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SAY IT ISN’T SO(CAL)

Unemployment and housing matters when it comes to gaming. Southern California provides 25% of the visitors to Las Vegas.
  • As can be seen in the first chart, both metrics are correlated to Strip gaming revenues. It’s no secret that the economy in SoCal is horrendous. The problem is that the unemployment rate is getting worse, and at a worse rate.

  • National unemployment and housing prices also matter. While not as bad as SoCal, the US unemployment picture is worsening as well. The second chart provides the most recent YoY and sequential changes in employment for the large feeder markets to Las Vegas. Los Angeles and San Diego look the worst on a YoY basis but Houston and Dallas are deteriorating the fastest.

  • We’ve addressed the global situation in previous posts and the picture there is not pretty either. Global economies are slowing and entering recessions. Las Vegas is no longer on sale to prospering overseas visitors.

  • Investors should adjust the timing of a recovery scenario until at least 2010. MGM, WYNN, and LVS are all levered to the Las Vegas Strip in that order.

SoCal housing prices and unemployment rates are highly correlated with LV Strip revs
The recent unemployment trends in the LV feeder markets are getting worse

EYE ON CONSUMER SPENDING: GASOLINE

Average retail gasoline in the U.S. reached $1.70 per gallon last week, which is its lowest level in more than 4-years on the back of demand destruction for oil which has driven the price of front-month NYMEX RBOB futures below 92 cents a gallon. According to estimates by General Motors, each $0.01 change in the retail price of gas has a $1.5 billion impact on annual consumer spending. Based on the current U.S. average retail price of regular gas of $1.70 per gallon and the 2007 average price of $2.81 per gallon, this equates to a $1.11 change or an additional $166.5 billion of annualized consumer spending injected into the economy (or about 1% of consumer spending in 2009), not an insignificant amount. And this could be just the beginning.

Not surprisingly a clear divergence has emerged between the Consumer Discretionary (XLY) and the broader S&P 500. Over the last month the XLY increase 3.6% versus the SPX at -2.3%. See today’s Early Look for more thoughts on some changes at the margin that may be influencing consumer trends down the road.


Howard Penney
Managing Director, Chief Sector Strategist

MCD – Loss in Translation

I fully appreciate that MCD’s currency issues have no implication on the company’s ability to generate free cash flow, but it will impact perception. And the current perception is that MCD can grow EPS at a double digit rate for the next five years. Those expectations need to come down.

MCD posted another month of strong comparable sales growth across the board yesterday with total company same-store sales up 7.7% in November. In today’s environment, it is hard to find weakness in a U.S. number up 4.5% and APMEA up 13.2%. MCD’s systemwide sales number of up 1.9%, however, was negatively impacted by foreign currency rates which reduced the reported number by 7.7%. MCD’s sales and operating income growth has benefited from currency translation every quarter since 3Q06 on both a total company basis and in Europe. The magnitude of this positive currency impact has grown rather steadily since that period until 3Q08. And in 3Q08, even with the slight contraction, currency still boosted consolidated and Europe’s reported EBIT growth by 5% and 9%, respectively.

Fourth-quarter 2008 will mark the first quarter since 3Q06 where that favorable currency trend reverses and actually hurts MCD’s reported results. From the chart below, it is easy to see that the currency impact has turned sharply negative in October and November, thereby reducing reported systemwide sales by 4.5% and 7.7%, respectively. According to the company’s guidance, “earnings are affected by changes in foreign currency exchange rates, particularly the Euro and the British Pound. If the Euro and the British Pound both move 10% in the same direction compared with 2007, the Company’s annual net income per share would change by about 8 cents to 9 cents.” MCD stated as a point of reference that the weighted average exchange rate used to translate the company’s income statement in 4Q07 (U.S. Dollar rate for one unit of foreign currency) was $1.45 for the Euro and $2.04 for the British Pound. Based on those numbers, both currencies have moved in the same direction in excess of 10% quarter-to-date on a YOY basis and should cost MCD about $0.10 in EPS. Although MCD’s same-store sales remain healthy, this currency headwind in 4Q and going forward could remove some of the company’s past quarters built-in earnings cushion.

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EYE ON THE UK: STILL FALLING

UK Industrial production contracted sharply in October according to data released today by the ONS with total production declining by 5.21% Y/Y and manufacturing specifically down by 4.86% Y/Y. Trade data released today showed the aggregate deficit expanded to £7.75 billion for the month while the EU specific trade gap narrowed slightly. Although industry accounts for less than an estimated 20% of the UK’s GDP the rapid slowdown still comes as a shock to the system and will inevitably add to employment pressure. Housing data released today painted an equally bleak picture as October prices measured by the DCLG declined 7.4% Y/Y.

Clearly, rate cuts will not be sufficient panacea for the present situation regardless of whether the banking sector actually starts to pass liquidity through to consumers (see our post yesterday which detailed liquidity issues there). Unfortunately, further rate cuts appear to be the only arrow left in the quiver at this point for Brown, Darling, King & Company Ltd.
We remain short the UK equity market via the EWU ETF and continue to see few prospects for revived growth that might stem the tide of the crisis there.

Andrew Barber
Director

SEIZE THE DAY

"A pessimist sees the difficulty in every opportunity; an optimist sees the opportunity in every difficulty."
- Sir Winston Churchill

I have worked on Wall Street for twenty years, I have three kids, I love sports (although getting a little tired of hockey analogies), I would pay big money to run The Ironman World Championships, I’m a consumer analyst, I’m a pessimist and I’m working through my 12-step program to seize the opportunity to make clients money on the long side – I work at Research Edge LLC.

In this market you don’t want to be early, but you definitely don’t want to be late either.   I remember the day when stocks moved 5% in a day and the phone would ring off the hook.  Today, 30-50% moves are the upper end of the range.  How can anyone manage for risk with that type of volatility? The current market environment calls for an intense focus on companies with strong brands, stable cash flow and a strong balance sheet.  Did I mention cash?  Cash is king, but you know that.

A true pessimist on the consumer believes that consumer stocks are dead for the next five years.  I think that is extreme.  In the context of other “market crashes” the consumer index has experienced a crash.  From the peak the Consumer discretionary Index (XLY) set in June 2007, the index has declined 56%.  I’m not trying to argue that the issues that have driven consumer spending lower are behind us, but that the rate of change may show a positive improvement in 1H09.  Improving consumer sentiment will be an important factor contributing to the bottom in consumer spending.  Among other things, the new administration and more confidence in Washington are critical.  But lower gas prices put real “cash” in the pockets of the consumer.

That being said, gas prices are now down nearly 60% from the peak levels experienced in July, down 40% YOY and have moved below 2005 levels.  Although gas prices account for only one factor among many (unemployment, declining house prices, etc.) that have impacted consumer demand, at some point, these lower gas prices will help to stabilize and reverse spending trends just as they played a major role in pulling down demand on their upward climb. In fact, every $0.01 change in the retail price of gas impacts annual consumer spending by about $1.5 billion.  Based on the current U.S. average retail price of regular gas of $1.70 per gallon and the 2007 average price of $2.81 per gallon, this equates to a $1.11 change or an additional $166.5 billion of annualized consumer spending injected into the economy (or about 1% of consumer spending in 2009), not an insignificant amount.

Today we are waking up to the reality that the US auto industry will be nationalized, but at some level this is good news as it will limit the losses the industry was facing in 2009.  There is also news that the airlines will not lose as much money in 2009 due to lower oil prices.  I could write another 5,000 words on the fact that lower oil prices will positively impact nearly every company in the S&P 500 in 2009, but I’ll save that for the industry experts.  Keeping me grounded is the fact that Sony joins a growing list of companies cutting jobs.  This trend implies that news on employment will not be good in early 2009, but that rate of change will also likely improve in 1H 2009.  The issue of employment raises interesting questions about what consumers will do with any incremental cash they may receive from lower gas prices or another stimulus program.  With the personal savings rate at 0%, a 1% move higher could mitigate any benefit seen from lower gas prices. 

Any real change in economic activity in 2009 will be closely related to growth in consumer credit and the biggest driver of that will be growth in residential mortgages.  Given the actions the government has taken, you can also argue that the appropriate steps have been taken to stabilize the financial system, which should invigorate the credit markets and allow businesses to lend so consumers start spending again. 

Again, all of these events are happening at the margin and are not having a big influence on how consumers feel today.  At Research Edge we focus on events that happen at the margin and today, this implies that being slightly more optimistic will allow us to see the opportunity in the difficulty of the environment.

Function in disaster and finish in style,

Howard Penney
Managing Director

Long ETFs
SPY-S&P 500 Depository Receipts –Front month CME futures contracts traded as high as 912.4 before 7AM this morning with the Auto sector bailout dominating media coverage.

XLV Health Care Select Sector SPDR – A Study released found that Cephalon‘s (XLV: 0.5%) non-Hodgkin’s lymphoma drug Treanda worked as well as standard chemotherapy and was associated with fewer side effects. Shares of the company closed down over 1% at 75.82.

GLD -SPDR Gold Shares – Front month COMEX gold contracts declined 0.51% to 766.1 in trading this morning.

OIL iPath ETN Crude Oil –Front month Light Sweet Crude contracts traded as low as 43.3 this morning as anticipation of the OPEC meeting on the 17th continued to dominate all media coverage of the market.

EWG – iShares Germany --Investor confidence rose unexpectedly in Germany with the ZEW economic sentiment index climbing to -45.2 from -53.5 last month. The benchmark DAX is up this morning 1.26% to 4775.07.

EWH –iShares Hong Kong -- Stocks fell for the first time in three days amid concern the government’s lowering of industry tax will not shore up the city’s economy.

FXI –iShares China – The CS1300 fell 2.59% to close at 2040.85. November’s export figures are expected to show a contraction.

Short ETFs
EWU – iShares United Kingdom –The FTSE100 is up 69.34 points this morning, or 1.61%, to 4369.40. UK manufacturing output fell 1.4 % from September, reports the Office for National Statistics in London. Economists predicted a 0.5 % decline.

UUP – U.S. Dollar Index – The Pound declined by over 1% reaching 1.474 in trading this morning while the Euro declined to 1.286.

FXY – CurrencyShares Japanese Yen Trust – Preliminary GDP figures for Q3 released by the cabinet office today showed a contraction of 1.8% seasonally adjusted over Q2, a larger than anticipated decline. The Yen rose to 92.46 USD in trading this morning.  


Casual Dining – Silver Lining?

The initial run up in retail gas prices in 2005 led to the precipitous decline in casual dining same-store sales and traffic growth trends. As gas prices increased at an accelerated rate in early to mid 2008, casual dining demand dropped at an accelerated pace as well. Casual dining operators posted their worst traffic declines in the July through October 2008 timeframe since at least 2000 with the October number falling 8.2%. And, based on recent comments from casual dining companies, we are expecting more of the same in November.

That being said, gas prices have been declining and are now down nearly 60% from the peak levels experienced in July, down 40% YOY and have moved below 2005 levels. Although gas prices account for only one factor among many (unemployment, declining house prices, etc.) that have impacted restaurant demand, at some point, these lower gas prices will help to stabilize and reverse traffic trends just as they played a major role in pulling down demand on their upward climb. In fact, SixthManResearch.com estimates that every $0.01 change in the retail price of gas impacts annual consumer spending by $1.5 billion. Based on the current U.S. average retail price of regular gas of $1.70 per gallon and the 2007 average price of $2.81 per gallon, this equates to a $1.11 change or an additional $166.5 billion of annualized consumer spending injected into the economy (or about 1% of consumer spending in 2009), not an insignificant amount.

The charts below highlight the inverse relationship between retail gas prices and casual dining same-store sales growth and traffic trends. If gas prices continue to fall, restaurant operators should begin to see some relief from a demand perspective.

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