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Japan’s Jugular 2.0: Will 2012 Be the Beginning of the End?

Conclusion: The perception of the Japanese sovereign debt market is at risk of a fundamental inflection point in 2012, as heavy issuance is likely to be accompanied by very public failures in passing much-needed fiscal reform. As such, we will seek to manage immediate-term risk within this long-term bearish thesis by trading Japanese equities and the Japanese yen with a bearish bias.

  

Current Virtual Portfolio Positioning: Short Japanese equities (EWJ).

 

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“I skate to where the puck is going to be, not where it has been.”
-Wayne Gretzky

 

For long-time Hedgeye clients, our long-term bearish outlook for Japanese economic growth is not new news; neither is our aggressive stance against their ultra-Keynesian monetary policy and fiscal positioning. That said, however, 2012 shapes up to be a rather interesting year for Japan’s sovereign debt market, as both a heavy auction calendar coincides with debates on key fiscal reforms – both of which possess the potential of dramatically surprising consensus expectations to the downside.

 

Given our own deep understanding of the tailwinds supporting the Japanese yen and the Japanese government bond market, it would be reckless to assign a timeline to a potential Japanese sovereign debt and/or banking crisis. We have, however, done the work and are comfortable in saying that, more so than any year prior, 2012 shapes up to be the year where confidence in the JGB market is lost – putting Japan at risk of being next in line to face the music of our Sovereign Debt Dichotomy theme.

 

As the aforementioned quote by hockey great Wayne Gretzky suggests, we think it’s appropriate for investors to begin hedging their portfolios against Japanese sovereign credit risk. As always, feel free to email us at if you have any follow-up questions and would like to dialogue further.

 

Darius Dale

Senior Analyst


BYI YOUTUBE

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

 

 

BALLY TECHNOLOGIES AND WMS INDUSTRIES SETTLE PATENT LITIGATION (01/30/2012)

  • As part of the agreement, Bally will obtain a license to the WMS and Aruze Transmissive Reels® gaming technology portfolio under confidential terms.

BMO CAPITAL MARKETS DIGITAL ENTERTAINMENT CONFERENCE (11/10/2011)

  • [Michael Jackson & Grease] “Those are both going to be wide-area progressive games. We actually have seen our wide-area progressive footprint decline over the past couple of years seem to stabilize at about 1000 units. We do have an expectation that both Michael and Grease could see similar-size install base once they get to maturity.  In terms of earnings the reality is since they are coming out later in the summer our fiscal year ending June 30, we probably won't see a lot of immediate revenue impact towards the tail end but that's just in time for the season for gaming, as you know, really starts ramping up around July 4 and goes through Labor Day. So we're hoping that at the height of the gaming season we'll have those titles out there.”
  • “In term of impact for us, we earn 6.25% of the net win per day, so at Yonkers that equates to about $18 a day and at Aqueduct, double that right now.”
  • “It looks like we're going to cap off this year in terms of replacement sales, somewhere in the 50,000 units; actually with IGT reporting earlier this week, WMS reporting and us reporting, it actually looks like as an industry we saw a tick up in the September quarter with replacements. So maybe the December quarter caps off a pretty decent year with about a 10% increase in replacement sales. If you apply the same metric to next year, maybe replacements are 50,000 units to 55,000 units.”
  • “I don't really see much of a technology driver for a replacement cycle right now. I think just natural replacements due to wear and tear are happening. What's more exciting for us in the upcoming calendar year is the fact that you do have more new properties coming on; Ohio has four properties, you have Revel opening, you have a couple of properties in Louisiana, Kansas. So there's been a lot of opportunity that will probably double the total sales into new openings and expansions from – call it roughly 7,500 to 10,000 this past calendar year that we're in, to call it roughly 20,000 next year.”
  • “We have seen operators spending more capital. Some of it actually going to rooms and the instance of Caesars finishing their tower in Las Vegas, some of it going to other entertainment venues. Caesars adding a Ferris wheel here in Las Vegas. So the good news is number one, they seem better capitalized. Our customers are not so much focused on debt covenants and making those. So we think naturally some additional capital will be available. And the finally, competition is lot of these newer jurisdictions like, I mentioned Ohio and Kansas come on line as well as some properties in Louisiana, we think that that will drive some regional refresh just because of some of those floors are fairly aged.”
  • “We've really ramped up our international infrastructure over the past five years going from about 5% of our revenue to 20% today. That was initially focused on South America, Latin America, Mexico as well, and then Europe. In the last year or two, we've put additional focus into Australia, so we do see a lot of growth opportunity in Australia just from our entrance into the market. We think there is a natural replacement cycle there that runs between 6,000 and 10,000 units. So if we were to be a 10% ship share that would increase our international sales by 25% a year to an additional 1,000 units."

YOUTUBE FROM FQ1 2012 CONFERENCE CALL

  • “Due to the size, nature and complexity of several of the larger contracts, we expect revenues during the initial months to be more weighted towards services than hardware sales and software licensee.”
  • “We signed major contracts with British Columbia and Sun International, both of which will contribute meaningfully to fiscal year '13 and beyond [some of it included in FY2012 guidance]. And the acquisition of market leading mobile applications company MacroView and the establishment of Bally Interactive ensures that we have a great foundation for the long-term.”
  • “Our systems' margin does vary based on the mix whether its software or hardware, we did mention that we had a record quarter for signing up high dues, but, which is a hardware with slightly lower margin than our software, but those will be rolled out over the next six or 12 months. So, we did have a high mix of software. We still believe a good range of margins for systems in sort of that 70% to 75% or 76%. We continue to develop more software products, but we are seeing a nice sort of breaking of the pipeline in the iVIEW DM arena, which can also mitigate that.”
  • “iVIEW DM has a slightly higher margin than iVIEW, but still slightly lower than our software margins, so look for iVIEW DM margins in the 50% to 65% range, whereas our software margins are sort of 80% to 95% range.”
  • “The Grease should be out in the customers in the April timeframe and Michael Jackson in the June timeframe and these are subject to sort of a month variability or so either way.”
  • “Our core products that we've had whether it's Cash Spin or Betty Boop and Money Vault are also doing well, and we've been expanding the WAP with them. So, we are expecting gaming operations to continue to grow year-over-year.”
  • “One of the early renditions of the Pro Series we've been able to shave about 12% off the cost over the next couple of quarters. We don't see at this point a huge change in gross margins, maybe 100 to 200 basis points, longer term over the next three to five quarters I think we do get back up to that higher 48, 49 tier.”
  • [Systems margin] “Our goal is to get back into the 50%, low 50% range, especially as we get more of the new cabinets out and can sell the conversion kits. Neil, I think was talking about over the next five quarters. Clearly, the Pro Series cabinet is more expensive. The iDeCK is expensive. But it does allow us to still maintain good dollar margins, and we do see in the near term getting to the 48%, 49%, but if we're out here 18 to 24 months, Steve, we would expect to be back at 50%-plus.”
  • “We would expect it to trend down over the next two or three quarters, but we had slightly less, maybe 200 basis points less royalty themes this quarter than last quarter.”
  • “There's a very modest, very small contribution from Italy expected in fiscal '12.”
  • “In terms of ship share, we've seen the past couple of quarters, we've had an incremental increases in our ship share. So, with our content as it stands now we would expect to see some upward ticking ship share over the rest of the year. With respect to replacements, we continue to remain fairly cautious on replacements. There really hasn't been any catalysts out in the market that we've seen that have driven up an increase in replacements. The one thing I would point out is new openings and expansions, we think they were somewhere in the neighborhood of 10,000, we closed out this calendar year with about 10,000, next calendar year that doubles, and so some of that will fall in our second half of the fiscal year.”
  • [Any additional stock buyback activity?] “We may assume about $30 million, or $40 million right now as long as we're above 2 turns levered, we're capped at $64 million for the rest of this year once we get below 2 turns, we can get back to an unlimited state.”
  • “Our new openings share has pretty much tracked our replacement ship shares. So, it's been trending upward over the last year or so.”
  • “It will be several years before we generate revenue from Massachusetts, whereas Ohio should start generating some revenue in fiscal '12 for us, Illinois probably not in fiscal '12, but fiscal '13.”

BYD TRADE UPDATE

Keith bought BYD in the Hedgeye Virtual Portfolio at $8.71. According to his model, the TRADE range for BYD is between $8.62 and $9.37. There is TREND support at $6.71.

 

 

Boyd Gaming has been a laggard in the regional gaming space past few year.  The sentiment surrounding the name is negative - JP Morgan and Lazard recently downgraded the stock and short interest is very high. We’ll make this contrarian call due to better than expected performance in Locals Las Vegas and Atlantic City.  A near-term earnings beat is likely and management should provide positive commentary on 2012, particularly as the LV Locals market starts to show consistent, albeit slow, growth going forward.  Any catalyst should impact the stock meaningfully given the attractive FCF valuation and negative sentiment.

 

BYD TRADE UPDATE - byd3


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C&I LOAN DEMAND SURGES, REVERSING LAST QUARTER'S LOSSES: 1Q12 SENIOR LOAN OFFICER SURVEY

1Q12 Senior Loan Officer Survey Takeaways

 

C&I Loan Demand Remains a Bright Spot

C&I showed sequential demand increase at both large and small size firms. After taking a stutter-step in 4Q with a sequential decline in demand, 1Q12's survey results showed that 19.6% of net respondents reported increasing demand for large and mid-size C&I loan demand as well as a net 15.1% of lenders reporting stronger demand for C&I loans from small borrowers. On the flip side, however, lenders also reported the first net tightening of standards since 4Q09. Though lenders reported only a net tightening of 5.4% on large borrowers and 1.9% on small borrowers, this is an inflection. Commentary from the report indicated that global US banks are reporting stronger demand in Europe reflecting the pullback from Europe's lenders. As a reminder, 4Q11 was the first quarter in which we saw broad-based sequential loan growth from the banks. It's fair to point out that the quality of this loan growth is somewhat circumspect from the Moneycenters to the Regionals. 

 

C&I LOAN DEMAND SURGES, REVERSING LAST QUARTER'S LOSSES: 1Q12 SENIOR LOAN OFFICER SURVEY - C I demand  

 

C&I LOAN DEMAND SURGES, REVERSING LAST QUARTER'S LOSSES: 1Q12 SENIOR LOAN OFFICER SURVEY - C I demand 2

 

C&I LOAN DEMAND SURGES, REVERSING LAST QUARTER'S LOSSES: 1Q12 SENIOR LOAN OFFICER SURVEY - C I loans banks tightening standards

 

C&I LOAN DEMAND SURGES, REVERSING LAST QUARTER'S LOSSES: 1Q12 SENIOR LOAN OFFICER SURVEY - C I loans   of banks increasing spreads

 

C&I LOAN DEMAND SURGES, REVERSING LAST QUARTER'S LOSSES: 1Q12 SENIOR LOAN OFFICER SURVEY - Total C I loans 

 

CRE Loan Demand Picks Up but Lenders Remain Cautious

CRE loan demand rose sharply in 1Q12. 33.9% of net respondents reporting increased demand. However, standards were essentially flat sequentially (-1.8% QoQ). It's worth noting that 2012 and 2013 will see significant increases in CRE loan maturities, much of which goes back to the frothy days of 2005/2006. As such, it's not surprising to see rising demand. The real question is whether the lenders will bite. 

 

C&I LOAN DEMAND SURGES, REVERSING LAST QUARTER'S LOSSES: 1Q12 SENIOR LOAN OFFICER SURVEY - CRE loans Banks tightening standards

 

C&I LOAN DEMAND SURGES, REVERSING LAST QUARTER'S LOSSES: 1Q12 SENIOR LOAN OFFICER SURVEY - cre demand 2

 

C&I LOAN DEMAND SURGES, REVERSING LAST QUARTER'S LOSSES: 1Q12 SENIOR LOAN OFFICER SURVEY - Total CRE loans

 

Residential Real Estate - Further Separating Prime from "Nontraditional"

Prime borrowers are facing with slightly relaxed terms, on the margin, while 3.8% of banks reported stronger demand for mortgages compared to 14.6% in the prior quarter. This is in contrast to nontraditional borrowers, who showed a sequential decline in demand and had banks tighten underwriting even further in the quarter.

 

C&I LOAN DEMAND SURGES, REVERSING LAST QUARTER'S LOSSES: 1Q12 SENIOR LOAN OFFICER SURVEY - Resi demand 2

 

C&I LOAN DEMAND SURGES, REVERSING LAST QUARTER'S LOSSES: 1Q12 SENIOR LOAN OFFICER SURVEY - resi demand

 

Consumer Loans - Are Cards and Auto Frothy Yet?

This is the seventh consecutive quarter of easing standards on credit card loans and the fourth consecutive quarter (perhaps longer, but the data only goes back four quarters) of easing standards on auto loans. Meanwhile, demand for both categories of credit has been rising steadily for the past year - also the extent of the data under the Fed's new reporting format. For reference, the cumulative easing cycle in cards has been 77.2% from 3Q10 through 1Q12. That compares with the prior record of 43.4% from 4Q04 through 3Q07. To be fair, the bang up from 4Q07 through 2Q10 was severe, and as such you'd expect there to be significant easing on the other side. The question, however, is how close to frothy are we? Clearly competition for prime borrowers has been escalating for many quarters and the industry is finally now starting to see loan growth. Especially given the lack of growth in other areas, we think standards around card lending are likely getting quite lax.

  

 C&I LOAN DEMAND SURGES, REVERSING LAST QUARTER'S LOSSES: 1Q12 SENIOR LOAN OFFICER SURVEY - Household loan standards

 

C&I LOAN DEMAND SURGES, REVERSING LAST QUARTER'S LOSSES: 1Q12 SENIOR LOAN OFFICER SURVEY - Total Consumer loans 

 

Joshua Steiner, CFA

 

Allison Kaptur

 

Robert Belsky

 

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ASCA YOUTUBE

In preparation for ASCA's Q4 earnings release tomorrow, we’ve put together the recent pertinent forward looking company commentary.


 

AMERISTAR CASINOS INCREASES CASH DIVIDEND BY 19% (01/30/2012)

  •  “ASCA announced that its Board of Directors has declared a quarterly cash dividend of $0.125 per share, payable March 15, 2012 to stockholders of record as of Feb. 29, 2012. This represents an annual rate of $0.50 per share, a 19% increase over the annual dividend for 2011.” 

ASCA ANNOUNCES CLOSING OF PURCHASE OF CASINO RESORT DEVELOPMENT SITE IN SPRINGFIELD, MASS (01/25/2012)

  • “Ameristar purchased the site at Page Blvd. and Interstate Highway 291 for $16 million from an affiliate of the O'Connell Development Group Inc. Westinghouse.”
  • “Ameristar's development plans are preliminary but are expected to include a state-of-the-art casino continuously updated with the newest and most popular slot machines (a hallmark of the Ameristar brand) and a variety of table games, a luxury hotel, a diverse offering of dining venues, retail outlets, entertainment and meeting space and structured parking.”

YOUTUBE FROM Q3 2011 CONFERENCE CALL

  • As I mentioned, we're obviously controlling our costs well across our properties, particularly in promotional spending.  And we're confident we can achieve a high flow through rate going forward.”
  • “We're allowed to have up to seven times on a total net leverage basis.  And the senior leverage ratio is now below three times at 2.92 for Q3. The allowable rate at this present time would be 4.5 times.”
  • “Q4 2011 estimates for non-cash stock-based compensation expense is expected to between $10 million and $11 million in the fourth quarter. For the year, we anticipate we'll hit $22 million to $23 million. Our blended federal and state tax rate is projected to be between 41% and 43% for the fourth quarter and for the year. Capital spending for the remainder of 2011 is expected to be in the range of $19 million to $24 million, which we anticipate will be predominantly maintenance CapEx. Interest expense in Q4 is expected to be near $27.4 million. Non-cash interest is expected to between $1.1 million and $1.6 million for Q4.”
  • “Based on our operational cash flow needs that occur every year in the fourth quarter, we'll probably only be making the one mandatory principal repayment at the end of the quarter, which will bring our full year debt repayment to somewhere around $184 million to $187 million, which obviously has been substantial. Use of our free cash flow was concentrated on retiring debt this year to get our debt multiple down, to put the company in a position to pursue other strategic opportunities. And the board has approved the fourth quarter dividend that will be paid in December.”
  • “Basically we've seen a significant decline in professional fees through the year and as we've wrapped up a few things. And there were some costs related to the share repurchase and to the refinancing and to some changes in personnel that occurred in the first six months of the year that are obviously not going to be reoccurring going forward.”
  • “We haven't made anything public as how we believe this will impact us or not impact us, other than to suggest people take a look at what South County's Pinnacle property impact had on our St. Charles property. They're literally the same distance from each other, 24, 25 miles. And that should give you a pretty good indication of what could happen in Kansas City once the racetrack casino opens.”

THE HBM: WEN, SBUX, YUM

THE HEDGEYE BREAKFAST MONITOR

 

MACRO NOTES

 

Commodities

 

The world is running out of time to make sure there is enough food, water and energy to meet the needs of a rapidly growing population and to avoid sending up to 3 billion people into poverty, a U.N. report warned on Monday. As the world's population looks set to grow to nearly 9 billion by 2040 from 7 billion now, and the number of middle-class consumers increases by 3 billion over the next 20 years, the demand for resources will rise exponentially. Even by 2030, the world will need at least 50 percent more food, 45 percent more energy and 30 percent more water, according to U.N. estimates, at a time when a changing environment is creating new limits to supply. – Cattle Network

 

 

Comments from CEO Keith McCullough

 

Everything has a time and a price – good spot to buy on yesterday’s lows; don’t chase into today’s month-end:

  1. GERMANY - Contrast of The Day: Italy's unemployment rate hits an 8yr high of 8.9% as Germany's hits 20yr low of 6.7% - the Germans are absolutely killing it right now – gaining big political power, seeing a +10.2% YTD stock market move, and unemployment fall #winning
  2. COMMODITIES – anyone long inflation has to be right fired up again this morning (I am – bought Energy yesterday); the Bernank Tax is obviously very bad for the country/economy, but great for commodity longs – Gold and Copper have gone vertical since the FOMC statement, up +11.4% and +12.5% for JAN respectively!
  3. MONTH-END – you know it, I know it – it is what it is. Today is the day where anyone can suspend disbelief that the best JAN for stocks since 1997 is going to straight line as what happens for the rest of the year. From an immediate-term TRADE overbought perspective, this looks a lot like FEB 2011 – lower long-term highs right as Growth Expectations start slowing.

Treasuries agree w/ me on that last part. 10 and 30yr collapsing again to 1.85% and 3.01% respectively – both remain in a Bearish Formation as US policies to inflate have funds flowing to US Treasuries instead of US Stocks.

 

SUBSECTOR PERFORMANCE

 

THE HBM: WEN, SBUX, YUM - subsector

 

QUICK SERVICE

 

WEN: Wendy’s held its annual Analyst Day in New York City yesterday.  As we wrote in our note, published last night, at least $3.7 billion of spending is needed to carry out the remodeling program, according to the company’s figures.

 

WEN: Wendy’s was reiterated “Sell” by Goldman after the Analyst Day.  The firm feels that “resources were lacking and that there is still a risk to guidance.”

 

SBUX: Starbucks plans to raise prices of some espresso-based beverages and fresh-brewed coffee products by 1 Yuan to 2 Yuan in China.

 

SBUX: Starbucks has officially backed gay marriage, according to media reports.  Starbucks EVP Kalen Holmes expressed the company’s support for legislation in Washington State recognizing marriage equality for same-sex couples, saying that the legislation is “core to who we are and what we value as a company.”

 

YUM: Pizza Hut expects to surpass 2 million pizzas sold on Super Bowl Sunday.

 

 

NOTABLE PERFORMANCE ON ACCELERATING VOLUME:

 

PNRA: Steps up expansion in CDA – reporting EPS on 2/7 AMC

 

YUM: 2nd day of strong volume – reporting EPS on 2/6 AMC

 

GMCR: 2nd day of strong volume – reporting EPS 2/1 AMC

 

SBUX: Tata surged 10% on JV with SBUX

 

WEN: See my note from yesterday – my outlook for WEN has diminished

 


CASUAL DINING


KONA: Kona Grill named Berke Bakay president and CEO.  Bakay is the investment manager to BBS Capital Fund, Kona Grill’s largest shareholder (15.2% stake).

 

NOTABLE PERFORMANCE ON ACCELERATING VOLUME:


CHUX: Trading well heading into EPS – reporting 2/7 BMO

 

BBRG: Another good day: up 12% over the past month

 

THE HBM: WEN, SBUX, YUM - stocks

 

 

Howard Penney

Managing Director

 

Rory Green

Analyst

 


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