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The Lighthouse

“Cernowitz proved to be Schumpeter’s lighthouse.”

-Sylvia Nasar


In her outstanding chapter on Creative Destruction, Sylvia Nasar captures the most critical moment of a creative thought by comparing Joseph Schumpeter’s time at the University of Vienna to Albert Einstein’s at the Bern patent office (1).


“It gave one time to think one’s thoughts and, of course, to write them down. It also cut down on the distracting buzz of other people’s ideas.” (Grand Pursuit, page 187)


For the those of us who didn’t blow up other people’s money in 2008 (and again in 2011), we look and feel confident into year-end for good reason. Whether it’s me writing to you at the top of every risk management morning, or you delivering on Warren Buffett’s #1 Rule of Investing (“Don’t Lose Money”) for your families and clients – it’s all one and the same thing. Winning.


Together, we’ve travelled the often broken road of groupthink and we’ve seen the investment stars of bull markets rise and fall.


We are Wall Street 2.0. We are the change people can believe in.


Back to the Global Macro Grind


From what I can discern, there are two very different types of players on this globally interconnected market’s ice right now:

  1. Those who have stayed the course with the fundamental research call of 2011 – Global Growth Slowing
  2. Those who wake up every morning looking for a central planner to bail them out

Watching the US Equity futures trade this morning captures the essence of how short-term the group-thinking associated with the Type 2 Player in this game has become:

  1. At 4AM EST, I jot down in my trusty notebook “China down -3.3% to down -16.9% YTD, testing October lows”
  2. At 6AM EST, headline hits “China cuts reserve requirements, 50 basis points”

First, set aside the fact that few, if any, market sources even mentioned point #1 (no surprise there) and then realize that the S&P futures went from down 8 points to up 8 in a nanosecond of what could be best described as media panting about point #2 on Twitter.


Twitter, you see, is replacing what Old Wall Street calls “the tape.” On Wall Street 2.0, tweeters with analytical competence not only capture the China like headline “news” in real-time but have it synthesized within seconds.


Being fast isn’t being a “short-term” investor. It’s just called being smarter and faster.


Back to the China thread…


Sometimes getting your brain somewhere fast helps you recognize you need to slow down. Doing nothing in a market that’s trading on the “distracting buzz of other people’s ideas” of what the headline actually means is critical. The media’s immediate-term reaction to an alleged 1.3 TRILLION Eurocrat bazooka in late October is a good example of that (i.e. they don’t have one yet).


What does China’s decision to cut reserve requirements on banks mean?


It means China’s economic slowdown is accelerating on the downside, big time. The Chinese act, proactively, when they see a domestic demand problem.


What happens as the #1 unlevered growth engine of the world slows from double digit GDP growth to mid-single digits? You don’t even have to think too hard to figure that answer out. Global Growth Slowing matters to market multiples.



  1. The last time China started cutting reserve requirement rates was September 2008
  2. China continued to cut those rates until December of 2008
  3. US stocks didn’t stop going down until March of 2009

If you didn’t know that most US centric “stock pickers” are growth investors, now you know. As growth slows, stocks fall. Pull up charts of Apple, Amazon, or American Airlines (kidding – just needed another company starting with an A for literary purposes) and you’ll see, quite clearly, what the market is already discounting about Q4 versus Q3 Global Growth and demand.


If you flip a switch back to how that Type 2 Player continues to play the game – the Top 3 Begging For Bailouts headlines they are looking for are now as follows:

  1. European “shock & awe” money printing
  2. Fed getting sucked into to a QE3
  3. China rate cuts

From the vantage point of The Hedgeye Lighthouse this morning, all I have to say about all 3 of those options is that the Type 2 Players better be very mindful of what they wish for. Growth Slowing is a requirement for all three.


My immediate-term support and resistance ranges for Gold, Brent Oil, French stocks (CAC40), Amazon, Apple, and the SP500 are now $1, $108.53-110.59, 2, $177-209, $361-385, and 1147-1203, respectively. Lower-highs across the board.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


The Lighthouse - Chart of the Day


The Lighthouse - Virtual Portfolio


Despite all the filings and the likely resulting panic, nothing has changed - that is, there will be no additional dilution and no equity raise.



MPEL’s shelf registration last night was required by the Hong Kong Stock Exchange to set up a backstop liquidity provision as part of the dual listing.  Nothing has changed.  This is a necessary step for the Listing By way of Introduction (LBI).  To be clear, there will be NO dilution from the listing and NO new equity.  That filing doesn’t change that. 


If the backstop is utilized, the process involves borrowing shares that ultimately are returned so no new shares are issued.  The shelf registration was not related to the shareholder loan conversion.  That was taken care of in an additional filing:  40 million ordinary shares were converted at US$8.61 per ADS, representing a dilution impact of 0.80%.  This was in line with previous announcements.  To our knowledge, the HKSE recommended that the shareholder loans be converted into equity to increase the perceived independence.


We've already received numerous client inquiries related to the filing, most of them expressing concern that MPEL is raising additional equity.  That is not the case.  Nevertheless, since management must comply with essentially a gag order related to the listing, we don't believe the ramifications (essentially none) of these filings are well understood by the investment community.  The stock may be down on this, but it shouldn't be which may present a buying opportunity.


In preparation for ISLE's FQ2 2012 earnings release Thursday, we’ve put together the recent pertinent forward looking company commentary.




  • “Given the uncertainty of the timing of the resolution of the appeal of the Nemacolin license, we have removed any capital spending related to Nemacolin from our guidance for the timing being. We will reintroduce once the timeline is clear.”
  • “We now expect our project capital for the rest of the year to be approximately $50 million almost solely related to Cape Girardeau. We still expect maintenance capital for the year to also be around $50 million or $40 million incremental after the first quarter.”
  • “We'll recognize income related to the lost profits and property damage in whatever period when the claims are settled with our insurance carriers. We are in discussion with our carriers regarding the claims and hope to have all of them filed within a very near-term. And historically, we've been successful in settling flood claims within a year after they're filed. Our goal is obviously to have them settled as soon as possible, possibly by the end of the fiscal year, but there is no guarantee of that. When the claims are settled, we will be able to include any business interruption income in our EBITDA for debt compliance purposes, much like happened when we settled the Hurricane Katrina claims a few years ago.”
  • “As it relates to the trends in July and August, I think choppy probably is the best way to describe it.”
  • [Pompano margins] “We've anniversaried as far as the tax rate is concerned, but remember we have two new competitors in the market….So I think you're probably looking at a pretty good run rate.”
  • “Pompano is the one property that is the most affected by seasonality for us, so the margins will bounce around a little bit between quarters based on the business volumes of the season.”
  • [Lula] “We have 640 positions on the Coral Reef. Hopefully, September 2, we'll open with 1,100 total. So 460 on the Palm Terrace, which will include about five high limit games, both blackjack and craps, and then some virtual blackjack games. So we have a reopening campaign that's in effect, and most of our impact so far has been on a weekend when we had lower capacity.”
  • “What we've looked at over the last couple of years is there is a higher correlation in our business to the unemployment rate.”
  • [Bally’s systems rollout] “For argument's sake, we're doing about two conversions a year.”
  • [Massachusetts]  “It's not anything that we're actively pursuing.”
  • [Crown Casino sale to New Bossier casino] “The next hurdle or the only really remaining significant hurdle as far as we're concerned is probably the passage of the referendum in Bossier in November [Passed on Nov 19]. Assuming that that passes, we would expect the sale to close then by the end of November and the proceeds, over a matter of time, probably will pretty much end up going back into that property, to some renovations to the Lake Charles property.”

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DNKN is trading at 14.75x EV/EBITDA NTM.  The multiple has come in as the float has expanded (secondary) but other higher quality growth names like SBUX and DPZ continue to trade at a discount to DNKN at 11.6x and 11.5x, respectively.


Dunkin’ Brands is in the news today announcing 25 new Dunkin’ Donuts and 2 new Baskin-Robbins locations set to open in Louisiana over the next several years.  As we have written in the past, comparable sales growth is important for Dunkin’ Donuts but, given that the Dunkin’ Donuts business is 97% franchised, new unit openings are far more important for EPS growth. 


The premium multiple assigned to DNKN by the Street, then, is largely dependent on the “white space” growth opportunity that lies west of the Mississippi.  Management has stated its goal to double the store base within 20 years.  In order to do this, the company must build a backlog of stores that will allow them to open 500 stores per year beginning in 2013, up from a projected range of 220-240 in 2011 (more or less flat versus 226 domestic development agreements last year).


The chart below shows two columns; the first illustrates the openings that have occurred over the past three quarters and what the company will need to open in 4Q to meet the midpoint of the 220-240 openings range for 2011.  The second, on the right, indicates the contracted openings that have been announced thus far in 2011.  The announcements of new contracted openings typically guides to the openings happening “over the next several years”.  Below the chart, we have included bullet points detailing the markets and quantity of stores detailed in each announcement of 2011.  It is also worth bearing in mind that announcements do not equal openings; attrition is a very real risk to these numbers.  Like with cash flows, a nearby penny is worth a distant dollar.


WHAT DOES DNKN RUN ON? - dunkinbacklog


  • April 27th, 2011 – Dunkin’ Donuts announced six new restaurants in Cincinnati.  Gilligan Oil Company, LLC, an existing franchisee is the development partner.  The six stores will be added to Gilligan’s set of locations and will be open and operating by 2016.
  • April 27th, 2011 – Dunkin’ Donuts announces five new restaurants in North Kansas City.  The first restaurant will open in 2012 and the remaining four units will be developed by 2016.  An agreement was struck with Savoureux Corporation to develop restaurants.  HEDGEYE: Why is there such a back-loading of the schedule of unit openings in this agreement?
  • August 3rd, 2011 – Dunkin’ Donuts announces development of eleven new restaurants in Little Rock, Arkansas.  Seven units are to be developed in Ft. Smith and Northwest Arkansas by Littlefield Oil Company.  The first restaurant is slated to open in 2012 with the remaining six to open by 2018. The remaining four units are to be opened by Eric McDuffie and Sam Carter in Hot Springs and Benton.  The first unit is scheduled to open in 2012 and the remaining locations are scheduled to open by 2015.  HEDGEYE: Again, why is there such a back-loading of the schedule of unit openings in this agreement?
  • August 3rd, 2011 – Dunkin’ Donuts announces twelve new restaurants in Cedar Rapids, Iowa.  The development agreement was signed with Eastern Iowa Food Service, Inc.  The first restaurant is slated to open in 2012 and the remainder by 2018.
  • October 31st, 2011 – Dunkin’ Donuts announces eighty-six new restaurants in Washington D.C. (really 64 “new” contracts – the 86 included 22 previously contracted restaurants).  15 development agreements were signed over the past year.
  • November 29th, 2011 – Dunkin’ Donuts announces twenty-five new restaurants and two Basin-Robbins locations in Louisiana.  6 development agreements were signed.  The schedules of each developer’s unit openings vary but, similar to the other announcements of 2011, the schedules are back-loaded 4 or 5 years out.

The number of contracted openings is clearly not increasing at the same rate that stores openings are accelerating.  We need to see that backlog grow considerably to gain confidence in management reaching of doubling the store base within 20 years.  The lack of disclosure during the most recent earnings call as to where the backlog stands was, in our view, less than encouraging.  K-Cups may drive same-store sales but if it is earnings growth you are seeking as an investor, we believe there are better vehicles in the restaurant (or coffee) space.


Howard Penney

Managing Director


Rory Green


Retail: Confident Again?

Key factors for December shopping in light of today’s strong Consumer Confidence reading.


Let’s add some context.

a)      First off, let’s not forget that last year’s confidence reading was 59.7 and 62.4 in November and December, respectively, and peaked out at an impressive 3-year high of 73.1 by February of this year. That’s a great pre-and post holiday set-up, and is what drove 5.2% growth in Holiday sales last year.

b)      For the past two months, however, everyone was scratching their heads trying to figure out why Retail Sales and PCE were both so robust (steady-mid single digit) in light of a precipitous decline in Confidence down to 41.2. No fewer than 20 people asked me “what’s the disconnect?”.

c)       Now we’re back to declaring victory for Retail because Confidence rebounded to a 56.2 level. Perhaps it should have been there all along over the past two months? Seriously…Check out the chart below. It’s as if the government’s BLS and BEA numbers simply ignored the 3-month decline in confidence – or the other way around.


Retail: Confident Again? - PCE  Retail Sales  Comps  Consumer Confidence  1 yr


Aside from Consumer Confidence, here’s Hedgeye’s updated Consumer Income Statement along with some observations for the month of October (Note: this is VERY rear-view mirror as the data is on a one-month lag).


Retail: Confident Again? - Consumer Income statement ACTUALS


Retail: Confident Again? - Consumer Income statement ESTIMATES

The punchline…

  1. Gross personal income slowed by 40 bps to 2.9%, with an interesting shift in mix. The unemployment rate went from 9.1% to 9.0%, but the rate for those with a college degree (that had otherwise been improving all year) eroded by 20 bps to 4.4%. The rate for those without a degree improved by 10 bps, and stands a full 50bps better than last year.  
  2. Here’s a funny one for you…(if not sad), the consolidated personal tax rate came in at 11%, up 10bps sequentially, but a full 150bps higher than last year.. That’s a direct hit to consumption. So what did the consumer do? You guessed it. The personal savings rate came down by another 10bps, and is 190bps below last year. The consumer, as always, is finding room to spend. This rate is sitting at a 3-year low. It can always head towards zero, but the set-up into 2012 would be downright scary, and worthy of me getting overtly bearish on virtually every part of retail.  

So what does this mean for Q4?

In our previous note “Retail: Key 4Q Themes” we highlighted 3 themes that emerged in the third quarter and will weigh heavily on Q4 execution:

  • Driving Operating Expenses Higher:  This was a common theme across all sub-categories -- especially among the poorer quality companies that need to catch up on years of deferred spending. Whether it be in the form of incremental marketing, added head count, or various IT improvements (e.g. mobile POS functionality), retailers are having to work harder and spend more to drive sales.
  • Price Elasticity: Simply put, the better the product, the lower the elasticity. This has nothing to do with price. It’s all about perceived value.
  • The Inventory Growth/Gross Margin Trade-Off: Five sequential quarters of sales/inventory erosion without commensurate decline in margins is absolutely unsustainable. There’s meaningful Gross Margin risk if the consumer does not comp the 5.2% holiday performance last year.

Downgrade Dominoes

Conclusion: Based on the potential for negative deltas across a few rather important credit ratings in a specified order, we think it will pay to stick with our King Dollar and Eurocrat Bazooka theses throughout the intermediate term.


This morning, in our firm-wide internal research meeting, Tom Tobin, Josh Steiner, and Keith McCullough all shared various thoughts on the ratings downgrade catalyst calendar. While we do not find much value in the opinions of ratings agencies, we do accept the implications that these downgrades have on market prices and financial market risk via hardwire ratings linkages with financial institutions and the perceived creditworthiness of bailout schemes such as the EFSF.


Given, we’ve decided to take the opportunity to quickly highlight what the calendar looks like on this front, which shows serious headwind of credit downgrade risk:


Downgrade Dominoes - 1


The recent and relevant commentary from the ratings agencies is as follows: 

  • Moody’s: “Moody's Investors Service has today placed on review for downgrade all subordinated, junior subordinated and Tier 3 debt ratings of banks in those European countries where the subordinated debt still incorporates some ratings uplift from Moody's assumptions of government support, with the potential complete removal of government support in these ratings. The review will affect 88 banks in 15 countries in Europe with average potential downgrades of subordinated debt by two notches and junior subordinated debt and Tier 3 debt by one notch... The review has been caused by the rating agency's view that within Europe, systemic support for subordinated debt may no longer be sufficiently predictable or reliable to be a sound basis for incorporating uplift into Moody's ratings…The banking systems and number of banks affected by the review are in the following countries: Austria (9), Belgium (3), Cyprus (2), Finland (3), France (8), Italy (17), Luxembourg (3), Netherlands (6), Norway (5), Poland (1), Portugal (2), Slovenia (2), Spain (21), Sweden (4),Switzerland (2). A list of affected institutions is attached: http://www.moodys.com/viewresearchdoc.aspx?docid=PBS_SF268891
  • Standard & Poor’s [per French newspaper La Tribune yesterday]: "It [revision to negative outlook] could happen within a week, perhaps 10 days." La Tribune further reports that it canceled at the last minute such an announcement that was originally supposed to accompany last Friday’s downgrade of Belgium. Recall that last week Fitch reiterated France’s AAA LT/LC rating, but that it would have “limited room” to absorb new fiscal shocks without endangering that status (i.e. backstopping it’s banking system or other large European sovereigns – both things France is likely to have to commit to doing in 2012).
  • Fitch: “The rating Outlook on the Long-term [U.S. sovereign LT/LC debt] rating is revised to Negative from Stable… The Negative Outlook indicates a slightly greater than 50% chance of a downgrade over a two-year horizon. Fitch will shortly publish its revised economic and fiscal projections for the U.S. and will conduct a further review of its sovereign ratings in 2012. However, in the absence of material adverse shocks, Fitch does not expect to resolve the Negative Outlook until late 2013, taking into account any deficit-reduction strategy that emerges after Congressional and Presidential elections.” 

As you can see from the aforementioned timing setup, we think there will be an opportunity to re-short the EUR vs. the USD (among other things) throughout the intermediate term – a view supported by this singular factor of potential negative deltas across a few rather important credit ratings in a specified order. While we would never gain conviction on any long or short position using a simple one-factor model such as this one, this is an incremental factor among a myriad of supportive data points for our intermediate-term King Dollar & Eurocrat Bazooka positioning, which is manifested in our current positioning below: 

  • Long the US Dollar;
  • Long long-term U.S. Treasuries and a Treasury curve flattener;
  • Long U.S. investment-grade corporate bonds;
  • Short French equities;
  • Zero percent allocation to U.S. money center banks; and
  • Zero percent allocation to European equities or credit. 

For the sake of brevity, we’ll keep it tight here. Email our sales team at if you’d like to dialogue further regarding any of the above; Steiner’s Financials team and Tobin’s Healthcare team have done a great deal of work regarding ratings linkages, etc. and the U.S. debt/deficit outlook.


Be mindful of that Global Macro calendar!


Darius Dale



Downgrade Dominoes - 2