“Conditions never persist. They change. Bureaucrats really hate that.”
That’s a quote from a book I read on my family vacation last week, “Bourbon for Breakfast – Living Outside of the Status Quo” (and, no I’m not taking up sipping on Canadian Club by the pool with my morning coffee). Nor do I aspire to ever be a professional politician in America.
Never mind understanding how the interconnectedness of the Global Macro market works, most professional politicians in America don’t get how a market works. Most of them still call this game of Big Government Intervention a “free market.” I call that a joke.
The good news is that a lot of people get the joke. Gaming Policy is the new hedge fund game in town – so game or be gamed. There are higher prices being paid (read: trading commissions) for “one-on-one” access to private meetings with DC bureaucrats than ever before. Sad, but true.
You don’t need inside information if you have a multi-factor, multi-duration, risk management process that flags real-time pricing of these “data points.” Anyone who has traded real-time risk capital in markets knows that someone always knows something…
We’ve titled one of our Q2 Global Macro Themes, “Indefinitely Dovish” (see yesterday’s Early Look) primarily because we think the market is pricing in Bernanke remaining dovish into and out of tomorrow’s FOMC meeting.
When we say “the market”, we mean the globally interconnected one – not just US stocks:
- Currency Market – the US Dollar Index is trading down again this week (for the 14th out of the last 18 weeks) and the Euro is making new highs by the day ($1.46 last) because, for the 1st time since Fed head Arthur Burns was attempting to monetize the US Debt and devalue the dollar (1970s), US monetary policy is more left leaning and dovish than even what the ex-Finance Minister of France is delivering. Jean-Claude Trichet’s comments overnight were explicitly hawkish: “it is extremely important to continue to solidly anchoring inflation expectations in a period which is marked by uncertainties and turbulence.”
- Bond Market – global bond yields continue to push higher as Asian and European central bankers continue to back their rhetoric with rate hike action. Meanwhile, US Treasury yields are breaking down through our intermediate-term TREND support lines of 0.71% and 3.46% for 2-year and 10-year UST yields, respectively. Indefinitely Dovish in America is as dovish does…
- Commodity Market – higher-highs on rallies and higher-lows on corrections for Gold, Silver, and Oil. This is where the US Dollar Devaluation driven monetary inflation is – not in GDP growth oriented commodity pricing (copper, sugar, etc.). With the Saudis trying to talk down oil prices at these levels (calling them “uncomfortable” overnight), WTI crude oil sold off a whopping 50 cents.
And Equities, well – we’re right back to where we were in mid-February where Asian Equities (growth markets) are starting to negatively diverge versus US Equities (the Gaming Policy market). China, India, and Indonesia are rightly worrying about The Inflation that will be perpetuated by a US Currency Crash.
Have no fear however – The Bernank and Groupthink Geithner are here. They have the world’s back on this Currency Crash thing. Having never seen an oil price (including $150/barrel oil) that they thought was inflationary, we don’t think they’re about to start calling $113/oil inflationary now. While Bernanke will acknowledge rising commodity prices tomorrow, he’ll offset that hawkish shift with an incrementally dovish one on US growth.
In the Chart of The Day (attached), Darius Dale calls out how super duper the sell-side has become in leading The Bernank and The Groupthinker’s Washington boys to believe that US GDP Growth was going to be all good and fine in Q1 of 2011 – then not so much.
The good news here is that Gaming The Sellside is still one of the oldest and most profitable games in town. They haven’t learned much since missing US GDP Growth Slowing in Q2 of 2008.
If you are looking for leadership on the Currency Crash thing, the President of the United States had this to say over the weekend on gas prices:
“There’s no silver bullet that can bring down gas prices right away…”
Really? If The Bernank raised rates at tomorrow’s FOMC meeting, oil prices would break $100/barrel in a day.
We’d like to remind all of our friends and foes who are still beer-bonging the Keynesian Kool-Aid that there are 3 things that burning your currency at the stake with generational levels of leverage (debt) does to an economy:
- It perpetuates The Inflation priced in US Dollars
- It structurally impairs the sustainability of long-term economic growth
- It dares institutional investors to chase “yield”
No, we’re not saying that these conditions will persist as a perpetually preferred dividend for those of us who are long of The Inflation. Neither are we saying this will end well. What we are saying is that playing the game in front of us right now is the game of Gaming Policy – and, as sad a state of a “free market” as this is, when this game changes, it will change abruptly.
The bureaucrats are going to really hate having to deal with that.
My immediate-term support and resistance lines for the SP500 are now 1320 and 1341, respectively.
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
Last week the theme from the companies that reported earnings was those management teams universally underestimate the impact of inflation on margins and earnings in 2011. Top line trends remain intact for the better positions companies, outside of one-off events like what happened at Taco Bell.
CAKE and MCD generated the most buzz as they both struck cautious tones, lowering guidance (from core operations), clearly surprising investors somewhat judging by the stock price action.
EAT (reporting 4/27 BMO): I continue to believe the EAT story. I see three key components to the story. First, the entire enterprise continues to benefit from the focus on the margin initiatives being put in place. Second, I am looking for continued improvement in top line sales for the Chili’s brand. Finally, I believe the street continues to underestimate the power of the margin initiatives and the improvement in sales trends at Chili’s, thus it appears that F3Q EPS estimates are low.
- Same-store sales: The Street will zero in on Chili’s sales trends. I think sales trend trended toward 0 to-1% at the end of the quarter. Key topics will include results from Oklahoma City (the first reimaged market) and the performance of the new value lunch initiative.
- Margin improvement: Importantly, any update on the kitchen technology initiatives.
- Demand Destruction Update: DRI and RT have talked about demand destruction. It will be interesting to see whether or not it will be a topic on the EAT call. My guess is that this theme will not be used as an excuse for why expectations for the quarter were not met.
SBUX (reporting on 4/27 AMC): At roughly11.1x NTM EBITDA, SBUX is trading at a fairly rich valuation. I remain positive on the long-term trend of the business, with some reservations around near-term issues. The company continues to transition through momentous changes in the overall business model as new growth channels are developed and more control is asserted over distribution and other facets of the enterprise. The increased focus on higher-margin, low capex areas of the coffee industry – particularly CPG – and the increases in efficiency that should follow will drive higher returns over time.
- Coffee prices will be under the spotlight: The most recent guidance includes a $0.20 hit from commodity pressures, primarily coming from coffee which is now locked for FY11.
- Limited upside to EPS: The significant increase in coffee prices and other commodities is limiting the upside in EPS outlook.
- I expect same-store sales in the USA to be 5-7%. This represents a marginal slow down on a one-year basis, but a continued acceleration on a two-year basis.
BWLD (reporting 4/26): Looking at the stock price performance alone, one could conclude the BWLD is having a great quarter. Relative to the rest of the industry, BWLD does not have commodity cost issues, so any up-tick in same-store sales will fully flow through the P&L and be a significant positive for earnings. The uncertainty surrounding the NFL player-owner dispute has not slowed the stock’s performance.
- Top line trends: The Company is facing an easier 1Q comparison and I would expect a slight acceleration in trends with same-store sales of 3-to-4%. At the time of the 4Q10 earnings call, same-store sales were up 3.8% at company-owned restaurants.
- Commodity costs remain favorable: Since the 2Q call on 2/8/11, chicken wing prices are down 20%.
- Margin trends: Investors will be keen to learn of the impact, if any, from the January price increase and the trend in alcohol sales.
PFCB (reporting 4/27 BMO): PFCB needs to post a good quarter; I just don’t think this is the one. As I wrote in February, I think the company’s fiscal 2011 guidance is going to be hard to achieve. I’m wary of the company’s ability to pull off a 1-2% comp growth at the Bistro, which implies a significant acceleration in two-year average trends from where the company was tracking early in the quarter. Although the +1% comp at the Bistro signals that company is on the right track toward achieving +1-2% growth for the full year, it is important to note that the company faced its easiest monthly comparison from 2010 in January when comps declined 4.4%.
- Margin improvement: PFCB’s FY11 guidance assumes a year-over-year improvement in restaurant level margins. The bulk of this favorability is expected to fall in 1Q11 as the company laps the nearly 220 bp decline in margin that occurred in 1Q10 as a result of inefficiencies associated with last year’s Happy Hour rollout. Margins should be helped in FY11 from the growing contribution of PFCB’s global brands business, which is a high-margin business (management guided to a nickel more of earnings from this business alone in 2011 relative to its reported $0.01 per share earnings contribution in 2010). Offsetting this benefit, however, is the expected inflationary headwinds which are expect to hit the COGS, labor and operating expense lines of the P&L. Specifically, management guided to a 3-4% increase in its total commodity basket, higher wage rates and healthcare costs and increasing energy and supply costs.
- Traffic Trends: Traffic declined for the first time in 2010 during the fourth quarter when average check increased, not surprisingly, also for the first time in 2010. Traffic declined 0.9% during 4Q10 versus negative traffic growth in 4Q09. Traffic turned positive in 1Q10, up 0.8% and remained positive in 2Q10 and 3Q10, up 2.6% and 2.8%, respectively.
- Sentiment: With 22% of the float held short, the buy-side is decidedly bearish on PFCB. Only 52% of the analysts that cover PFCB are positive and there are 12% that have an outright sell on the stock.
KONA (reporting 4/27): is a name that is generating plenty of attention of late. As the recent Knapp Track data for March illustrates, casual dining performed strongly through 1Q despite rising gas prices. The Knapp Track report highlighted the inverse relationship between income level and share of wallet spent on gasoline. The implication here is that higher-end concepts, such as KONA, will be less impacted by rising gasoline prices than will lower-end concepts. With this in mind, as I wrote on 4/14 in my note titled, “KONA – GAIN ALPHA ON THE KONAVORE DIET”, I estimate that comparable restaurant sales were trending at approximately +4% in 1Q11, bringing an acceleration in two-year average trends to 0.8% for the quarter. Operational initiatives are also set to add earnings power to a stock that I think will print its first profitable quarter as a public company in 2011. These factors, along with a relatively low valuation versus peer companies, should attract investors over the coming quarters.
- Same-store sales: The Street will want to see continuing momentum after a strong 4Q10. We know from management commentary that the same-store sales bounce in 4Q10 was broad-based; the key at this juncture for investors is whether or not it is sustainable.
- Margin initiatives and inflation: Improving comps will go a long way towards offsetting inflation on the food line for KONA in 1Q11. Exposure to seafood remains an issue and what management says on this subject during the earnings call will be of interest. The company is targeting rent, G&A, and labor as areas of focus where margin can be gained to offset commodity inflation.
- The road to profitability and growth: If comparable restaurant sales come in strong and management has positive news to report in terms of operational initiatives, I would expect that the earnings call may focus, in part, on returning the company to profitability and – ultimately – growth over the intermediate term.
PNRA (reporting 4/26 AMC): PNRA has been a standout stock during 1Q; its stock gained appreciably on 4Q10 earnings results in February and the company, fortunately, has wheat prices locked roughly flat with 2010. Early indications from this earnings season are that commodity outlook is going to be a central theme for the restaurant space. Last quarter, PNRA raised the mid-point of its margin guidance 25 bps which, based on the maintained same-store sales guidance, implied an upward revision to EPS. With sentiment as positive as it is, the company needs to both print a strong quarter and provide robust outlook for this stock to continue on its 2011 to-date trajectory.
- Same-store sales: Consensus is calling for an acceleration in two-year average trends for PNRA company stores and, given the generally strong/stable trends in restaurants of late and PNRA’s recent performance, I would expect the company to meet expectations of a +3.9% comp for 1Q.
- Margin performance and outlook: PNRA currently has its commodity inflation guidance for the year set at 3% and, while wheat is locked for the year roughly flat versus 2010, it will be interesting to see if management raises its inflation outlook. Furthermore, to the extent that contracts are coming up for renewal, particularly the wheat contract, and the company could see pressure on margins over the intermediate term.
- Sentiment: Sentiment on this one is as dovish as dovish gets. Any deviation from the script that sentiment implies could see a meaningful swing in sentiment and – more than likely – the stock price.
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Yeah, we all know they’ll beat big. Market share trends have been so dominant – which is solid given higher inventories last quarter. Top-line trajectory is more vital here than any other name in retail (sans lulu). We need to start to envision $4 in earnings power – else margin of error is nil at $78.
You don’t need to take too much time out of your day running regressions around POS market share data to tell you that Under Armour is performing well at retail. The market is telling you all you need to know. Well, almost…
1) First off, market share trajectory is looking very good in a category that’s been outperforming.
- In apparel, UA’s share gains in the quarter were very meaningful, and its share of the industry is sitting at about 11.5%, a full 150bps ahead of last year. Not bad for a $15bn category at retail.
- Footwear is still down yy, so clearly it’s less upbeat there at face value. But the trendline has been hitting higher highs and higher lows. ASPs look very good, and inventories look very clean. This is happening about one quarter away from when we should see meaningfully accelerating growth in the footwear business that was structurally built over the past 2-years by Gene McCarthy.
2) The bad news is that top line trends HAVE TO continue to work. Aside from the obvious cost pressures that everyone on the planet is talking about, UA is also building working capital business to support retail as well as footwear. So with no margin trigger, no capex/working capital trigger, it needs to be revenue, revenue, revenue. I’m not going to get lost in ‘comps’ here, but UA posted 20-30% organic growth in each of the past four quarters. That’s fantastic, and it’s right in line with the long term plan. But the numbers do get harder as the year progress.
Will this still be a super-human growth rate for a company in this environment? Heck yeah. But I just don’t see how you get paid buying the stock at $78 on $1.60 in EPS with cash flow eroding on the margin.
Putting on my ‘where could I be wrong’ hat, we’d need to get a big jolt in realizing that this company has $4 in earnings power over the next 3-years (5-years is more realistic). That’s about 20x earnings and 10x EBITDA on a 20% long term grower – without penalizing valuation due to having to wait until 2014 to see the earnings.
I think that this company will continue to do the right thing, and invest where it’s warranted in order to enhance long-term value. When it does so, the market tends to get overly punitive. That’s when I’d be more interested in getting involved.
APPAREL MARKET SHARE IS INCREASING ITS DOMINANCE
FOOTWEAR IS PUTTING UP HIGHER HIGHS AND HIGHER LOWS – CLEARING THE DECK
In preparation for WMS's FQ3 2011 earnings release tomorrow, we’ve put together the pertinent forward looking commentary from its preliminary guidance on April 11, FQ2 2011 earnings call, and other releases.
POST EARNINGS BUSINESS COMMENTARY
Preliminary FQ3 Results:
- Revenue $191-193MM (previously $209-215MM)
- Diluted EPS: $0.40-0.42
- “Our third quarter results are clearly a disappointment and reflect several factors including lower-than-anticipated new unit demand in the March 2011 quarter, WMS’ execution challenges that resulted in approximately $8 million in product sales revenue from customers’ orders that shipped in April instead of the March 2011 quarter, and continued challenges in commercializing new products, including a slower rate of initial regulatory process approvals arising from the increased complexity of our newest gaming features and networked-technology enablers.”
- Cash: $144MM; no debt
- Repurchased $30MM (750k shares) of WMS stock; for FY2011, have repurchased $80MM (2.1MM shares) of WMS stock.
- "Following the introduction of several new successful participation themes during the March 2011 quarter, WMS expects gaming operations revenue to have stabilized and be approximately in-line with the December 2010 quarter [$72.7MM], partially reflecting a quarterly sequential increase in average daily revenue per gaming machine."
- "The Company expects total gross profit margin to be in-line with the December 2010 quarter total gross profit margin reflecting an improvement in gaming operations gross margin with gaming operations being a slightly higher percentage of total revenues, and a decline in product sales gross margin primarily due to higher revenues and lower margin from used gaming machines. The Company’s operating margin for the March 2011 quarter is also expected to be relatively flat on a quarterly sequential basis reflecting lower gross profit due to lower revenues offset by lower operating costs related to expense containment initiatives."
- “Casino operators’ capital budgets for replacing slot machines have been at historically low levels for several years, and new casino openings and expansions are now at their lowest level in many years.”
- “Based on recent customer capital budgets and unit demand trends, we don’t expect meaningful improvements in the industry environment over the remainder of CY 2011 or, at this point, for CY 2012 and today we issued revenue guidance accordingly. Until we begin to see consistent economic recovery, growth in consumer spending and improvements in industry replacement and new unit demand, we believe WMS’ annual revenue will continue to grow at a mid-to-high single-digit percentage rate consistent with the growth achieved in FY 2009 and FY 2010, and now in FY 2011.”
Revised FQ4 and FY2012 Outlook
- F4Q revenues: $210-$220MM
- FY2011 revenues: $790-800MM
- FY20112 revenues: $810-850MM
- "The expected revenue growth is based on continued market penetration, especially in international markets, new market openings domestically and internationally, growing revenues from new networked gaming and online gaming products and increased participation revenues."
- “Operating margin guidance for the June 2011 quarter of 22.0%-to-23.5% reflects expected quarterly sequential improvements in product sales gross margin and operating costs declining as a percentage of revenues compared to the March 2011 quarter.”
- FY 2012 operating margin: 21-22%
- Gaming Laboratories International (GLI) approved the commercial version of WAGE-NET networked gaming system solution and Jackpot Explosion, the first themed application in the Ultra Hit Progressive (“UHP”) Portal application family.
- “Our initial beta placements have clearly demonstrated the incremental value of a Portal application interoperating with a base game, with coin-in premiums averaging 35%-to-40% across more than 270 Bluebird2, Bluebird xD and upgraded Bluebird gaming machines at 12 casinos.”
- Anticipates initial installations of WAGE-NET and Jackpot Explosion in Native American casinos in California that are currently running beta-tests of the products, followed by other tribal and commercial casinos among the 12 casinos presently acting as beta-test sites.
- Recently began a WAGE-NET/Jackpot Explosion field trial in Nevada at a popular Las Vegas casino
YOUTUBE FROM FQ2 CONFERENCE CALL
- “We remain on track to further improve Bluebird xD gross margins on a quarterly sequential basis throughout fiscal 2011...We continue to expect that the Bluebird xD gross margin will attain parity with Bluebird2 gross margin in the June 2011 quarter.”
- “With the growth anticipated in the installed base during the next two quarters, we believe that the average installed base for the full year will be a couple hundred units higher than fiscal 2010 but will be somewhat below the low end of our original guidance range we provided in August 2010.”
- “With ... new participation products launching in the current quarter such as YAHTZEE, Revenge From Mars/Attack From Mars and the new PRICE IS RIGHT video game and additional new participation products in the June quarter, we expect further growth in the installed footprint throughout the remainder of fiscal 2011, helping to continue our strong momentum as we head into fiscal 2012.”
- ”We expect to see further incremental increases in depreciation in the March and June quarters as we continue this transition in our installed-participation base and selectively invest in other high return lease opportunities.”
- “In the March and June 2011 quarters, we expect our effective consolidated income tax rate to be in a range of 35% to 36%, inclusive of the ongoing R&D tax credit benefit and the small impact from the increase in the Illinois state corporate income tax rate.”
- “With respect to international markets in general, our recent discussions with casino operators here suggest that the environment in Europe is stabilizing and could translate in a more positive sentiment for capital spending much later this calendar year. In the interim, we continue to see strength in Latin America, Asia and Australia.”
- “We now expect to place our first units on a lease basis in Italy early in the September quarter after we complete the certification process.”
- “In Illinois, we expect to hear shortly who’s been awarded the central system contract for the VLTs following a resubmission of bids back in early December. Following the announcement and signing of that contract and the awarding of licenses, we expect to generate our first sales in the second half of calendar 2011.”
- “Our accelerating launch schedule throughout calendar 2011 followed in early calendar 2012 by the expected launch of the highly anticipated first games based on a next generation CPU-NXT3 operating system along with having the highest daily revenue amongst our competitive set provides WMS with the opportunity to generate enhance value from the meaningful opportunities to expand our share of the participation business.”
- “I’m very confident that the participation business will get back on track in Q3. We will have a significant ramp up in Q4 based on the product launches and particularly in the WAP area.”
- “We’ve got 12 new G Plus deluxe games for sale that are coming out over the next few months. Those games, we’ve already got four approved and there’s eight more coming. They’re doing spectacularly well for the additional placement so that gives us great confidence.”
- “Used games, as Scott mentioned, is about 240 basis points off of our product margin and it’s about 100 points more than we had anticipated. So that the strong demand for our Bluebird1 trade-ins is actually a good thing because we’re starting to harvest our own market share replacement cycle.”
- [UK online wagering marketing] “We’ve started initially rolling out some of the marketing programs as of last week, I believe, and we’ll start to ramp that up more aggressively in February, March and April. So we will get more aggressive as the year goes on but, again, as we guided before, those revenues for fiscal ‘11 will be deminimus.”
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