It’s time to focus on US Jobless Stagflation. It’s time to cut the US deficit. It’s time to strengthen America’s handshake with the world via the credibility of her currency.

 

It’s time.

 

Not only is it time because America is out of time to cut spending, but it’s Game Time for the US Dollar Index’s price. The US Dollar closed down -1.1% last week and was down for the 3rd week out of the last four. It’s testing what we call its intermediate-term TREND line of support at $78.66, and if this week’s comments from both the President and the Fed don’t support it, this country could be heading toward a very dark place again.

 

What’s darkening? The math.

 

My defense partner, Daryl Jones, wrote a great summary updating the math on Friday (send an email if you’d like the full note). Currently, the Congressional Budget Office (CBO), which we consider consensus for this purpose, projects that the federal budget deficit for 2011, 2012 and 2013 will be $-1,066BN, $-665BN, and $-525BN, respectively.  This is a combined deficit of $-2.3TN.  (Yes, that is a big number.)  So, all else being equal and setting aside any maturities, the United States will have to issue $2.3TN in treasuries to fund the CBO’s projected budget deficit over the next three years.  So if we accept that there is ~$14TN in government debt outstanding (Source: usdebtclock.org), then the outstanding government debt over the next three years will grow 16%. That is, supply is going up.  Given this outlook, it does make sense that interest rates on 30-year Treasuries are moving higher.

 

Interestingly, we think that the CBO’s budget deficit projections are low, and perhaps meaningfully so. Currently our U.S. budget deficit projections for 2011, 2012, and 2013 are $-1.2TN, $-1.0TN, and $-0.9TN, respectively.  Combined, this is a total deficit for the ensuing three years of $3.1TN.  In aggregate, our projections are $800BN more than the CBO, or 34% higher for the three year period.  The implication being that the issuance of U.S. Treasuries may be almost 34% higher than “consensus” expects over the coming three years.  No doubt some of this is priced in, but our models have supply growing at an accelerated rate relative to what is likely priced in. And the question remains, who is going to buy these US Treasuries?

 

The cover of The Economist this weekend had a title that represents what we have been belaboring for the last 3 months – “The Rich and The Rest” – and, without going into every detail, we see this simply as a function of a US Government policy to print debt and inflate. Sure, inflation is great for some of us – but it’s really bad, in the end, for most of us. Global inflation is perpetuated by a policy to abuse and debauch the world’s reserve currency.

 

For the last 3 years, as a way to express my distaste for who I have labeled the Fiat Fools, on balance I have been short the US Dollar and long Gold. Since US Mid-term election promises were made to cut spending and address our fiscal imbalances, I have been long the US Dollar (bought it on November 4th) and short Gold (sold long position December 6th and shorted GLD on December 29th).  

 

Today, I am long the US Dollar and flat out frightened. Being in the hands of professional politicians who lie and backpedal on their promises is never a good place to be. It’s time, Mr. President. This Burning Buck stops with you.

 

Looking back at last week’s action in Global Macro prices, Dollar Down wasn’t good for much else than a low-quality European short squeeze:

  1. US Dollar Index = -1.1%
  2. Euro = +2.3%
  3. SP500 = -0.8%
  4. Nasdaq = -2.4%
  5. Russell 2000 = -4.2%
  6. Spain’s IBEX = +4.3%
  7. Italy’s MIB = +3.0%
  8. Greece’s Athex = +6.3%
  9. China’s Shanghai Composite = -2.7%
  10. Indonesia’s Jakarta Composite = -5.3%
  11. Philippines PSEi Index = -4.4%
  12. CRB Commodities Index = FLAT
  13. Oil = -2.6%
  14. Gold = -1.4%
  15. US stock market Volatility (VIX) = +19.3%
  16. US Treasury Yields = UP again, across the board

And for a US centric stock market investor, while it’s always nice to say ‘hey, look at the Dow’ and extrapolate that reading as a barometer for the rest of the world’s health, remember the simple arithmetic associated with the Dow (a sample of 30 stocks) where General Electric (GE) had a monster +7% day Friday. That’s a great day for what’s been a dog since 2008; not what’s going on in terms of Interconnected Global Macro Market Risk.

 

What the aforementioned weekly moves meant to me was:

  1. US Jobless Stagflation Continues – Commodity prices are sticky because the US Dollar is weak; US unemployment remains bearish.
  2. The Great December Beta TRADE – It’s a problem when stock market reflation becomes Global Inflation (Russell2000 down YTD).
  3. Volatility Is Back, Because Risk is Never “off” – VIX up +19.3%, with Bond and Emerging Markets getting smoked by inflation is self evident.

Again, if the Dow closing up +0.7% on the week is the risk “on/off” bogey that people who missed all of the Global Risk Management signals of early 2008 are still using – all I have to say about that is Godspeed. I’m keeping a big fat position in Cash as it’s the only way to protect against that dogma.

 

From an asset allocation perspective, I did take some weakness in market prices to invest some of my Cash position. Last Monday, I had a 67% position in Cash. This morning that position is down to 61% with the following allocations in the Hedgeye Asset Allocation Model:

  1. Cash = 61%
  2. International FX = 18%
  3. International Equities = 6%
  4. US Equities = 6%
  5. Fixed Income = 6%
  6. Commodities = 3%

And yes, if this country’s Golden Silence on the obvious breaks tonight like the price of gold itself has, I’ll be the first to get in line and get more invested. A strong US Dollar will make Global Inflation deflate. It will also strengthen America’s balance sheet and have the international investing community believe in America’s handshake again.

 

My immediate term support and resistance levels for the SP500 are now 1267 and 1295, respectively.

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Golden Silence - aaaa


CHART OF THE DAY: Mr. President; The Burning Buck Stops with You

 

CHART OF THE DAY: Mr. President; The Burning Buck Stops with You -  chart of the day


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