If consumers in Asia develop a fondness of pizza and cheeseburgers, what happens to CAKE's margins?


Cheese prices led the gainers last week, rising 4.1% to new highs which will surely put some pressure on CAKE’s 2H11 commodity guidance.  TXRH, too, has some dairy exposure and will likely be watching this recent price surge in dairy prices with keen interest.  Apparently, the growing popularity of pizza and cheeseburgers in Asia is driving cheese prices higher!  Coffee prices nose-dived week-over-week as concerns grew that a slowing global economy may bring slower demand.  Beef prices slid as news on Russia’s increase in beef and poultry production in 1H11 emerged.  Corn prices also dropped as yields in Ukraine’s average grain crops were 20% higher than last year.  However, concern over the hot and dry weather in the U.S. cutting yields has pulled prices higher for the second consecutive day.







Cheese prices are not supportive of CAKE’s call for +2.5% inflation in 2H11 versus +4.5% in the first half (guided, not reported).  Looking at the chart below, it is clear that dairy – as an important component of CAKE’s commodity basket – is far in excess of the average 1H11 price.   Kraft has cited Asia’s growing demand for pizza and cheeseburgers as being a driver of cheese exports from the U.S.  Recently, some large holders of DPZ have been paring their positions of late as cheese prices have marched higher.  Given the volatility in dairy markets this year, it is unwise to extrapolate any given data point, but trusting the guidance of management teams on cheese prices could prove equally unwise.  Below is a selection of comments from management teams pertaining to cheese prices from recent earnings calls.




  • DPZ (5.5.11):  “And really the one to watch as always is cheese and our best bet right now is that it's going to stay relatively close to where it is right now but cheese is the one that often gives the biggest surprises either up or down and that's the one to kind of watch but assuming cheese stays relatively flat from here on out then, the absolute food costs from – through the rest of the year are probably going to stay pretty consistent with where they were in Q1 which to your point means the percentage year-over-year increase will probably ease a little bit over the course of the year.”  Hedgeye: Hope is not an investment process.  DPZ’s earnings call took place at a trough in cheese prices.  I expect a different tone on the next earnings call in discussing this particular item.
  • CAKE (4.20.11):  “The first half of the year, we're expecting food cost inflation of about 4.5% plus and then in the last half of the year, about 2.5% minus. And a lot of that has to do with the fact that we expect to lap a lot of high dairy costs from 2010 and the fourth quarter of 2011, but also due to the fact that we expect to have slightly lower fresh fish costs, slightly lower cheese prices, than last year as well.”
  • CMG (4.20.11):  “As we move into 2011, we’re expanding our use of cheese and sour cream made with milk from cows.”  Hedgeye: This company has driven sufficient traffic to gain leverage over commodity costs but, I would caution, some margin pressure has been taken (last night's earnings) and cheese was cited in particular.  If dairy prices continue higher, CMG could see food costs negatively impacted.  The company is rolling out a 4.5% price increase, however, as our note from earlier this morning discusses in more detail.
  • TXHR (5.2.11): “We've also got a lot of flow in the dairy markets, in cheese, so there's other things beyond produce that do move around throughout the year.”  Hedgeye: In 1Q09, TXRH called out favorable beef and cheese prices as being primary drivers of cost of sales being down 126 bps in the quarter.  We think it is highly likely that cheese will be a contributor to a cost of sales increase in 2Q11.





A stronger outlook for the dollar is bearish for coffee and coffee prices slid almost 9% after a -2.7% decline last week.  While prices remain elevated, up 52% year-over-year, the past couple of weeks’ decline is positive for SBUX, PEET, GMCR, MCD, DNKN, CBOU, and THI.  Even taking this recent decline into account, the still-elevated level of prices means that any coffee concepts that have to renegotiate contracts may face an increase in food costs on their P&Ls.  Below is a selection of comments from management teams pertaining to coffee prices from recent earnings calls.




  • PEET (5/3/2011): We believe we're better off lowering our earnings guidance by $0.10 this year and continuing with the plans we have in place than we would be curtailing spending activity or taking extraordinary pricing action that would be inconsistent with our long-term business interests, and the more sustainable long term cost of coffee we foresee.  As a result, you will see throughout our call today that we have a very strong performing fundamental business, but we have to buy some unusually high priced coffee in the short term, then we're not going to do unnatural things in reaction to an unnatural market environment short term. Hedgeye: We’ve noted this before: coffee prices trade on a very tight inverse-correlation to the US Dollar.  While it seems that price may have been “unusual” to management teams in May, it is taking quite a while for prices to adjust, making these levels less and less unusual.
  • GMCR: (5/3/11): Before closing, I also want to touch on rising coffee costs and the effect of our business. Like others in the industry, we are closely watching coffee prices. When we announced our last price increase in September of 2010, coffee prices had increased roughly 30% from $1.45 to $1.90 per pound over the course of roughly three months. Since then, costs have continued to escalate, recently hitting historic highs of more than $3 a pound, a nearly 60% increase since September.  In attempt to offset rising green coffee costs, as well as increases in other input costs, we are currently in the process of raising prices for all packaged types. We expect that consumers will see an increase of approximately 10% at the point-of-purchase as the result of this price increase. We expect to see the full benefit of this price increase during our fiscal fourth quarter of 2011.  We generally fix the price of our coffee contracts three to nine months prior to delivery so that we can adjust our sales prices to the marketplace.  Hedgeye: Coffee has backed off the “historic” high of more than $3 per pound but is still at $2.60 plus.  Demand remains strong; without a rising dollar, expect price to continue to pressure retailers.
  • SBUX (4/27/11): Regarding coffee costs, as I have indicated previously, we have fully locked our coffee costs for 2011 and are price-protected for a couple months into fiscal 2012.  As we progress through the balance of 2011, we will progressively take actions to secure our coffee needs and lock coffee costs for additional months into 2012. While we expect that the costs we pay for coffee may be higher in '12 than they are in '11, we remain confident that we can offset those increased costs and preserve our long-term earnings growth targets.  Hedgeye: SBUX is confident that it can pass on price and offset coffee inflation with other efficiencies.  It is interesting that it expects higher coffee prices in 2012 than in 2011, which would somewhat contradict PEET’s assertion that in May that prices at the time had been unusual.  SBUX expects higher prices to come.



Live Cattle


Beef prices have declined -2.7% week-over-week to +18.5% year-over-year.  Corn prices moving higher over the past couple of days has provided some price support but news of Russia’s meat and poultry production surging 3.8% YTD boosted supply.  Additionally, news of contaminated beef in Japan as a result of cattle from the area near the crippled nuclear power plant in Fukushima may also have an impact on prices.  Japan’s government said it “can’t rule out” the possibility that contaminated beef has been exported.


As we mentioned before, the slaughtering of livestock in Texas and surrounding areas suffering from drought may have provided some relief in beef prices.  According to the Henry County Local this morning, cattle need 13 to 20 gallons of water in hot weather.  The arduous and costly task of maintaining herds could be leading to further slaughtering of cattle.  While this boosts supply in the short term, it could mean smaller herds and higher prices over the intermediate term.  Below is a selection of comments from management teams pertaining to beef prices from recent earnings calls.





  • RRGB (5/20/11): Ground beef could be higher by as much as 20% year-over-year, which has a meaningful negative impact to our margins.  Hedgeye: live cattle prices are up +18.5% y/y.
  • JACK (5/19/11): Beef accounts for more than 20% of our spend and is the biggest factor driving the change in our guidance. For the full year, we are now anticipating beef cost to be up nearly 14% versus our previous expectation of 9% inflation. We expect beef cost to be up approximately 14% to 15% in the third quarter. 
  • WEN (5/10/11): We communicated to you back in March that we expected beef cost to rise approximately 10% to 15% and that we expected our total commodity costs to rise 2% to 3% in 2011. We are now forecasting that our beef cost will rise 20%. Hedgeye: there is moderate upside risk to beef price guidance for WEN.
  • EAT (4/27/11):  Well, consistent with what we've talked about in the last month or so as we visited many of you, beef continues to present the most significant inflationary pressure in our commodity basket.
  • MCD (4/21/11): And so if the commodity markets move significantly from here and the main ones obviously looking at beef, looking at corn, wheat, coffee, et cetera, our guidance reflects where the markets are today. If they stay around these levels, the 4% to 4.5% [commodity guidance for 2011] should be locked in. If they move dramatically up or down, then we'll have to reflect that as we move forward. Hedgeye: inflation guidance may have to be adjusted higher.
  • MRT (5/4/11): Q: I wanted to revisit the overall expectations for your commodities basket, and I missed the part about beef, just wanted to verify that it was up in the 20% range.  A: no, no, no.  I said in the low double-digits.  Hedgeye: This is possible, even probable, for the year looking at average 2010 versus average YTD 2011 prices, and given the easier compares in the fourth quarter, but will require no sustained upturns from here.



Howard Penney

Managing Director


Rory Green



WMT: Odds on WMT



Keith bought WMT this morning in the Hedgeye virtual portfolio after successfully going 2-for-2 on the short-side in 1Q. We’ve had a bearish view on the company for a number of reasons, but the fact of the matter is that the near-term and intermediate-term setup is now shaping up somewhat favorably for the first time in a while.


Among the factors behind our bearish view were concerns over internal execution, inventory build into year-end, and a hyper-focus on price leadership capping the potential for margin improvement. While not much has changed as it relates to internal execution, the fact of the matter is that it is lapping sins of the past. We have a pretty low degree of confidence that WMT is any closer to right-sizing the ship. But as it relates to the near term setup, expectations appear to be in check and fundamental downside risk is low – particularly on gross margins given the favorable sales/inventory spread, as well as sss comps.


We realize that this does not come across as having outsized conviction in our edge on Wal-Mart’s fundamentals.  And in fact, from a longer-term standpoint (TAIL duration), we’d rather own Target by a long shot.


But when WMT gets to a point where things simply stop getting worse, and the stock looks good in Keith’s multi-factor model, the odds are in favor of a long here.


WMT: Odds on WMT - WMT VP 7 20 11



HBI: There’s More Downside To Go


Even with today’s blow up, people are currently paying for uninterrupted growth today at HBI. Not only is the growth suspect, but the cadence is as well. We should see the top line growth rate erode meaningfully throughout the next 6 quarters. The risk/reward here is NOT favorable.



Not a surprise with HBI’s reaction to its print today. Yes, it was an in-line quarter, but we’re starting to see cracks for which its valuation left little margin of error. We’ve been concerned about HBI for about two quarters now, and have had it near the top of our short list more recently (along with JC Penney, Carter’s, Gildan, and more recently, Under Armour).


Our conclusion on HBI is that it could be a very good story, if the management team realizes what it is and manages its playbook accordingly. They’ve been executing very well with their factory consolidation – to an extent that no one (except Gildan) has done so in the past. The problem, however, is that HBI is trying to be a growth company, instead of a ‘steady-but-slower-growth top-line with meaningful cash flow and de-levering balance sheet’ story. More specifically…


Long  term top line growth is should be 2—4%. The category grows 1%. Then they take 1-3% share as they use proceeds of factory cost reductions to pass to retailers and consumers. But they’ve been printing top line of around 9% for the past 6 quarters. Much of that (5-6%) has been shelf space gains at Dollar Stores, WMT and TGT. But then, as they started to anniversary growth, what did they do?  They started doing deals. One was big, the other small. But they both happened within a quarter of one another.  Remember, the pitch upon the spin-off was lsd top line, hsd ebit, and mid-teens eps due to delevering the massive $2.6bn debt load that Sara Lee dropped on it. But instead of de-levering and paying underfunded pension liability, they’re doing deals?  In addition, CFO Lee Wyatt just resigned. Our sense is that Wyatt and Knoll simply did not agree on strategy.  Wyatt wanted to improve the balance sheet. Knoll wants to pursue an aggressive growth strategy – even if they have to buy growth.


People say it is cheap on earnings, which is absurd. There’s no reason why an asset-intensive vertically-integrated apparel company with $2bn in debt should be valued on anything other than EBITDA. It’s trading at about 8.2x EBITDA today.  When vertically integrated apparel assets have traded hands in the past, they’ve gone for 3-5x EBITDA (ask the folks at VFC who had to give away their ops several yrs back at 4.6x EBITDA). If HBI trades below 4x EBITDA, there’s no equity value left.


People are currently paying for uninterrupted growth today at HBI. Not only is the growth suspect, but the cadence is as well. We should see the top line growth rate erode meaningfully throughout the next 6 quarters – unless HBI does more deals. That’s possible, but we suspect that the market will start to see through this.


The risk/reward here is NOT favorable.


Here are some of the more notable statements from management on the call.

  1. The volatility in this model is picking up.
    • Moved from steady outlook to more volatility
    • They’re looking for a price hike in Q4 to offset increase costs in the first half of 2012.
    • Looking for negative price elasticity in back half
    • Cutting back on unit inventory levels to manage inflation, and units are falling off less than prices going up
    • But...HBI leads on price which allows temporary gaps in pricing against competitors
  2. They’re banking on MORE shelf space gains
    • Space gains happen again after back to school and into holiday
    • lot of programs across a lot of retailers in all categories
    • Looking for new offerings throughout a whole host of accounts (“lots of wins in lots of places”)
  3. On channel inventory levels, Knoll noted that some channels are up, and some are down. But the ones that are having the most success are those that are being the most liberal with inventory build. (This synchs with our view that retailers overall need to accelerate inventory growth to command any kind of growth multiple).
  4. Inflation outlook
    • Cotton went as low as a dollar – that was too low
    • Need to be above a dollar and a quarter to maintain acreage against other crops
    • Retailers don’t want low cotton as it will lead to negative comps in the back half of 2012


HBI: There’s More Downside To Go - HBI S 7 11






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Our notes from the call that just ended.




  • "Comparable hotel RevPAR increased 6.7%"
  • "During the quarter, eleven of the Company's comparable hotels were undergoing significant renovation projects, including two of the Company's larger properties, the Sheraton New York Hotel & Towers and the Philadelphia Marriott Downtown."
  • "On July 14, 2011, the Company reached an agreement to acquire the 888-room Grand Hyatt Washington, D.C. for $442 million, which may include the assumption of a $166 million mortgage loan."
  • "On June 27, 2011, the Company signed an amendment to the partnership agreement to expand its investment in the European joint venture through the establishment of a new fund (the "Euro JV Fund II")."
    • Target size of euro 450 million of new equity/target investment of~ euro 1 billion with leverage
    • Current partners in the European joint venture owns a 33.3% LP interest
    • June 28, 2011: HST transferred the Le Meridien Piccadilly to the Euro JV Fund II for a transfer price of GBP 64MM, including the assumption of the 32MM pounds mortgage loan. Cash received in the transfer was used to repay $41MM of HST's credit facility.
    • "July 6, 2011, the Euro JV Fund II reached an agreement to acquire the 396-room Pullman Bercy in Paris for approximately euro 96 million."
  • Capex in 2Q:
    • $75MM in capital improvement projects and $71MM in renewal and maintenance projects
    • "Major ROI projects substantially completed during the second quarter include: the first phase of our re-development project at the 1,756-room Sheraton New York Hotel & Towers and the expansion and renovation of 21,000 square feet of meeting space at the St. Regis Hotel, Houston."
    • "Major renewal and replacement projects substantially completed during the second quarter include phase one of the renovation at the New York Marriott Marquis, which included 991 of its guest rooms, and the renovation of the meeting space and the 1,200 rooms in the main tower of the Philadelphia Marriott Downtown."
  • "Investment in ROI expenditures for 2011 will total approximately $220 million to $240 million" and "expects that renewal and replacement expenditures for 2011 will total approximately $320 million to $345 million"
    • ROI capex guidance lowered by $10MM and renewal and replacement capex was increased by $30-35MM
  • During 2Q11 HST issued 11 million shares at an average price of $17.29 per share, for net proceeds of $189MM.
  • "Subsequent to the contribution of the Le Meridien Piccadilly to the Euro JV Fund II, and the partial redemption of the 3.25% Exchangeable Senior Debentures, the Company has total debt outstanding of $5.6 billion and approximately $479 million of available capacity under its credit facility."
  • "Based on the current guidance for 2011, the Company intends to declare, subject to approval by the Company's board of directors, an aggregate annual dividend for 2011 of between $0.14 and $0.15 per share."
  • Outlook for 2011:
    • Comparable RevPAR: +6-7.5%
      • Prior guidance of 6-8%
    • Operating profit margins +150-200bps
      • Prior guidance of 210-260bps
    • Comparable hotel adjusted operating profit margins: 90-120bps
      • Prior guidance of 100-140bps
    • EPS: -$.04 to $0.00/ Net income: -$25MM to $4MM
    • FFO: $0.87 to $0.91 (includes $0.03 debt extinguishment costs, pursuit costs for completed acquisitions and non-cash impairments)
      • Prior guidance of $0.88-$0.91 which included 1 penny of unusual expenses
    • Adjusted EBITDA: $1.02-$1.05BN
      • Prior guidance of $1.01-$1.045BN



  • RevPAR would have increased 7.6% if not for renovations.  The Comp RevPAR doesn't include the 18% RevPAR growth experienced by newly acquired hotels
  • 1 penny impact of acquisition expenses, non-cash expenses and debt extinguishments costs on FFO and 2 cents YTD
  • Saw strong demand increases from higher rated business segments - especially on the transient side. 7.5% increase in special corporate demand. Discount room nights increased 1%.  Transient revenue grew 8%.
  • Group demand was flat with higher priced segments offset by lower business from discount groups.  Group rate increased 4.7% and revenues increased by 4.5% due to mix shift.
    • Group bookings: 3Q pace up 3% and 4Q up 2%. 2012 pace is up materially YoY
  • Guidance doesn't include any additional acquisitions aside from what was already announced
  • Performance in the second quarter was consistent with their expectations and expect 2H11 results will be better due to less disruptions from renovations and improving economic outlook
  • Transient demand has returned to peak 2007 levels
  • Construction costs are beginning to increase again which should help suppress new supply
  • Estimate that the replacement value of their portfolio is $400k per key vs. implied value of $260 per key imbedded in their stock price
  • San Fran: +17% RevPAR - strong transient demand. Expect 3Q to continue to outperform due to excellent transient and group demand.
  • Hawaii: +16.5% - expect Hawaii to underperform in 3Q due to renovation disruption
  • Tampa: Expect that the hotels will perform well in 3Q
  • Miami/Ft Lauderdale: +14.9% RevPAR; 3Q to be great and outperform portfolio
  • Phoenix: +11.3% RevPAR; expect significant outperformance in the 3Q
  • San Diego: +9.2% RevPAR -occupancy improved 7%; 3Q expect them to underperform
  • Chicago: +6.7% RevPAR due to solely ADR growth; expect strong 3Q performance
  • NY: +2.9% RevPAR; expect RevPAR to improve significantly in the balance of the year
  • D.C.: +2.5% RevPAR; expect the market to continue to underperform in the 3Q
  • Boston: -0.4% RevPAR; Expected to underperform in the 3Q
  • Philadelphia: -2.4% RevPAR; expect to outperform in 3Q as renovations wrap up
  • Euro JV: +10.1% RevPAR increase in constant dollars
  • Expect strong flow through for the balance of the year despite higher than inflationary growth in expenses (labor, utilities, property taxes, insurance). Expect strong growth in F&B and other revenues in 2H11.
  • Hope that their properties in New Zealand will re-open in mid-2012. Have business interruption insurance. Have not included proceeds from insurance in their guidance though.
  • They will have to record an additional $5MM tax liability (non-cash charge) related to their European JV


  • D.C. is underperforming this year because it held up better during the downturn. There are also budget issues in the government and as a consequence of uncertainty the government has reduced their group bookings which account for ~20% of D.C. area bookings. However, longer term they believe that Washington is a great market to invest in - from 1 it was one of the best performing markets and held up better during the downturn - they are already back at peak 2007 levels.  Lots of things are happening to make Washington a 24/hr city in the future. Past 2012, they are very excited about the market.  Think that they are buying the Grand Hyatt at a 10% discount to replacement - also think that there will be synergies with their other Hyatt DC asset as well as their other DC hotels.
  • Some of the southern European markets that have weaker economies have seen increases in tourism from stronger European economies
  • M&A market in the US is still largely a REIT market; as debt markets improve, they expect there will be more interest by private capital. 
  • Last year, their near term bookings driving results. This year, near term bookings aren't as robust but future bookings 2-4 quarters out are a lot stronger.  However, short term bookings were unusually strong.
  • Confidence in the 2H11 guidance is driven by performance of +7% excluding renovation disruptions. Renovation disruptions abate in back half.  Group bookings are also better. GDP outlook is still robust at +3%, don't see any reason for business travel to slow in the back half.
  • Their new hotels don't come into their comp set until they own them for 1 year. If those new hotels were in their comp set, then their RevPAR would be about 1pt higher (1%)
  • 2012 group pace is ahead of where it was in 2011 at this time. Revenues on the books is up about 6-7% - almost all occupancy driven. Most of the rate improvement is driven by near term bookings.
  • ROI capital investment in 2012 should be meaningful next year.  Grand Hyatt in D.C. only needs between $10-12MM over the next few years, unless they want to re-optimize the F&B outlets. That asset had a lot of capex invested in it over the last few years.
  • Lenders that have only focused on top 8-10 markets have started branching out more.  As that happens, levels in secondary markets should improve and that will help them sell more assets over the next few years
  • Supply growth in NY should be less of an issue beyond 2012
  • Helmsley - spend $65-70MM starting in the fall of 2011 and complete renovations in 2Q 2012
  • Generally would pay a higher multiple in NY than DC for similar properties in similar locations. 
  • Excluding NY & PA disruptions, group demand would have been up 1%. 
  • Will fund the Hyatt acquisition with their cash on their balance sheet and assume a mortgage on the property.  Their goal is to keep the mortgage but are in negotiations with the current lender.
  • Have $475MM of liquidity on their line of credit. Expect to fund future acquisitions with a combination of ATM equity, debt and cash from operations as well as proceeds from asset sales which should pick up over the next few years.
  • Expect 4Q to be stronger than 3Q because of the general economic outlook, moderation of renovation disruptions, and investment spend in 4Q10 was also a lot larger (i.e. more disruptions in 4Q10).


Notable news items and price action from the restaurant space as well as our fundamental view on select names.





Yesterday, the ICSC chain store sales index reported that chain store sales grew at an above-trend pace last week. Recent data points on consumer spending does not seem to be hit by the reductions in confidence as the debt ceiling debate continues along with fears of a European debt crisis and weaker stock prices.  Year-over-year growth posted its best two weeks since late December, topping 4.5% for two consecutive weeks for the first time since April 2010, when sales were benefiting from a shift in Easter. 





For the week ending July 15, 2011, the MBA mortgage composite index surged 15.5% week-over-week driven by a sharp rise in the refinance index; the refinance index jumped 23.1% on the back of the 30-year fixed mortgage rate well below its 3 month moving average.  The reality is that the purchase index declined 0.1% from the previous week, indicative of a struggling economic recovery and low consumer confidence.  So if no one is buying a new home there is lots of money left over to go out to eat!!


General Mills CEO on food costs - CEO Ken Powell said that higher food prices are here to stay and it was unlikely that food prices will slip into a deflationary cycle as they did last year. "The long-term trends are inflationary, not deflationary and you are going to see pricing in a significant way,"


In our subsector model, food processing stocks continue to underperform.






  • CMG reported $1.59 in EPS, below street expectations, but the company’s strong top line outlook and plan to take price in 3Q has convinced JP Morgan to raise estimates and Piper Jaffray to raise its price target to $352.
  • SBUX “ready-to-eat” chicken products have been recalled by Flying Food Group LLC.  Approximately 204 pounds of ready-to-eat chicken wraps and plates that may be contaminated with Listeria monocytogenes are being sought by the Lawrenceville, Ga., establishment.
  • SBUX has named Kris Engskov as the managing director for its UK and Ireland stores.
  • MCD The first McDonald's restaurant in Bosnia opened for business in the capital Sarajevo on Wednesday.



  • MSSR - Discovery Group, a Chicago-based investment firm, acquired a 6.3-percent stake in McCormick & Schmick’s Seafood Restaurants Inc. in what some see as a move to take advantage of an expected higher sale price.




Howard Penney

Managing Director


Rory Green



In preparation for PENN’s Q2 earnings release tomorrow, we’ve put together the pertinent forward looking commentary from PENN’s Q1 earnings release/call and subsequent conferences/articles.



Columbus water/sewer annexation deal misses deadline (7/20/2011)

  • "The pending settlement expired at the deadline because the two contingencies were not satisfied. Penn National continues to be in discussion with all parties.”
    • 2 contingencies
      • PENN had to have an agreement to sell its original casino site in the Arena District for at least $11MM. Nationwide Realty Investors had acknowledged it was in talks with PENN to purchase the land.
      • PENN had to settle separate lawsuits with The Dispatch Printing Company, which publishes The Dispatch and
  • "We are prepared to go to trial and are confident in a fair hearing from Judge (Gregory L.) Frost."

$2.15BN Senior notes refinancing (7/19/2011)

  • $700MM RC facility—matures July 2016, L+175bps
  • $700MM Term Loan A—matures July 2016, L+175bps
  • $750MM Term Loan B—matures July 2018, L+275bps (LIBOR floor of 100 bps)
  • $250MM 6.75% Senior Sub Notes—matures August 2015
  • $325MM 8.75% Senior Sub Notes—matures March 2019s
  • Refi replaces the existing $640.6MM RC facility maturing July 2012 and the $1.52BN secured TL B loan maturing Oct 2012

Ohio Governor Kasich signs the racetrack relocation bill—HB 277 (7/15/2011)

  • Permits PENN to move Beulah Park from Columbus to Dayton, and Raceway Park from Toledo to Youngstown.  The Ohio Racing Commission will have the final say on the matter.

Highlights of the Ohio casino agreement (6/17/2011)

  • Penn would pay Ohio $110 million over 10 years–$10 million per year for the first five years and $12 million per year for the next five year
  • Tax certainty for gaming companies: Ohio’s Commercial Activity Tax (CAT) would be applied to casinos’ total dollars wagered minus winnings and prizes paid out to customers
  • Capital Expenditures: Gaming companies would make a combined capital expenditure in their casino facilities of at least $700 million (ROC: Cleveland and Cincinnati, PENN: Columbus and Toledo)
  • VLT Licenses: The Lottery Commission intends to allow each of Ohio’s seven horse racing permit holders to apply for a 10-year sales agent license to operate a VLT facility. Licenses would cost $50 million and be paid over time: $10 million upon application, $15 million at the onset of VLT sales, and $25 million one year later
  • The state tax on racetrack gaming machines would be set at 33.5%

PENN divests Maryland Jockey Club (6/16/2011)

  • “While we are divesting our interest in the Maryland Jockey Club, Penn National Gaming remains committed to racing and gaming in Maryland. With our acquisition earlier this year of Rosecroft Raceway in Oxon Hill and our successful opening last fall of the state’s first VLT facility, we will focus our resources on further strengthening the racing and operations at Rosecroft and building on the initial success of Hollywood Casino Perryville. We believe that the Maryland Jockey Club, Pimlico and Laurel Park will be well served under the single ownership of The Stronach Group and we wish them success with these historic racing venues.”
  • Transaction expected to be completed in the next few months and is subject to approvals from the Maryland Racing Commission.

Post Earnings Conference Commentary (Jefferies & Co. Global Consumer Conference/ Wells Fargo Securities Consumer Gaming and Lodging Conference/ UBS Leveraged Finance Conference)

  • [Perryville Capex budget/ROI] “I think we’ve budgeted $98. We’re probably going to come in around $94. And I think you’ll see here we’ve generated $8.8 million since opening -- six months -- plus $17 million over a year’s timeframe and that’s still ramping. So you can see that’s at least a 17% to 20% of return on invested capital regardless of how small it is we still only think about returns on invested capital.”
  • [M Resorts] “Net of cash, we’re in for about $210 million on this $1 billion facility. So, the property is running less than 10% margin and we think that there is a big opportunity for us here to get margins up to a level that commensurate with our overall company operating margin.”
  • [Leverage] “So from a leverage perspective, our leverage should not go up in 2011, should not go up in ‘12. And once we bring these facilities on in 2013 and the CapEx goes away, we should be able to de-lever very, very quickly even though we already have very low leverage.”
  • [April/May] “April was a good month.  April was one of our better months and we’re very encouraged by that. May has been okay; it hasn’t been as strong as April, but [we’re] still very happy with the month of May.”
  • [Business interruption insurance] “Our policy is we have a $5 million deductible and a two-day business interruption and we’ve got a flood insurance coverage from the federal government for like a million bucks, which will help. So basically net deductible should be like $4 million. I’m not sure we’re really going to go very deep into that claim because candidly we’ll see.”
  • Q: If gaming got passed in Texas or any other jurisdiction in general, how long do you think is usually between the time it gets passed and time you can have something running?
    • “It depends to the extent that they preordain or they preselect sites and that will indicate who is eligible for site, it can be probably two years from the actual authorization to the extent that they’re going to have a process and what we affectionately refer to is a beauty contest, then that usually generally takes three years.”
  • [$1.25 BN interest-free loan in 2015] “There is another issue in 2015, which is the Fortress and Centerbridge, what we call the preferred equity slug, comes to a maturity in 2015 and if we haven’t been able to find a good mechanism for deploying our capital in terms of expansion opportunities by then, obviously we would look to eliminate that delusion at that point we would go out, raise the debt and pay it off….So really through 2015 that speaks to roughly $1.2 billion of commitment of where we would spend the money.”
  • [EBITDA] “I think one of the best things that happened ironically for the gaming industry was this financial crisis or economic crisis. Pretty much across the boards, people have stopped worrying about market share and that’s a good thing, because they’ve started to worry about EBITDA. And EBITDA is basically where we’ve always been focused.”
  • [Joliet] “When we look at all of our properties, and we do a monthly review, which is at a very high level review at each of the properties, we’ve been incredibly pleased with really the operations for all of our properties and if there is one that’s been a little bit of a disappointment, it’s probably Joliet. Joliet, we’ve clearly not really executing – and I don’t mean this in any way to be discouraging to the team in Joliet, but clearly the property, when you look at it, we’re struggling with the margins, we’ve put some significant CapEx in, not astronomical amounts, but $50 million or so, put a new parking garage on – it’s just been a really tough environment there.  Other than there, I think we’re pretty pleased across the boards.”
  • [Slot Capex] “So this year, we had a very small reduction in our slot machine maintenance CapEx. So we’re probably replacing just slightly less.”
  • [Thoughts on slot purchases] “Most of our other competitors have almost like stopped ordering slot machines, I think we’re probably more inclined to follow – not follow to the extent and the degree to which they followed, but if it’s not making a difference and the customer’s don’t care, then why would you want to run around buy a bunch of new slot machines other than to make the slot manufacturers happy with you. There’s really not a whole lot of benefit there….And the other issue that’s out there, which is candidly starting to get addressed, is the slot manufacturers were year-over-year having significant increases in their pricing, but the production of their slot machines in the way we measure production is win per unit was not matching the increases in the price. So that’s a bit of a concern because obviously that’s a relationship that just says that the slot manufacturers are taking more and more money out of our investors pockets for their benefit of their investor’s pockets and they’re not delivering.”

Youtube from Q1 Conference Call

  • [Margin guidance] “I think as we look out, certainly we are incorporating operations from Rosecroft well as the Sam Houston Raceway Park into our EBITDA guidance. But some of the other components that are out there is that we are also moving up the date of which we expect the 10th license in Illinois to open up. And candidly, we are looking at it going forward and recognizing that our margin improvement has been a gradual process. I think certainly on a year-over-year basis, we are ecstatic with how we’ve done this year, but as we went along last year, our margins were continually developing and improving throughout the year. So I don’t know that we certainly can’t take this year’s or this quarter’s margin improvement and extrapolate that out for the rest of the year, certainly not the rate of improvement. We’re certainly reflecting I think margin improvement in the next quarter and the combination of all of those events together is kind of where we look at.”
  • [Flat revenue guidance] “We’re not including a rebound in revenues going forward or some kind of improvement. We are assuming revenues are basically flat on a year-over-year basis other than the properties that have table games obviously in the second quarter at Charles Town and Penn National will continue to see robust growth. And then going forward from that we’ll start to anniversary to the table games. So we would expect our year-over-year revenue improvement to basically come back in line. Not to say that we don’t expect some growth in Charles Town, but once we get the year-over-year comparisons our revenue growth will not be quite as strong as what you’ve seen here in the first quarter.”
  • [M Resorts] "I think that that property will trend like all the other Las Vegas local properties trend."
  • [JV properties] “I mean on an overall basis for the year, I think we’ll find that we should at least for the properties that are continuing in a year-over-year basis that we should see some progress in terms of reducing those levels of losses. Clearly, within Maryland Jockey Club right now, which is a number that’s included, it’s a pretty decent number in the first quarter, that does not take into account any kind of rebates and other issues that are in front of the Maryland legislature in terms of reimbursing operating losses. When in fact those monies are authorized and finalized and start getting paid, that would obviously reduce the operating losses significantly from the Maryland Jockey Club.”
  • [MJC] “Well, clearly in the second quarter, Maryland Jockey Club will swing from a negative to a positive because of the Preakness. So, clearly in the second quarter, you are going to see a dramatic improvement. First quarter results are probably some of the weakest results, the winter months in the racing business is probably the worst quarter. So I would expect that as you go out throughout the year, the seasonality combined with the concept of the fact that we are doing some stuff to try to reduce our operating losses should see better results going forward than what you’ve seen in the first quarter.”
  • [Charles Town table games] “We are going to be adding 20 more table games come the end of the second quarter to the operations to take advantage of that growth. We’ll have over 100 games heading in to the summer. [They currently have 104 tables, ex poker.] And we also will be completing our $40 million capital program opening up our entertainment lounge and sports bar come June, July, to complete the transformation of Charles Town.”
  • [MS promotional spending] “Down there on the Gulf Coast, promotional spending has been fairly rational.”
  • [Impact of 10th IL gaming license] “We think the property that’s going to be most affected will be Elgin, followed by Aurora, followed by the properties down in Joliet…. And there also will probably some effect in the Northwest Indiana as well with customers from within the loop.”
  • [Why 2H EBITDA margin guidance much lower than 1H?] “You certainly cannot expect us to continue to have the same margins in 3Q/4Q as you see us having in 1Q/2Q, so there is a seasonality effect. There is the impact of the M. There is the impact of these additional racing operations, which do generate revenues and generate losses. So those are clearly counterproductive to overall margins…. We also have for five months the removal of the Rama management fee, which is extremely high margin that we have concluded at the end of July. However, we are in negotiations with the Ontario government and we do believe we’re going to get a short-term extension on that that will carry us through the first quarter of 2012, but that’s not in our numbers as well.”

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