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Wait & Watch: SP500 Levels, Refreshed



Despite registering some of the most alarming combo volume/volatility studies I have ever registered in my risk management model, the SP500’s mean reversion toward the prior closing highs continues. We’re headed right back to the zone I was highlighting in mid-February and, once again, I think the probabilities of a market crash will start to go up if we get there (1).


I don’t use the word crash very often – primarily because I don’t get the interconnected signals that call for using the word very often. There is a big difference between calling for a correction as opposed to a crash. Over the course of the last 3 years we’ve built a track record in calling for some of both.


The three main factors that are flashing amber lights in my model right here and now are: 

  1. The US Dollar – at a point, correction becomes crash… and a crashing USD (from here) is going to deliver you $120-130 oil.
  2. Volatility (VIX) – after an unprecedented -43% collapse in less than 3-weeks, the VIX is holding its long-term TAIL of support (15.40)
  3. Sentiment – today’s Bullish/Bearish II Sentiment survey blew out to an extreme (Bulls minus Bears = 41 points) 

The reality of the institutionalization of our business is that a lot of people have to chase performance. The only problem with that is that there is no historical basis for everyone winning with the same strategy in perpetuity. There is a gargantuan amount of correlation risk to the USD being built into commodity and equity markets. The Bernank is holding the bag in creating both expectations of easy money and the net long exposure associated with it.


The math tells me a lot of people effectively are no longer allowed to be bearish (and I mean legitimately bearish, running -20-30% net short). Waiting and watching for my price level to short the SP500 again has been my plan. That level is currently 1 and I don’t plan on being one of the people who says they couldn’t see the next swoon coming.



Keith R. McCullough
Chief Executive Officer


Wait & Watch: SP500 Levels, Refreshed - 1


We are expecting an in-line quarter and guidance.



F2Q Details:


We are projecting revenues of $475MM and EPS of $0.19 when IGT reports its F2Q11 results on April 21st, $10MM and 1 penny below street estimates.


We have factored in company guidance that F2Q will have the lowest margins in FY11, with 3Q and 4Q getting better sequentially but not exceeding 1Q margin levels, into our numbers.  


We estimate that IGT will report $208MM of product sales at 48.8% gross margins.

  • Domestic product revenues of $124MM and gross margin of $63MM (50.5%)
    • Domestic box sales of $70MM: 4.9k domestic unit sales - comprised of 4,200 replacements and 700 new units at an ASP of $14,250
      • IGT has recently started a new promotion similar to Dynamix (although we have no details on it at the moment) which should keep reported ASP’s at depressed levels for the remainder of the year.  Excluding promotional activity, our understanding is that the IGT has modestly increased pricing (1-2%)
      • New NA shipments should include shipments to Ocean Downs (43% share), Trump, and recognition of some of Gun Lake units (45% share)
    • Domestic non-box sales of $55MM, up 10% YoY
  • International product revenues of $84MM and gross margins of $40MM (46.5%)
    • $62MM of box sales: 5.3k international unit sales at an ASP of $11.7­k
      • Unit sales should include shipments to Galaxy Macau and some Italian shipments.  The first of roughly 1,500 Italian for sale shipments started last quarter and should continue through FY2011.
    • Non-box sales of $22MM
    • The company is now thinking that international unit shipments will be in the 22,000 range for the year. They realize that the Street could use some help in modeling international shipments and are working on better disclosure/guidance going forward.

Gaming operations revenue of $267.5MM at 61.5% gross margins

  • We expect the install base to increase by 100 units to 56,800 and average win per day to increase 1.4% YoY to $52.4
  • The Italian CIRSA units (~1,500) will be participation units but we don’t have them starting to come in until F1Q12
  • IGT will get 36% of Acqueduct units coming online in 4Q11
  • The company expects gaming operations yields to increase throughout the rest of the year and to see the install base up modestly as well.  Although they did caution that international growth which has been relatively strong for them could put a hamper on yield growth
  • Expect gross margins for FY11 to be ~62%

Other assumptions:

  • SG&A of $82MM (should come down sequentially given the absence of G2E expenses)
  • D&A: $20MM
  • R&D: $52.5MM
  • Net interest expense: $20MM


Unfortunately, we are coming down for Q1. Low VIP hold will drag down margins disproportionately despite strong top line.



Our issue with MPEL’s Q1 can be considered cosmetic.  Not that we are suggesting a miss, but we are no longer predicting a big beat.  The ongoing takeaway is actually quite positive.  Volumes were strong in Q1 as were revenues and if sustainable, MPEL should blow away estimates going forward, assuming normal hold.  However, because VIP hold percentage was very low, it affects EBITDA disproportionately.  Essentially, MPEL primarily maintains rolling junket commission structures which are based on volumes not revenue share.  Hold risk stays with MPEL.  Of course, with strong hold, MPEL captures the upside.


Despite having better than expected volumes on the VIP side, luck was not on MPEL’s side this quarter.  While we knew that the hold percentage wasn’t great for the first two months of the quarter, March’s luck was simply terrible.  Therefore, what we believed would be a blow away quarter now just looks like consensus.  That said, luck comes and goes, but volumes are a much better predictor of a companies’ health and on that front, MPEL continues to exceed our expectations.  Unfortunately, given the recent run up in the stock and investor concerns about the impact of Galaxy Macau, a meet may not be good enough this quarter. 


We estimate that MPEL will report $788MM of net revenue and $125MM of EBITDA in 1Q2011.




We are projecting net revenue of $487MM and EBITDA of $89MM.  Our revenue estimate is 2% ahead of consensus, but our EBITDA estimate is 6% lower than the Street’s.

  • Net casino win of $466MM (gross win of $644MM)
  • Net VIP table win of $284MM
    • We assume 18.5% direct play, $19.9BN of RC volume (a massive 102% YoY increase), 2.33% hold and a 90bps rebate rate
    • We estimate that in March, CoD’s VIP hold plunged to just 1.9%.  Given that most of the CoD’s junkets get compensated based on RC volume vs. RevShare, flow through and EBITDA margins are very sensitive to win rates.
    • We estimate that low hold impacted CoD net revenues by $100MM and EBITDA by $40-50MM
  • Mass table win of $143MM
    • Mass drop of $680MM (up 42% YoY) and hold of 21%
  • Slot win of $38MM
    • $653MM handle and slot win of 5.85%
  • $21MM of net non-gaming revenue
  • Variable costs of $321MM ($251MM of gaming taxes and $60MM of incremental junket commissions)
  • $17MM of non-gaming expenses
  • $60MM of fixed expenses


We estimate that Altira will report net revenue of $268MM and EBITDA of $45MM, 3% and 2% ahead of Street estimates, respectively.

  • Net casino win of $268MM (gross win of $382.5MM)
  • Net VIP table win of $248MM
    • $12.7BN of RC volume (28% YoY increase), 2.85% hold and a 90bps rebate rate
  • We estimate that in March, Altira’s VIP hold dropped to 2.7%
  • Mass table win of $20.5MM
    • Mass drop of $117MM (up 65% YoY) and hold of 17.5%
  • Variable costs of $198MM ($149MM of gaming taxes and $45MM of incremental junket commissions)
  • $22MM of fixed expenses


Mocha slot revenue of $33MM and EBITDA of $9MM

Look Out To May


We have two months of sales noise until we see the extent to which the masters of our economy have pulled the goalie. Calendar shift provides some ground cover (i.e. excuse). Then the choice between growth, gross margin sustenance, both, or none of the above will become apparent for each retailer.


Not too many people will dispute that sales will take a hit when the 16 companies left that actually report same store sales print their numbers. The biggest factor is the Easter shift, which was very meaningful this year versus last (it was April 4 last year, and is April 24th this year).


By our math, last years’ spike accounted for roughly +11% growth in comps.  If we get aggregate numbers in the (-1%) range for March 2011, we’d be looking at a steady rate of about +5% in the 2-year trend, and +1% in the 3-year (which we find most relevant). Anything below that, we’re going to be looking at a deceleration a month or two before we’d otherwise expect to see it.


Look Out To May - PCE SSS GvtR 3 11


Putting on our Historical Macro Hat


Let’s put our Macro hats on for a minute and not worry about a couple months worth of timing, or whether jeggings are still ok to wear this Spring. Take a longer look at two key components of consumption: 1) Taxes, and 2) the Personal Savings Rate.


Let’s go back a few decades to 1947. As you see, for the better part of 40 years, they moved in tandem – for the most part.  Consumers felt good, they got a good return on their cash  (even if sitting idle in a bank account), so not only did they save a greater proportion of income, but did so while taxes went higher.   Then that relationship started to break down in 1985, and was completely polar by the 1990s.


We’re not trying to give a history lesson. Everyone knows these numbers, as well as the political and economic forces that drove them.  But today, we’re looking at the personal savings rate of 5.6%. There has been only three times since 1991 where it was higher – and those were all over the past six months). 


As it relates to the Personal Tax Rate, it stands at 9.5%. There has been only five periods since 1949 where it’s been this low.


So from a Consumer analysts’ perspective, we’re stuck with a near 20-year (close to a generation) high savings rate even though Bernanke and Geithner give virtually zero percent interest on our cash. Other countries are unceremoniously unloading US Dollars. And our collective tax rate is sitting near all time low. The government probably can’t cut taxes any further, and mathematically they can’t take interest rates down enough to matter. What’s going to stimulate the Consumer???  


Look Out To May - PCE SS 3 11 2


Employment and wage growth is one of the answers, no doubt.   The chart below is particularly noteworthy, which shows the year/year change in real average weekly earnings.  At risk of stating the obvious, come May/June we’ll really geta  solid glimpse into the Consumers’ earnings power, and whether that is translating itself into enough Gross Margin dollars to offset cost inflation (keeping in mind that it is about the April/May timeframe that the higher costs begin to flow through financial statements).


Look Out To May - PCE SS 3 11 3



Aussie Dollar Getting Long In The Tooth?

Conclusion: We remain bearish on the Aussie dollar for the intermediate-term TREND and forsee a correction from its near all-time high (AUDUSD), primarily due to slowing economic growth down under in part aided by slowing growth in key export markets, which may lead to lower interest rates and more accommodative monetary policy.


Position: Bearish on the Australian Dollar over the intermediate-term TREND; Bullish over the long-term TAIL.


In screening for and analyzing foreign exchange opportunities, we focus primarily on a three-factor model, which incorporates real GDP growth, inflation, and the a combination of monetary and fiscal policy.  Using this framework, our objective is to absorb any/all relevant data points that could help point us to the correct slopes of these factors, especially versus the perceived slopes embedded in consensus expectations.


On the margin, the factors supporting the Aussie dollar’s +28% rise since when we first turned bullish on it in June of 2009 are deteriorating and look to worsen over the intermediate term. While we remain bullish on the AUD over the long term (especially against the USD and JPY), we do think we’re setup to see some near-term weakness in the currency and are inclined to short what we feel is the start of what may be a meaningful correction, a position we introduced in mid-March (email us if you need a copy of the report).


Below we analyze all three of the driving factors individually in support of our recent call for the AUD to correct over the immediate-to-intermediate term.



We think the near-term growth data points in Australia are setup to rollover in advance of what should be a sequential deceleration when 1Q11 Real GDP is reported. This may seem contrary to our current positioning, as we are currently long Chinese equities in the Hedgeye Virtual Portfolio, but we are keen to point out the duration mismatch between the Chinese equity market(s) signaling a bottoming in China’s growth rate and Australian economic data slowing as China bottoms.


Comparing 4Q10 vs. 1Q11 on various metrics of economic data do indeed support our view that 1Q11 GDP growth will slow sequentially from 4Q10 with upside/downside risk in 2Q11 is skewed to the downside (Japan is Australia’s second largest export market at 19.2%; China is first at 21.8%). Of course, Australia’s economic growth will eventually rebound alongside China and Japan’s but near term, growth looks to poised to slow.


With the notable exception of Retail Sales , Private Sector Credit growth, and Business Confidence, Australia’s economic data has largely being trending in the wrong direction, particularly when analyzed on a quarter vs. quarter basis:


Aussie Dollar Getting Long In The Tooth? - 1


Aussie Dollar Getting Long In The Tooth? - 2


Aussie Dollar Getting Long In The Tooth? - 3


Aussie Dollar Getting Long In The Tooth? - 4


Aussie Dollar Getting Long In The Tooth? - 5



Our forecast for the slope of inflation in Australia is largely a wash. Yesterday we saw the TD Securities Inflation Index accelerate to +3.8% YoY in March, driven in part by higher crude oil prices. Still, on a quarterly basis, official reported inflation looks to continue its deceleration in 1Q11 based on the trajectory of this unofficial gauge. The current strength of the currency is also a supporting factor for a deceleration in Australian CPI and as RBA Governor Glenn Stevens recently said, “The central bank’s goal is being assisted by the high level of the exchange rate.”


Aussie Dollar Getting Long In The Tooth? - 6


Aussie Dollar Getting Long In The Tooth? - 7


Where Australian inflation data heads in 2Q11 will be largely based on crude oil prices and the resiliency of the Australian consumer, which is currently growing less resilient on the margin, based on consumer confidence readings, and that trend looks to continue over the intermediate term as lagging 1Q growth data weighs on hiring. On the flip side, we maintain our bullish intermediate-term position on crude oil prices, so Australian inflation looks like a wash at this point/we need more data to confirm a view in either direction.


Given this mixed outlook for inflation, we can be reasonably assured that the RBA will continue their hold on interest rates over the intermediate term, as the proactive Glenn Stevens has a history of being data dependent. And with growth data expected to look sour in the near-to-intermediate term, we wouldn’t be surprised if Stevens elects to cut rates. Australia is one of the few developed economies in the world that has headroom in this direction, so Australia remains home to one of our favorite equity markets, particularly in a softer policy setting. The current quantitative setup in the All Ordinaries Index supports this view.


Aussie Dollar Getting Long In The Tooth? - 8


Monetary & Fiscal Policy

As mentioned before, Glenn Stevens and the RBA have been incredibly proactive in addressing the current global surge in inflation – perhaps more so than any other central bank in recent years. As a result of their prudence, they’ve been able to wait and watch economic trends develop since their last hike in early November, rather than playing a dangerous game of “policy catch-up” like we’ve seen in India, for example.


As it relates to the slope of future monetary policy, we continue to believe that the RBA will minimally remain on pause over the intermediate-term and could potentially cut rates if 1H11 Real GDP growth comes in where we expected it to back in early December (email us for a copy of the report). In fact, Stevens called the 4.75% target cash rate “mildly restrictive” and “appropriate given the economy’s outlook”; we contend “mildly restrictive” could turn into “very restrictive” in a heartbeat – particularly if you use Hedgeye estimates for the slope of Australian growth.


While both the buy-side and sell-side are starting to sniff this out, the major risk to the Aussie dollar is that, potentially, neither side is bearish enough on Australian interest rates.


Aussie Dollar Getting Long In The Tooth? - 9


The Australian bond market, however, does appear to be bearish enough on Australian interest rates. Since rallying from putting on an impressive rally from the August 2010 lows, Australian 2Y and 10Y sovereign yields appear to have hit an invisible ceiling, falling (-27bps) and (-4bps) YTD, respectively. For normalization purposes, that equates to declines of (-5.3%) and (-0.8%), respectively.


Aussie Dollar Getting Long In The Tooth? - 10


This bullish bid for Aussie bonds is weighing on Australian swap rates – particularly at the short end of the curve. As such, the compressing interest rate differentials relative to the USD, JPY, and EUR are setup to weigh on the currency going forward.


Aussie Dollar Getting Long In The Tooth? - 11


Aussie Dollar Getting Long In The Tooth? - 12


Aussie Dollar Getting Long In The Tooth? - 13


Shifting gears to fiscal policy, we continue to favor the hawkish direction of Australian fiscal policy (a key reason we are bullish on the AUD for the long term), as it continues to distance itself from the egregious laxity showcased here in America.


Rather than use the recent flooding and cyclone as an excuse to allow government finances to deteriorate, Prime Minister Julia Gillard maintained her pledge to return the government budget to a surplus by 2013. To fund the rebuilding, her government announced spending cuts and a one-time levy designed to collect at least A$5.6B, though that tax may have to be revised upward in the coming weeks as official estimates for the damage have been revised up recently to A$9.4B.


All told, we remain bearish on the Aussie dollar for the intermediate-term TREND and expect a correction from its near all-time high (AUDUSD), primarily due to slowing domestic growth in part aided by slowing growth in key export markets, which is likely to continue to weigh on Aussie interest rates.


Longer term, however, we remain bullish on the currency due to its sober and proactive monetary and fiscal policy, in addition to its positive exposure to China and commodity prices – which are likely to remain elevated much longer than consensus thinks, based on the findings of empirical studies which suggest commodity inflation is a leading indicator for the sovereign debt default cycle.


Darius Dale



Corn is the big standout week over week, trading at $7.66 per bushel yesterday.


Corn has been trading softly over the past few weeks but moved up 14.1% in the last week to bring the item to +122% YoY.  Regarding proteins, this is certainly a meaningful move that will likely support meat prices going forward.  For a number of weeks now the commodities we monitor have been mixed in terms of the direction of the weekly price action.  While corn and wheat have gained strongly (14% and 7%) on the last week, dairy costs have decreased by similar respective magnitudes. 


In this note, I'm raising the red flag on the chicken producers, SAFM, TSN and PPC due to the surge in corn prices.  As you can see from the table below the surge in corn is happening at the same time chicken prices are getting weaker.  




As the chart below shows, corn prices have bounced sharply following a brief decline in the second half of March.  An increase in global demand is expected to provide sustained support for corn prices.  For restaurant companies with a high level of exposure to protein costs, increasing corn prices are a concern.  Below is some commentary from management teams on corn prices.


CMG, 4Q10 Earnings Transcript, 2/10/11:

“Though we have contracted for most of our corn for our salsa for the year, reports of continuing or even worsening supply shortages of corn will only add to inflationary pressure on the meats that we serve.”


JACK, 1Q11 Earnings Transcript, 2/24/11:

“There are some Act of God provisions that will get us north of our contract bands, but at a reduced rate from what the current market pricing is ... And then also grain, corn, wheat and soybean impact, and there are input costs for a number of the proteins. And that's really what's driving up beef at this point.”


SAFM, J.P. Morgan Insurance Conference, 3/30/11:

“Corn and soybean mill prices remain significantly higher than historical average and we think there are going to be instances and times up from now through the growing season that they could spike higher.”


“The year 2006 was the year of avian influenza and 2008 was $8 corn and the collapse of our export market in the fall. That – 2010 – 2011 will be another year like 2008 right now.”




Wheat prices are also rising with corn and this is, as with corn, largely attributable to global demand.  Corn and wheat prices in Asia are likely to continue to rise for the next number of weeks due to tight supplies in exporting countries.  Wheat crop conditions in the U.S. are also a concern.  Interestingly, the surge in corn prices is also pushing wheat higher as the corn surge spurs a livestock-feed swap.




Chicken wing prices continue to decline.  While this is helpful for BWLD margins, the NFL lockout hearing today is even more important.  Today, NFL players are asking a federal judge to grant an injunction preventing the NFL lockout and forcing the league to resume operations.  It seems more likely that the injunction will be granted with a stay than without but a denial of the injunction would put the NFL in the driver’s seat and the prospect of a NFL-less fall could become more real.  We know which side BWLD is cheering for!




Dairy costs have declined significantly over the past week and this is providing some relief for CAKE (which is not hedged on their dairy costs), DPZ and PZZA.  On a year-over-year basis, dairy prices are up but the step down over the past few weeks has been meaningful.






Howard Penney

Managing Director

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