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Could the Kingdom Fall?

Conclusion: Though once unthinkable, the fall of the Saudi kingdom now seems at least in the realm of reality.  That is, popular unrest in Saudi Arabia and the Middle East could lead to a shift away from the autocratic rule in Saudi Arabia.  Keep March 11th on your calendars as Saudi youths have organized a day of protests against the monarchy called the Day of Rage.


Conventional wisdom suggests that Saudi Arabia will be immune from the popular upheaval that is occurring more broadly in the Middle East. The key factor supporting this view is simply that the standard of living is quite high in Saudi Arabia.  In fact, Saudi Arabia’s GDP per capita was $23.7K in 2010 based on the most recent data from the International Monetary Fund, which ranks it 39th in the world and just below such stable democracies as New Zealand. 


We often use market prices as a leading indicator for fundamentals in our model, and the Saudi stock market has been flashing some amber lights.  In the chart below, we’ve attached a 3-week chart of the Saudi primary equity index and 5Y CDS quotes.  As you can see, there has been a severe correction in the Saudi stock market of more than 10% and an expansion by more than 20% in CDS spreads.


Could the Kingdom Fall? - 1


While this correction is not surprising given the geo-political uncertainty in the Middle East (Tunisia, Egypt, Libya, and so on), on the other hand, the price of oil has gone up dramatically in that period, which, on a fundamental basis, improves the financial position of Saudi Arabia.  Specifically, almost 90% of Saudi Arabia’s export revenues are petroleum based.  Moreover, Saudi Arabia has 260 billion barrels in oil reserves, which is about 1/5 of the world’s total, and is the world’s largest exporter of oil.


Despite this and higher relative GDP per capita, all is not well in the Kingdom of Saudi Arabia.  In fact, both inflation and unemployment are pervasive in Saudi Arabia.  While data from the Saudi government is questionable at best, some reports reasonably put inflation at north of 5%, which is clearly squeezing those near the bottom of the income pyramid.  In the same vein, while unemployment measures are also difficult to come by, most estimates put the national rate at close to 11%.  The International Labor Organization (ILO), considered more credible, has put the unemployment rate for those between the ages of 20 – 25 at closer to 30%.  This is particularly important given then demographics of Saudi Arabia, where the population is young with median age of 23.4 years old.  (This is compared to 36.9 in the United States.)


Directly below, we’ve highlighted a chart from ILO, which compares unemployment, youth unemployment, and GDP globally.  The slow growth and high unemployment issues are quite clear in MENA.


Could the Kingdom Fall? - 2


In signal that the Saudi royal family is taking the risk of social upheaval  very seriously, last week Saudi King Abdullah bin Abdul-Aziz’s announced a $37 billion benefits package to create 1,200 new jobs, raise cost-of-living allowances, grant interest-free home loans, and more.   This was underscored by Prince Alwaleed bin Talal from Saudi Arabia, said to be the world's eighth-richest man, who wrote an op-ed in the New York Times, calling for "unwavering, enduring and sincere" reform.


The stock market, despite this package, the strong price of oil, and positive rhetoric, continues to signal danger.  In fact, the Tadawul, the largest stock market in the Arab world by capitalization, plunged (-6.78%) to 5,538.72 overnight, bringing its decline for the year to date to (-16.34%).


So, could the Kingdom of Saudi Arabia fall? While the Royal family has much in the way of wealth to appease it citizens, sharing power and democratic rights could be the real lynchpin to satisfy popular protests.  To that end, it is not clear the royal family is there yet.  The Day of Rage on March 11th could be a key catalyst in the future of Saudi Arabia, and its royal family.


Daryl G. Jones

Managing Director


In-line quarter but turnaround pushed off to Q2.



"As expected, fourth-quarter comparisons were the best of the year, as business conditions and consumer confidence continued to improve. As the economic recovery gains momentum, we anticipate we will see increases in both visitation and spend-per-visit, resulting in a return to consistent growth across our business this year."

- Keith Smith, President and Chief Executive Officer of Boyd Gaming



  • Locals Las Vegas: "local economic conditions began to stabilize."
  • "While we continued to expand our leading market share Downtown, business results were impacted by our Hawaiian charter operation."
  • Midwest and South: The "increase was the region's best year-over-year comparison in five quarters. The gain was primarily driven by strong business volumes at our southern Louisiana properties."
  • Borgata: "While we were encouraged by growth in slot win, non-gaming revenue and overall market share, these gains were offset by higher promotional expense, declines in table game hold and volume, and increased regional competition."



  • Core business is improving and they are on track to begin reporting improvements starting 2Q11. 1Q11 may reflect a slight decline YoY given the difficult comparisons in the Las Vegas Locals market. 1Q was also impacted by severe weather in the Midwest. They do expect a sequential pickup in EBITDA though.
  • Convention and meeting business looks to be poised for additional growth in 2011 in Las Vegas. Projected that their group business in Las Vegas will be up 15% YoY.
  • Even a modest increase in spend per visit - $5/ per visit - will lead to a $20MM increase in Las Vegas locals EBITDA
  • Optimistic about the legislative changes in AC and the potential impact they will have on the market there
  • Grew market share in Locals LV by 20 bps - with the strongest growth at Orleans - which has benefited from a new marketing campaign and a pickup in group and meeting business
  • Increasingly encouraged by the trends in the locals market, but are concerned by the promotional activity. Competitor [Station Casinos] introduced a new aggressive campaign.
  • Downtown - 35% market share. However, higher fuel costs impacted their quarter and should continue to do so.
  • Rated play from their Hawaiian tourism increased and is continuing to perform well.
  • Treasure Chest grew their market share by a full percentage point
  • Midwest and South: Winter weather cost 3MM in EBITDA
  • Borgata continued to outperform the market despite lower than normal table hold and new regional competition.  Promotional spend increased due to rising competition but remains low compared to others in the market. In January slot revenues were flat YoY and they had the highest slot share
  • 4.2x Sr Leverage ratio vs. 4.5x, total leverage ratio was 7.0x vs (7.75x)
  • Borgata was also in compliance with their covenants - their leverage was about 5x at 12/31/2010 (they don't have financial covenants).  Called the remaining balance of their 7.125% notes.
  • $40-42MM of corporate expense for 2011 - spread evenly throughout the year
  • D&A for 2011: $195-200MM - $130-135MM attributable to BYD, balance to Borgata
  • Share based comp of $12MM for 2011
  • Consolidated Interest expense for 2011: $145-150MM, Borgata $85-87MM  - total $230-237MM 
  • Tax rate of 35% for 2011
  • Capex: $50MM in 2H2011(maintenance), Borgata will start a room remodel starting in 2H2011 lasting through 1H2012 - $40MM in 2011 ($25MM spend on remodel and $15MM on maintenance). 40MM target also for 2012.


  • Are they seeing higher spend per visit yet or just more frequency?
    • Frequency is getting better not seeing a lift in spend yet
  • Impact of oil prices on their business
    • Impact on charter operations in Downtown
    • Airfare impact too
    • Unclear whether their So Cal business will be impacted by higher fuel
    • Haven't seen any impact yet
  • Don't think they have any deferred maintenance at any property but have postponed room remodel.  There are about 700 rooms that need remodeled.
  • Coin-in was up in the locals market in Jan 2011
  • In Q1 2011 - their comments were in reference to both revenue and EBITDA
  • Cash rooms in the LV Market account for 25-35% of their business mix.  Trends are continuing to strengthen in 2Q.
  • Opening of shopping area next to the Sun Coast should be positive. They will be opening the retail in phases and are working with the developer to promote the opening.

Oil fear trade: How Middle East unrest could lead to lower...

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Hedgeye CEO Keith McCullough handpicks the “best of the best” long and short ideas delivered to him by our team of over 30 research analysts across myriad sectors.

Lower-Highs: SP500 Levels, Refreshed

POSITION: no position in SPY 


From the vantage point of my core 3-factor model (PRICE, VOLUME, VOLATILITY), the risk/reward tells me I’m best served to continue to managing risk towards the probability of the US stock market making lower-highs.


As a reminder, here’s where the SP500 price of 1320 fits across my core 3 risk management durations: 

  1. TRADE support = 1312
  2. TREND support = 1258
  3. TAIL resistance = 1343 

Meanwhile, here’s how the Volatility Index (VIX) looks 

  1. TRADE support = 18.11
  2. TREND support = 17.74
  3. TAIL resistance = 22.02 

Convergence of TRADE and TREND durations like this in the VIX could be a very bullish leading indicator for future volatility. Fundamentally, with Global Growth Slowing as Global Inflation accelerates, that risk management scenario makes perfect sense to me. And I don’t think consensus is positioned for it.



Keith R. McCullough
Chief Executive Officer


Lower-Highs: SP500 Levels, Refreshed - 1

R3: WRC, SHOO, M, New Balance


March 1, 2011






  • For those who don’t believe shopping is an American pastime you may want to think again.  A study conducted by OnePoll discovered that the average woman spends 399 hours and 46 minutes shopping per year over 301 trips.  Interestingly apparel shopping edges out food shopping with average time spent at 100 hours on clothing vs. 94 for groceries.
  • Add New Balance to the list of athletic footwear companies looking to focus on new product and innovation in 2011.  The company launches its latest marketing campaign entitled “Let’s Make Excellence Happen” with a presence on TV, print, digital, viral video, and in-store visuals.  The effort focuses on a slew of new product intros and marks the end of the company’s “softer” marketing efforts via its “Made in the USA” campaign.
  • In one of the more optimistic views we’ve heard regarding pricing dynamics, WRC’s management suggested that in addition to expecting higher selling prices to largely offset increased product costs, unit volume is also likely to remain flat over the balance of the year providing a source of comp upside. Compared to the rest of retail that expects unit volume declines as an offset to price, WRC would be a clear standout in the space if they manage to grow both.  



Reliance Brands closes Deal with Steven Madden Ltd. -  India’s Reliance Brands has taken a step closer to its vision of becoming an apparel and lifestyle powerhouse in the Asian country with a new license for accessories and footwear under the Steve Madden brand. The license, with Steven Madden Ltd., brings the Madden collections to all major cities across India through monobrand and premium department stores.  Darshan Mehta, president and chief executive officer of Reliance Brands, said the firm aims “to [translate] the brand’s unique fashion sense into the mind-set of the Indian female consumer.”  Reliance has joint venture partnerships with Paul & Shark, Diesel and Ermenegildo Zegna, as well as distribution agreements with Timberland and Quiksilver. <WWD>

Hedgeye Retail’s Take:  With foreign direct investment still up in the air, western brands are not sitting still.  Clearly sharing the cost of an Indian market entry with a partner like Reliance has its benefits to building a brand with very little, if any awareness at this point.


Sustainable Apparel Coalition Formed - Sustainability is on the road to standardization. After years of largely going it alone and producing a patchwork of overlapping efforts to reduce fashion’s social and environmental footprint, a group of major brands, nonprofit groups and the Environmental Protection Agency have banded together to form the Sustainable Apparel Coalition. Next month, the coalition, which was spearheaded by Patagonia and Wal-Mart Stores Inc., will begin testing the next generation of an index that measures the sustainability of apparel and footwear. That index is expected to evolve into a label or hangtag that would help shoppers understand the ramifications of their apparel or footwear purchases, from carbon emissions and water and chemical usage to conditions in factories. <WWD>

Hedgeye Retail’s Take:   For anyone interested in seeing where these efforts are headed take a look at Patagonia’s blog which actually tracks the entire production of its garments, component by component, factory by factory.  The complexity in coordinating the global supply chain to produce just one piece of outerwear is eyeopening.


Swiss Banker Buys Stake in JJB Sports - A Swiss investment bank acquired warrants convertible to a nearly 6% stake in JJB Sports last week as the insolvent British sporting goods retailer prepared to reorganize under protection from its creditors.  JJB Sports notified investors Feb. 25 that a group led by Adriano Agosti, chairman and  managing director for GoldenPeaks Capital Partners AG, acquired warrants convertible to 7.46 million shares, or 5.76% of the retailer. The retailer also said it had delivered a final draft of its revised business plan to Bank of Scotland detailing how it plans to restructure  under a "corporate voluntary arrangement," or CVA, which is the United Kingdom’s version of a Chapter 11 bankruptcy reorganization.  <SportsOneSource>

Hedgeye Retail’s Take:  Long rumored to be a potential “takeout” candidate, JJB looks to be heading more in the direction of survival mode.  Bonus points for anyone who can remember when sporting goods was actually a decent and money-making business in the UK. 


Macy’s Mobile Commerce - Macy’s is adding a little star power to its mobile channel. The retailer is using text messages and two-dimensional bar code scanning of the Quick Response, or QR, code variety to deliver video content to shoppers from the retailer’s celebrity designers, including Bobbi Brown, Sean “Diddy” Combs, Tommy Hilfiger, Michael Kors, Greg Norman, Rachel Roy, Irina Shabayeva and Martha Stewart. The program, called Macy’s Backstage Pass, was developed with the help of marketing firm JWT New York and lets in-store shoppers use a mobile device to scan a QR code on a product or send a text message to access videos about the designers and brands. <InternetRetailer>

Hedgeye Retail’s Take:  Expect to see even more mobile marketing from Macy’s as the company overall digital budget expands at the expense of traditional media. 


Facebook will Surpass Yahoo! in Display Ad Revenues This Year -  For the first time, the largest share of US display ad revenues will go to Facebook, eMarketer estimates. The social network’s 80.9% growth in display ad revenues, to $2.19 billion this year, will mean Facebook sees 21.6% of all US display ad dollars. That will put it ahead of Yahoo!, where eMarketer estimates display revenues will be up 16%. Yahoo!’s market share will inch up to 16.4%, while display gains at Google push the site’s share of display spending to 12.6%. Meanwhile, AOL will drop from 5.3% of display ad revenues in 2010 to 4.4% this year. <eMarketer>

Hedgeye Retail’s Take:  Definitely good for Facebook but probably not good for the Facebook user.  In other words, Facebook has quickly become the world’s largest billboard.


R3: WRC, SHOO, M, New Balance - r3 3 1 11



Counterpoint: Middle East Turmoil is Bullish for Oil

Lou Gagliardi is Hedgeye's Managing Director of Energy Research.  The following is a note he published yesterday in response to Daryl Jones' note "Could the Turmoil in the Middle East be Bearish for Oil?"


At Hedgeye, we emphasize risk management; that entails encouraging different perspectives and in-house debate to ensure our clients are presented with a breadth and depth of thoughtful research. In the pursuit of that goal, my colleague Daryl Jones, our Macro Managing Director, this past Friday wrote a compelling and thoughtful view titled “Could the Turmoil in the Middle East be Bearish for Oil?’


In the spirit of debate where reasonable men may disagree, I will present a counter view.


Daryl is right; “fear” is driving the price of oil in the markets. But it is a credible fear. As I wrote this past Friday, “The market has seized upon the reality that these Mid-Eastern regimes are vulnerable and could collapse, and to which political wind is uncertain. Who will control these significant global energy supplies is still unknown. This new realization breeds uncertainty in the market.” That uncertainty breeds oil price volatility.


Whether these political regimes collapse or not, and to which political view, is not my focus here, nor is whether political liberalization could actually support growing production. Indeed, incremental production can grow under any political persuasion. Political liberalization will be good for the people of the Mid-East, and for international relations. It will calm the oil markets and remove much of the “fear” premium recently baked into oil prices. It can also create a more positive environment to grow global production supplies. But political liberalization will NOT over the long run be a catalyst for lower crude prices. Why? Because incremental production from Mid-East is “insufficient” to arrest global crude oil production decline and meet growing global consumption. The next three charts highlight these points.


First, the major global crude oil basins are in significant decline: Mexico, Venezuela, U.K., Norway, Nigeria, Alaska North Slope, U.S. lower 48 conventional, and Canadian conventional.


Counterpoint: Middle East Turmoil is Bullish for Oil  - lg1


Global crude oil consumption continues to outstrip global production: global consumption since 2000 has averaged about 1.1% per annum; global production has grown at about 0.7% per annum.


Counterpoint: Middle East Turmoil is Bullish for Oil  - lg2


Lastly, the major global oil basins in decline are the major global crude oil exporters: since 2004 the combined average drop off in production for only the UK, Norway, Mexico, Nigeria and Venezuela has been over 622,000 b/d per year, or 3.1 MM b/d in total production lost, and increasing.


Counterpoint: Middle East Turmoil is Bullish for Oil  - lg3


On closer examination, Russia is not a clear example of what Iraq can do with production growth; its growth will depend on its reservoirs and the laws of physics. According to the BP Statistical Review of World Energy and the IEA, Russian oil production peaked in 1987 at 11.484 MM b/d, reached a low of 6.114 MM b/d in 1996, ramped up to 9.287 MM b/d by 2004, and hit 10.150 MM b/d in 2010 – a 1.5% per annum increase from 2004 to 2010. As I wrote in an energy note on Jan 7th, “Can Russia Maintain Oil Production at 10 MM b/d?” Russia has struggled to return to its production level of 10.45 MM b/d in 1990, and twenty years is a long time; Russia has never returned to Soviet era levels. Indeed, since 2005 Russia’s year-over-year crude production rate has steadily declined, as seen from the graph below.


Counterpoint: Middle East Turmoil is Bullish for Oil  - lg4


Why has Russia struggled despite its “political liberalization”? Recall Yukos and Mikhail Khodorkovsky as a prime example that Russia’s “democracy” is not exactly comparable to western standards.  First, Russian oil fields were opened up to Russian bureaucratic cronies, not to the Western Multinationals (IOCs). Secondly, Mother Nature, or the natural laws of physics, has hampered growth. Once Russian fields were privatized, albeit to Russian insiders, economic incentives became the production drivers; Russian fields registered a significant uptick in production growth as secondary recovery techniques were applied to Russia’s aging Western Siberian fields. The rate of production growth began to increase in 2000, peaked in 2003, and the rate of growth has declined ever since. The difficulty in sustaining an increasing rate of growth is due to the natural rate of decline in oil and gas fields, and economics. The marginal cost of investment begins to erode the marginal return from mature Russian fields, even at high oil prices.


These are the same issues that Iraqi production growth faces today. First, as to claims that Iraqi production could eventually hit 12 MM b/d: since 1965 the highest Iraq production has ever been is 3.489 MM b/d in 1979; no country produces at 12 MM b/d, not even Saudi Arabia (today at ~8.9 MM b/d). The last country to come close to 12 MM b/d, Russia, fell short by roughly 500,000 b/d and has taken over twenty years since 1990 to get back to 10 MM b/d.


Furthermore, higher production that leads to lower crude prices is not in Iraq’s national interest, and the country knows this. Their goal is not to maximize production, but to maximize revenue.  The dilemma the Iraqis will run into is dealing with a“mutually exclusive” choice: you maximize production or you maximize ultimate recovery, you cannot have both unless you alter the laws of physics. When you run the reservoirs hard to speed up production, in the long-run you impair reservoir pressure and limit ultimate resource recovery; and that, in the long-run, limits ultimate revenue as barrels are lost.


In the initial years, Iraq will see a significant uptick in production as the Russians did, coming off a low base and as the dramatic effect of secondary enhanced recovery techniques kicks in. But successive increases in growth rates will become increasingly difficult to maintain, as natural reservoir decline accelerates due to falling pressure. Increasing capital investment to increase reservoir pressure and arrest natural decline will run into the wall of the laws of diminishing returns, as the cost of the incremental barrel exceeds its incremental return.


Today, Iraqi production is at 2.7 MM b/d with 2.75 MM b/d targeted at the end of this year. To hit 12 MM b/d within a decade demands a ~16% per annum compounded growth rate, and if they could attain it, it would require massive inflows of capital. Most of the Majors have avoided Iraq’s initial offering of licenses, due to unprofitable terms. This is a prime example of“Resource Nationalism.” Will Iraq invite the Majors back by offering better terms? They may, but, that means less for Iraq which they will seek to offset through higher oil prices. Iraq will get higher prices through production cutbacks – basic supply/demand/price levers. Greater capital investment will flow to Iraq only if commensurate returns increase, and that demands higher oil prices.


Understanding what is at stake for Iraq and many of the other oil-rich Mid-East nations cuts to the heart of the issue. Higher production is to whose benefit? The West? Or the local people, for whom it is intended? The road through greater oil wealth lies through less oil supply, which drives prices higher; even the Iraqis understand this, despite public relations statements to the contrary.


In conclusion, supply will remain increasingly constrained due to natural global decline, higher costs, inadequate infrastructure, accelerating demand from the developing world, continued geo-political tension, and “national self-interest”; combined these catalysts will limit global oil production and inevitably fuel higher prices.


From the Oil and Gas Patch,


Lou Gagliardi


Kevin Kaiser

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