Shorting Peru

Conclusion: Over the next few years, we expect investors to negatively reset their expectations for Peru’s long-term growth potential as a result of structurally higher inflation and interest rates (provided the central bank is allowed to remain independent). That’s bearish for Peruvian equities and we’ll look to short strength on rallies over the long-term TAIL absent a change in political strategies by new President Ollanta Humala.


Position: Short Peruvian Equities (EPU).


This afternoon, we added a short position in Peruvian equities to our Virtual Portfolio.  We written extensively on our long-term outlook for Peru and are using today’s “strength” (Lima General up +13bps) to express our conviction in a core belief that Big Government Intervention (via a measured shift towards socialism in Peru’s case) is negative for the long-term health of any functioning economy. Simply put, we think newly elected President Ollanta Humala will grow increasingly motivated to over-tax the country’s vast mineral resource initiatives, as well as use pension funds and potentially FX reserves in an attempt to push his populist agenda.


Any attempts on Humala’s behalf to run the currency devaluation/overregulation strategies of his long-time mentor, President Hugo Chavez of Venezuela, and we’re likely to see a measured uptick in CPI in Peru over the long-term TAIL. That’s bullish for Peruvian interest rates and bearish for Peruvian growth, and we’d argue that the long-term expectations for both require an adjustment that is negative for Peruvian equities. Some would argue that the “Humala effect” is priced in with the Lima General down -13.4% YTD, but we firmly believe the process by which the market resets the aforementioned expectations will be one that plays out over the long-term TAIL.


Shorting Peru - 1


Near-term, however (we prefer to keep our catalysts as close in duration as possible on the short side), we think Peruvian growth is slowing. In fact, Peru’s monthly Real GDP growth slowed to +0.47% MoM in May, good for the slowest pace in over a year and our models portend more downside from a YoY perspective for at least the next two quarters. From an inflation perspective, easy comps will supply upward pressure to Peru’s YoY CPI over the intermediate-term trend. Indeed, Peru is one of the few countries we model that won’t necessarily see the full benefit of our Deflating the Inflation thesis playing out in the commodity complex.


Net-net, we’re short Peru and the future socialism embedded therein. For more background on this thesis, please refer to our April 27 report titled: “Everyone’s a Winner – Except Peru”.


Darius Dale



Shorting Peru - 2


Keith just covered CBRL in the Hedgeye Virtual Portfolio as the stock is immediate term TRADE oversold.  Both the quantitative and fundamental setups are bearish on the intermediate term TREND duration.     


I hold a cynical view of the CBRL announcement today.  My impression even before today's "news" was that they were going to miss the quarter and today’s headline only confirms that view.  The charge the company is taking, estimated to be between $0.14 and $0.17, is related to the reduction of staff and management levels.


Why do you think CBRL made the decision now to get religion on the cost structure?  The answer is clear; they are going to miss the quarter.  There is also a possibility that an activist investor may be exerting some pressure on the company's management team.


As the chart below illustrates, the stock is immediate-term TRADE oversold from a quantitative perspective.  While Keith covered the stock in the Hedgeye Virtual Portfolio this afternoon, the intermediate term TREND setup remains bearish.


CBRL - A CLASSIC MOVE      - cbrl quant setup



Howard Penney

Managing Director


Rory Green


The Week Ahead

The Economic Data calendar for the week of the 18th of July through the 22nd is full of critical releases and events.  Attached below is a snapshot of some (though far from all) of the headline numbers that we will be focused on.


The Week Ahead - lac1

The Week Ahead - lac2


real-time alerts

real edge in real-time

This indispensable trading tool is based on a risk management signaling process Hedgeye CEO Keith McCullough developed during his years as a hedge fund manager and continues to refine. Nearly every trading day, you’ll receive Keith’s latest signals - buy, sell, short or cover.


HEDGEYE MACRO 3Q11 THEMES: Policy Pong, Risk Ranger & Chinese Cowboys


July 15, 2011


Valued Client,

Hedgeye's Macro Team, led by CEO Keith McCullough and DOR Daryl G. Jones, recently hosted their quarterly themes conference call. The key topics included: 

  • Policy Pong - Between the debt ceiling debate, spiraling sovereign debt issues in Europe, and updated growth/inflation dynamics, the Fiat Fools will continue to play monetary and fiscal policy pong, which will inform the EUR/USD exchange rate.
  • Risk Ranger - Given the sharp oscillations in investor sentiment and the danger of Fiat Fool experimentation, many global asset classes are range bound and keeping these ranges in focus will be key to managing risk over the intermediate term.
  • Chinese Cowboys - In a marriage of research and timing, we are long China. We believe inflation and the pace of tightening in China will moderate in 2H and that fear has made Chinese growth cheap.




Should either of the links fail to work, please copy/paste it into the URL of your browser. If you have any follow-up questions please email us at .



The Hedgeye Macro Team


Not surprisingly, the University of Michigan consumer sentiment index plunged in July. 


It’s not a great time to be an American consumer as confidence in Washington’s ability to run the country effectively wanes.  No doubt the current debt ceiling debate is doing little to boost consumers’ perception of their representatives. 


Today it was reported that confidence fell 7.7 points sequentially to 63.8 in June, the biggest decline since March and the lowest level since March 2009.  The expectations component led the decline, dropping 9 points to 55.8 (lowest level since March 2009) and the assessments of current conditions dropped 5.7 points to 76.3 (lowest level since November 2009).  This is not a shock to anyone paying attention to the data; the economic drivers of confidence remain very weak.


The remedies required to address the serious fiscal issues facing the U.S., “eating peas” at the President calls it, are likely to impact growth negatively – at least initially.  At the same time, politicians’ inability to address the nation’s debt is a serious concern for consumers’ confidence. 


The decline in confidence comes on the same day that the New York Empire State Manufacturing Survey's weaker than anticipated.  This survey is the first look at factory conditions during the month of July. Within the survey, the employment indicators weakened significantly; the employment index barely stayed in expansionary territory, falling from 10.2 to 1.1 in July. The average employee workweek (hours) index fell sharply from -2 to -15.6.


Looking at the overall set up, confidence and manufacturing data are decidedly bearish.  This bearishness is being compounded by a volatile political climate.  The uncertainty is hurting business confidence, which is discouraging hiring and impairing income growth.  While I would like to strike a more positive tone this Friday afternoon, the preponderance of the evidence suggests that confidence will remain in the doldrums for, at least, the immediate term.





Howard Penney

Managing Director


Not much to worry about here other than the timing of a replacement demand recovery. Didn’t need accounting specialists to tell us that.



On June 29th, Gradient initiated on BYI with “D” – basically a sell rating. The crux of Gradient’s opinion rest’s on BYI’s exposure to the weak replacement cycle coupled with concerns over declining deferred revenues and rising inventory and accounts receivable balances.  The ‘flags’ that Gradient raises are not new.  CFRA has been blowing the same horn for at least a year now.  While we won’t deny that BYI has some issues, we’re not concerned about the ones raised by Gradient and CRFA.




Point 1: Negative fundamental trends

“The domestic replacement cycle seems to have been prolonged as casino operators take longer to make purchasing decisions. As a result of a decline in international sales, the company now sources 81.3% of its revenue from the United States and Canada—raising our level of concern as BYI’s exposure to the slow domestic replacement has increased at an inopportune time”


HE Response: The replacement cycle is at a trough.  Current levels are unsustainable and this is exactly why we like the slot manufacturers.  We’ve written extensively on this topic (see UNDERSTANDING THE REPLACEMENT MARKET  published on 8/17/2010) so we won’t rehash our entire thesis but in a nutshell,  an 18 year replacement cycle is not sustainable since even poker machines die and yes, get replaced after 12-15 years.  Mechanical spinning reels last about 8-12 years while video slots become obsolete after about 8 years.   While we don’t know exactly when the replacement cycle will make its big upswing we do think that the new markets coming online over the next few years will help spur at least defensive investment by casino operators.


Point 2: Divergence between earnings and cash flow

“In recent periods, both earnings and cash flow have declined. However, cash flows have experienced much larger declines”


HE Response: This is a fair point, but the correct comparison would add back the investment that BYI makes in their gaming operations business to Cash Flow from Operations.  The balance of the divergence are explained by growth in A/R and Inventory.


 Point 3: Increase in accounts receivable

Throughout FY2011, accounts receivable have increased disproportionally faster than sales have increased. The rise in total receivables is driven by a large increase in long-term receivables. According to the company’s most recent 10Q, BYI has extended payment terms for select customers. This may indicate that the company has (1) potentially pulled forward demand from future quarters, and/or (2) taken on

a greater level of collection risk.”


HE Response: $26MM of the increase in accounts receivable since 2010 is due to loans that BYI made to the Italian concessionaires to help them finance the VLT licenses (Euro 15k/device).  The loans will be paid back in 5-9 years.   Floor financing for customers is more typical in international deals since they tend to be longer in nature.   As Bally expands more internationally, we will likely see a continuance of this trend.


Point 4: Increase in inventory

The largest driver behind the increase in accruals was the change in BYI’s inventory level. Inventories consumed $89.8 million in CFOA for the 12 months ended 03/31/11. In our opinion, the increase in inventory is likely related to the introduction of the company’s Pro Series cabinets”


HE Response: The vast majority of the increase in inventory is Italy.  Bally has contracts to place 5,000 VLTs in the Italian market over the next year and to provide systems for those units.  Most of the units will be in gaming operations and so far BYI has not started collecting revenue on those units.  Gaming operations expenditures sit on the balance sheet of the supplier and get depreciated over the life of the machine.   A small part of the inventory increase is due to BYI stocking up on parts for the new Pro Series cabinet – particularly the Alpha 2 processor.


Point 5: Decline in deferred revenue

“Revenue sustainability may be at risk as the company’s deferred-revenue balance has declined significantly in recent periods. Growth in deferred revenue has trailed revenue growth for 11 consecutive quarters. As a result, deferred revenue is now at a level not seen since FY2007. While a portion of the decline relates to a change in the company’s revenue-recognition policy, at a minimum the decline in deferred revenue suggests less balance-sheet support for future revenue growth.”


HE Response: As Gradient points out, in 2009, there was a change in account policy that allows BYI to book non-software revenue at the time of delivery.  Previously, BYI often had to defer revenue from contracts that ‘bundled’ systems and unit sales.  The best example is what happened with the 2,300 unit sale to Oregon in 2008 which BYI had to recognize over 7 years (the life of the systems contract with the state).  The change in accounting policy affects all industry participants, not just BYI, and allows GAAP to more accurately reflect cash revenue.

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