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



Stifel Nicolaus Technology & Telecom Conference (2/8/2012)

  • “We have completely reorganized our international operations and are growing that business in the kind of the mid-teens right now.”
  • "If you look at those 950,000 boxes that are in the U.S., and Canada, in the North American market, about 600,000... are eligible for replacements in any given year... Right now, we're running at about 50,000 replacement units and then probably another 10,000 to 15,000 conversion kits as an industry. So, we're replacing a little bit more than 10% of the floor in any given year, which feels like about normal for us. And so we're not expecting any kind of major investment in the replacement cycle. Moving forward, we're actually trying to lower that tentpole right now by – again, looking for more distribution channels for that content whether that would be into the international markets, the online wager based or the virtual currency social based schemes."
  • “There's only 1.5 million...fully regulated licensed slot machines outside the U.S. And that 1.5 million number is growing at three times the rate high single-digits versus low single-digits.”
  • "For online gaming in the U.S., I think ... it's going to be kind of on a state-by-state basis... the first step will likely be poker which is peer-to-peer gaming rather than house-banked gaming like sports or casino... The states will probably try to ring fence the player liquidity. There will be four or five networks within each state and it will promote online gaming, but it won't be a very attractive product."
  • [Cloud technology]  “I think this month we'll be going into a casino in Estonia, then the following month it will be going into a casino in France, following that a casino into Mexico and then by October of this year at the big trade show, it will be a commercially available product and be adding to our systems revenue.”
  • [Stock buyback] “We're confident that we'll do about $100 million this year still, which will be about $25 million a quarter. We just started a little slow this fiscal year. So we'll be making that up over the course of the next nine months and that free cash flow, like I said, combined with dividends and the share repurchase program we're returning about $200 million a year to our shareholders."
  • "We're making about $200 million of investment in CapEx, which is mostly into the gaming operations business."


Youtube from FQ1 2012 Conference Call

  • "Our newest participation products, Ghostbusters, Hangover and Pinball MLD are all performing above average.  The product pipeline remains robust as well.  We expect Big Buck Hunter, Elvis the King and another exciting version of Sex in the City to launch this fiscal year."
  • "We anticipate average revenue per day and gross margins in gaming operations to improve throughout the remainder of fiscal 2012."
  • "We anticipate units and revenues to be up double digits year-over-year for our international business for 2012."
  • "We would anticipate seeing sequential improvements in yields due to the seasonality of the business as we move into this quarter and then June and then September generally is the seasonally strongest." 
  • "We think we are going to grow with the market, continuing to believe that, we will be in the 45 to 50% for new openings, given the increase that we typically get for new openings driven by our poker platform and then given the historically longer length of replacement for poker, we tend to be in the mid-30s in the replacement share. And that's what we continue to expect will happen in the upcoming quarters." 
  • "Essentially we understand how much R&D our P&L will support and then against that level of R&D we run a portfolio management approach where we look at the projects and we always have more appetite to spend than we have capacity to spend. So we make sure that we just draw the cut line at the $200 million, and make sure that all of those projects have a significantly higher return on investment than our average WACC."
  • "We are anticipating improving volumes and gross margin from our North American product sales over the course of 2012. For example, our premium core products like the G23 MLD and Universal Slant MLD represent a significant portion of our shipments and have gained quick acceptance in the marketplace. Our ship shares are improving and the new openings in Ohio and New Jersey are currently planned to ship this year."
  • "We are reiterating our adjusted earnings guidance from continuing operations of $0.93 to $1.03 per share, not including any potential impact from the Double Down acquisition."
  • "In Macau we still have relatively low market shares, sub 20%."
  • [Domestic replacement sales] "We feel like it's headed north....And I think the way to think about it in terms of unit flow in total, on a consolidated basis is, a nice step up in the March quarter, and then kind of consistent in the June quarter. And then it would appear that the fourth quarter, as is quite often the case, is going to be the strongest quarter, not due to any one thing, other than just timing of openings and the like."

President Obama's Reelection Odds Fall Below 60% -- Hedgeye Election Indicator


President Obama's Reelection Odds Fall Below 60% -- Hedgeye Election Indicator  - Screen Shot 2012 04 23 at 8.22.33 PM 



If the Presidential election were held today, President Obama's would have a 59.3% of winning reelection, according to the Hedgeye Election Indicator (HEI). It marks the fourth consecutive weekly decline in the HEI when President Obama's reelection odds peaked at 62.3% on March 26. 


Hedgeye developed the HEI to understand the relationship between key market and economic data and the US Presidential Election. After rigorous back testing, Hedgeye has determined that there are a short list of real time market-based indicators, that move ahead of President Obama’s position in conventional polls or other measures of sentiment. Two of those measures, the overall performance of US equities and the performance of equities in the US financial sector, declined, and those moves translated into lower odds of President Obama winning in November, according to the HEI.



President Obama's Reelection Odds Fall Below 60% -- Hedgeye Election Indicator  - HEI



Based on our analysis, market prices will adjust in real-time ahead of economic conditions, which will ultimately shape voters’ perception of the Obama Presidency, the Republican candidates and influence the probability of an Obama reelection.  The model assumes that the Presidential election would be held today against any Republican candidate. Our model is indifferent toward who the Republican candidate is as the sentiment for Obama and for any Republican opponent is imputed in the market prices that determine the HEI. The HEI is based on a scale of 0 – 200, with 100 equating to a 50% probability that President Obama would win or lose if the election were held today.


Hedgeye releases the HEI every Tuesday at 7 a.m. ET, all the way until election day Tuesday November 6.

PVH: Upside


PVH remains one of our favorite longs in 2012. Less than four weeks after reporting Q4 results, PVH preannounced after the close that Q1 EPS will come in ‘at least at the high end of guidance’ suggesting that CK and Tommy sales are still coming in ahead of plan and upside to Q1 EPS.


This is not new news. In fact, an in-line quarter would have been suggesting a deceleration in trends at CK, Tommy, or both since March to get there. As highlighted in our post on 3/28 ("PVH: Levers & Drivers"), we think PVH is going to pull a RL and end up coming in above the Street’s original $1.32E despite guiding to a more conservative $1.20-$1.25 range. This afternoon’s announcement suggests this scenario is increasingly likely. We’re at $1.36 for the quarter vs. the Street at $1.25E.


The company is also tracking towards the high-end of its full-year outlook of $6.10-$6.20. We’re at $6.45 in EPS for 2012 driven by stronger sales rather than a reduction in spending. More importantly, PVH is doing what the best brands do that license out their brands in order to grow into international markets – it’s starting to take back control of its own content. Driving brand sales directly at higher margin was key to RL’s success through much of the last decade as the company bought in its licenses. We don’t expect PVH to be any different. With earnings power of $8 in 2013, we think the stock and estimates are headed higher.


For more detail following Q4 results, see our post "PVH: Levers & Drivers."


Casey Flavin



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Money Talks: Donation Trends as a Leading Indicator for the 2012 Presidential Election

Conclusion:  While Obama has a clear edge in polls, indicators, and electoral college math, he has a less decisive edge in fundraising and is trailing his 2008 performance. 

As we’ve been writing in recent political notes, the outlook for President Obama’s re-election odds currently look very positive based on a number of indicators.  The first and foremost for us is likely our own proprietary indicator, the Hedgeye Election Index (HEI).  The indicator currently has President Obama’s chances of re-election at just over 59.3%.  The HEI is based on a number of real time economic indicators that correlate closely with Obama’s performance in conventional polls.


Money Talks: Donation Trends as a Leading Indicator for the 2012 Presidential Election - chart1


On InTrade, the world’s largest predictive market, the chance of Obama being re-elected is currently pegged at 60.4% and that figure has held steadily above 60% since March.  This followed a relatively lengthy period of time in which, as can be seen in the chart below, President Obama’s chances of re-election were much closer to 50%.  In fact, in September and October of 2011, the chances were solidly below 50%.


Money Talks: Donation Trends as a Leading Indicator for the 2012 Presidential Election - chart2


In traditional polls comparing Romney versus Obama, we see a similar trend.  Specifically, if we look at the last ten major polls that compare Obama and Romney, Obama wins in 7 of 10, Romney wins in 2 of 10, and one poll is a tie.  Based on the Real Clear Politics poll average, Obama currently has an advantage of +3.1 versus Romney. 


As we drill down into the electoral vote math as driven by state-by-state polls, Obama’s situation also looks convincing.  Most pundits, including us, agree that Obama would safely carry 14 states, mostly on the coasts, which would garner him 186 electoral votes.  Meanwhile, it is likely that Romney safely carries 20 states in the South and West, which would garner him 156 electoral votes.  Since the magic number of electoral votes needed is 270, this leaves many states still up for grabs. 


In the scenario that Romney then won all of the states that Bush won in 2008, which includes Florida, Ohio, North Carolina, Virginia, Colorado, Indiana, Iowa, New Mexico, and Nevada, Romney would receive an additional 112 electoral college votes.   Assuming that occurs, Romney’s total would then be 268 total Electoral College votes, which would obviously still be two short of the total needed for Romney to win the Presidency.  As well, a lot would have to go right for Romney to win every single one of the aforementioned states.


So, as things stand today, an Obama re-election looks likely.  There are two factors that we think may not be totally accounted for in today’s polls and indicators.  The first is deterioration in the economy over the next couple of quarters, a factor that is becoming increasingly likely.  The second is political fundraising, which has historically been a good leading indicator for electoral success.


In fact, political scientist Adam R. Brown published a paper titled, “Does Money Buy Votes? The Case of Self-Financed Gubernatorial Candidates, 1998 – 2008”, that looked at this the relationship between money and votes.   His conclusion was:


“Because campaign spending correlates strongly with election results, observers of American politics frequently lament that money seems to buy votes. However, the apparent effect of spending on votes is severely inflated by omitted variable bias: The best candidates also happen to be the best fundraisers. Acting strategically, campaign donors direct their funds toward the “best” candidates, who would be more likely to win even in a moneyless world. These donor behaviors spuriously amplify the correlation between spending and votes. As evidence for this argument, I show that (non-strategic) self-financed spending has no statistical effect on election results, whereas (strategic) externally-financed spending does.”


If we take this a step further, it implies that in a Presidential election the money that is raised directly by the President, or his competitor, versus by his Party or a Super Pac, is strategic in nature and the most likely indicator of success.  In this vein, Obama looks to be struggling.


Currently, President Obama has raised only $196 million as of the end of Q1 2012 for his re-election campaign.  This is almost $40 million less than was raised by the same point in the 2008 election.   Further, donations by specific industries are down dramatically from the last election.  Most notably, donations from the investment industry are down -68% and donations from law firms are down -47%.


Not only are Obama’s fundraising efforts lagging, but it appears that Democrats in aggregate have been lagging Republicans.  Certainly some of this has to do with the fact that the Republicans had a Presidential primary that attracted a large amount of donations, but the trends remain somewhat staggering versus 2008.  The allocation of donations, so far at least, has shifted towards the Republicans in almost every major sector of the economy, even from unions.  The chart below highlights these trends.


Money Talks: Donation Trends as a Leading Indicator for the 2012 Presidential Election - chart3


If we look at corporations exclusively, a very similar trend emerges.  The chart below shows donations from major corporate sectors for 2008, 2010, and 2012. Once again, we see the trends shifting steadily towards the Republicans. (The reason some of these percentages do not add up to 100% is due to some money going to third parties and some being classified by the Center for Responsive Politics as “soft” money.)


Money Talks: Donation Trends as a Leading Indicator for the 2012 Presidential Election - chart4


The most staggering shift in donations is coming from, no surprise, the financial sector.  As an example, in 2008, 75% of donations from Goldman Sachs went to Democrats.  In 2012, only 21% of donations from Goldman Sachs went to Democrats.  Now, to be fair, part of this is once again that the Republicans just had a competitive Presidential primary, but as the chart below highlights these trends also occurred in 2010.


Money Talks: Donation Trends as a Leading Indicator for the 2012 Presidential Election - chart5




The other key area where the Republicans are leading the Democrats in the cycle is in Super Pac funding.  There are two Super PACs supporting Romney, American Crossroads and Restore Our Future, which have a combined $34 million on hand.  Meanwhile, there is one Super PAC that is supporting President Obama, Priorities USA, which has $2.8 million on hand.  Studies suggest Super PAC money is not as much of an indicator of electoral success as direct donations to the candidate, but, nonetheless, even here the Romney edge is meaningful.


In conclusion, while President Obama continues to look solid in many of the real time indicators we follow, the money appears to be flowing to the Republicans and Romney.  In the arms race that is a Presidential campaign, money talks.   




Daryl G. Jones


Director of Research




A Refreshed Look at Asian and Latin American G/I/P Trends

Conclusion: Growth Slowing continues to be the predominant theme across both regions and the monetary policy outlook is generally less supportive than it was 3-6 months ago. Combined with our forward-looking G/I/P analysis, this backdrop makes consensus valuation/"buying opportunity" calls risky from a TREND-duration perspective.


On red days like today, naturally higher-beta names lead to the downside from a single stock perspective; the same can generally be said from a country risk perspective as well, given the relatively high volatility of the various emerging market equity indices, currencies, and bond markets. Rather than overreact to these proactively-predicted drawdowns, we find it helpful from a research perspective to head back to the trenches of fundamental analysis in order to refresh our general thoughts on each region.



Looking at the trailing data points out of both Asia and Latin America, it’s clear that rates of economic growth continues to make lower-highs across both regions. The ~2yr trend of slowing Real GDP growth continued unabated in 4Q11, with Asia (+6.8% YoY) and Latin America (+3.2% YoY) both posting headline numbers that were the lowest since 2H09 for each region, respectively.


A Refreshed Look at Asian and Latin American G/I/P Trends - 1


For a more up-to-date measure of regional demand, we turn to each region’s GDP-weighted Imports, with the premise that the growth rate of the quantity of goods imported represents a broad read-through into the demand trends of a particular country or region – irrespective of their ultimate destinations (consumption, fixed asset investment, manufacturing and re-export, etc.). As the chart below shows (though MAR ’12) demand in Asia and Latin America continues to slow:


A Refreshed Look at Asian and Latin American G/I/P Trends - 2



Looking at each region’s trailing inflation trends, a bifurcation has emerged in timing, with Asian CPI peaking from a cyclical perspective in 3Q11 and Latin American CPI having done the same in 4Q11. In Asia, inflation (+3.6% YoY) hasn’t been this slow since 4Q09; in Latin America since 3Q10 (+6.6% YoY):


A Refreshed Look at Asian and Latin American G/I/P Trends - 3


The trend of slowing inflation across both regions has been supported by relative currency strength vs. global food and energy prices, which have become increasingly driven by U.S. monetary policy. Still, despite what the Chinese, Brazilians and South Koreans have identified as a Fed/ECB-induced “flood of destabilizing liquidity”, their currencies have recently experienced less downside on the margin relative to the USD than key commodity prices over the LTM – thus providing a disinflationary tailwind to each region’s CPI indices:


A Refreshed Look at Asian and Latin American G/I/P Trends - ADXY


A Refreshed Look at Asian and Latin American G/I/P Trends - LACI 



Monetary policy, which is far less easy and insightful to aggregate, is fairly bifurcated across both region – a noteworthy delta from late in 2011, when the country-to-country outlooks collectively sang the tune of easier policy across the board. While forward-looking currency markets generally continue to suggest easier policy ahead across both regions, forward-looking interest rate markets are pricing in a wide range of outcomes over the NTM – largely due to expectations of easier policy (on the margin) being pared back over the last 3-6 months:


A Refreshed Look at Asian and Latin American G/I/P Trends - 6


When analyzed on a holistic basis country-to-country, both the direction and magnitude of anticipated monetary policy throughout various counties in Asia and Latin America leads to some clear divergences, as outlined in the chart below:


A Refreshed Look at Asian and Latin American G/I/P Trends - 7



Looking ahead, our predictive tracking algorithms suggest Asian Real GDP growth bottoms here in 2Q, while that of Latin America slows at a demonstrably slower rate in the quarter. Jumping the 3Q, our models are currently pointing to a modest inflection point in the slopes of both region’s rates of economic growth. The 3-6 month inflation outlook for both regions is fairly muted from both a directional and magnitude perspective. We are comfortable with this fundamental outlook provided we see a continued Deflating of the Inflation across key commodity markets. As always, we will continue to vet all the relevant information (market prices, economic data, policy maneuvers, etc.) on a daily basis to either confirm or dispel this baseline scenario, flagging to you in real-time any meaningful divergences.


Darius Dale

Senior Analyst


A Refreshed Look at Asian and Latin American G/I/P Trends - 8


A Refreshed Look at Asian and Latin American G/I/P Trends - 9


McDonald’s continues to be the de facto safety trade of the restaurant space.  Our opinion at this point is that there are some subtle changes taking place as the new Chief Executive Office takes over that are worth noting.


On Friday we took the opportunity to ask Don Thompson what he thinks his legacy will be when he finds himself – hopefully long from now – closing in on retirement as Jim Skinner currently is.  His response was, in our view, interesting in that he mentioned the “Plan to Win” but also spoke of the importance of growing organically and building new restaurants coincidentally.  Specifically, Thompson stated that “we are much smarter now” and that McDonald’s “can walk and chew gum at the same time” [organic unit growth].  We do not view this as a negative for the company but it does represent a lower return growth profile for the company than we have seen over the past five years.


Thompson’s three “global priorities” are:

  1. Optimizing the menu [transitioning from dollar menu]
  2. Modernizing the customer experience [remodel/reimage program]
  3. Broadening accessibility to Brand McDonald’s [unit growth]

Unfortunately, the McDonald’s conference call was littered with headwinds facing the company that are, on a relative basis, greater than those facing competitors such as Yum Brands.  McDonald’s highlighted three major hurdles facing the company in 2012.  Firstly, the economic climate remains challenging, particularly in Europe.  Secondly, consumer confidence remains varied across markets.  Finally, the company highlighted “economic pressures and inflationary costs”.  Beef has been a key driver of these cost pressures.


Simply comparing McDonald’s to Yum Brands under the specter of these three factors paints McDonald’s in an unfavorable light relative to its rival. Yum has shrugged off concerns related to China’s rate of growth but McDonald’s’ exposure to Europe seems to be causing some concern among management personnel and investors alike. 





Changes on the margin are all-important and we see the decrease in emphasis on beverages as a strategy going forward as being important.  While management said that “the U.S. also continues to strengthen its position as a as a beverage destination”, total beverage units were only up 6% versus up 20% in 4Q11, 16% in 3Q11, and 29% in 2Q11.  In fact, the word “beverage” was only mentioned twice on the 1Q12 call.  The 4Q11, 3Q11, and 2Q11 calls included 4, 8, and 18 mentions of the word “beverage”, respectively.  The word “McCafé” was mentioned twice on the 1Q12 call.  The 4Q11, 3Q11, and 2Q11 calls included zero, 7, and 11 mentions of the word “McCafé”, respectively. 


The evidence suggests that beverages are increasingly becoming a less important part of the vocabulary from McDonald’s’ management team.  With that in mind, foremost in our thoughts is what the company’s strategy will be to maintain top-line momentum over the next few months.


MCD: WHERE TO FROM HERE? - mentions mcd




The beverage initiative last year clearly helped McDonald’s take share from competitors.  Don Thompson did provide an interesting take on the industry when he said, “around the world we continue to gain market share in an industry with minimal-to-negative growth”.  For a frame of reference, the Justice Holdings presentation touting the upcoming Burger King presentation cited an industry growth number of +6%!


For McDonald’s, one of the core initiatives in the U.S. this year is an attempt to evolve the company’s value proposition with the new Extra Value Menu and, in doing so, turn away from the existing dollar menu.  Beginning in April, McDonald’s is focusing the menu on four tiers (excluding combo meals):

  1. Premium ($4.50-5.50)
  2. Core ($3.50-4.50)
  3. The new Extra Value Menu ($1.20-3.50)
  4. The Dollar Menu

Given that the company is guiding to 4.5-5.5% inflation in the U.S. in 2012, we believe that management is attempting to manage check and margin by forcing customers to trade up to the Extra Value Menu from the Dollar Menu.  This belief is supported by the fact that one of the biggest changes that the company is undertaking is the addition of fresh baked cookies and ice cream cones to the Dollar Menu in place of small drinks and small fries. 


Our view remains that this is a big risk for McDonald’s.  If this change goes against consumer preference, there is a

possibility that satisfaction scores will be negatively impacted.  When we spoke to the company in March when the menu changes were first announced, we learned that a “mini-combo meal” offering may bundle the fries, burger, and drink but a decision has not been made on that yet.  Still, ordering the $1 items individually is no longer an option. 







Turning to Europe, McDonald’s has been significantly impacted by the macroeconomic environment there, more so than any other multi-national restaurant company due to its relatively larger exposure to the region.  Europe represents 40% of total revenues for McDonald’s and 39% of operating profit.  As Don Thompson said, Europe is a region that “continues to experience unprecedented economic challenges from widespread austerity measures, concerns over the sovereign debt crisis and unemployment levels averaging about 10%”.


The company has long been focused on upgrading the customer experience; 80% of the system’s interiors have been refreshed as well as 50% of the exteriors.  Roughly 150 McCafés will be added to the Europe system in 2012.







In APMEA, McDonald’s called out the challenging economic conditions in China (8.5% same-store sales), ongoing “tightening” in Australia, and uneven results in Japan.  Again, the company is looking to value as a strategy with the recent launch of the Loose Change Menu in Australia last month.


We think that APMEA is an important component of the long-term strategy for McDonald’s but, given that it only comprises 18% of EBIT, the near term story will be dictated far more by business in the US and Europe, which account for 43% and 38% of EBIT, respectively.


MCD: WHERE TO FROM HERE? - mcd apmea





McDonald’s trends are not disastrous but going forward, we see plenty to be concerned about.  Specifically, lapping the outsized performance of the U.S. business last summer, which was driven by impressive beverage sales, and maintaining momentum in Europe are two key issues.  As we wrote earlier, beverage unit growth is sequentially slowing so we believe that catalyst is no longer a major factor. 


Given the pending IPO of Burger King and our view that the brand is “too big to fix”, it struck a chord when McDonald’s management emphasized that it is “willing and able to invest for continued growth and to widen our competitive advantages”.  In reimaging 2,400 restaurants globally (800 U.S., 900 Europe, and 475 APMEA) and rebuilding 200 U.S. locations, the company is clearly in a position of strength versus its closest rivals.  The longer-term outlook for McDonald’s is positive, with competitors like Wendy’s and Burger King floundering, but growth in that segment of quick service pales in comparison to fast casual/specialty.  We would look elsewhere for top long QSR ideas at this price.  Jack in the Box is one company that we believe has upside potential from here.


Globally, the price factor flowing through the company’s income statement is roughly 3%.  With inflation pressuring margins, particularly in the U.S., sales trends will take on an increased importance.  Given the difficult top-line compares and uncertainty around the transition from Dollar Menu to Extra Value Menu, our conviction on the top-line continuing to meet consensus is tenuous at best.


MCD: WHERE TO FROM HERE? - mcd quadrant



Howard Penney

Managing Director


Rory Green



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