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Risk Managing Inflation Expectations: TIP Trade Update

Conclusion: As we have seen repeatedly throughout history, stability in the U.S. Dollar is acting as a governor on the slope of inflation expectations. As such, we have sold our long position in TIPS.


Virtual Portfolio Positioning: Sold our long position in the iShares Barclays TIPS Bond Fund (TIP).


Yesterday afternoon, Keith sold our long position in Treasury Inflation Protected Securities on the strength of a TRADE line breakdown amid signs of stability in the U.S. Dollar Index, our leading indicator for the slope of intermediate-term inflationary pressures. Conversely, a breakdown of the DXY through its TREND line would, once again, get us increasingly hawkish on the intermediate-term slopes of domestic and global inflation readings.


Risk Managing Inflation Expectations: TIP Trade Update - 1


Risk Managing Inflation Expectations: TIP Trade Update - 2


Fundamentally, USD stability acts as a governor on global food, energy, and raw materials prices, and, as a result, a governor on global producer and consumer prices due to the marginal decrease in supply-chain pressures. Particularly in the U.S., given that there is “slack in the labor markets” and that “capacity utilization remains subdued” (to borrow the Fed’s own lingo), the only thing really moving the dial on domestic PPI and CPI readings  is the purchasing power of the U.S. dollar and its impact on price-setting across global commodity markets.


Further, increased clarity in the Republican primary has also been interpreted as dollar-bullish, because it inches consensus one step closer to the generational debate about debts, deficits and monetary policy that we expect to come alive in the months leading up to the general election.


All told, keep your eyes on the aforementioned quantitative levels, as the slope of inflation expectations continues to be the driving force of asset prices globally – a relationship we attribute to investors favoring the reflationary effects of easy monetary policy in the absence of true underlying economic growth momentum and improving fundamentals.


Darius Dale

Senior Analyst


Risk Managing Inflation Expectations: TIP Trade Update - 3


Market share stabilizing in more than one area.



The big takeaways from the following charts are that slot sales are surging and IGT’s installed base and participation share is (finally) stabilizing.  While we liked the slot sector over the near and long term, our concern surrounding IGT was continued declines in their participation share.  That is why chart 2 is so encouraging for our IGT thesis.  The stock is looking pretty washed out here.


Now that Aristocrat has reported, we can confirm that the top 5 manufacturers have shipped 62.4k units to North America.  If we include MGAM, which sold 1.4k units, that gets us to a total of 63.8k.  Our best guess is that the rest of the smaller suppliers (Speilo, Aruze, Ainsworth, etc) shipped a total of approximately 3k units. Tallying up the total gets us to a total of 67k North America shipments in 2011 compared to 63k in 2010.   We estimate that replacement comprised 54.6k of the total shipments to NA vs. 49.4k replacements in 2010 – an 11% increase.


In 2H11, replacements increased 7% YoY to 26.2k.  Almost all the YoY growth in 2H11 occurred in the 3rd quarter, which we estimate had 13.3k replacement shipments and was up 14% YoY while 4Q was up only 1% YoY at 12.9k shipments.


Our estimate for 2012 replacements hasn’t changed much since our last replacement market recap 6 months ago. We believe 2012 will come in at around 59k units with most of the growth back-end loaded, given the tougher 1H comparisons.




The following chart shows our estimate of participation and lease revenue share for the three largest players in the space.  As shown, IGT’s market share has been in a steady decline for almost 7 years since 2004. However, over the last 6 quarters, IGT’s share has been stable to slightly improving.  We view this very favorably.  Growth for IGT and the industry should resume with all of the new markets and casinos opening in the next few years.





VFC: M&A the Other Way

(Correction: Last sentance of opening paragraph was cut off in prior version)


We’re used to seeing VFC involved in M&A deals. It’s simply part of it corporate fabric and for good reason they have had a solid track record of success. But this morning VF is in a less familiar role as the seller of its John Varvatos brand. This is hardly a blockbuster deal (less than $100mm), but we like it for the following reasons:

  • There’s a lot of variety in the 26 primary brands that make up VFC’s consumer branded portfolio (see below), but Varvatos simply didn’t fit in. It’s a luxury men’s apparel brand that sells through luxury department stores like Barneys, Neimans, Bloomie’s, etc. in addition to its 10 free standing stores. VF has plenty of premium brands, but this was its only luxury brand. It was requiring incremental effort in order to maintain relationships with the department stores that VF wouldn’t have been dealing with otherwise – that’s now alleviated.
  • We like the timing. While not a blockbuster deal (financial terms weren’t disclosed), VF is selling an asset in the luxury end of its portfolio just when luxury retail is shinning. As such, whatever the value the deal comes out to (we suspect around $100mm; over $100mm in sales at HSD margin), it’s not likely to have been at depressed multiples.
  • It improves the balance sheet. The proceeds of this deal can be put towards reducing VFC’s debt-to-capital ratio. VF ended the year with a debt-to-capital ratio of 32% well below 40% where the company ended Q3 following the TBL acquisition. While slightly above plan (30% by year end), the company paid off nearly $900mm in debt during Q4 and can generate over $1Bn in FCF this year reflecting a 9% FCF margin despite ramping CapEx spending nearly 2x its historical rate in order to support continued growth, HQ relocation, new DCs, etc. With this level of FCF generation plus an additional ~$100mm from Varvatos, we expect VF to reduce its debt-to-capital ratio to the low-20s in-line with pre acquisition levels by year-end.

All in, this deal isn’t going to have a material financial impact, but the company is selling off a fringe asset in the least profitable segment of the business – it makes perfect sense. We like the stock here and the fact of the matter is that VFC continues to give the market reasons as to why it will likely never look cheap. Moreover, we think VF’s initial F12 outlook appears overly conservative, which shouldn’t come as a surprise to those that have followed this team.


Our model has VF growing EPS at a mid-teens rate over the next two years – without any stretch assumptions. Timberland growth alone gets us there, and we’re not making any heroic assumptions as to the use of VFC’s $1bn in free cash. With the stock trading at 13.9x our F13 estimate of $10.75, and about 10x EBITDA we can’t exactly call it cheap. But estimate revisions are likely to be headed up from here, and you generally don’t want to be on the wrong side of VFC when estimates are heading higher.


Casey Flavin



VFC: M&A the Other Way - VFC JVarvatos



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February gross gaming revenues (GGR) increased 23% YoY to $3.03BN.  The timing of the Chinese New Year celebration in January of this year versus February of last year had a negative impact on YoY growth comparison which was offset by an easy hold comparison and an extra day this year.  We estimate that total direct play this month accounted for 7.0% of the market, compared to 6.6% last year.  The total VIP market held at 2.88% vs. 2.68% in February 2011.  Accounting for direct play and theoretical hold of 2.85% in both months, February revenues would have increased 16% YoY.  Without the benefit of the leap day, revenues would have been up about 13% YoY. 


In a sign of slowing VIP growth, February was the first month since March 2009, that 4 of the 6 concessionaires saw declines in Junket RC volumes.  On the bright side, Mass market table revenues continued to be strong, growing 31% YoY, and the 4th straight month of growth that led the market.  Rolling Chip “only” increased 12% YoY.  Obviously, the higher margin profile of the Mass business makes this trend a very palatable one for the operators.  Commission rates do need to be monitored, however, given the slower growth of VIP coupled with the aggressive Four Seasons/Neptune deals.


February market shares were very similar to January.  After a slow start, MPEL was the biggest winner sequentially, driven by its highest Mass share ever at 12.5%, up 80bps MoM.  Fundamentally, MPEL continues to knock the cover off the ball.  If management would just come out and say they will not do a dilutive equity deal, this stock could have a real multiple.


Galaxy’s share fell sequentially following a strong, hold aided couple of months.  Yes, VIP hold was low but Mass share fell

120bps MoM.  Even on a normalized basis, Galaxy’s share is quite disappointing.


LVS posted another solid share month driven by higher hold and solid Rolling Chip growth.  However, Mass share fell 80bps.  LVS, WYNN, and Galaxy seem to be losing on the Mass side to SJM and MPEL.



Y-o-Y Table Revenue Observations


Total table revenue grew 23% YoY this month, on top of 47% growth last January.  Given the extra day this year and the easy hold comparison from last year, the impact of the shift in the CNY holiday was likely neutral.  Mass revenue growth of 31% was healthy but marked a deceleration from the +40% average growth we’ve seen since June 2011.  VIP revenues grew 21%, while Junket RC “only” increased 12%, with both continuing the ‘slowing trend’ that we began to observe in October.




Table revenues grew 28% YoY, outpacing the market mostly due to strong hold across Sands and Four Seasons.  We estimate that LVS’s properties held at 3.2% in February.  At 32%, LVS had the best VIP growth after Galaxy and ranked #4 behind Galaxy, MPEL, and SJM for Mass table growth.

  • Sands was only up 0.4% YoY despite high hold and an easy hold comparison
    • Mass was up 1%
    • VIP was up 0.1%.  Sands held high in February.  Assuming $300MM/month of direct play or 15% (in-line with the monthly absolute average in 4Q11), hold was 3.86% vs. 2.74% last February, assuming 10% direct play or $270MM/month (in-line with 4Q10).
    • Junket RC was down 21%, the first double digit decline since September 09
  • Venetian table revenues decreased 4% YoY, driven by a combination of a difficult hold comparison and low hold, and a drop in junket VIP RC volume
    • Mass increased of 23%
    • VIP decreased 18%, while junket VIP RC decreased 7%
    • Assuming 27% direct play in the quarter (below the 28% we saw in 4Q11 but higher than 2011), hold was 2.67% compared to 3.24% in February 2011, assuming 19% direct play (in-line with 1Q11)
  • Four Seasons grew 253% YoY, driven by a huge Junket RC growth, high hold, and an 87% increase in Mass revenues.
    • Junket VIP RC increased 3.7x YoY
    • Four Seasons is clearly seeing a benefit from LVS’s recent initiatives.  If we assume that monthly direct play volume of ~$725MM from 687MM/month in 4Q11, that implies a direct play percentage of 15% and a hold rate of 3.43%.  In comparison, if February 2011 direct play was around 50% (54% in 4Q10 and 40% in 1Q11) then hold was 2.46%.



Wynn table revenues only increased 2.5%, exhibiting the lowest growth of all 6 concessionaires.  While Wynn’s hold was low, last year’s comparison was also easy.  Wynn’s average growth over the last 4 months has slowed to an average of 6%.

  • Mass was up 10% and VIP increased 1%
  • Junket RC fell 4%
  • Assuming 11% of total VIP play was direct (in-line with 4Q11), we estimate that hold was 2.75% compared to 2.62% last year (assuming 10% direct play – in-line with 1Q11)



MPEL grew 13%, propelled by strong Mass table growth at 37% behind Galaxy, offset by slower 8% growth in VIP

  • Altira revenues fell 2%, due to a 3% decrease in VIP.  Altira revenues have declined 3 of the last 4 months.
    • Mass revenues increased 12%
    • VIP RC decreased 10% - marking the 3rd consecutive month of declines
    • We estimate that hold was 2.7%, compared to 2.5% in the prior year
  • CoD table revenue was up 21%, driven by 41% growth in Mass and 15% growth in VIP
    • Junket VIP RC fell 3%
    • Assuming a 16% direct play level, hold was 3.2% in February compared to 2.8% last year (assuming 13.7% direct play levels in-line with 1Q11)


Revs grew 12%

  • Mass was up 22% and VIP was up 8%
  • Junket RC was down 7%, implying 2.89% hold across the company’s properties




For the 9th month in a row, Galaxy posted table revenues growth north of 100% - at 122%. Mass soared 239%, while VIP grew 105%.

  • StarWorld table revenues grew 14%
    • Mass grew 35% and VIP revenue grew 12%
    • Junket RC grew 19%
    • Hold was low at 2.3% but the comparison from last February was also easy, at 2.4%
  • Galaxy Macau's total table revenues were $253MM – down MoM and 25% lower than October’s seasonal high and below November to January run rate of $281MM
    • Mass table declined 23% MoM to $52MM, the lowest level since September 2011
    • VIP table revenue declined 6% MoM to $201MM, also the lowest level since September
    • Hold was 2.74% - the property’s lowest hold since opening
    • RC volume of $7.3BN was 8% higher than January and compares to a peak of $8.3BN in October



Table revenues grew 6%, giving MGM the second slowest growth slot in February despite high hold

  • Mass revenue growth was 4% - the slowest of the concessionaires for the 2nd month in a row
  • VIP revenue grew 6%
  • Junket RC declined 4%
  • Assuming a direct play level of 9% for both periods, we estimate that hold was 3.12% this month vs. 2.83% in February 2011


Sequential Market Share




LVS share was flatish at 18.5% in February vs. 18.6% in January.  This compares to a 6 month trailing market share of 15.5% and 2011 average share of 15.7%.

  • Sands' share dropped 50bps to 4.2%.  For comparison purposes, February share was below 2011's share of 4.6% and 6M trailing average share of 4.3%.
    • VIP rev share decreased 50bps while Mass share fell 30 bps
    • RC share decreased 30bps to just 2.4%, an all-time low for the property
  • Venetian’s share dropped 1.8% to 7.9% from 9.7% in 4Q11- the lowest market share in 6 months.  2011 share was 8.4% and 6 month trailing share was 8.2%.
    • VIP share decreased 1.9% to 5.9%
    • Mass share fell 1.1% bps to 13.9%
    • Junket RC fell 70bps to 4.8%
  • January was the 5th consecutive month where FS gained share.  FS share was 6.2%, up 2.4% and an all-time high.  This compares to 2011 share of 2.2% and 6M trailing average share of 2.5%.
    • VIP share increased 3.0% to 7.4%, an all-time property best –aided by high hold.  This is the first time that FS VIP revenues exceeded those of Venetian and the second month in a row where they exceed Sands’ revenue.
    • Mass share increased 50bps to 2.4%
    • Junket RC improved 60bps to 5.9% - an all-time high for the property.  January marked the second month where RC share at Four Seasons exceeded that of Sands Macao and the first where volumes exceeded Venetian's.



Wynn’s share inched up 10bps to 12.6%, below its 6 month trailing average share of 12.9% and well below its 2011 average share of 14.1%.  We expect Wynn’s share to continue to struggle with the opening of Sands Cotai Central in April.

  • Mass market share fell 60bps to 9.4%
  • VIP market share improved 30bps to 13.3%, despite below market hold
  • Junket RC share fell to 13.3%, a 90bps MoM decline



Flip-flopping once again, MPEL was the largest share winner in February. Market share bounced back 1.6% points to 14.1%.  This compares to their 6 month trailing share of 14.2% and 2011 share of 14.8%.

  • Altira share improved 30bps to 4.1%, still well below the property’s 2011 share of 5.3% and 6M trailing share of 4.6%
    • Mass share ticked down 10bps to 1.4% while VIP share increased 30bps
  • CoD’s share improved 1.1% to 9.8%; above its 2011 share of 9.3% and 6M trailing share of 9.5%
    • Mass market share increased 80bps to 11%
    • VIP share increased 80bps to 9.4%
    • Junket RC was flat at 7.7%



SJM gained 60bps of share to 28.0%, better than their 6-month trailing average of 27.2% but below their 2011 average of 29.2%.

  • Mass market share increased 3% off of January lows to 36.6%
  • VIP share ticked down 30bps to 26.0%
  • Junket RC share fell 1% to 27.8%



Galaxy was the biggest share loser in February, impacted by low hold.  Galaxy’s share fell for the 5th consecutive month after ‘peaking’ at 20.9% in October.  February share of 16.6% was 1.9%, down MoM and below the 6-month trailing average of 19.7%. 

  • Galaxy Macau share declined 70bps to 8.7% below its 6-month trailing average of 9.8%, partly due to low hold
    • Mass share fell 1.5% to 7.2%, the lowest share in 6 months
    • VIP decreased 50bps to 9.2%, the lowest share in 7 months
    • RC share ticked increased 40bps to 10.4% - consistent with the 4 month average
  • Starworld share fell 1.1% to 6.7% below its TTM average share of 9.1% before Galaxy Macau opened.
    • Low hold was largely to blame for the share loss as Junket RC share increased 50bps to 10.8%



MGM share was flat at 10.3%. February share sits a little below MGM’s 2011 and 6-month trailing average share of 10.5%.

  • Mass share ticked down 10 bps to 6.7%
  • VIP share was flat at 11.2%
  • Junket RC ticked up 10bps to 10.1% 


Slot Revenue

Slot revenue totaled $132MM in February, with growth decelerating to just 9% YoY. None of the concessionaires hit records this month.

  • As expected, GALAXY slot revenues grew the most with 251% YoY to $16MM
  • MGM slot revenues had the second best growth at 16% YoY to $19MM
  • MPEL slot revenues grew 9% YoY to $24MM
  • SJM slot revenues grew 7% YoY to $17MM
  • LVS slot revenues fell 10% YoY to $29MM- the company’s absolute lowest level since June 2011 and marking the 3rd YoY decline in 7 months
  • Wynn experience the highest YoY decline with a 11% YoY drop to $25MM.  This was Wynn’s first month of declines in 2 years.







February is only one month but MCD needs global sales trends to remain strong to maintain its current valuation.  February, if this morning’s release is any indication, could be the first sign that MCD is not immune to the global economic reality. 


Our stance on the stock at this point is to wait and see.  We are not buyers of the stock on this selloff.  In short, if austerity is having an impact it will not be a one month phenomenon.





Adjusting for all the noise (weather and the trading days), in the month of February there was a sequential slow down in traffic trends in McDonald’s global business.  In Japan the “Great American Burger” promotion, in its third year, lost steam and the Chinese New Year also negatively impacted the headline APMEA number.  In Europe, France and Italy are a drag on same-store sales, while Spain – albeit modeslty – and Germany are having a positive impact.


Adjusting for calendar-shifts, all three divisions saw declines in two-year average comparable restaurant sales trends.  Japan reporting -1.2% was also a disappointment for the company. 


The February top line results in the USA adjusting for the leap year suggest a decline in two year trends as well as in the rest of the world.  Japan reporting down 1.2% was a big disappointment to the Asia region. 


McDonald’s reported sales of 11.1%, 4.0%, and 2.4% for the U.S., Europe, and APMEA, respectively.  Consensus was looking for 8.7%, 6.8%, and 8.6%, respectively.  Due to calendar shifts, the numbers include an adjustment ranging from approximately 3.1% to 3.4%. 











We were struck by the words “as previously communicated” in this morning’s press release because, while management did highlight the uncertain economy, austerity in Europe, and inflation as issues that posed business risk to the company, these factors have been withstood for some time by the McDonald’s business.  The oft-repeated explanation for MCD being the Teflon Don of the restaurant space last year was that the economic malaise actually benefitted the company.  Management’s commentary on conference calls never explicitly said this, but it was certainly inferred by many in the investment community;  management recently said, “…at the same time, Europe stayed committed to delivering compelling fourth-tier options and promoting everyday affordable pricing for consumers feeling the pressure in their local economies”… “despite this backdrop, our European business remains strong” (1/24 transcript).   The question is, from here, has the game changed for McDonald’s?  Was the investment community far too optimistic in its reading of management’s commentary and the apparent immunity of McDonald’s business to economic uncertainty?  Why is the soft economy now impacting results when it has little effect previously?


From a bottom line perspective, the impact of any top line slow down will be compounded by the fact that both D&A (from the all the remodels last year) and G&A, which will be up 6% in 2012 (due to technology, the Olympics, and world-wide franchise convention), are putting pressure on reported operating profit.


A quick scan of all of MCD recent filings terms “austerity” is mentioned two times in the  most recent 10-K and nine times in the most earnings call.  “Labor cost pressures” was mentioned once in the most recent 10-K and zero times in the most recent earnings call. “Economic uncertainty” was mentioned three times in the most recent 10-K and zero times in the most recent earrings call transcript. Again, management did communicate these issues, but we need to read between the lines to get to the conclusion about the impact on 1Q12.


The economic uncertainty and austerity measures in Europe are not new.  Commodity inflation is not a new trend either; beef prices have been moving higher but that is neither a new trend nor should it be a surprise.  Management highlighted mid-teen inflation in beef costs as being the most significant impact on COGS in 2011 and guided to a similar level in 2012 during the 4Q EPS call on 1/24. 


From the 10-K filed on 2/24/12: “In 2012, our European business will continue to face headwinds due to economic uncertainty and additional government-initiated austerity measures implemented in many countries. While we will closely monitor consumer reactions to these measures, we remain confident that our business model will continue to drive profitable growth.”   Again, no sign that there was going to be any real margin pressure – in fact this suggests less pressure in Europe this year versus last year.


From the most recent earnings transcript management filed on 1/24/12: “Europe's commodity inflation is expected to moderate a bit in 2012, with a projected increase of 2.5% to 3.5%.”  Additionally, the company said that the impact of “austerity” in 2012 was going to be less severe than in 2011, stating, “…some of these incremental austerity measures, so the increased social charges and some of the other taxes that are hitting the restaurants, those are going to be, while we'll have some new ones, the magnitude of those will be lower than we saw in 2011.”


Our stance on the stock at this point is to wait and see.  We are not buyers of the stock on this selloff.  In short, if austerity is having an impact it will not be a one month phenomenon.



Howard Penney

Managing Director


Rory Green




When Confusion Reigns, Call in the Sine Wave

The headline initial claims number rose 11k WoW to 362k (up 8k after a 3k upward revision to last week’s data).  Rolling claims rose 0.3k to 355k. On a non-seasonally-adjusted basis, reported claims rose 32k WoW to 366k.


Today's print is consistent with our "Lehman's Ghost" thesis. To recap, the collapse of Lehman Brothers in late 2008 distorted the seasonal adjustment factors in various government data sets. The dislocation in the economic data was incorrectly read as a seasonal pattern and the factors were revised accordingly. 


The seasonal distortion plays out as follows.  Claims were understated in the last weeks of February by the largest amount. From now through May, the understatement disappears.  Absent an underlying trend in the series, this effect will drive claims higher by 20-30k over the next three months. This trend continues to push claims higher by another 20k through July, by which time the series will be seeing its peak overstatement (claims are being reported higher than they actually are). Thereafter, the cycle starts over again. We do our best to depict this graphically with the sine wave chart below. The red arrow represents the current underlying trend in the jobs series, which is improving at a rate of around 3k per month. The blue sine wave represents the distortive impact the seasonal adjustment model is having on the data.  














2-10 Spread

The 2-10 spread widened less than 1 bps versus last week to 168 bps as of yesterday.  The ten-year bond yield also stayed relatively flat over last week, increasing less than 1 bps to 198 bps.






Financial Subsector Performance

The table below shows the stock performance of each Financial subsector over four durations. 




Joshua Steiner, CFA


Allison Kaptur


Robert Belsky


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Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.46%
  • SHORT SIGNALS 78.35%