October Sales Preview - Updating the Macro View of the Consumer

Retailers are scheduled to report their October comparable sales numbers on Thursday. As we are anticipating less than pretty results from most retailers, we thought this would be a good time to take another look at the state of the consumer over the last 2 years. In early October, we analyzed the changing state of the consumer over the last 40-plus years (please refer to Brian McGough’s two posts dated October 12 for more details). Specifically, we wanted to see how consumers were faring in the year-ago period to gauge what type of consumer environment retailers are comparing against in their upcoming reported October results.

Since January 2007, personal consumption expenditures hit their YOY peak in growth in November 2007 and have since grown at a moderated to declining rate. Nondurable goods spending has helped to support total PCE growth as gasoline, fuel oil and other energy spending picked up in September 2007 and began to really accelerate in October followed by four months of 30%-plus YOY increases. Energy spending continued to grow at double-digit rates since that period through July as gasoline prices hit historical highs.

At the same time energy costs took a larger share of wallet, consumers were hit with overall inflationary pressures as CPI reflected these higher energy costs and began its steady YOY increase in August 2007. The unemployment rate, which has been on an upward trend since January 2007, also began to increase at a more significant pace during this October to November 2007 timeframe. Not surprising, disposable personal income growth decelerated in October as well as it coincided with the uptick in unemployment rates. Since then, disposable income growth has continued to moderate until it turned relatively flat in March 2008. The government’s rebate checks helped to boost numbers in May (also provided a lift to May, June, July retail sales numbers), but this government intervention only provided a short-term fix and disposable income growth has since abated. So needless to say, consumers were already under pressure in the year-ago October period. These pressures, however, were only beginning to emerge, albeit at a fairly rapid pace, so it is safe to assume that consumers had not fully realized the severity of the issues.

As we think about October 2008 retail sales, consumer confidence has waned on a YOY basis, unemployment rates have worsened and disposable personal incomes have deteriorated further. The consumer has gotten some relief in recent months as it relates to gasoline prices and overall inflationary pressures, but as I said earlier, we are anticipating another month of toxic results and as Brian McGough stated on October 12, discretionary spending could finally turn negative in 1Q09 and be down about $170 billion in FY09.


I believe Ted Chan will be named the new Chief Executive of Crown Macau, replacing Keith Heise who may have been fired. This appointment would make sense as Amax Entertainment announced on Monday that Mr. Chan resigned to pursue another Macau opportunity.

Amax owns 80% of AMA, which is currently the sole junket aggregator for Crown Macau. The arrival of Mr. Chan would appear to be fairly seamless and confirm Crown’s position as primarily a VIP property. I’m not sure what this means for the AMA/Crown relationship. We had been hearing that it was somewhat strained already.

The management change was probably driven by what we expect was an awful Q3 at Crown, both on the volume and hold side. MPEL will announce Q3 earnings later this month and investors shouldn’t be surprised when it is not pretty.

RL: Quick Take

Execution, execution, execution… Numbers are heading higher – as is the stock. Still one of my favorites.

Clean beat. $1.58 vs. my $1.36 and the Street at $1.24. If there’s one thing I need to see, it is that sales were +10% and inventories were -3%. Cash flow algorithm looks solid: sales +10%, gross profit +13%, EBIT +26%, capex was down 40%, and stock repo accelerated by 3x sequentially.

In typical RL fashion, the company threw out a cautionary flag to keep estimates in check. I’d be intellectually dishonest if I called it a complete sandbag. The fact is that things simply are not good out there. But as I’ve noted over the past few days, and months, this company has more levers to pull than any other in the space. It probably does itself no justice by taking up numbers right now. I’m inclined to go towards $4.35 for the year unless I hear compelling evidence on the call to suggest otherwise.

Check out our margin walk from 2 days ago showing the detailed puts and takes in this model.

The New Reality

“A man may die, nations may rise and fall, but an idea lives forever.”
-John F. Kennedy

America has voted. Obama wins. Today is another great day for the “New American Capitalist” who is on board with our 2009 Investment Theme – “The New Reality.”

Long gone are the days of the levered long investor. Bah bye to the days of low-cost long term debt. Today, not unlike yesterday, and all of the days between this one and that (I think that sounds like Braveheart!), is a great day to be taking advantage of market opportunities. Being liquid long cash will allow you to prosper in “The New Reality.” The yield curve continues to steepen. Borrow short, lend long, and get out there and prioritize getting your client paid before you pay yourself.

I, for one, haven’t paid myself this year, so I am in the comfortable position of not giving you lip service or a “World Wise” token advertisement. Transparency, Accountability, and Trust may be a simpleton’s set of principles, but they are our promise here at Research Edge. If we do not over deliver on those expectations, please ‘You Tube’ us.

Building back the confidence of Americans is going to be a steeper climb than the recent one in the US yield curve. That said, the darkness of the deepest black hole of US market pessimism looks like it may very well be in our rear view mirror now. The US Consumer’s confidence is responsible for over 70% of this economy’s GDP, and perhaps more importantly, almost 20% of Global GDP. It is “global this time”, and American confidence matters. Don’t forget that.

Don’t forget to quantify things either. Math trumps political rhetoric. Those who doubted Obama’s math in the polls have been run over by the S&P500 train in the last week of trading. As a reminder to the bears, you have missed a +18.5% rally in the S&P500 in the last week alone! We’re still bullish because the math is. Being on the other side of our “Macro” call in 2008 will likely put the onus on you to explain why you deserve to be paid 2 and 20. I wouldn’t want to be that guy.

The math on the sentiment front supports more of the same. This morning’s II Bullish to Bearish survey is flashing a meaningful pop. The delta between bulls/bears has moved from -32 to -18 in the last 2 weeks. Additionally, the weekly ABC Washington Post confidence reading came in last night with its 3rd consecutive weekly improvement. Boxer Jimmy Braddock (played by Russell Crowe in Cinderella Man), used to hear his corner of the ring whisper “Pop, pop… bang”, then he’d come back from being down and out and crush his doubters. American short sellers of consensus, do you hear me now? Pop, pop…

Today is not a day to doubt “The New Reality.” Volatility (VIX) has dropped -40% since some of the masters of the “hedgie” universe capitulated and proclaimed to their faithful book pushers that “we are going to cash!” That was really embarrassing. Market breadth continues to expand not only domestically, but internationally. Breadth on the NYSE expanded for the 6th consecutive day yesterday, after European stock markets punched clock on their 6th consecutive positive day of closing prices. Since October 27th, stocks in Hong Kong have ripped the shorts for a +35% move; even lowly Japan has rallied +33% off the bottom. Thank God, we are long China and that we covered our EWJ (Japanese short)!

Russian stocks opened higher this morning and are flashing another positive divergence versus European equities, trading up another +4%. This is new; don’t ignore it. The Russian Trading System Index (RTSI) has melted the short sellers since October 24th, rallying stiffly for a +52% move. Brazil closed up another +5.2% yesterday. Mexico was squeezed for a +4.5% move, and the Canadians tacked on a +4.1% day on the Toronto Stock Exchange, after their currency appreciated +10% in less than a week! If someone is whining to you about how “impossible” it is to make money in this interconnected global market of asset classes, send them my morning notes. Math doesn’t lie, people do.

Predictably, with the futures down early this morning, the manic media will be talking about “profit taking” and whatever narrative fallacy they can dig up from the talking heads. Don’t listen to them. They are entertainers. They have no proactive process that allows them to predict Macro market moves. Instead, we suggest you enjoy your coffee and sit back and read. This is how new ideas are formed. This is the self directed confidence of the new American capitalist has. This is “The New Reality.”

Our S&P500 line in the sand is now 982. As long as we hold that line, like Braveheart, we are going to stand our ground, continuing to be the new bulls. William Wallace is metaphorically on the advisory board of our 2009 Investment Themes, and he reminds us all on this day of new beginnings that “your heart is free… have the courage to follow it.” An idea like that lives forever.

Best of luck out there today,
KM Your heart is free, have the courage to follow it.

Long ETFs

JO – iPath Coffee – Reuters reports that an unidentified bank seized more than 10,000 tons of beans from an exporter in Sumatra, Indonesia, who missed interest payments. More concern over credit conditions and weather in Vietnam drove Robusta prices higher in London.

EWG – iShares Germany –Chancellor Merkel's Cabinet agreed on a ``bold'' 50bn EUR stimulus package including tax incentives for car buyers to energy efficiency programs. According to Merkel the plan is ``completely different from an artificial, state-sponsored program to stimulate demand that costs billions. We emphatically want to avoid this.''

FXI – iShares China – CSI 300 index gained almost 4% today on announcements of increasing economic cooperation with Taiwan, including direct cargo shipping, and the US election. The finance ministry asked state agencies to keep 2009 budgets frozen at 2008 levels.

VYM – Vanguard High Dividend Yield ETF – Ambac posted a third-quarter loss as it set aside at least $3 billion to pay additional anticipated claims.

Short ETFs

UUP – U.S. Dollar Index – The Euro declined against the dollar on the US election results.

EWU – iShares United Kingdom – Office of National Statistics data released today show that Industrial Production declined 2.2% y-o-y in August BRC Nielsen Shop Index showed a sharp decline in food inflation for October, falling to 3% from 3.6% in September.

IFN – The India Fund – SENSEX and the Rupee rose on second straight day of reported increased foreign equity investments.

Keith R. McCullough
CEO & Chief Investment Officer

COLM: Bull By The Horns

I hate to show any enthusiasm over people losing their jobs, but I really like the 4% workforce cut Columbia announced after the close. By my math, we’re looking at about $100k per employee in net savings, or $0.15 per share (5% EPS accretion). Several factors to consider…

1) Timing: This was in the works when the company announced earnings just 2 weeks ago. Usually when a company announces a workforce cut it accompanies admission that business outright stinks. We all found that out 12 days ago when COLM reported an 11% decline it its backlog. The biz has not changed meaningfully since.

2) One reason the company is doing this now is not only because it should, but because it CAN. The latter has never been the case as COLM habitually stripped capital out of its P&L and balance sheet in an attempt to buoy margins. But over the past two years, SG&A has grown 2x the rate of sales, as COLM has shown greater commitment towards investing in its brands. One might argue that it is going the other way with today’s announcement. That’s fair. But the point I like about brand and infrastructure investment is that if the business slows, a company at least has levers it can pull and capital to redirect to stabilize business. COLM has never had that – until now.

3) Don’t forget that a workforce cut of this magnitude does not come lightly to this family-run business. COLM has resisted this in the past. They dipped their toe in the water w layoffs last year, and now are diving in. I respect the ‘hometown hero’ aspect of the culture – but when return on capital goes from 25% to 10% over 5 years, that’s probably being a bit too blind. Sight restored.

4) COLM is no stranger to down years—but the consensus never forecasted it. Now the Street is calling for a down year in ’09 – but next year I actually think earnings will be up. My estimates were ahead of consensus heading into 3Q, and my ’09 estimate is 13% higher than the Street.

5) Lastly, sentiment on this name smells rank. Over 30% of the float is short, the sell side is calling for a down year, and 91% of the ratings are not Buy.

For what it’s worth, words usually flow off my fingertips when I write comments on our Portal. But I had to stop several times throughout this note and ask myself the question “McGough, are you actually getting bullish???” While I still think there are plenty of Zeros out there, I definitely see value in names like this. So “am I getting more bullish?” Yes.


PNK reports on Thursday morning. Every gaming company that has released calendar Q3 earnings has experienced a positive move in its stock. However, those stocks didn’t double the week heading into earnings.

Since we posted “A SHORT SQUEEZE COMETH” last week, PNK is up 114%. After such a big move, how much more upside can there be? Considering that the stock is still down 75% year to date, even after the recent surge, I’d say quite a bit.

PNK is a victim, self inflicted to an extent, of a major consumer pull back, a leveraged balance sheet, and the (investor) perception of tight liquidity. However, while not predicting blow out operating results, I believe the performance and outlook will be much better than bad. PNK’s market exposure is more advantageous than most casino companies. Texas and markets less exposed to the housing bubble generate most of PNK's customers. October commentary should be positive, on the margin, relative to September.

Regarding liquidity, management should be able to allay those fears on the conference call. There are no covenant issues until possibly Q2 but the company has a lot of levers to pull to maintain the appropriate leverage including, cessation of construction in St. Louis, cost cutting, and a temporary cut in maintenance (slot) capex. PNK could stop construction on St. Louis and be able to pay off its entire credit facility before it matures in 2010. They have a significant amount of flexibility and, as such, we moved them to the right side of the liquidity trade last week.

The following table highlights some key forward looking comments issued by management on the Q2 conference call. Unlike most of the commentary from the other casino operators, I actually think PNK management will reiterate their Q2 assertions. Maybe not Reno but who cares?

Management may affirm all or most of these assertions issued during Q2 conference call

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