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It’s been no secret the Research Edge crew has been negative on consumer spending. Our view on falling housing prices, rising employment, the wealth effect, and a rising savings rate has been pretty consistent. For the regional gaming players, the three macro factors that matter are local housing prices, unemployment levels, and gas prices.
  • Housing prices have been running down YoY mid to high teens since January and have fallen every month since January 2007. In fact, the last month where the YoY change in housing prices increased sequentially occurred way back in November, 2005. Assuming housing prices stay at current levels, prices will fall 3-4% in 2009.

    Unemployment, of course, is accelerating, up to 6.1% in October and 1.3% higher than last year. Enough with the bad news. Gas prices are plummeting which is good for the regional casino business. If they stay at this level, gas prices will be down a whopping 35-40% in 2009 vs. 2008.
  • So I’ve run the regressions and I have a macro model based on the three factors. If we hold gas prices and housing prices constant as discussed, and assume an average 7% unemployment rate in 2009, regional same store revenues are projected to be flat. I’ve charted consensus same store revenues for ASCA, BYD, PENN, and PNK which look surprisingly reasonable. Analysts project positive same store revenue growth for only PNK and ASCA due to the removal of the loss limit in Missouri while BYD and PENN are projected to be negative again.
  • The regional gaming stocks are dirt cheap. Any indication that revenue trends may stabilize in 2009 should be a huge catalyst. Gas may be the stabilizer to offset the continued softness in housing and rising unemployment.
Regional gaming revenues negatively correlated to gas prices
Analysts' 2009 projections actually look reasonable

J Crew Needs Macro...And A Referee

Unknown Speaker*
So we're supposed to sit here and believe that you just got the memo in October about inventory?
I mean correct me if I'm wrong. I thought we were down comp in Q2. So when do we finally get some kind of confidence that you guys are ahead of the game and that we don't have a Q1 that looks like this?

What is one thing we can hang our hats on to let --

Unknown Speaker*
I think there is more but Jim will explain the answer to that. Because unless you're in our business I'm not sure you understand how it works. But Jim you want to answer that.

Unknown Speaker*
But weren't you the guy who told us there was a recession back in January?

Unknown Speaker*
Hey listen -- no, no, let's play polite here okay? Seriously there is no reason for that.
We're trying to do the best we can do. I don't ask you to buy our stock and you don't have to. But let's play this game professionally and politely? Okay --

Unknown Speaker*
Fair enough, so give us something that shows us that you have got inventories down for spring.

Unknown Speaker*
All right, you want to listen to the answer now.
Inventories vs sales vs margins vs capex are all just flat-out wrong. This chart is noisy, but it tells a lot. Email or call for more color.

Eyes on the Curve: Still upward sloping, but...

In the morning meeting today, Keith highlighted as a marginal negative the yield curve. On November 10th, 2-year treasuries were trading at a yield of 1.27% and 10-year treasuries were trading at a yield of 3.82% for a spread of 2.55%. As of yesterday, 2-year treasuries were yielding 1.31% and 10-year Treasuries were yielding 3.35% for a spread of 2.04%, so in the space of two weeks the spread between 2s and 10s has narrowed by 51 basis points.

When we highlighted the yield curve on October 30th, 2008 in our note, “Yield Curve: Steep and Steepening”, the spread was 235 basis points and while the curve continued to steepen immediately following that note, yields at the long end of the curve have started to come in once again.

On the margin, this is incrementally negative and foretells, once again, of a slightly tighter credit environment and an economic recovery that could take some time to play itself out. That said, the curve is still upward sloping, which implies that interest rates should rise in the future as growth begins to reaccelerate.

We will continue to have our Eyes on the curve.

Daryl Jones
Managing Director

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German GDP for Q3 released today in final form today showed a year-over-year increase of 1.3% suggesting degree of resilience that may make the official forecast of 0.2% GDP growth in 2009 plausible. The “five wise men” government advisory panel’s more pessimistic annual report delivered on the 12th predicted increased unemployment and recommended rate cuts –but even they only foresee flat GDP for next year rather than the negative being factored in other countries.

Two other glass-half-full data points emerged today:

· Q3 data released today by the Federal Statistics office indicated that the balance of trade is contracting; however the numbers suggest that the overall health of the economy remains sound. Exports for the quarter totaled 294 billion EUR, a decline of only 0.37% from Q2 and a year-over-year increase of 3.16%, While Imports totaled 257 billion EUR - an increase of 3.81 over the last period or 5.21% year-over-year.

· The GfK Marktforschung monthly survey of financial services, consumer and savings climate was released today, with the response of German consumers surveyed coming in at 2.2, up from 1.9 last month and much better than the average economist estimates of 1.7. Clearly, the mood of German consumers heading into the holidays will be significantly better than that of many of their neighbors.
We continue to be long Germany via the EWG ETF. As we have stated often, we believe that the German is significantly sounder structurally than other major EU economies and we like it on a relative basis.

Andrew Barber

PFCB – Clearing the decks

I’m actually a fan of Russell Owens. I believe he did the best he could in a very difficult situation. PFCB’s core concept “The Bistro” is an extremely successful concept generating very strong returns for shareholders. In an effort to maintain growth, PFCB senior management tried to reinvest the Bistro’s cash flow into another growth concept. Unfortunately, we now know how this story ends. With Russell Owens moving on to greener pastures, the decks are cleared for PFCB senior management to make significant changes to the Pei Wei concept. It’s now likely that we will see the company close more stores to focus on a core group of restaurants. So far management has closed 10 of the165 Pei Wei stores. I suspect there are another 15-25 stores that need to be closed. The Pei Wei concept has been struggling under the weight of operational issues, which have hindered the concept’s margins.
  • Unfortunately, PFCB was one of the last casual dining companies to come to grips with the reality of today’s restaurant environment. As a result, it was not until 2Q08 that the company slowed its capital spending on new units for both Pei Wei and the Bistro and closed underperforming stores. Some of the benefit of the 10 closed Pei Wei’s will help the company as we head into 2009. Specifically, management said that they expect pretax income to improve by $2 million annually and for Pei Wei’s operating margins to improve by 70 to 80 basis points.
  • Clearly, there are some critical changes that PFCB can make to better position the company that will allow PFCB to weather the severe issues facing the industry. Unfortunately, the company has a significant number of its stores in parts of the country that have been severely affected by the downturn in the economy. Specifically, Arizona, California, Florida and Nevada accounted for 78% of the company’s total same-store sales decline in 3Q08. See our post “Casual Dining Exposed” for specific details on a number of casual dining concepts’ regional exposure within the U.S.
  • The last time the company provided guidance to the street management guided FY08 EPS to $1.34-$1.40, lowering the range from $1.36-$1.42. Currently the street is at $1.38. Complicating this guidance has been a significant downturn in sales trends since PFCB provided guidance.

OIL : Keeping our eye on the curve

We are long Oil and so far it has been a profitable trade. The primary thesis relates to the likelihood that the dollar will weaken and, therefore, commodities such as Oil should inflate. This weak dollar view is in conjunction with an Oil market that has seen a broad and dramatic decline, so may have already reached a stage of selling capitulation.

Under the guidance of our futures guru, Andrew Barber, we keep our eyes diligently focused on many futures markets to find anomalies. Currently the Oil futures market is showing a widening contango, which is a data point that is actually contrary to our long thesis, for a Trade, on Oil. Obviously, the futures curve is only one data point, but is still worth noting.

As the chart below depicts, contango in the Oil market has widened dramatically in the last month, primarily based on the almost $10 per barrel decline in front month futures. Longer out on the curve, futures have stayed largely stable, which suggests the longer term view of supply and demand has not changed. In the short term, with the decline in front month futures, the Oil futures market, at least, seems to signaling short term over supply as physical producers are being paid to store Oil, which could lead to building inventory.

Daryl Jones
Managing Director

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