We think ASCA will soon close a major refinancing that will reduce average borrowing cost and combined with the buyback, will be hugely accretive. P/E multiples anyone?
For the first time in years, a gaming stock is looking attractive on a P/E basis. That stock is ASCA and its earnings multiple on our 2012 estimate is only 9x. It also carries the highest free cash flow yield at over 20%. Sure, the huge free cash flow will go to paying down debt for a couple of years but longer term, the cash will flow to equity holders.
ASCA has a couple of near-term catalysts including improving regional gaming demand and a likely Q1 earnings beat. The company should also close a major refinancing in the next week or two that will substantially lower average cost of debt. The refinancing combined with the already announced buyback of stock from the Craig Nielsen Trust, should result in huge EPS and FCF per share accretion.
Our 2011 EPS estimate of $1.50 is substantially higher than the Street at $1.10, mostly as a result of the refinancing and share buyback. Other discrepancies may include no cash taxes this year, lower debt and the elimination of a significant amount of non-cash interest expense from the retirement of the swaps on July 19, 2010. Our EBITDA estimate is also higher by approximately $6 million.
Some analysts may have some of these factors reflected in their model. We do not believe any other analyst have the refinancing in their models. Per our math, despite the repurchase of 27 million shares, interest expense should not be that much higher. Average borrowing rate could go down 120 bps, almost offsetting the $360 million increase in average debt for 2011 as a result of the buyback. We think most analysts just assume a high yield raise and not a complete restructuring of the debt including a new credit facility.
In the years we’ve been covering ASCA, we’ve found that the best time to own it is when the FCF yield climbs over 20% and the company starts beating estimates. We believe we are in that scenario here ahead of the Q1 earnings release.
Below we provide brief commentary on today’s European data releases:
Ireland stress tests reveal that four banks need to raise €24 Billion in additional capital vs expectation of €27.5 Billion.
The breakdown of capital needs to cope with potential losses include:
Bank of Ireland €5.2bn
Irish Life & Permanent €4bn
Portugal’s debt (as a % of GDP) 8.6% in 2010 vs government expectations of 7.0-7.3%
Eurozone CPI 2.6% MAR Y/Y vs 2.4% FEB
Turkey Q4 GDP 9.2% Y/Y vs 5.2% [3.6% Q/Q vs 1.2%]
UK Nationwide House Prices 0.1% MAR Y/Y vs -0.1% FEB [0.5% MAR M/M vs 0.7% FEB]
Germany Retail Sales 1.1% FEB Y/Y vs 2.6% JAN [-0.3% FEB M/M vs 0.4%]
Germany Unemployment Rate 7.1% MAR vs 7.3% FEB
-Anecdotally, Volkswagen recently said it plans to create 50K new jobs, 6K of which in Germany. Robert Bosch (world’s biggest auto-parts maker) said it will add 9K graduates this year, 1.2K in Germany.
France Producer Prices 6.3% FEB Y/Y vs 5.6% [0.8% FEB M/M vs 0.9% JAN]
Spain Total Housing Permits -15% JAN M/M vs -0.4% DEC [4.0% JAN Y/Y vs -6.3%]
Italy PPI 5.7% FEB Y/Y vs 5.3% MAR [0.6% FEB M/M vs 1.2%]
Italy CPI 2.6% MAR P Y/Y vs 2.1% FEB
Greece Retail Sales -10.5% JAN Y/Y vs -13.5% DEC
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March 31, 2011
OUR TAKE ON OVERNIGHT NEWS
Prada File for IPO on Hong Kong Exchange - Prada SpA, the Italian maker of Miu Miu bags and Church’s shoes, submitted an application to the Hong Kong exchange to hold an initial public offering in the city by July, said two people familiar with the company. The planned sale may give the company a valuation of about $10.7 billion excluding debt, said one of the people, who declined to be identified because the matter is private. Prada made the IPO filing yesterday, the people said. Prada, based in Milan, follows European brand-name companies including L’Occitane International SA (973) in selling shares in Hong Kong, where IPOs reached a record last year. The city is a popular luxury-shopping destination for tourists from China, which allowed individual travel to Hong Kong in 2003. Intesa Sanpaolo SpA (ISP), Credit Agricole SA’s CLSA Asia-Pacific Markets, Goldman Sachs Group Inc. (GS) and UniCredit SpA (UCG) are managing the IPO. Sally Kwong, a Prada spokeswoman in Hong Kong, declined to comment. <Bloomberg>
Hedgeye Retail’s Take: Just days after posting record profits, the luxury retailer has finally filed its long awaited IPO papers in Hong Kong with aspirations to float this summer. While hardly a surprise, the papers are not definitive until the deal is complete. As you may recall, this process has been delayed on three separate occasions over the last 10-years.
Gap Opens a Chinese Web Store - Gap Inc. is selling online in China. This morning, Gap, No. 23 in the Internet Retailer Top 500 Guide opened an online store on Taobao Mall, one of China’s biggest business-to-consumer e-commerce marketplaces. Gap, which late last year opened Gap bricks-and-mortar stores in Shanghai and Beijing, initially will use its web store on Taobao.com to sell merchandise from its Gap, Baby Gap and Gap Kids brands, the retailer says. Taobao reaches 370 million registered users, Gap says. Taobao also receives more than 50 million unique visitors daily and features more than 800 million individual product listings. “Given China is the cornerstone of Gap Inc’s global growth strategy, we believe that partnering with Taobao, with its phenomenal reach all throughout the country, is an important next step as we build on the success we’ve seen so far with our store openings and e-commerce offering,” says Redmond Yeung, president of Gap China. <InternetRetailer>
Hedgeye Retail’s Take: Even more cost effective than partnering with local franchisees, selling through one of the country’s more popular web portals will help grow brand awareness ahead of future owned retail expansion. Given the company’s success selling through the e-commerce channel domestically, this is a no brainer – particularly with the number of stores in China growing from 4 to 12-15 this year.
Fed Says Credit Card Swipe Fee Regulations Will be Ready by Summer - Federal Reserve Chairman Ben Bernanke assured Congress Tuesday that the agency is on track to implement swipe fee reform regulations by summer that will save retailers an estimated $1 billion in fees. “Retailers want to begin passing on swipe fee savings to their customers as soon as possible, and today’s announcement means those plans will be able to move forward as planned despite the anti-consumer efforts of some in Congress,” NRF Senior Vice President and General Counsel Mallory Duncan said. “The Fed has received thousands of comments on this proposal and it is appropriate for that input to be carefully and thoroughly reviewed. If they take a few extra weeks, we understand.” “The banking industry and some in Congress want to delay swipe fee reform for as long as two years, but Chairman Bernanke has made it clear that the Fed doesn’t need a delay in implementation,” Duncan said. “Congress held seven hearings and ordered two GAO studies of swipe fees before enacting this law last year. Congress has made its decision and should allow the Fed to complete its work. Delay beyond this summer’s deadline would amount to a $1 billion-a-month bailout for big banks.” <SportsOneSource>
Hedgeye Retail’s Take: This regulation comes at a critical time for retailers just as input costs ramp into the back half. The question remains whether retailers will choose to enhance overall margins with the potential savings or put the cost savings back into price.
Disparity Between Advertising Dollars and Usage - Despite the projection that online advertising will increase its share of US major media ad spending by more than 10 percentage points between 2009 and 2015, spending on digital, including internet and mobile, has not yet risen to match consumption patterns, eMarketer estimates. Among the major media of television, internet, radio, mobile, newspapers and magazines, US adults still spend the most time each day with TV. eMarketer estimates adults watched television for 42.9% of the time they spent each day with those media in 2010, and ad dollars align closely, at 42.7%. The internet, by contrast, took up 25.2% of adults’ daily media time in 2010, but received just 18.7% of US ad spending.
Hedgeye Retail’s Take: Legacy media is still getting over 25% of all ad dollar spend despite accounting for only 8% of where consumers spend their time. An even greater disconnect exists in mobile accounting for less than 1% of spend despite 8% of time spent. Our sense is that translation issues such as flash compatibility, text sizing, etc. play a key factor here, but don’t expect this spread to last for much longer as retailers commit to greater mobile visibility.
On Monday we wrote a research note on the valuation of the SP500 using the Shiller CAPE P/E, which suggested that the market was overvalued by at least one standard deviation. Not surprisingly the note elicited a fair amount of feedback, some positive, some negative, but mostly constructive and all worth contemplating. Below I’ve categorized the main areas of feedback and attempted to address them appropriately.
1. On a relative basis aren’t equities still a good buy?
Clearly, money managers need to make allocation decisions between stocks, sectors, and asset classes. Therefore, one could argue, looking at U.S. equities on purely a valuation perspective and saying they are expensive only makes sense in the context of the investment alternatives, and the relative after-tax returns.
It is hard to disagree with that. As investors, we have various options of asset classes from which to consider allocating our clients’ heard-earned capital. On a very basic level, then, we should consider the relative value of bonds versus equities as an indicator of whether equities are truly expensive. (The one caveat here is that we also don’t have to be fully-invested when there are as few opportunities for true value as there are today.)
To examine this relative valuation, we’ve taken a look at the earnings yield of the CAPE P/E versus the average yield of a 10Y AAA corporate bond going back to 1954. In this analysis, a lower yield implies a more expensive asset class which is less appealing from an asset allocation perspective, in theory. Currently, bonds, based on this proxy, are a cheaper asset class as they have a 5.2% yield versus equities with a 4.23% yield.
Interestingly, on a standalone basis, while bonds are expensive versus their historical standards, not surprising given the current interest rate policy of the Federal Reserve, they are not as expensive as equities versus their historical average. In fact, 10Y AAA corporate bonds are currently only 0.74 of one standard deviation more expensive than their long run average yield of 7.2% going back to 1954 versus more than one standard deviation for equities.
2. The CAPE P/E is based on historical earnings and equities are based on future estimates, so aren’t equities still cheap?
While we would agree with this to a point, in aggregate it is important to remember that analyst estimates of future earnings are typically wildly disparate versus future actual earnings. So, while the valuation of a stock, and equities broadly, will eventually reflect their future earnings or cash flow, looking at the broad forward earnings of a market is rarely a great gauge of the valuation of the market and whether it is cheap or expensive.
Simply put, forward earnings estimates are typically inaccurate and usually too high. To highlight this, we’ve attached a chart below from McKinsey Consulting that emphasizes our point that EPS forecasts for the broad market are consistently grossly off their mark. We would submit that the primary driver of this disparity is that the bottoms up earnings projections rarely include accurate economic forecasts.
Obviously, we also have a negative view on future earnings based on corporate margins being very close to cycle highs as growth slows while inflation accelerates, so we have a hard time making the case that earnings will grow into their multiples. In addition, it is somewhat dangerous to make a “valuation” call on the collective sell-side’s earnings projections, particularly given their preponderance for inaccuracy.
3. The CPI is not a great gauge of inflation since it has changed over time, so how would CAPE P/E look with real inflation?
The calculation of CPI has changed many times over the last few decades with significant changes coming in 1983 when housing prices were replaced with owners’ equivalent rent and in 1999 when the Bureau of Labor Statistics stopped using Laspeyres indices in its calculation.
In the chart below, we have an estimate from shadowstatistics.com of what CPI would look like from 1980 onwards if the calculation of CPI hadn’t changed. The obvious take-away is that inflation would be substantially higher.
Whether we agree that CPI should be calculated the same now as it was 30+ years ago is not the point, but rather the point is that markets, commodities prices, and basic goods are indicating quite clearly that CPI understates inflation. So, the question is, if we use a more realistic, and presumably higher measure of inflation, how would the CAPE P/E for the SP500 look?
Shiller’s methodology for accounting for inflation is to use a CPI-adjusted S&P500 index and to then divide that by a 10-year average inflation-adjusted (using CPI) earnings to impute his CAPE P/E. Absent being able to actually recreate these numbers for a constant measure of inflation, which would presumably be higher than CPI, another way to look at this market valuation is on a nominal basis, which would at least normalize the valuation for changes in CPI calculations and allow us to compare apples to apples historically.
This analysis was actually done by Chris Turner (email me at if you’d like a copy of the paper with hat tip to a certain subscriber for pointing it out). He found that by using nominal numbers, for both the index and earnings, that nominally speaking (which really only makes the measure of inflation constant) the market trades at a higher multiple historically (no surpise) and is about as overvalued as it is currently without such adjustments.
We would further submit, that in a period of higher inflation the inflation-adjusted valuation of the market would be higher since the price is based on current inflation, while the earnings is based on cycically smoothed inflation. Thus, if you believe, as we do, that inflation is higher than reported today, than the market is likely more expensive. This is disconcerting because in periods of high inflation market multiples decline dramatically.
To the last point, the table below shows that as inflation accelerates, earnings multiples decline. This occurs due to a combination of margin compression due to higher input costs, which slows earnings growth and naturally leads to lower multiples; as well as, to the point highlighed earlier, the relative value trade: as inflation goes up, interest rates will as well and bonds will likely become more appealing from total-return perspectve (so “The Flows” will follow).
Daryl G. Jones
This note was originally published March 29, 2011 at 07:59 in
“Most of those in political office, quite understandably, are firmly against inflation and firmly in favor of policies producing it.”
-Warren Buffett, May 1977
I’ve studied Warren Buffett very closely since I came to America in the mid 90’s. I wrote my Senior Thesis about him while I was an undergrad at Yale. I’ve applied many of his value-investing strategies to both the long and short side of my portfolios for the last 12 years.
Sadly, Buffett’s Politics have compromised the integrity of some of his post 2008 investment opinions. His 2010 testimony on Moody’s reminded me that if there is a transparent and accountable investment God on this good earth, it’s not him. That said, if I were in his shoes, I’d probably game these government people for my own benefit too.
If you didn’t know that Buffett’s Politics largely focus on pushing his own book, now you know. His #1 priority has been, and always will be, generating returns for the shareholders of Berkshire Hathaway. If you think this jolly looking fella has you in mind when he sits down with The President of the United States, think again…
If you go back and study the late 1970s Buffett, you’ll find a man who didn’t need the market to succeed in order for his overall invested position to. In fact, I think if you go back and read the article that we snagged the aforementioned quote from (“How Inflation Swindles The Equity Investor” – Fortune Magazine, 1977) and change the date on it to 2011, you might think it was something Hedgeye’s Howard Penney wrote last night.
Ah the 1970s…
Those were the days when Growth Was Slowing As Inflation Accelerated. Those were the days when the US Government’s heavy hand of Big Intervention tried everything from the Fed monetizing America’s debt to both Nixon and Carter signing off on a debauchery of the US Dollar. Those were the days of the 1970s – days when plenty of buy-the-dip folks went away.
My defense partner (and Columbia Business School Value Investing Program graduate) Daryl Jones, wrote an outstanding research note intraday yesterday questioning the premise of buying-the-dip on “valuation” (email firstname.lastname@example.org if you’d like a copy). Without rehashing the note in full, the conclusion was based on my old Yale professor’s (Robert Shiller) CAPE P/E multiple whereby the US stock market looks at least one standard deviation overvalued.
We’ve been saying this since the start of the year, but it’s worth repeating. With corporate margins at 30-year highs, it’s unlikely that earnings will grow into their multiple. And while this wasn’t the topic of Buffett’s 1977 article on The Inflation, he’d be the first to remind you that you don’t buy a cyclical (the SP500) on peak earnings and peak margins of a cycle (you buy it before the cycle turns, like we did with the SP500 in March of 2009).
Back to what The Warren Buffett really thinks about The Bernank’s Inflation…
1979 Shareholder Letter:
“Our book value at the end of 1964 would have bought about one-half ounce of gold and, fifteen years later, after we have plowed back all earnings along with much blood, sweat and tears, the book value produced will buy about the same half ounce.”
“The rub has been that government has been exceptionally able in printing money and creating promises, but is unable to print gold or create oil.”
“… but you should understand that external conditions affecting the stability of the currency may very well be the most important factor in determining whether there are any real rewards from your investment in Berkshire Hathaway.”
1980 Shareholder Letter:
“High rates of inflation create a tax on capital that makes much corporate investment unwise.”
“The average tax paying investor is now running up a down escalator whose pace has accelerated…”
“As we said last year, Berkshire has no corporate solution to the problem. We’ll say it again next year, too. Inflation does not improve our return on equity.”
Back to the morning Global Macro Grind…
No matter where you go this morning, there is no “stability of the currency” in this country. The US Dollar is already down again for the week-to-date. There’s only The Bernank and The Inflation. Sure we can turn on the TV and watch the latest disciple of the Keynesian Kingdom cheer on the last leg of The Policy to inflate. But we don’t have to support them. We should fight them – out loud - and hold them accountable… before it’s too late.
Inflation is sticky. So … as Growth Slows, you end up with The Stagflation. This morning, you can see slower global economic growth being priced into many asset classes, across durations:
Now, quickly, the US-centric stock market bull should be yelling at me – “buy-the-damn-dip.” At least until month and quarter end on Thursday… (that’s when most of us get paid). But that’s not going to stop gravity. If you want to do that – and I mean stop The Inflation before you stop The Stagflation – you’ll need to have your local Central Planner in Washington re-read Buffett circa 1977.
My immediate-term TRADE lines of support and resistance for WTI Crude Oil are $100.34 and $107.94, respectively (we are long oil). My immediate-term TRADE lines of support and resistance for the SP500 are 1292 and 1323, respectively (we are short the SP500).
God bless America and a Strong US Dollar.
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
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