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Macau gaming revenues dropped an estimated 7% year over year in October, distorted lower by a high hold percentage last year on rolling chip (RC) play. Using the same hold % as last year, revenue would’ve fallen only 3%. Of course, MGM wasn’t open last year so the market is clearly challenged from a same store sales perspective.

Total RC volume looked to be down about 4% YoY, down from +3% growth in September. Crown’s growth rate continues to deteriorate. AMA flooded the market with credit earlier this year but has pulled back considerably as of late. YoY volume grew 50% in October, down from 140% in September. The other properties have been fairly consistent. Wynn Macau continues to generate around 50% volume growth, due in part to the expansion. LVS, Galaxy, and SJM are decidedly negative in that order.

On the high margin mass market side, revenue actually increased about 2% in October but not quite as strong as the 5% generated in September. Crown had a big step up here but still couldn’t move into positive territory. Wynn continues to drive positive growth that actually accelerated from September. Despite strong growth at The Venetian and the opening of The Four Seasons, LVS’s mass market revenue declined about 4%.

Overall, Wynn and Crown were the only two companies to generate positive growth in total Baccarat revenue. Wynn had a pretty good month, up 8% despite a lower than normal RC hold in October. LVS saw its Macau Baccarat revenues fall about 4% as a much higher hold % (but still normal) was offset by a significant decline in RC play.

GMCR – An Aggressive Business Model, Not Without Risk

GMCR reported 45% 4Q sales growth yesterday. Although this is an impressive number and management outlined its many “enabling moves” for future growth, there are real risks to GMCR’s business model. The first of which stems from the fact that the company’s sales growth projections rely on increased sales of the company’s Keurig At Home Single-Cup Brewers, which are sold at cost. GMCR’s sales mix has been shifting more toward this is zero gross margin product, which has resulted in lower YOY gross margins for the last five quarters (FY08 gross margins down 300 bps). Thus far, the company has been able to generate improved profitability by offsetting these huge gross margin declines with significant cuts to its SG&A line. GMCR has increasingly leveraged its SG&A expenses in the most recent quarters as gross profit margins have deteriorated further with SG&A as a percent of sales declining 280 bps, nearly 570 bps and 200 bps YOY in 2Q, 3Q and 4Q, respectively.
  • GMCR will not be able to cut SG&A forever. It is not a sustainable business strategy and does not match with the company’s future growth projections. The company expects to close on its Tully’s acquisition in early FY09 and is pursuing a national retail footprint for its Keurig brewers. Both of these initiatives will require increased investment. That being said, although GMCR did post 45% sales growth, the company’s sales trajectory is slowing on a 2 year basis. This will make it increasing more difficult for the company to leverage its SG&A expenses at a time when the company’s SG&A needs will be growing.
  • Looking out to 1Q09, these challenges will already start to play out. Management is forecasting operating margin contraction in the first quarter to 3.7%-4.4%, which represents at least an 80 bp decline from 1Q08’s reported 5.2% number. The company is expecting this YOY operating margin decline as a result of its planned sales of more at home brewers (so lower YOY gross margins) and flat selling and marketing expenses as a percent of sales. In the first quarter, GMCR will not be able to leverage its SG&A expenses, or pull the goalie as we like to say at Research Edge, and therefore, the gross profit losses will be reflected on the operating profit line. And, this is expected in 1Q09 with flat SG&A expenses YOY. I would expect SG&A as a percent of sales to grow as we trend through the year with gross margins still under pressure from increased at home brewer sales so according to my math, it will be very difficult for the company to achieve its FY09 operating margin objective of 8.5%-9.3% relative to its reported FY08 operating margin of 8.5%.
  • Other risks to the model:

    GMCR started producing K-cups at its new manufacturing plant in Tennessee at the end of the quarter. In the long-term, the company hopes this new plant’s increased capacity will provide the company with more flexibility to support its growth targets, but in the near-term, particularly in FY09, it could hurt margins as the company works through new plant inefficiencies. These plant inefficiencies will hit margins at the same time the company is working through increased SG&A expenses.
  • GMCR is trying to establish a national retail footprint for its Keurig brewers, but it does not have the support of national coffee brand. Instead, the company relies on a patchwork of regional brands: primarily Green Mountain, Newman’s Own, Caribou and Tully’s (assuming the deal gets done). GMCR does not even control two of these brands, but rather has a licensing agreement in place with Newman’s Own and only partners with Caribou, which leaves the company’s national growth strategy susceptible to risk.
  • Turning to the company’s balance sheet, GMCR reported its fourth consecutive quarter of inventory growth in excess of sales growth, which is another unsustainable business practice. In the fourth quarter alone, inventories grew 119% relative to the company’s 45% sales growth. The company said this increase in inventory was necessary to meet expected strong holiday sales of its at home brewers and K-cups. Although some inventory build is warranted prior to the holiday selling season, this seems aggressive and what was the reasoning for the outpaced inventory growth in the prior three quarters? For reference, Wal-Mart, which I would call a well-managed company, reported today that its 3Q inventory grew 3.4%, half the rate of its sales growth (also ahead of the company’s important holiday selling season).
  • GMCR is burning cash. The company’s FY08 capital spending exceeded its cash from operations (partly as a result of the significant increase in inventory) and GMCR is expecting its capital expenditures to go up in FY09…again, not sustainable.

Here little Sharky... Come And Get It!

Earlier this week, we walked through the concept of the “Shark Line”, or the line that the shorts better be very careful of getting sucked under…

A Research Edge picture often trumps my prose – this is an investment classic.


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Still short Mexico: The Drug Trade Is Cyclical...

A brutal war is being fought within miles of the US border…

Late last month an ice chest was delivered to the police headquarters in Ascension - a Mexican town less than 30 miles from the US border. The chest contained four severed human heads - a message of intimidation from local drug traffickers.

The drug war in Mexico continues to escalate with atrocities that rival those occurring in the conflicts of the Middle East or Africa as revitalized law enforcement agencies are locked in a struggle with trafficking gangs that are entrenched in the economy after decades of corruption and incompetence on the part of previous officials.

In September, Finance Minister Agustin Carstens estimated that the conflict may be costing the nation as much as 1% of GDP growth annually. That estimate may be low; some Mexican academics estimate the total contribution of tourism to GDP at 8%.

With the recent slide of the Peso, Mexico’s fabulous beaches should be teeming with budget conscious tourists this winter. Instead, the violence has caused a chill for tourism has increasingly been commented on by industry observers. The latest warning issued by the US state department on October 18th contained the following message: “Mexican drug cartels are engaged in an increasingly violent fight for control of narcotics trafficking routes along the U.S. - Mexico border in an apparent response to the Government of Mexico’s initiatives to crack down on narco-trafficking organizations. In order to combat violence, the government of Mexico has deployed military troops in various parts of the country. U.S. citizens should cooperate fully with official checkpoints when traveling on Mexican highways”. This type of publicity will not help fill the beaches anytime soon.

Mexico is not alone in the fight. Last week president Calderon announced and intensified strategic partnership with Columbia in the fight against cocaine trafficking. In some ways, Columbia could provide the Mexican government with a blueprint for the way forward. President Uribe has made significant gains in recent years through relentless military action and a close partnership with the US government (under the Uribe administration over 900 drug offenders have been extradited to face trial in the US). Even if the strategy does succeed, the violence will likely get worse before it gets better as the traffickers come under more pressure and fight back harder. The criminals have the equipment to put up a fight - last week the Mexican army seized 314 heavy automatic weapons with a half million rounds of ammunition, 160 hand grenades and a rocket launcher from a single gang cell in Tamaulipas.

Mexico (EWW) is one of the few short positions that we have not covered on weakness this week.

Andrew Barber

Yen putting in another top?

We had a preview of the world's largest carry trade unwinding in March, then the full movie plaid out on a CNBC channel near you in October. Scary stuff… particularly if you were short the Yen...

The November melt up is not unlike that which we have seen in the US$... it's just another reminder that levering up long with a cheap currency has another side to the trade.

October was a worldwide liquidity crisis capitulation. November is the thaw - it's a process, not a point. The Yen putting in a lower high on this latest liquidity rally will be too. We shorted the Yen today via the FXY (etf) in the Hedgeye Portfolio. Goldman was out positive on the other side of us.

Why We Covered Our India (IFN) Short Today...

'You Tubing' ourselves is cool. It allows us to pump our own tires and also feel shame. Using the chart below as a proxy for our successes being short India in 2008 is the kind of You Tubing that we like!

As inflation began to accelerate (on the margin) in November of 2007, we became cautious on Asia, overall. Then, as Asian growth began to slow in Q1 of 2008 and inflation continued to ramp, we got aggressively short.

Today's inflation data out of India (see chart) confirms a new "Trend" (intermediate term) call we are making on Asia. We remain long China, and covering our short position in India. This isn't our religion. It's math.

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