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MACAU: A BRUTAL JANUARY

The impact of Rolling Chip credit crunch is now very apparent. The South China Morning Post cited a government source in reporting that gaming revenues fell 30% in January 2009 vs. January 2008. January will be the first of many months of significant declines as the junkets flooded the market with credit last year. Of course, the mass market segment is not there to pick up the slack as significant visa restrictions remain in mainland China.

WYNN and LVS are the two US operators most exposed to Macau. As we’ve been forecasting in our posts, both are likely to report disappointing Q4s in the coming weeks and estimates are coming down. Invest at your own peril.


WMS: PUSHING OUT THE PAIN

Maybe my assessment is unique, but management seemed less confident than I’ve heard them in a while. I believe they have reason to be.

WMS put up a very respectable FQ2 last night, but not nearly as strong as we had predicted. The whisper numbers also appeared to be higher than the $0.36 that was posted. Disappointing unit sales and recurring revenue placements offset strong pricing.

While FQ3 (March) revenue guidance of $178-185 million fell short of the $188 million consensus projection, I don’t believe it is low enough. WMS will struggle to generate $170 million, in my opinion. The company is generating significant growth in itS gaming operations but the problem is twofold. First, industry wide slot shipments to new casinos and expansions will decline 70% in the March quarter. Second, very few casinos are buying slots and as IGT indicated on their conference call, replacement demand will be lower in 2009 than 2008.

WMS could see domestic slot shipments slip from 5,700 in FQ2 to 3,000 in FQ3. Slot sales are still the company’s largest business so how can total revenues increase sequentially with such a large drop off in this segment? I just don’t see it. The June quarter could be even more at risk. By implicitly lower FQ3 revenue guidance, WMS back-ended loaded the year as annual revenue guidance remained at $712-718 million. June replacement will once again be awful and industry wide slot shipments to new casinos and expansions should be down 40%. The EPS impact of our projected revenues shortfalls could be $0.04 and $0.08 in the March and June quarters, respectively.

No doubt most of the sell side analysts will blindly adjust their revenue estimates perfectly in line with management’s guidance. This sets the company up for its first earnings miss in years.

Revenue guidance unlikely to be met

A GIRAFFE FROM HEAD TO TAIL

The Giraffe is on record as the animal with the longest tail. Unfortunately, the current lodging depression may have a longer tail than any we’ve seen in quite a while. RevPAR peaked in the fall of 2007 at an all-time high. Occupancy has been falling since the spring of 2006 which should’ve been THE signal to sell the lodging stocks as it usually is. Likewise, as we discussed in our 01/07/09 post, “FILL ‘EM AND THEY (INVESTORS) WILL COME”, the stocks do not typically sustain rallies until occupancy begins an uptrend.

Unfortunately, we don’t appear to be close to trough occupancy as the rate of decline is accelerating, never mind going up. Further, we believe analysts are vastly underestimating the margin hit. Average daily rate follows occupancy down and recovers after as illustrated in the first chart. Rate has only just begun to fall. Rate changes have a much bigger impact on margins. As can be seen in the 2nd chart, margins follow rate pretty closely.

A few issues will exacerbate and extend the current downturn. The hotel environment deteriorated so quickly that 2009 will actually benefit from group and corporate business that was booked closer to the height of the cycle. Even if demand improves in 2010, business booked in 2008 and 2009 will be a major drag. Second, FX is a major headwind for lodgers with significant European exposure such as HOT. Third, the gateway US cities, especially New York, will face difficult comparisons as the global economy deteriorates with a lag to the US. Finally, timeshare operations, which have been a big boom to earnings and EBITDA, will be inconsequential until inventory is built back up. We are probably 5 years from that potential.

Our best guess is that 2009 is not the trough. RevPAR and EBITDA will likely decelerate further from 2009 levels. Margins will continue to compress, even with significant cost cutting, as ADR comprises the bulk of the RevPAR declines. Cost cutting initiatives, particularly by HOT, are aggressive and necessary. However, there is only so far a company can go without damaging its brand.

Occupancy drives stocks
ADR drives margins

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Europe Trending Downward

There is a growing list of bearish European data points out today, which are as follows:

European Confidence in the economic outlook fell to 68.9 this month from 70.4 in December to reach a new record low, reports the European Commission.

European retail sales—based on a Bloomberg survey of more than 1,000 retail executives in Germany, France, Italy, and Spain—measured 44 in January, well below 50 indicating contraction, despite rising slightly from 41.4 in December.

Eight of the largest labor unions in France called a general strike today, proclaiming Sarkozy’s $34 Billion economic stimulus as inadequate and demanding that more be done to counter rising unemployment. As reference, the EU predicts France’s unemployment rate at 9.8% this year and 10.6% next year.


The data points speak for themselves. The Eurozone economy is in its deepest recession since World War II. Credit is tightening (or has eroded in some cases) across the region with unemployment climbing. Not surprisingly, consumer confidence is at an all-time low as Europeans feel the squeeze.

Sarkozy will have to answer to hundreds of thousands of people who marched in cities across France today. Likely there are more protest to come as these dismal economic conditions naturally lead to social unrest, which is a tail risk we have our Eyes on.

Matthew Hedrick
Analyst

SP500 Levels, Refreshed...

Today is hammering home more of the same – without a US Dollar breaking down, US equities cannot breakout.

The US$ Index is +0.81% today and the SP500 is down -2.9%. Importantly, the market backed off a significant immediate term “Trade” momentum line at 873, and backed off hard.

The chart below paints the lines that I think matter. There is a green dotted line of immediate term support for the SP500 at 840.11, but if that breaks, and the US$ continues to strengthen, watch-out below – 804 is the only line of support from there.
KM

Keith R. McCullough
CEO / Chief Investment Officer

US HOUSING – Declining New Home sales – What does it mean? Maybe nothing!

In the month of December, new home sales in the U.S. fell 14.7% to the lowest level on record, according to the Commerce Department. The decline in new-home sales to a seasonally adjusted annual rate of 331,000 was below the 390,000 consensus estimate. Year-over-year the pace of new homes sold in 2008 declined 37.9%; this is the lowest since 1982. The months' supply of homes on the market rose to 12.9 months in December from 12.5 months in November.

The Census Bureau collects new home sales based upon the following definition: "A sale of the new house occurs with the signing of a sales contract or the acceptance of a deposit." The house can be in any stage of construction: not yet started, under construction, or already completed. Typically about 25% of the houses are sold at the time of completion. The remaining 75% are evenly split between those not yet started and those under construction.

Existing home sales data are provided by the National Association of Realtors®. According to NAR, "the majority of transactions are reported when the sales contract is closed." Most transactions usually involve a mortgage which takes 30-60 days to close. Therefore an existing home sale (closing) most likely involves a sales contract that was signed a month or two prior.

Given the difference in definition, new home sales usually lead existing home sales regarding changes in the residential sales market by a month or two. For example, an existing home sale in January was probably signed 30 to 45 days earlier which would have been in November or December. This is based on the usual time it takes to obtain and close a mortgage.
Plus with the number of homes sitting in foreclosure, the banks are much more motivated to unload a home at a big discount than a builder is. Naturally, in this environment you would expect to see new home inventory increase, as there is better value in the foreclosed homes. Importantly, foreclosures aren’t in inventory of unsold homes and a growing portion of sales.

It appears that the homebuilders are competition with banks to unload inventory and the banks are winning!

Howard W. Penney
Managing Director

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