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Will management announce the elephant in the room on the earnings call next Tuesday?  They did not do so during a conference presentation three weeks ago. We believe they have to; at 20% of sales, the cost of bone-in chicken wings is too critical a factor for the company's EPS this year.  




Howard Penney

Managing Director


Rory Green



Ohio slippage shouldn’t stop the BYI train.



Even with the deferral of recognition of the Ohio units, BYI should still at least meet the consensus estimate for the quarter.  Our EPS and revenue projections of 67 cents and $232MM are in-line with consensus.  BYI will print their number after the close next Thursday. 


For those that have been getting our research for a while, you already know that we like BYI over the long and intermediate term.  Since we turned positive on BYI on October 6th (see our note, “BYI: WE’VE GOT THAT GOOD FEELING”), the stock has been on a nice ride up from $27.  Of course, with the stock up over 70%, they need to keep delivering for the stock to work from here.  While we’re not projecting a huge beat, a solid quarter and a favorable outlook shouldn’t disappoint investors who are in for the long term.



FQ3 Detail:


We’re projecting $81MM of gaming equipment revenue at a 44.5% gross margin.

  • 4,500 units
    • 1,000 international unit sales
    • 3,500 NA unit sales
      • 775 new unit sales, the majority of which were shipped to Revel.  Other shipments in the quarter should include:
        • Valley Forge, PA
        • Several Tribal expansion in Florida
        • Ohio casinos were shipped in the quarter but we do not believe that BYI will recognize revenues from these units until next quarter
      • 2,725 replacement units - The March quarter is usually a stronger replacement quarter than December.  We believe that replacement shipments in the March 2011 quarter for the market were just under 15k and estimate low single digit growth in replacements for the March 2012 quarter.  In the December Q, we estimate that BYI garnered 17% replacement share vs. 15% in the March 2011 quarter.  We expect their share to increase sequentially this Q.
  • ASP of $16.3k down QoQ but up YoY.  On the last earnings call the company cautioned that the high ASPs in the December quarter were driven by a high mix of Pro Curve games but that ASP’s going forward should be “more reminiscent of the prior two quarters.”
  • Margins on new game sales should increase sequentially as the December quarter was also negatively impacted by a high mix of Pro Curve units sold
  • $8MM of parts and other revenue

We’re projecting $58MM of systems revenue at a 70% margin

  • The opening of PH1 of Sands Cotai Central should provide a boost to revenues
  • Estimating 12% QoQ increase

We expect gaming operations revenue of $92.6MM at a 70% margin

  • March has always been a better quarter seasonally for BYI vs. the December quarter for gaming operations revenue
  • With the shipment of Greece units, we should see a tick up in WAP revenues
  • Another good quarter from NY lottery VLTs, benefiting from a full quarter of Resorts World NY at full capacity and continued growth in average win per day in NY, which were up 14% YoY this quarter

Other stuff:

  • SG&A: $61.5MM
  • R&D: $24MM
  • D&A: $6MM
  • Net interest expense: $2.5MM
  • Tax rate: 36.5%

HBI: Severe Pricing Gap Remains

We revisited the pricing disparity within HBI’s core basics category across 3 of its largest customers (WMT, KSS, JCP) which was prevalent in February. The pricing gap on like-for-like product remains what we’d call severe. 


In our 2/13 note "HBI: Pricing Disparity = Uncertainty" we addressed the gap in Hanes’ basics pricing across various mid tier department stores and mass retailers.  Additionally, we outlined our expectations for competition on price to heat up in 2H and as a result, while costs ease, pricing will buckle for HBI and offset the improvements on the cost side. In February, there was a prominent bifurcation in price points for like goods at KSS, WMT, AMZN & JCP. This gap is still in place today – down to the penny. Perhaps this is a positive for HBI that its customers are able to maintain such opacity. But we question how long the balloon can be held underwater.


Our expectations for price competition to headline the back half of 2012 stem from industry dynamics, primarily JC Penny’s radical shift in pricing which will stir defensive responses from KSS, SHLD (if it still exists), M, TGT and Amazon.  As of today, we have little transparency into what kind of traction JC Penney’s “Fair and Square” pricing strategy has gained on the consumer however we can say that from where we sit, Ron Johnson and team have started doing a better job conveying the strategy’s message. Previous ads have been replaced with the actual math (see below) – a watch that cost $30 last year, cost $21.99 when on sale (last year) and then $17.59 with an additional 20% off now costs $15…. everyday – clear as clear can be. Compare messaging from KSS vs. JCP. It’s like night and day.


Right now (and unchanged from February’s check), for the same commodity Hanes 5 pack of crew T-Shirts, KSS pricing is 36% above JCP. Likewise, for an identical 4 pack of boxer briefs, KSS pricing is 44% above JCP. After adjusting for online BOGO and volume incentives, KSS remains 42% and 50% above JCP for the same two items respectively. The pricing disparity here doesn’t address Wal-Mart who actually has the best price for Hanes’ basics in undershirts, boxer briefs & socks (see chart 2 below). Interestingly though, at WMT, across the 3 basics categories, Hanes’ pricing is at a premium to Fruit of the Loom & Starter (GIL) for the items we analyzed (chart 1).


Near term, we expect the results tomorrow after the close to be in line with consensus (-$0.33), if not slightly better. The company has been on the road constantly over the past two months and has been extremely bullish about its prospects. It has all the visibility it needs this quarter. But as for visibility into 2H, the lock on revenue evaporates.  Looking out to the intermediate term however and considering the implications a price battle could have for the commodity retailers like HBI, we’re shaking out at $1.54 vs $2.50E for F12. For additional takeaways following the 2/15 call, see our note "HBI: Fail"


HBI: Severe Pricing Gap Remains - WMT brand pricing


HBI: Severe Pricing Gap Remains - HBI basics


HBI: Severe Pricing Gap Remains - JCP ad


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Earnings Week At Hedgeye: Spotlight on Retail


Earnings Season for the Retail Supply Chain kicks off in earnest later this week with both Hanesbrands and UnderArmour showing their wares. We think that the broader take-away from this earnings season will be one of complacency – though it might not be fully apparent at the time. Companies have a great excuse in unfavorable winter weather, and little visibility into what the real underlying sales trends are in April due to the rather severe impact that the change in the holiday calendar is having on the top line. Specifically, Easter was on April 24th last year, while this year it fell on the 8th. Given what we think is about a 3-week ramp of sales into the Easter holiday, the event definitely pulled sales forward into the month of March. As a result, companies who operate on a January – December fiscal calendar will recognize Easter spending in Q1 vs Q2 last year. We can argue anywhere from a 1% to 5% impact on sales results for March/April. The reality is that the companies are largely unaware of the actual magnitude of the shift either. But any kind of soft comps in April will probably be given a free pass.


On top of the holiday calendar shift, the industry is at the tail end of a meaningful ramp in commodity costs that has the Street modeling a significant ramp in earnings growth in 2H12. That’s where we get concerned. People tend to forget that Gross Margins are not all about costs, there’s also a revenue/pricing component. All of the retailers are planning to keep lower commodity costs in 2H. But no one is banking on any peers breaking rank. JC Penney’s EDLP strategy will absolutely put Kohl’s on defense. That’s 12% of the apparel industry right there. What about Target, Sears, Amazon, Gap/Old Navy… The numbers start adding up. Margins are a zero sum game in this business. If prices come down, someone has to pay for it – either the brand, the manufacturer in Asia, the retailer, or the consumer. The only safe bet for us is that it won’t be the consumer.


To put some numbers behind the madness, consider the following:


a)      The current consensus earnings growth forecast for the next 12-months is 23%. We have not seen this kind of growth since we came off of recessionary earnings numbers in 2010.


b)      The market is giving this earnings growth a 17x p/e. We’ve only seen that kind of multiple five times in 3-years, but always at times when the group was still clearly under-earning. Who are we to say that it is NOT under-earning today? But to make this case, we need to see a considerable upshift in consumer spending alongside another decline in raw materials costs. We don’t like that call.


c)       Revenue: 4Q was the first time in 3-years where revenue growth in retail was below 7%. Granted, it was on a tough comp vs the prior year, but the 2-year run rate has been stuck squarely at 10% for the past five quarters.


d)      EBIT Margins have been down for the past  three quarters by an average of about 50bps. The consensus is banking on a reversal in EBIT margins in 2H and in 2013. Such a sharp reversal would be the first time we’ve seen a non-recessionary rebound to that degree in well over five years.


e)      We’re going on six consecutive quarters where inventories are growing faster than sales. Maybe this supports the case for a sustained top line, but certainly not at the margin levels people are expecting in 2H.


So where do we want to be invested? We like stories that have asymmetric factors that will allow them to work in any climate, such as LIZ, URBN, FINL, DECK, ANF, NKE and RL. We don’t like names that will get stuck in the middle of the margin madness, such as KSS, JCP, HBI, GIL, CRI and JNY.






Brian P. McGough
Managing Director

Argentina, Imploding

Conclusion: Keep a small space on your white board(s) for the risk of another large-scale Argentine default over the long-term TAIL. At a bare minimum, another bout with domestic hyperinflation is an elevated risk over that duration, as the country seeks to deplete the very resources it needs to maintain stability in its currency.


In NOV of 2010, we wrote a note titled, “Is Argentina Signaling a Cyclical Peak in Emerging Market Asset Values?” in which we used Argentina’s country-specific fundamental outlook to highlight our generally-bearish thoughts on EMs. Using the MSCI EM Equity Index as a proxy for “EM asset values” we were roughly +4% too early in making that call (though the index did experience a -31% peak-to-trough decline in the months following our publication). Looking to Argentine equities specifically, the country’s benchmark Merval Index is down roughly -29% since NOV 4, 2010. In addition to the equity market crash, the nation’s 5yr CDS jumped +378bps (roughly +62%) since then and its currency, the Argentine peso, is down -10% as well.


Argentina, Imploding - 1


As with all of our research, the point is never to take victory laps, but rather to inform our clients on pending material risks (+/-) that we view as increasingly probable. With Argentina, another round of domestic hyperinflation (per IASB standards) is not at all out of the realm of possibility over the long-term TAIL. Ironically, this is likely to come alongside a continued popping of Bernanke’s Bubbles across the commodity market(s). As we walk through in the analysis below, structurally lower commodity prices = a structurally higher probability that Argentina is forced to default on its external sovereign debt over the long term.


Per the oft-maligned Institute of Statistics and Census of Argentina (INDEC), agricultural and petroleum products account for 66.2% of Argentina’s export revenue. Soybeans alone make up 24.1% of the total, followed by fuel and energy products at 12.2%, and then cereals (mostly wheat and corn) at 8.3%. The reason we focus on Argentina’s export revenue is because FX reserves have become the primary source for Argentina’s servicing of its existing stock of external debt – especially given that Argentina remains locked out of international credit markets largely as a result of private creditor holdouts from its $95B default in 2001 and subsequent ’05 and ’10 restructurings (eventually totaling 92.6% of the original defaulted amount).


Recent legislation has dramatically increased Argentina’s reliance on its stock of FX reserves to service international debt. In MAR, the Argentine Senate approved President Fernandez’s proposal to eliminate the “free-and available” clause from the 1991 Dollar Convertibility law that was largely responsible for helping Argentina overcome hyperinflation by pegging the peso at a 1x1 rate vs. the USD. This allows the Argentine Treasury to use all of the central bank’s FX reserves to fund whatever purchases policymakers desire, including servicing international debt. Previously, the law had stipulated that the country was only able to tap FX reserves in excess of the domestic monetary base.


The Treasury, which now has unmitigated access to the central bank’s $47.5B in FX reserves, has already used $16.2B of FX reserves since 2010 to service the country’s external debt; another $5.7B of those reserves are budgeted for debt service in 2012, leaving the country with $41.8B at year-end (assuming no little-to-no growth in the existing stock). At that pace – which could easily accelerate given the socialist agenda of President Fernandez – Argentina will run out of reserves by 2020 (again, assuming no growth). Per Bloomberg, Argentina has $82.3B, $31.5B, and $2.2B in USD, EUR, and JPY denominated debt outstanding, respectively.


Argentina, Imploding - 2


In addition to tapping FX reserves for debt service, the rule change now gives the president access to increased “loans” from the central bank (now 20% of LTM total vs. 10% prior). We view it as highly unlikely that the central bank is paid back on time and/or at all if the sovereign is ever in a pinch – lest it continue nationalizing domestic assets, such as the recent YPF SA takeover. The ouster of Spain’s Respol from its controlling stake in its Argentine unit is but one of a long series of credibility-damaging maneuvers Fernandez has either initiated or endorsed since winning reelection last fall:

  • New legal restrictions (up to criminal prosecution) on domestic purchases of foreign exchange;
  • Legislation forcing importers to require approval from the federal tax agency for all overseas purchases; and
  • Forcing dividend-paying banks to hold 75% more capital (designed to deter them from making dividend payments to international shareholders).

The common theme with these measures is that they have each been more-or-less designed promote financial repression in the form of quashing capital outflows, which, in essence, artificially prop up central bank reserves. Over the long term, however, there is little the country can do to salvage the near-irreparable damage Fernandez has done to the country’s already-low international credibility among investors. Capital inflows will become increasingly scarce over the long-term TAIL, limiting growth in FX reserves, which would already be under assault in a sustained Strong Dollar environment. The following commentary in the wake of the YPF SA seizure lends credence to our long-held view:

  • “I am seriously disappointed by yesterday’s announcement. We expect the Argentine authorities to uphold their international commitments and obligations, in particular those resulting from a bilateral agreement on investments with Spain.” – European Commission President Jose Barroso
  • “A takeover sends a very negative signal to international investors and it could seriously harm the business environment in Argentina. The measure creates legal insecurity for all European Union and foreign firms in the country.” – European Union Foreign Policy Chief Catherine Ashton
  • “Argentina aimed to take over YPF cheaply and the company demands compensation… The expropriation isn’t anything more than a way to cover up the social and economic crisis Argentina is suffering at the moment.” – Repsol Chief Executive Officer Antonio Brufau

As an anecdote, I’ve exchanged correspondences with former Argentine Central Bank Chief Martin Redrado over his 2010 termination for refusing to tap FX reserves to supplement public spending and service international debt due to its inflationary consequences; needless to say, his worst fears are being realized in real-time. More importantly, perhaps the worst is yet to come for his home country.


As such, keep a small space on your white board(s) for the risk of another large-scale Argentine default over the long-term TAIL. At a bare minimum, another bout with domestic hyperinflation is an elevated risk over that duration, as the country seeks to deplete the very resources it needs to maintain stability in its currency. Per the chart below, the FX non-deliverable forwards market is pricing in a -20% decline in the Argentine peso over the NTM. At this pace of introducing new [bad] economic policy initiatives, we’d expect even more downside over the long-term TAIL.


Darius Dale

Senior Analyst


Argentina, Imploding - 3

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