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THE PINNACLE’S DILEMMA

We’ve liked this one. So far so good. As we discussed in our 11/11/08 post, “LIKE PEANUT BUTTER AND CHOCOLATE”, there is a decent likelihood that PENN makes a run at PNK. Furthermore, the valuation looks reasonable, even after the recent run-up. The stock is up 133% since our 10/29/08 opus, “A SHORT SQUEEZE COMMETH” highlighted PNK as having the most upside.

Analyzing operations is where it gets tricky. The removal of the Missouri loss limit in early November continues to have a positive impact and will probably result in at least 10% revenue growth. PNK probably reported the strongest Q3 of all of the gaming/lodging operators. Approximately 75% of the company’s EBITDA is generated in Louisiana. Due to the relative strength of the Texas economy this year, those markets have done well. As we discussed in our recent unemployment posts, the Texas economy is deteriorating, perhaps at a faster rate than most of the country. Given the recent strength, it is the delta here that is disconcerting.

The important metro markets for PNK are Houston, New Orleans, Cincinnati, St. Louis, and Dallas/Shreveport. The recent unemployment trends are charted below and they aren’t pretty, on a year over year and sequential basis. Given the size of PNK’s properties on those markets, the sequential trends in Houston and New Orleans warrant the most concern. Obviously, oil is a major component of some of these local economies so the escalating unemployment shouldn’t be a surprise.

Thus far, through early December, our sources indicate that gaming revenues have held up pretty well in Louisiana, despite the plunge in oil. Q4 probably looks as safe as any gaming operator out there. However, unemployment is a statistically significant macro factor in driving gaming revenues so Q1 could be at risk.

Unlike most operators, positive catalysts remain for PNK. If the Texas and Louisiana economies were to stabilize there would be no dilemma.

Despite the deteriorating unemployment trends in LA/TX, PNK's gaming revs there are holding up

PRE-ANNOUNCEMENT POTENTIAL

The good news is that gaming/lodging earnings season is still over a month away. The bad news is earnings pre-announcements could happen at any time.

Many companies in the space no longer issue formal guidance so they may not feel the need to pre-announce. Generally, earnings and guidance look at risk. However, if Isle of Capri’s disastrous FQ2 with, nevertheless, an-up move in the stock is any indication, investors will generally shrug off any shortfalls.

The following companies have pre-announced in the past:

• WYNN – LV and Macau are under pressure. WYNN pre-announced negatively for Q3 (on 10/13) and could do so again for Q4. We think WYNN is very well positioned long-term but near term earnings could disappoint.
• PENN – The company pre-announced negatively on October 2nd so there is precedent. PENN, more than any other company should benefit from being on the right side of the liquidity trade. However, the near-term remains difficult. Lower gas prices have not yet made a meaningful difference. A pre-announcement is possible here as well but probably wouldn’t change the long term thesis.
• ASCA – The removal of the Missouri loss limit should offset some of the difficulty elsewhere. We do not expect any pre-announcement.
• BYI – We believe BYI is likely to meet or exceed FQ2 estimates. Although they have pre-announced favorable results in the past, they are unlikely to do so this quarter in our opinion.
• MAR – Marriott will probably miss earnings expectations and will most certainly lower forward guidance. We do not expect an update earlier than their regular earning release, however.

The following companies do not provide guidance and historically have not pre-announced earnings:

• BYD – BYD’s strong liquidity position vis-à-vis Station Casinos, its primary competitor in the Las Vegas locals market, should result in growing market share. However, this will take some time and in the meantime results could fall below sell-side estimates. Since management does not provide quarterly guidance we do not expect a pre-announcement.
• IGT – Considering the number of new casinos and expansions opening in the quarter, IGT should meet consensus expectations.
• WMS – We expect WMS to handily beat consensus earnings expectations. However, as we’ve written about extensively, slot sales should be down significantly in 1H CY2009. Analysts continue to project almost 10% revenue growth in that period. Management should cut forward guidance in their FQ2 earnings release.
• LVS – We expect Macau and Las Vegas to disappoint again in Q4. Any pre-announcement would likely coincide with an update on financing.
• MPEL – Macau centric, not good for earnings. Haven’t pre-announced since going public last year.
• HOT – Starwood could make the Q4 number but forward guidance should come down again. The company does not typically pre-announce.

EYE ON JAPAN: STALLING OUT

The final cabinet Office tally for Q3 GDP came in at a decline of -1.8% more than 4 times the initial estimate of -0.4% released last month as the full impact of the global slowdown reverberates through Japan’s export industries –illustrated by the 16,000 employee headcount reduction announced by Sony (50% comprised of hapless haken) this morning.

If you read our work regularly you know that we think Japan bulls looking for a glass-half-full scenario in which US and EU government stimulus packages shore up demand are going to be sorely tested as they wait for income derived from public works projects to be converted into flat screen TV purchases. Furthermore, we don’t see domestic demand helping to close the gap in Japan: BOJ has only 30 BP of wiggle room left and, if consumers there were content to build of $15 trillion in the zero rate environment that ended less than 3 years ago presumably they won’t be rushing out to spend now.

We closed on EWJ short out last Friday, but we will be looking for opportunities to go short again in the near term if we can sell into strength.


Andrew Barber
Director

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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.


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

Early Look

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