As we all know, the Q4 meltdown spurred a sharp contraction in trade globally and regardless of relative strength China could not avoid the pain, even if they are better off than many of their neighbors (Korea for instance, which we are short via the EWY ETF, printed numbers showing a 5.6% contraction in GDP and an 11.9% contraction in exports). We knew the backdrop for all of this was in the cards, but that is looking in the rear view mirror. In the here and now, a 4 trillion Yuan spending package is just starting to trickle through the system and the five cuts in the key lending rate, initiated in Sept. are just starting to nudge the Dragon.
It is critical to remind ourselves that China is still a communist nation –as such the party leaders are very aware that they must stem job losses and rescue symbolic industries in order to sustain the minimal rate of economic growth assumed to prevent internal social problems. Critics of some of our work on China often point out, correctly, that there is a good deal of “massaging” in reported Chinese economic data -but you can’t fool your hungry people with fake data (something that Christina Kirchner is discovering too late in Argentina).
These leaders don’t run for election, they don’t need to build consensus and they don’t have to apologize for bending rules. To achieve the growth levels they need, the Chinese government will use ANY and ALL tools at their disposal -including shrugging off any protests by team Obama over currency manipulation no matter how loud.
We are Watching China and its derivative economies closely and as always will be looking to change our exposure as data points present themselves.
Analyst question: Why were domestic product sales better than I expected?
My answer: Because you don’t do the work.
Industry unit sales were up around 40% in the December quarter based on our exhaustively detailed schedule of new casinos and expansions. Clearly, the sell side doesn’t maintain this incredibly useful database.
All the slot guys will have a strong December quarter in terms of slot sales. I was actually very happy to hear this question because if the analysts didn’t know that Q4 slot sales were going to be good, then they certainly don’t know that 1H CY2009 slot sales will be awful. We project industry unit sales to new and expanded casinos to fall 40% and 70% in FQ1 and FQ2 2009, respectively.
Yeah but replacement demand is facing an easy comp from 2008 so that will pick up some of the slack, right? Wrong. IGT’s CEO, TJ Mathews, clearly stated that industry replacement demand will be lower in 2009 than 2008 due to capex cutbacks by the operators.
So with these industry dynamics, how does WMS meet the 10% revenue growth projections? More market share gains? WMS market share would have to almost double from its recent 15-20% to make the consensus revenue projections for 1H CY2009. WMS market share has actually trended lower the last 2 quarters. How about gaming operations? Slot play is trending lower, not higher, due to the economy. I wouldn’t bet on gaming ops beating consensus expectations.
IGT’s quarter essentially confirmed our thesis that slot sales, while strong in Q4 CY2008, will be down considerably in 1H CY2009. This is not good for WMS.
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On a relative basis there was plenty of pain to go around with orders declining for Germany, France and Italy by 29.3%, 27.7% and 27.2% respectively.
The sector hardest hit was transport equipment (including ships and railways) which fell 46% Y/Y -a quick look at the Baltic Dry Index will make it very clear that new ship orders will not be staging a comeback anytime soon. Orders for metals and machinery dropped 28% and 24% Y/Y respectively.
The EU officially expects the economy of the 16 nations that use the euro to shrink 1.9% this year. With European economic confidence at a record low and services and manufacturing activity contracting for a seventh month in December, this data point suggests that might be wishful thinking.
We will keep our eye on the Eurozone economies looking for trading opportunities (we are short the UK via the EWU ETF currently, but that is a different, and even worse, story altogether).
Looking at the chart below, this data point puts the thesis of making lower highs in US weekly claims under assault, for now… next week we’ll get the river card.
In between now and then, I expect the SP500 to give the Bear camp the benefit of the doubt. I have downside support for the SP500 at 799 (5% lower than yesterday’s close.)
Keith R. McCullough
CEO & Chief Investment Officer
1. I calculate operating EPS of $0.22 which is below the Street at $0.26
2. Margins were well below expectations but looks like a “kitchen sink” quarter
3. Domestic unit sales were in-line but pricing was strong
4. Play levels on revenue sharing games was surprisingly high
5. International sales were awful
Management will likely lower guidance on the call at 9am. That is certainly the consensus view. Our view on 1H CY 2009 industry slot sales is very negative. At least for IGT, since most analysts are negative, projections, while high, are not that far off.
If were IGT I would have done the same thing this quarter. Take the charges, sacrifice near-term margins, and lower expectations. Management appears to be setting the stage for better future results. The stock is deathly cheap. Confidence needs to be restored for IGT to work. This quarter may be the first step in that process. When it does, IGT will move and move fast. Keep an eye on this one.
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