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Industrial Indicator: The Worst Cycle We See

The Worst Cycle We See

While you may not usually look at shipbuilding, it is a very interesting and globally relevant industry – and it is poised for a severe downturn within the next year.

  • Severe: The shipbuilding downturn will be disruptive, making it important to avoid suppliers, creditors and customers, in our view.  Freight capacity should be well supplied for years, leaving indicators like Baltic Dry less useful for macro analysis.
  • Just Past Peak:  Since ships last for about 30 years, capacity added after WWII was replaced in the 1970s and that capacity was just replaced, with peak deliveries in 2011-2012.
  • Next Two Years Painful: The drop-off will be unusually sharp this cycle because the financial crisis clipped off orders in 2008.  2014 capacity utilization at ship yards will be a fraction of current levels (something like 20% of current utilization).  Many shipyards will not survive. 
  • Avoid/Short: We suggest staying away from or shorting Samsung Heavy, Hyundai Heavy, and other shipbuilding exposed names, and even avoiding high quality suppliers like Wartsila.


Industrial Indicator: The Worst Cycle We See - shipping cycle



  • Tough Industry: The shipbuilding industry has a difficult industry structure – fragmented competition, high barriers to capacity exit, consolidated suppliers, and consolidated customers by shipyards.  Except for cycle peaks, margins tend to be low.


Industrial Indicator: The Worst Cycle We See - shipping share



UPCOMING EVENT:  On August 16th at 11:00AM we will be hosting a call on the launch of our Trucking OEM Black Book that will discuss Navistar, PACCAR, Cummins and other key names in the space.



Industrial Indicator: The Worst Cycle We See - perf 8712


In an effort to evaluate performance and as a follow up to our YouTube, we compare how the quarter measured up to previous management commentary and guidance




  • WORSE:  While Mass was strong, VIP was worse than expectations after the Q1 conference call.  EBITDA missed our estimate by a little bit but the MSC commentary seemed positive on the margin.


  • WORSE:  We did not see a sequential or YoY in RC volume despite the additions below.  RC volume increased 0.5% QoQ and was flat YoY despite opening of the new junket rooms at CoD. 
  • PREVIOUSLY: "We recently opened three new fixed junket rooms at City of Dreams, which we believe will start to contribute to our results [higher rolling chip volume] from the second quarter of 2012.  We add totally about 23 tables for these three new junket operator, which means about 10% more on the VIP tables allocated in VIP in COD compared to last quarter last year."


  • SAME:  Hold rate did improve but Mass drop fell 5% QoQ 
  • PREVIOUSLY: "Earlier this month [May], we opened our new Premium Mass gaming and entertainment area at City of Dreams. We aligned more Grand Hyatt rooms to our high end Premium Mass segment...we anticipate an improvement in hold percentage and also result from the length of stay for this segment customers."


  • BETTER:  MPEL "received from the Macau Government the revised formal land grant approval and permit to restart construction" which we already knew.  However, management seemed very optimistic about gaining the necessary casino approvals
  • PREVIOUSLY: [Studio City] "We remain optimistic that we can restart construction towards the end of this quarter, subject, of course, to government approval. Our $1.9 billion budget for Studio City remains."



  • WORSE: MPEL saw a temporary impact on their mid and lower end business, although they claim that since July that business has rebounded and come back to them
  • PREVIOUSLY: "And even with the limited offering, we have seen an uplift in terms of visitation into City of Dreams."




To Debase A Currency







We’re essentially in a no volume, no volatility market. Think about it for a second: the VIX remains below 16 and yesterday’s NYSE volume was -30% yesterday vs the average down day for August. Must be great to be an equity broker these days. And of course everyone is back on the permabull bandwagon as they desperately try to hit 1400 on the S&P 500. Close, but no cigar. Best of luck trying to ride the beta wave, permabulls.




Brent crude oil is up +25% since June! Isn’t that awesome? $110 a barrel oil thanks to Jon Hilsenrath and Ben Bernanke. Consumers at the pump have to be loving this three week trend of the US Dollar falling; lord knows it certainly helps pad their wallets when they hit the pump and grocery store (kidding.) As long as the Wall Street Journal continues to cheerlead for the Fed, expect more of this dollar debauchery and central planning madness.




Devaluing your country’s currency is so chic these days. Seriously. Venezuela had their currency devalued 50% by Hugo Chavez and now their stock market is up +110% year-to-date. No, that was not a typo – you read that number correctly. People seem to enjoy these little market rallies and the inability to earn a return on capital. Remember the days when you could put some money in fixed income or even a savings account and get a little return? We won’t be seeing a return to those days anytime soon, that much is certain.







 Cash:               Flat  U.S. Equities:    Flat


 Int'l Equities:   Flat                   Commodities:    Flat


 Fixed Income:  Flat Int'l Currencies: DOWN









This company is transitioning from cash burn to $75mm annual free cash flow generation thanks to completion of a reimaging program and refranchising of JIB units. Qdoba is the leverage; a maturing and growing store base will bring higher margins. We see 8.5% upside over the next 6-9 months.

  • TAIL:      LONG            



The former Liz Claiborne (LIZ) is on the path to prosperity. There’s a fantastic growth story with FNP. The Kate Spade brand is growing at an almost unprecedented clip. Save for Juicy Couture, the company has brands performing strongly throughout its entire portfolio. We’re bullish on FNP for all three durations: TRADE, TREND and TAIL.

  • TAIL:      LONG



We continue to expect outpatient utilization to pick up in 2H12 alongside stabilization in acuity with ortho and cardiac/ICD volumes supporting both pricing and inpatient admissions growth. Births should serve as a tailwind into year-end, recent and prospective acquisitions offer some upside to 2012/13 numbers and the in place repo offers some earnings flexibility. With European and Asian growth slowing, we like targeted domestic revenue exposure as well.

  • TAIL:      LONG







“$EURUSD Tests its 55 DMA for 1st time in 3 months as Stocks Hit New 3mth Highs bit.ly/MKvmmd #forex” -@alaidi




“The reason why so few good books are written is that so few people who can write know anything.” – Walter Bagehot




$250 billion. The amount of illegal Iranian transactions that Standard Chartered allegedly helped conceal.




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Not the greatest of quarters but positive outlook on gaining casino approvals for Studio City was a main takeaway from the call. 



"In addition to the recent slow-down in the market-wide rolling chip segment, our rolling chip volumes also continue to be impacted by our table optimization strategies, which we are optimistic will generate improved future group-wide table yields across our rolling chip and mass market table games segments, giving us greater flexibility to participate in the changing gaming landscape in Macau and drive long term and sustainable improvements in future operating fundamentals."


 - Mr. Lawrence Ho, Co-Chairman and Chief Executive Officer of Melco Crown Entertainment




  • Continue to shift tables from Altira to CoD and shifting tables between Mass and VIP
  • Altira's table use has stabilized and reached competitive levels
  • Introduced a limited run caberet show at CoD
  • Mgmt likes the high end of the mass market which they believe will provide them with a more stable and loyal customer base
  • Excited about Macau's improving infrastructure which should provide better access to the region
  • MSC:  1,650 rooms targeting the mass market.  Capacity for 400-500 gaming tables.  Feel that the location will given them a competitive advantage - near the Lotus Bridge and along one of the rail stops.
  • Assuming hold would have been 2.85% - their EBITDA would have been unchanged.  Despite a slightly higher blended win rate of 2.88%, they were negatively impacted by unfavorable mix between their RC and Revshare programs.
  • 3Q12 guidance:
    • $90-95MM of D&A
    • $18-20MM of corporate expense
    • $23-25MM of net interest expense



  • MSC land grant:  mentions the 5-star resort and hotel.  This isn't a direct grant from the government to a concessionaire and it's not wholly-owned by a concessionaire.  The DICJ is the one that grants them gaming tables not the Department of Transportation which grants the land and construction grant. The site was already approved for a casino management license so they think that the process of getting a casino license for them is the same as for WYNN or any other site.
  • Higher range of mass hold at CoD (25-30%) going forward
  • They are short of rooms at CoD and Tower 5 has always been at their plans.  They are at 90%+ occupancy every day.  They have completed the design work for Tower 5 and plan on building once the land gets re-gazetted.  Hope to start construction of the tower as early as next year.
  • Can't really comment on the Philippine project but basically they will have a 50% ownership stake
  • MSC financing:  still in discussions with their bank group. Expect that since it will be a project loan it will have a higher spread than their corporate facility at +175bps.  Expect that they will have financing in place by year end.
  • Philippine partner database has 5MM customers and they will use that database.  They will try to use their own database to create synergies as well.
  • Continue to lobby in Taiwan and Japan.  They are keenly interested in developing in these markets.
  • Condition of the premium Mass market? Grew more than 50% in 1Q so that gave them a high base and difficult comp. So they were pleased to maintain that level of business in 2Q (despite the sequential supply).  They did experience some movement of their mid-lower tier customer movement to SCC but recently have seen that customer returning and have had a rebound in July.
  • See more promotional activity in Macau.  The mid-lower tier of the market is more sensitive to these promotions.
  • They are not surprised that the VIP market has slowed down.  At the beginning of the year, they were expecting 15% growth in the market.  This year is really a transitional year for the Chinese government and the Chinese economy should rebound in 2013.  That's why they have really spent time on improving their VIP product (since things are slower). They are still building for the future.
  • Earlier this year, they decided to allocate more of the Altira VIP tables to CoD.  On the cost side, they maintain a very lean operating team at Altira.  Going forward, it's more about improving the productivity of their tables there rather than cutting operating costs.
  • Think that the productivity of Altira is quite close to CoD at this point.  No comment on shutting down in the future to use that table capacity at MSC.
  • The table shift is mainly done - there may be some more "moderate" changes.  They are very happy with the last 2 months performance at Altira. Expect improvement in EBITDA at Altira. Sounds like they had an unfavorable mix of business at Altira.  
  • At June 30th: VIP:354; Mass: 271 tables. 
  • Increase in promotional allowance? They have taken a more aggressive approach to comping room or expanding their casino block. They think having more gaming customers in the rooms is a net positive for business.
  • Minority interest represents the 40% interest of MSC that they don't own.  There is $10MM of expense related to MSC which are both above and below the EBITDA line.




  • Net revenue of $939MM and Adjusted EBITDA of $204MM
    • CoD: net revenue of $684MM and adjusted EBITDA of $184MM. 
      • YoY EBITDA growth due to: "improved mass market table games and gaming machine volumes, a substantially improved mass market table games hold percentage as well as a higher rolling chip win rate, partially offset by higher wage costs as a result of the wage rate increase in April 2012."
    • Altira: net revenue of $209MM and adjusted EBITDA of $26MM
      • "The decrease in Adjusted EBITDA was primarily attributable to a lower rolling chip win rate together with reduced rolling chip volumes, as well as higher wage costs associated with the wage increase in April 2012"
    • Mocha slots: net revenue of $35MM and adjusted EBITDA of $9MM
      • Average slots: 2,100; average win per device: $181
  • "The decline in net revenue was primarily attributable to lower group-wide rolling chip volumes, partially offset by strong improvements in the mass market table games and gaming machine segments, particularly at City of Dreams."
  • YoY NI improvement "primarily a result of improvements within the mass market gaming segments, reduced non-operating expenses, including lower net interest costs and one-off costs associated with the refinancing of the City of Dreams Project Facility, partially offset by the amortization of land use rights at Studio City, the impact of increased wage costs as a result of the wage rate increase in April 2012 as well as lower group-wide rolling chip volumes and win rate." 
  • "In relation to Studio City, we are delighted to have received from the Macau Government the revised formal land grant approval and permit to restart construction, enabling us to move forward with the development of our exciting Studio City Project – a large-scale integrated entertainment, retail and gaming resort which will include significant gaming capacity, five-star hotel offerings and various entertainment, retail and food and beverage outlets to attract a diverse range of customers, with a particular focus on the mass market segment in Asia and, in particular, from Greater China."
  • "We have also recently entered into a memorandum of agreement for the development and operation of an integrated casino resort in the Philippines, which will further diversify our exposure in Asia and deliver incremental sources of earnings and cashflow. We will provide further details on this project when we finalize the terms and conditions of the definitive agreements."
  • Capitalized interest: $2.4MM
  • Cash & equivalents: $1.8BN; total debt: $2.4BN
  • Capex: $51.9MM (primarily related to projects at CoD and preliminary MSC costs)





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



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