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There was enough in FQ4 and guidance to round out a complete Top Ten. Unfortunately, most of them were negative.



We’re not exactly going against consensus (there were at least 3 downgrades to underperform today) by pointing out the negatives in this release/conference call but we do think we have some original thoughts.  So here we go:

  1. Guidance was terrible…and perplexing
    • The guidance for a YoY revenue decline in 1Q13 implies a $45MM sequential revenue decline.  They must have pulled forward a lot of demand into the 4Q.
    • The decline in guidance comes despite:
      • A supposed sequential increase in install base 
      • Projected increase of new openings and expansion to the tune of 75% in September 2012 vs 2011
      • WMS should be shipping replacing units to Alberta in September
    • Our projections for new openings and expansions during for the period of July 1, 2012-June 30, 2013 are about flat with WMS’s fiscal 2012 period but we have replacement units increasing, largely due to Canada
    • Management response:
      • They believe that new openings and expansions will be down YoY, primarily because they are not including shipments to Penn’s Hollywood Columbus which should open with about 3,000 slot machines on October 8th
        • We think it’s a safe assumption that units will ship in the September opening
        • WMS already shipped units to Cape Girardeau in the June Q
      • WMS’s 500 Alberta units will be spread over the September and December quarters
      • Given the timing of G2E, they expect that operators will want to kick the tires before placing orders.  Therefore, they expect a big drop off in replacement units.  Last year's G2E was during the same time period and the market for replacements in September was about flat with June.  WMS did see their shipments plummet from 3,700 to 1,600 last year (from 28% share to just 12%).
        • We call that kind of sequential drop off “pulling forward” of demand.
        • BYI also saw a drop-off in replacement units shipped between their June and September Q’s but the magnitude was much less (2,700 to 2,200)
      • International continues to struggle – well, it was down 40% YoY – how much worse can it get?
      • As far as full year guidance, WMS is not including shipments to any of the Ohio VLT’s.  WMS also assumes that the Western Canadian Lottery units don’t ship until 2H2013.
        • We have Thistledown in our numbers
        • We have the Lottery units shipping a bit earlier.
  2. Is this IGT or WMS?  Wasn’t WMS taking a measured approach to investing in interactive.
    • What’s the hurry in pouring good money after bad into interactive?  Last we checked, nothing is moving on the I-gaming front and social gaming companies like Zynga are getting crushed.
    • WMS claims that the investment will ramp over the course of the year.   
  3. WMS spent $83MM on refreshing their install base and the payoff was that participation revenues declined $43MM or 15%.  F4Q12 marked the 7th consecutive quarter of revenue declines in participation revenue.  WMS should be gaining share, not losing share. 
  4. Despite refreshing 2/3 of their install base with BB2 boxes and their “exciting” new content releases, win per day has been decreasing at an accelerating pace for the last 4 quarters.  The guidance for FY13 implies that the bleeding on win per day isn’t going to stop anytime soon.  WMS has had 8 straight quarters of win per day declines.
  5. FY12 marked the 5th consecutive year that notes receivable grew and increased as a % of product sales revenue.  We know that WMS is not alone in the practice of lending to their customers but at some point, you’ve got to wonder if they are just buying the business. 
  6. The excitement about growth in other gaming operations revenue last quarter looks short lived as other revenues declined $2.3MM QoQ
    • Several of licensing agreements rolled off this quarter and there were a few unusual licensing fees last quarter.
    • Would have been nice if the company pointed this out last quarter since they clearly have visibility on expiring contracts. 
  7. Reposting the question that one of our clients asked us:  While the large number of conversion kits and used units are all well and good, how much does this cannibalize demand for replacement units?
    • While great for margins, conversion kits are clearly an alternative to replacing a box
    • Used units typically get shipped into lower priced markets or simply to more price sensitive buyers
  8. Replacement market is looking better than we expected.  WMS did not ship any replacement units of size to Canada this quarter.  Unless BYI really disappoints, replacement shipments look like they will be up double digits YoY.
    • Yes, we’re excluding ~1000 used units that IGT included in their replacement number   
  9. International is just terrible…oh wait, that’s obvious
    • Down 40% YoY and 32% in FY12
  10. While WMS did not guide on EPS for FY13, their guidance and commentary on the call implies flat operating income.  That said, as one of our clients pointed out and as we were already modeling, with the expiration of the R&D tax credits, the tax rate in FY13 is going to be 36-37% vs. 31.5% in FY12.  


On its last earnings call, the McDonald’s management team did not strike a positive tone, saying that “persistent unfavorable economic conditions are weighing on consumer sentiment and spending”.


We wrote on April 24th that we saw “plenty to be concerned about” regarding the outlook for McDonald’s top-line trends.  Many of those concerns are persisting; weak economic conditions in Europe and the U.S. are front and center while our thesis on McDonald’s value proposition in the US weakening has not changed.  The company is now pricing – at roughly 3% – in line with Food Away from Home CPI whereas last year that difference was roughly -50 basis points.  Even with price of that level on the menu, we are unconvinced that traffic trends will be sufficient to bring the overall July comp in line with consensus for the U.S. division.



Macro Growth Slowing Matters


We called this out on July 20th in our 2Q preview note but it is worth posting again.  We won’t be using the charts below to make month-to-month calls, but in terms of the trends that we can expect to see in McDonald’s U.S. and APMEA businesses over the next few months, it is worth referring to these charts. 


MCD JULY SALES PREVIEW - industrial production vs MCD comps



Sales Preview


Below we go through what we would view as good, bad, or neutral comparable restaurant sales numbers for McDonald’s three regions.  For comparison purposes, we have adjusted for historical calendar and trading day impacts (but not weather).


Compared to July 2011, July 2012 had one less Saturday, one less Friday, one additional Monday and one additional Tuesday.   Ramadan starting early – impacting 10 days of July versus 0 last year – will also contribute to the shift that management has guided to as -1.8%. 


U.S.  – facing a compare of 4.4%, including a calendar shift of between -0.4% and +0.7%, varying by area of the world.


GOOD: A print above 2.5% would be considered a good result, as it would imply a sequential acceleration in calendar adjusted, two-year average trends.  It is important to note that this would imply negative traffic but, as management noted on the 2Q12 earnings conference call, a trading day shift and the year-over-year change in the timing of Ramadan will result in the headline number understating actual business trends.  We are anticipating a print of 2% for MCD U.S. comparable restaurant sales in July.


NEUTRAL: Same-restaurant sales growth of between 1.5% and 2.5% would be considered neutral by investors as it would imply calendar-adjusted two year average trends roughly level with June.  While June’s trends were at (historically) trough levels, we believe that the market is expecting the underlying business in July to have fared similarly to June. 


BAD: A print below 1.5% would imply a sequential deceleration in calendar-adjusted two-year average trends and could spur some analysts to further lower their FY12 EPS expectations.


MCD JULY SALES PREVIEW - mcd us preview



Europe – facing a compare of 5.3%, including a calendar shift of between -0.4% and +0.7%, varying by area of the world.


GOOD: A same-restaurant sales number in excess of 2.5% would be considered a strong result because it would imply, on a calendar-adjusted basis, two-year average trends roughly in line with those seen in June and above the weaker trends seen in May. 


NEUTRAL: 1.5-2.5% would be a neutral result for Europe as it would imply trends roughly in line with the year-to-date average.  While this is not a positive, given the commentary management provided on the earnings call on July 23rd, it seems likely July was another difficult month for MCD in Europe.


BAD: A print below 1.5% would imply a significant sequential deceleration in calendar-adjusted, two year average trends. 


MCD JULY SALES PREVIEW - mcd europe preview



APMEA – facing a compare of 4.0%, including a calendar shift of between -0.4% and +0.7%, varying by area of the world:


GOOD: Same-restaurants sales growth of 2.0% or more would be received as a good result as it would imply a sequential acceleration in calendar-adjusted two-year average trends.  On July 23rd, management cited weakness in Japan and consumer caution in China, particularly in tier-one cities where McDonald’s stores are most heavily concentrated. 


NEUTRAL:  A print between 1.0% and 2.0% would be considered neutral for investors as it would imply calendar-adjusted two year average trends roughly flat with June. 


BAD: Below 1.0% would imply a sequential deceleration in calendar-adjusted two-year average trends from June to July.  While expectations are low, at 1.56% according to Consensus Metrix, we believe that further deceleration would be a red flag for investors.


MCD JULY SALES PREVIEW - mcd apmea preview



Howard Penney

Managing Director


Rory Green



Too Big To Bail

This note was originally published at 8am on July 24, 2012. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“It occurs at first very slowly, then all at once.”

-Ernest Hemingway


That’s what Hemingway said about going broke. That’s also what I said in response to my research team’s questions in the morning meeting yesterday about levered sovereign nations and their banks. From a time and price, this entire thing becomes Too Big To Bail. If it wasn’t, why are the Spaniards banning short selling?


But do people really believe they won’t be bailed out? Listening to the sad whisper of Qe Begging each and every market day, I’m not so sure. While the likes of Timmy Geithner may believe “deeply” that it would be “irresponsible” to not raise taxes, this economy is digging into a deepening hole that some of these banks may not be able to exit without the government’s hand.


But how many hands does the US government have? How many Spanish and Italian banks is Geithner going to have to attempt to bailout via the US tax payer backstopped IMF? How much time does the government have in a stagflating economy to bailout a domestic bank like Morgan Stanley? If it’s happening All At Once, neither you nor I know.


Back to the Global Macro Grind


As Keynesian central planners around the world continue to spin their wheels looking for the next “growth policy”, they continue to perpetuate #GrowthSlowing by piling more debt-upon-debt.


As Growth Slowing’s Slope accelerates on the downside, some of the few remaining leading indicators that were relatively stable for the last 6 weeks are now showing signs of the same economic gravity that has gripped them since March:

  1. Hong Kong’s Hang Seng Index – down -3.8% in the last 2-days has once again snapped intermediate-term TREND support
  2. Italy’s MIB Index – down -13% from its July high has snapped its YTD closing lows established at the end of May
  3. USA’s Russell 2000 – down -5% from its early July high has snapped both its TRADE and TREND lines of support

Oh snap.


All the while, some investors are obviously getting whipped around, buying high and shorting low. But that institutional performance chasing problem isn’t nearly as problematic as the causality driving the whip.


The worse the global economic data gets, the more Qe begging for bailouts the market hears. The more they beg, the more the government creates an expectation that they’ll be there to bail them out. These expectations are now in and of themselves becoming the market’s biggest risk.


Now, you could say that “growth expectations are low and stocks are cheap.” If I hear that a dozen times a day, I see it tweeted 100x over. So that’s consensus. It’s also what consensus has been saying since March. Growth continues to surprise on the downside and “cheap” stocks keep getting cheaper.


Looking at the Big Macro Data this morning, you can say whatever you want to say – but the data is the data:

  1. German PMI (manufacturing index) tanked in July at 43.3 versus 45.0 in June
  2. Chinese “flash” PMI rose in July from 48.2 to 49.5
  3. Brazilian inflation rose “surprisingly” on the mid-July reading back up to 5.2%

Hedgeye Playbook: get the slopes of Growth and Inflation right (sequentially) and you’ll get a lot of other things right:


1.   GROWTH: given that any PMI reading below 50 is just plain bad, you can call the growth data better than awful in China – but, at the same time, agree with Moody’s that Germany’s economic growth picture is, well, awful.


2.   INFLATION: that’s the most important Global Macro inflation data point we’ve had so far in July (primarily because it’s one of the few July numbers that have been reported!). This is the first sequential uptick in Brazilian inflation since September.


Does anyone remember September 2011? Ooh-lah-lah. Lots of bad stuff started happening to markets All At Once. In a #GrowthSlowing global economy, marginal food/energy price inflations also slow growth further.


Whether you go back to the July 2011 highs in stocks or commodities (and trace a draw-down line to the October lows), you’ll see the same thing. The world’s growth slowed, All At Once, after the Qe2 sponsored commodity price inflation shocks of July-August.


Now, I’ll be the first to agree, this is not 2011. This isn’t 2008 either. This Time Is Different! This is 2012. And, oh my, does the entire world have more sovereign and bank liquidity issues today than Lehman or Greece did in either of those periods. In 2012-2013, this globally interconnected web of debt, banks, and broken political promises might just be Too Big To Bail.


My immediate-term support and resistance risk ranges for Gold, Oil (Brent), US Dollar, EUR/USD, Hang Seng, and the SP500 are now $1559-1580, $98.39-108.37, $83.22-83.98, $1.20-1.22, 18829-19364, and 1331-1356, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Too Big To Bail - Chart of the Day


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Early Look

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The Macau Metro Monitor, August 7, 2012




Neptune Group Ltd announced it has entered into several MOUs to enlarge its footprint in Macau by investing in new junket operations.  The agreements involve the junket promoter of the Guangdong 31 Sky Club at Grand Lisboa, the junket representative of the Guangdong VIP Club at MGM Macau, and the junket promoter of Wynn Guangdong VIP Club at Wynn Macau.


According to HK filings, the Guangdong 31 Sky Club generates an average rolling turnover of HK$4.8BN (US$619MM) per month and has at least 11 gaming tables.  The Guangdong VIP Club at MGM Macau has at least 24 gaming tables, generating a rolling turnover averaging at approximately HK$15.1BN per month.  The Wynn Guangdong VIP Club at Wynn includes at least 29 gaming tables, posting an average monthly rolling turnover of HK$9.3BN.



AERL announced it has entered into a non-binding MOU to acquire junket operator Bao Li Gaming Promotion Ltd.  Bao Li currently operates one VIP room with 5 tables at City of Dreams.

AERL expects to close the transaction by the end of September, paying US$15MM (MOP120MM) for 100% of Bao Li’s operations. The price could be higher, depending on Bao Li’s performance.  Upon the closing of the acquisition, AERL will have 34 tables in four VIP rooms.



Legislative Assembly (AL) yesterday passed a new law increasing the age of those allowed to work or play in casinos from 18 to 21.  The new law would take effect from November 11, 2012. 


TODAY’S S&P 500 SET-UP – August 7, 2012

As we look at today’s set up for the S&P 500, the range is 34 points or -1.45% downside to 1374 and 0.99% upside to 1408. 











    • Down  versus the prior day’s trading of 1998
  • VOLUME: on 08/06 NYSE 647.20
    • Decrease versus prior day’s trading of -14.12%
  • VIX:  as of 08/06 was at 15.95
    • Increase versus most recent day’s trading of 1.98%
    • Year-to-date decrease of -31.84%
  • SPX PUT/CALL RATIO: as of 08/06 closed at 1.54
    • Up from the day prior at 1.27 


  • TED SPREAD: as of this morning 36
  • 3-MONTH T-BILL YIELD: as of this morning 0.08%
  • 10-Year: as of this morning 1.59%
    • Increase from prior day’s trading of 1.57%
  • YIELD CURVE: as of this morning 1.35
    • Up from prior day’s trading at 1.33 

MACRO DATA POINTS (Bloomberg Estimates):

  • 6am: EFSF to sell up to EU1.5b 91-day bills
  • 7:45am/8:55am: ICSC/Redbook retail sales
  • 10am: JOLTs Job Openings, June, est. 3717 (prior 3642)
  • 11am: U.S. Fed to purchase $4.25b-$5b notes in 8/15/2018 to 5/15/2020 range
  • 11:30am: U.S. to sell 4-week bills
  • 1pm: U.S. to sell $32b 3-year notes
  • 2:30pm: Fed’s Bernanke speaks by video on financial education in Washington
  • 3pm: Consumer Credit, June, est. $10.5b (prior $17.118b, revised)
  • 4:30pm: API inventories 


    • House, Senate meet in pro-forma sessions
    • Senate Majority Leader Harry Reid, D-Nev., Center for American Progress host National Clean Energy Summit, with speakers include Interior Secretary Ken Salazar, former President Bill Clinton
    • FCC Chairman Julius Genachowski, Ben Hecht, chairman of Connect2Compete announce launch of nationwide computer recycling, donation effort, 11am 


  • Standard Chartered plunges; faces New York suspension on Iran
  • HTC extends decline to 2008 low after forecast of sales drop
  • Pfizer-J&J drop Alzheimer’s drug trials after second failure
  • Chesapeake posts record profit as asset-sale goals expand
  • Knight Capital’s three new board members will be picked by Blackstone, General Atlantic, the board w/ Jefferies approval
  • SEC freezes another $6m in Nexen insider-trading case
  • Icahn seeks talks to buy remaining CVR Energy shrs, $29 ea.
  • Second TSE system error in seven months halts derivatives
  • Italian economy contracts for 4th straight quarter amid slump
  • CFA Level III exam results due today
  • Hedge funds gained 0.2% last month, trailing stocks
  • U.S. CEOs less confident on economy: survey 


    • Emerson Electric (EMR) 6:30am, $1.00
    • CVS Caremark (CVS) 6:45am, $0.80; Preview
    • Church & Dwight (CHD) 7am, $0.55
    • Fossil (FOSL) 7am, $0.79
    • Marsh & McLennan (MMC) 7am, $0.58
    • Sirius XM Radio (SIRI) 7am, $0.02
    • TransDigm Group (TDG) 7am, $1.70
    • MGM Resorts (MGM) 7:30am, $(0.15)
    • Molson Coors Brewing (TAP) 7:30am, $1.20
    • Oaktree Capital (OAK) 7:30am, $0.61
    • Tenet Healthcare (THC) 7:30am, $0.05
    • Pepco Holdings (POM) 7:35am, $0.31
    • Melco Crown (MPEL) 7:40am, $0.17
    • Brookfield Renewable Energy (BEP-U CN) 8am, $0.10
    • Charter Communications (CHTR) 8am, $(0.21)
    • Cablevision Systems (CVC) 8:30am, $0.19
    • FirstEnergy (FE) 8:30am, $0.64
    • PG&E (PCG) 9:01am, $0.82
    • Primaris Retail REIT (PMZ-U CN) 4pm, C$0.36
    • Rackspace Hosting (RAX) 4pm, $0.18
    • TW Telecom (TWTC) 4pm, $0.14
    • Priceline.com (PCLN) 4:01pm, $7.36
    • XL Group (XL) 4:01pm, $0.55
    • Alterra Capital Holdings (ALTE) 4:04pm, $0.58
    • Live Nation Entertainment (LYV) 4:04pm, $0.06
    • Express Scripts Holding (ESRX) 4:05pm, $0.82; Preview
    • Walt Disney (DIS) 4:14pm, $0.93
    • Energy Transfer Equity (ETE) 4:40pm, $0.38
    • Energy Transfer Partners (ETP) 4:40pm, $0.46
    • Renren (RENN) 5pm, $(0.04) 



OIL – ripping humanity a new one this morning on the real (inflation adjusted) consumption growth front. At $110, Brent is up +25% since June! So get ready for every CPI and PPI report to accelerate, after they’ve deflated for the last few months; economic tailwind is now a big headwind.

  • Iron-Ore Rout Seen Curbing Losses for Commodity Ships: Freight
  • Rice Hoard Offers World Respite as Food Costs Surge: Commodities
  • SovEcon Says Russian Wheat Harvest May Be Lower Than in 2010
  • Soybeans Gain as Rains Seen Failing to Revive Drought-Hit Crop
  • Barrick Gold Studies Acquiring Assets as It Reviews Costly Mines
  • Chinese Smelters May Boost Copper Exports After Tolling Tax Cut
  • Gold Increases on Speculation a Weaker Dollar Will Spur Demand
  • Japan Seeks to Buy 106,530 Tons of Milling Wheat in Tender
  • Copper Gains for Third Day Before China Inflation Data This Week
  • CBH Says Western Australia Grain Shipments May Climb to Record
  • Crude Supplies Fall to Three-Month Low in Survey: Energy Markets
  • Palm Oil to Drop on Weak Demand, Stockpiles, TransGraph Says
  • Asteroid Mining Venture Adds Google-Backed Billionaire Investors
  • Richest Family Offices Seeing Fastest Growth as Firms Oust Banks
  • Cotton Harvest in India to Tumble as Dry Weather Hurts Crops
  • China Overtakes South Africa on Ferrochrome Output, Merafe Says










ITALY – good news, Italy is experiencing a stagflating recession (Q2 GDP -2.5% y/y), youth unemployment just hit 36%, but “the stock market is up.” So is Venezuela’s. This short squeeze has been impressive.






ASIA – Asia’s 2-day equity rally ends on a whimper w/ China closing +0.13%, KOSPI +0.05%, and Singapore -0.14% (Japan was up +0.88%, failed right at immediate-term TRADE resistance of 8813). Where do we go from here? Australia said no more rate cuts for you. Brent Oil at $110 is not good for whatever is left of Eastern consumption growth.











The Hedgeye Macro Team