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Weekly Latin America Risk Monitor

As usual, we’re keeping it brief. Email us at if you’d like to dialogue further on anything you see below.

 

THEME

Growth continues to slow in Latin America while recent and future policy actions are creating some obvious warnings signs in the system – particularly as it relates to the FX exposure of investors and corporations alike.

 

PRICES

Last week was rough week for Latin American equity markets, closing down -2.2% wk/wk on average. We did see the larger markets like Brazil’s Bovespa Index and Mexico’s IPC Index outperform the smaller, more illiquid markets like Argentina’s Merval Index and Colombia’s IGBC General Index, with the notable exception of Venezuela’s Stock Market Index (up +51.4% YTD). In Latin American FX markets, currencies broadly appreciated vs. the USD wk/wk, with the exception of the Argentinean peso (ARS) who’s -0.5% wk/wk decline echoes a developing trend of capital flight from the country.

 

The big callout in Latin American fixed income markets is the -50bps wk/wk decline in Brazilian 2yr sovereign debt yields as expectations for future interest rate cuts continue to get priced into Brazil’s interest rate market (1yr on-shore swap rates declined -37bps wk/wk and -95bps MoM). Interestingly, Friday’s closing yield of 11.54% is a full 96bps below the Brazilian central bank’s benchmark interest rate (the Selic), currently at 12.5%. In Latin American CDS markets, the key callout is the +10bps backup in Argentina’s 5yr swaps amid broad-based declines throughout the region.

 

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KEY CALLOUTS

 

Brazil: Last week was a busy week for Latin America’s largest economy. Early in the week, it was reported by O Globo that the external debt for large Brazilian corporations had increased +74% from 3Q08 levels. We continue to flag the external debt buildup of many emerging-market economies over the last ~2 years as an incremental risk for some emerging market equities heading into an environment of slower global growth – particularly if the dollar continues to strengthen against EM currencies (a lower exchange rate increases their nominal debt burden). The Brazilian real in particular is down -2.3% vs. the USD over the last month, in part due to the latest 1% tax on FX derivatives (imposed on July 27). Anecdotally, the latest measure has been said to have increased volatility in Brazil’s on-shore FX derivatives market as well as reduced corporate incentive to hedge the FX risk.

 

Elsewhere in the Brazilian economy, we see signs that Brazil is headed in the wrong direction from a fiscal policy/regulatory perspective per the roadmap we outlined in our recent deep dive on the Brazilian economy (email us if you’d like a copy). First, it was reported by Miriam Leitao that president Rousseff vetoed proposed legislation that contained a balanced budget proposal, as well as other legislation that would have added transparency to the Treasury’s dealings with BNDES – both supportive of higher rates of inflation over the long-term TAIL as the government rejects fiscal discipline on the margin. Secondly, the government added yet another layer to the Brazilian bureaucracy by creating the National Commission of Airport Authorities – a move we see as negative on the margin for the expediency of getting the country’s airport infrastructure up to speed in time for the 2014 World Cup. Lastly, it was leaked to Brazilian newspaper Valor Economico that the government was considering reducing its primary surplus in 2012 – a negative development for the necessary positive adjustment to Brazil’s gross national savings rate in light of the country’s infrastructure initiatives over the next 2-3 years.

 

From an economic data perspective, Brazilian growth continued to slow with registered job creation slowing to +140.6k MoM in July and the Economic Activity Index (proxy for GDP) slowing in June to +2.9% YoY and -0.26% MoM – the first MoM decline since December 2008! We remain bearish on Brazilian equities for the intermediate-term TREND as growth continues to slow and inflation remains sticky.

 

Mexico: The key callout as it relates to Mexico last week was a slowing 2Q GDP print of +3.3% YoY (vs. a prior reading of +4.6%). Moreover, the Global Economic Indicator Index (a proxy for GDP) slowed in June to +3.6% YoY (vs. a prior reading of +4.6%). The late-quarter slowdown highlights a key point we’ve been aggressively making since March – the slowdown in global growth is not merely a function of Japan’s earthquake/tsunami.

 

Mexico’s Ministry of Finance believes the country is likely to expand +4% YoY in 2011 and, while accelerating same store sales growth (+6.4% YoY in July) remains supportive of Mexico’s consumer story, our models continue to point to a full-year GDP growth rate roughly 100bps shy of those expectations. Net-net, we remain the bears on Mexican equities for the intermediate-term TREND as growth slows and the bears on the Mexican peso (MXN) over the same duration as said economic slowdown causes Banco de Mexico president Ron Carstens to continue with Indefinitely Dovish policy well into 2012 as TIIE futures are indicating.

 

Chile: Another country, another growth slowdown; 2Q GDP growth slowed from +9.9% YoY to +6.8% YoY. Our models point to Chilean economic growth continuing to slow in 2H (though to rates just shy of current levels), and, apparently, so do the central bank’s. Last week they held their benchmark interest rate flat at 5.25%, marking their third pause YTD. In the monetary policy announcement, board members dropped previous mention of possibly raising borrowing costs in the future, citing “the implications of internal and external macroeconomic conditions”.

 

Like us and the Chilean central bank, the country’s Ministry of Finance is also modeling in a continuation of the current slowdown in Chilean economic growth in 2H. Finance Minster Felipe Larrain is on record saying, “Chile’s economic growth, as well as consumption and investment levels will decelerate in the second half of the year after a solid first-half expansion.” We remain the bears on Chilean equities for the intermediate-term TREND.

 

Colombia: Like Brazil, Colombia screened poorly in our (growing) external debt monitor. In fact, it was reported last week that Colombian corporations have borrowed externally at a record pace YTD, growing the stock of external debt by a +$1.1B YoY in just the first seven months alone! For a sense of the magnitude, this is on top of a mere -$184M decline in full-year 2010. As with most emerging markets, the gaping interest rate differentials between on-shore paper (4.5% benchmark lending rate) and US dollar/euro/yen denominated paper is driving Colombian debtors abroad.

 

Both Colombia’s central bank and Ministry of Finance are griping about the “rising dollar inflows” putting upward pressure on Colombia’s exchange rate and we believe interventionist measures, like the deposit scheme of 2007, are on the policy debate table in the coming weeks. Colombian President Juan Manuel Santos explicitly agrees, saying last week that, “Latin American governments must intervene in [FX] markets to correct any failures… authorities can’t take a passive approach to currency appreciation that diminishes the competitiveness of exporters.” Holders of the Colombian peso, peso-denominate assets, and highly-levered Colombian equities beware.

 

Argentina: The key callouts out of Argentina last week centered on President Fernandez’s sweeping victory in the Argentinean primary election and capital flight/currency devaluation. To the first point, Christina Fernandez garnered just over 50% of the votes while the closest opposition candidate came away with just over 12% apiece – all but ensuring she’ll win a second term as president in upcoming election on the 23rd of October. Her victory is leading some to believe that she’ll purse a more expedient form of currency devaluation upon re-taking office. This is due to the likelihood that Argentina’s “free and available reserves” (FX reserves less monetary base/M0) shrinks to ~$4.7B by year-end (down -65.6% YoY). This is important because Argentina, like Venezuela, favors using FX reserves to fund government expenditures, like the repayment of external debt, for instance.

 

A currency devaluation would increase the convertible value of Argentina’s “free and available reserves” and give the Argentinean government some wiggle room to continue servicing restructured debt and potentially pursuing expansionary fiscal policy in 2012. The central bank is held hostage from lowering interest rates to support the economy (in the event it becomes necessary) due to the record pace of capital flight (-$9.8B YTD vs. -$11.4B in all of 2010) and elevated rates of consumer price inflation, which Argentinean consumers and private economists believe to be around +25% YoY (vs. the government’s officially-tainted report of +9.7% YoY).

 

Venezuela: The major news out Venezuela last week that is relevant on a Global Macro basis is ailing president Hugo Chavez’s decision to nationalize Venezuela’s gold mining industry. He also announced that Venezuela plans to repatriate $11B of gold assets held abroad in a scheme designed to shift Venezuela’s liquid reserves to “allied countries” (including itself, China, Russia, and Brazil). The key callout here is that you typically see aggressive maneuvers like this near the peak of bubbles – something gold investors must become increasingly cognizant of.

 

Darius Dale

Analyst


INCREASED BURDEN ON DISCRETIONARY INCOME

 

Continuing on a theme I wrote about last week…  Some of the differences between 2008 and today are more problematic than the similarities: joblessness is higher, more people are reliant on food stamps for sustenance, and the financial crisis threatening to wreak havoc on our economy is not here in the US and therefore less within our government’s control. 

 

I’m going to add two more differences:

 

First, in 2008 Bernanke had not yet shown his hand and had not started the printing presses; we now we have negative real rates, with more to come, and people actually know how ineffective the Fed’s tools are.  In 2008, we didn't really know. 

 

The second comes from today’s Hedgeye Healthcaster.  The cost of funding healthcare premiums is being transferred from the employers to the individuals, further limiting the consumer’s discretionary spending.  

 

The following is taken from the today’s Hedgeye Healthcaster.

 

Employer Cost Shifting/Discretionary Healthcare:  In the latest Large Employer Survey on Expected 2012 benefit offerings, the National Business Group on Health (Here) found that some 53% of Employers would increase the amount workers pay toward their premiums next year while 40% said they would increase deductibles for in-network care. 

 

The music on this cost shifting dance has been playing for the better part of the last decade as benefit expense continues to grow at healthy premium to GDP.  

 

Employers have responded by attempting to transfer costs back to the individual – a move which has resulted in the accelerated growth in high deductible/co-pay health plans; which inhibits health consumption for many individuals, and is a meaningful contributor to the growing population classified as ‘underinsured’. 

 

The net effect of this ongoing cost shift has been an to push healthcare spending increasingly into the discretionary camp; especially into a downturn.  The correlation between Healthcare Spending and Discretionary Spending has been making higher highs over the last decade, reaching a peak TTM correlation of 0.97 into the March 2009 trough.  Looking back over prior recessionary periods, the most recent downturn showed the strongest correlation between healthcare & discretionary spending by a large margin.    

 

We’ve been highlighting the increasingly discretionary nature of healthcare spending for some time, but it’s probably worth another callout here as growth slows and employers continue to cost shift health expenses back on an employee base now mired in negative real wage growth. 

 

The similarities, given that we are comparing the present situation to crisis of 2008, are inherently negative.  Energy prices and the VIX are elevated, stocks have fallen off a cliff, and consumer confidence is depressed.

 

INCREASED BURDEN ON DISCRETIONARY INCOME - hpce

 

 

Howard Penney

Managing Director

          

 

Rory Green

Analyst

 

 


MPEL YOUTUBE

Look for MPEL to beat even recently revised Q2 EBITDA estimates tomorrow. The bigger story is how much Q3 needs to go up (20%).


 

MPEL Proposed Dual Listing on HK Exchange (Aug 4)

  • We believe our proposed dual listing on the local bourse will not only put us on a par with our competitors, but will also provide our existing shareholders with much enhanced liquidity, while providing us with access to an additional source of capital. A dual listing on the SEHK will also allow local and Asian investors to directly access investment opportunities in our Company, thus broadening our investor universe."
  • According to a Dow Jones source, MPEL is looking to raise $400-600MM for its HK IPO.  The source also said the IPO would launch in Q4.

MPEL Announced Successful Completion of the Acquisition of a 60% Interest in the Developer of the Macau Studio City Project (July 27)

  • Successful completion of the acquisition of a 60% equity interest and shareholder loan in the developer of Macau Studio City, a large scale integrated gaming, retail and entertainment resort to be developed in Macau jointly by MCE and New Cotai Holdings, LLC ("New Cotai Holdings"), an entity controlled by funds managed by Silver Point Capital, L.P. and Oaktree Capital.
  • Signing of a shareholders' agreement for Cyber One Agents Limited (together with its direct and indirect subsidiaries, the "Cyber One Group") with an affiliate of New Cotai Holdings. New Cotai Holdings retains its 40% indirect equity interest in the Cyber One Group.
  • Will open with 300 to 400 gambling tables and 1,200 slot machines, pending government approval. The project would cost a further US$1.7 BN (MOP13.6 BN).  It will include 2,000 hotel rooms, 200,000 square feet of retail space and entertainment offerings.
  • The tentative deadline to open the property is the first half of 2015.

Melco Crown Gaming (Macau) Limited Closes Refinancing (July 1)

  • The refinancing credit facilities ("New Facilities") are for approximately US$1,200 million
    • Amortizing term loan facility for the equivalent of approximatelyUS$800MM ("Term Loan Facility") for the purpose of partially refinancing existing debt and the payment of associated fees, costs and other expenses and a revolving credit facility for the equivalent of approximately US$400MM ("Revolving Credit Facility") to fund the partial refinancing of existing debt, certain maintenance capital expenditure and general working capital purposes. The Term Loan Facility has been fully drawn and the balance of the Revolving Credit Facility will be available for drawdown in Hong Kong dollars, each bearing interest at HIBOR plus a margin.
  • Although the pricing terms of the New Facilities are higher than the pricing terms of the City of Dreams Project Facility, we believe they are in line with market pricing terms. 
  • The term of the New Facilities is five years

 

Youtube from Q1 Conference Call

  • “Our customer database now has over 650,000 members and continues to grow, further allowing us to strategically target profitable customers now and in the future. GGR in Macau has continued to show strong growth with a year-over-year increase in April of 45% and May is off to a good start. As such, we continue to see upside in both our mass market and VIP gaming revenues as well as incremental revenue growth from our non-gaming operations for the remainder of the year.”
  • “The House of Dancing Water continues to sell out and remains at breakeven on a standalone basis while continuing to contribute to our casino, food and beverage, and hotel segments. With the addition of Cubic, as well as the opening of the Hard Rock Café scheduled for year-end, we believe that our entertainment offerings will continue to differentiate City of Dreams and drive visitation and revenue.”
  • “Depreciation and amortization expense is expected to be approximately $85 million. Corporate expense is expected to come in at approximately $20 million to $22 million. Net interest expense is expected to be approximately $30 million. We do not expect any meaningful pre-opening expense or capitalized interest in the second quarter of 2011.”
  • “We believe that the Galaxy opening is great for Macau and it’s even better for Cotai. We’ve seen traffic hold up at our property quite well; if anything, it’s increasing quite a bit.”
  • “Given the state of the site of Macau Studio City, if the two shareholders were to restart construction, I think it certainly would have a head start over some of the other sites that haven’t even gotten land approvals yet.”
  • [CoD development space] “It’s probably unlikely that the government will approve apartment hotels, after all they have been looking at it for the past five years. So I think the latest design that we have looked at is, really potentially looking at doing adding additional hotel rooms, being a pure hotel, it’s a big project because to give you a comparison, Altira is only 1 million square feet and the developable space at City of Dreams, which we call Phase III now, is 1.5 million, so, with 500,000 potentially in the podium and 1 million in the hotel tower…. it could be another 800-plus room hotel tower.”
  • “I think operating leverage and margin is a continued focus of ours and since our main focus at City of Dreams is on the premium mass segment, we’ve been able to do that by turning off some of the marketing expenses.”
  • [CoD margin] “The margin is stable and other than a small increase from Cubic, stable going into the second quarter as well.”
  • “We view our hold percentage of mass to be something that is really not an anomaly of luck at the table, that’s really a reflection of improvements in the experience that we’re providing to our gaming customers. So, it’s not normalized because we view that as being something that’s sustainable going forward.”

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DNKN - VALUATION IS NOT A CATALYST BUT A STARTING POINT

Paying a higher multiple for DNKN over SBUX, MCD and YUM does not make sense to us.  In just about a week’s time, we will be getting a close look at what the “paid supporters” think of the stock at these levels.  My guess is that we will see the sell-side consensus build around the “I like the long term prospects, but valuation is expensive” theme.     

 

We published our Black Book at the time of the IPO outlining our longer term view of the fundamentals and our view that the coffee space was in a “bubble.”  Valuations have since corrected, with the exception of DNKN.  As we have written, DNKN is a domestic regional brand with a plan to grow domestically into new markets within the U.S.  We find the practicalities of that plan less-than-certain and would absolutely not support a higher valuation for DNKN versus SBUX MCD and YUM which have more convincing growth prospects via international markets. 

 

Additionally, given the fact that broader economic growth in the U.S. is and will likely continue to be below that of international markets where Starbucks, McDonald’s and YUM are focusing their growth, we are only further convinced that the DNKN premium is unsustainable. 

 

I can appreciate that there is a K-CUP story developing at DNKN, but that is reflected in the current valuation.  What is not discounted is the potential for SSS to be less that blockbuster in the upcoming quarter if the K-Cups sell thru are less than stellar.  Not to mention the potential for K-Cup supply constraints coming from GMCR.     

 

DNKN - VALUATION IS NOT A CATALYST BUT A STARTING POINT - DNKNVAL


European Risk Monitor: Summer’s Uncertainty

Positions in Europe: Short EUR-USD (FXE); Short UK (EWU); Short Italy (EWI)


We’ve titled this week’s European Risk Monitor “Summer’s Uncertainty” for it’s the continued lack of resolve on a credible plan to mitigate sovereign debt contagion that perpetuates uncertainty on the region’s economic outlook—and here the core is just as exposed as the periphery.  This uncertainty is further enhanced by the lack of near term catalysts: ratification on the terms of the EFSF—which doesn’t include expansion of the €750 Billion facility—won’t come until late September/early October. Never mind that we think this facility needs to be enlarged—we’d expect pushback on the terms from Finland, Netherlands, Austria, and Slovakia, and therefore continued volatility across European capital markets, with a bias to the downside.

 

Notable callouts over the week include: Q2 GDP reports; Switzerland’s handcuffed currency intervention; proposals of a French austerity package; tempered remarks from Merkel on Eurobonds, and the slide in equity markets:

 

A.)   EU-27 GDP fell to +0.2% in Q2 vs +0.8% in Q1 quarter-over-quarter, or +1.7% vs +2.5% year-over-year. Importantly, German GDP, the country thought to be “carrying” the region, fell considerably in Q2 as compared to Q1 (+0.1% vs 1.3% Q/Q; or +2.8% vs 4.6% Y/Y). The report reflects our call in late Q1/early Q2 of the slowing high frequency data in Germany.

 

B.)    While the initial announcement by the Swiss National Bank to curb the strength of the CHF on 8/10 sent it tumbling versus major currencies, uncertainty remains to the extent the SNB can make a dent in the CHF’s +15.8% year-to-date gain versus the USD, or +9.2% vs the EUR, especially as Europe’s sovereign debt contagion pushes onward.   Week-over-week the CHF-USD fell -1.2% and the CHF-EUR weakened -2.4%.

 

C.)    France will unveil austerity measures this Wednesday, which will include budget cuts and higher taxes on the highest income earners. Critically, the terms of the package are essential to monitor for they could limit threats to a downgrade in the country’s AAA credit rating, an important point we’ve highlighted in our research, in particular as it relates to the EFSF.

 

D.)   Finally, over the weekend German Chancellor Angela Merkel reaffirmed her resistance to the issuance of Eurobonds, saying that “they lead us into a debt union, not a stability union and each country has to take its own steps to reduce its debt.” Yet she left a slight window open in saying “euro bonds at this time would further undermine economic stability and so they are not the answer right now.”

 

E.)   The DAX and CAC led European equity indices to the downside week-over-week at -8.6% and -6.1%, respectively; the equity markets of the PIIGS followed, down -4 to -5%, and we saw massive declines across European banks. As we look further out, expect no country to be immune from contagion risk. 

 

Continuing on the point of Merkel’s stance on Eurobonds, it’s noteworthy that recent polls suggest 75% of Germans are against issuing Eurobonds. The real position at hand is the lack of fiscal accountability for the Eurozone member states and German resistance to a go-at-it-alone approach in which its borrowing cost move higher to subsidize its neighbors, in particular those without fiscal discipline. Germany’s finance ministry has calculated that the burden on the federal budget by issuing Eurobonds would be an extra €2.5 Billion in the first year, €5 Billion in the second year, and €20-25 Billion over the next 10 years. One issue to consider is that issuance of Eurobonds does NOT comply with the terms of the Lisbon Treaty. While an amendment could be passed, keep in mind that such an amending clause could take considerable time (years).

 

 

Risk Monitors


A look at 10YR government bond yields shows that Italy and Spain are trading just below 5%, or around 100 bps below our critical breakout line of 6%. We think this level is supported by the re-activation of the ECB's SMP bond buying program, however we do not see the SMP involvement as a long term solution to arrest yields as the ECB's mandate is solely to maintain price stability through monetary policy and not fiscal policy. Hence the importance on the EFSF decision. 

 

European Risk Monitor: Summer’s Uncertainty - ME 1

 

Our European Financials CDS Monitor shows that Bank swaps in Europe were mostly wider last week: 28 of the 38 swaps were wider and 10 tightened.  We expect downside in European banks so long as sovereign threats remain in the forefront. The lack of resolve on a credible plan to limit contagion, the ability to punish fiscal excesses, and allow banks to fail, are all points that need to collectively be addressed. We don’t think that the EFSF, even if it is resolved in its current state in late September/early October, is a panacea for the region’s ills.

 

European Risk Monitor: Summer’s Uncertainty - ME 2

 

We shorted Italy via the eft EWI today in the Virtual Portfolio. We remain short the UK and its sticky stagflation via the etf EWU. We are also short the EUR-USD via FXE. Our immediate term TRADE levels are $1.41 to $1.45.

 

Matthew Hedrick

Senior Analyst


MACAU ON PACE FOR 44-50% YOY GROWTH IN AUGUST

August revenue target range of HK$22-23BN


 

Macau slowed in the past week which, from our sources, appears to be hold related.  In fact, Mass traffic looked very strong over the weekend.  Daily table revenue per day averaged HK$678 million versus HK$706 million for the month to date.  We have narrowed our projection range to HK$22-23 billion for full month gross gaming revenues (including slots) from our previous range of HK$22.0-23.5 billion.  Our new range represents YoY growth of 44-50%.

 

For market share, Wynn was the big loser as MTD market share fell from 2 full percentage points in only one week which is undoubtedly a result of bad luck.  In fact, the low Wynn hold probably explains the entire market’s slowdown this week.  SJM and MPEL picked up the most share in the past week.  At 14.7%, MPEL is now back above its post Galaxy Macau average share after holding poorly in the first week of August.  Q3 consensus EBITDA estimates for MPEL look about 20% too low based on the quarter to date numbers so far.  LVS’s market share remains disappointing this month and actually fell 20bps in the past week alone.

 

MACAU ON PACE FOR 44-50% YOY GROWTH IN AUGUST - macau


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