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River Baptisms

“A half-truth is more dangerous than a lie.”

-Saint Thomas Aquinas

 

The aforementioned quote comes by way of Saint Thomas Aquinas, who, to this day, is still considered among the most influential priests in the history of the Catholic Church as a function of his bridging the gap between ancient philosophical works and theology. While this is certainly not the proper forum to discuss religion in any detail, we do think modern-day financial markets could use a scholar of Aquinas’ caliber to help bridge the gap between the prices of many liquid asset classes and the fundamental data underpinning them.

 

Furthermore, the Manic Media outlets tasked with delivering us our economic and financial news could certainly use an army of Aquinas-like editors to help bridge the gap between what has occurred and what is reported.

 

To say that a large portion of the headlines and stories we’ve consumed in recent quarters were delivered in one of the following two formats would be a gross understatement: “ABC Occurred On XYZ Stimulus Speculation” or “[INSERT: Policymaker Name] Signals Further [INSERT: Stimulus Measures; Bailout Funds; etc.]”. In effect, the financial media can be considered guilty of incessantly stoking the broad-based optimism bias of both investors and corporate executives alike in priming news – particularly anything negative – with rumors and expectations for future improvement via “stimulus” or bailouts.

 

For reference, we use quotations around the word “stimulus” because we have shown repeatedly since 2010 that Policies To Inflate do little beyond stoking commodity price inflation that ultimately slows the pace of economic activity. In fact, if we had a burning Bernanke buck for every article in the last three months that anchored on some form of “stimulus”, Hedgeye would have enough capital to create all of the jobs QE3 is allegedly supposed to produce! River baptisms continue to dominate the heavily-biased study of economics in Western academia.

 

Take China, for instance. For much of the year-to-date, just about every occurrence in the Chinese economy was reported on in the context of “stimulus”. Moreover, a great deal of what Chinese policymakers have said publically in the YTD has been interpreted as a general update on the size and scope of China’s pending stimulus package. Alas, the bazooka has yet to be spotted and, perhaps more importantly, we continue see limited scope for and probability of a large-scale Chinese stimulus package over the intermediate term. We have published a compendium of work detailing our thoughts on the subject, analyzing the key data series, political catalysts and rationale(s) of Chinese policymakers pertaining to this topic and are happy email them to you upon request.

 

A couple of the more entertaining rumors emanating from China in recent weeks were centered around actions by the China Securities Regulatory Commission and the National Development and Reform Commission. Last week, it was reported that Chinese stocks rallied over +2% during the last 90 minutes of trading on a rumor that the CSRC was going to hold a press conference to announce measures to boost the stock market after the close. The event turned out to be a previously-scheduled meeting with no major reforms or announcements to speak of. We’re sure you remember the CNY1 trillion of infrastructure initiatives from early SEP that got a large swath of the financial media and international investment community to both celebrate and cheer on further stimulus measures (“globally coordinated easing” was the catch-phrase of the day). Since then, Xu Lin, head of the planning department at the NDRC, has come out and blatantly refuted the consensus interpretation of the event:

 

“The recent accelerated infrastructure project approvals did not mean the government is rolling out more stimulus. These projects are already in our plan... [The] 4-trillion yuan package of state spending and tax cuts announced in 2008 stoked inflation and sparked concern local governments took on more debt than they can afford.”

– Xu Lin speaking to reporters at Peking University on SEP 17, 2012

 

Of course, Chinese policymakers could emerge from Golden Week next week or from their 18th Communist Party Congress in the second week of NOV with plans to materially reflate their ailing economy. The desire to pursue social and economic stability – particularly on the inflation and employment fronts – is great among Communist Party officials and, per the latest China Beige Book from CBB International LLC, the percentage of mainland companies reporting net firings increased +700bps QoQ to 20% in 3Q.

 

Despite obvious growing pressure to “do something” (as IMF Director Christine Lagarde would put it), we continue to take the view that Chinese policymakers have a much longer horizon for economic planning than most Westerners are able to comprehend through the prism of democracy. Xi Jinping and Li Keqiang (China’s likely future President and Premier) will be in power for a decade. Do you think it’s in their best interests to perpetuate China’s “unstable, unbalanced, uncoordinated and unsustainable” growth model (per current Premier Wen Jiabao) by reflating the Chinese economy just ahead of or early in their administration? Perhaps, though we’d argue anyone taking a longer-term view would be keen to anticipate the negative impact of a mid-regime property market bust and subsequent financial crisis upon Chinese economic growth and social stability. Unlike most Western financial market participants, the Politburo does not operate in the vacuum of YTD gains or with respect to some year-end bonus pool.

 

All told, the Chinese economy will continue to grow; it probably just won’t grow as fast or necessarily in the same manner as international investors and corporations have become accustomed to. That’s one of the core tenets of prospect theory, specifically in that myopic loss aversion from the status quo occurs not just from present states, but also from future states that were previously assumed to be true.

 

In this light, how will companies like Caterpillar Inc. and Fortescue Metals Group Ltd. react when the Chinese “stimulus” bazooka they’ve all been anticipating to varying degrees does not show up? How will international investors respond to this potential scenario? After accounting for 43.9% of global real GDP growth since 2008, does China even matter anymore? Why can’t everyone just buy the SPDRs and hold on for dear life until the data starts to improve?

 

While we are certain that none of these questions have easy answers, we are convinced that they need to be pondered by anyone managing risk in today’s choppy Global Macro environment. Best of luck out there, everyone.

 

Our immediate-term risk ranges for Gold, Oil (Brent), US Dollar, EUR/USD, UST 10yr Yield and the SP500 are now 1, 106.78-110.99, 79.60-80.23, 1.27-1.29, 1.58-1.69 and 1, respectively.

 

Darius Dale

Senior Analyst

 

River Baptisms - Chart of the Day

 

River Baptisms - Virtual Portfolio


COH/Idea Alert: Eight is Enough

Takeaway: Eight reds and one green on a nine-factor fundamental model looks bad even before the poor quantitative setup.

We think COH is a short here. Yes, the brand is very good, but the company only scores positive on one of our nine-factor fundamental model that we include a summary of below. Eight negative factors is enough for us to be bearish across at least a TRADE and TREND duration. Add to that the current trading level (i.e. lousy quantitative setup) and it’s time to reinsert COH into the short side of our ledger.

 

To be clear, if Keith covers on red over the near-term, don’t wonder “But I thought McGough thought COH was a short?”  The answer is that over a TREND duration, I do. There is literally nothing to get excited about until next summer. Then there could be money to be made long…who knows. But until then, Keith will TRADE in and out as risk management levels suggest.

 

One might argue that the Street thinks it’s a short too, with short interest tripling since midsummer. But it still sits at only 5.5% of the float. Furthermore, of the 33 analysts that cover COH, there’s not a single Sell rating, and Buy ratings are near all time peaks. (Check out Nike – the stats are the exact opposite).

 

COH/Idea Alert: Eight is Enough - coh poduration

 

Coach Risk Management Levels

COH/Idea Alert: Eight is Enough - coh TTT chart 2

 

Coach Looking Risky In Our SIGMA Analysis

COH/Idea Alert: Eight is Enough - cohsigma4

 

Does ANYONE Hate It? You'd think that with its growth rate being cut by 80% it might have some more critics?

COH/Idea Alert: Eight is Enough - coh 4


The Tipping Point

 

Hedgeye CEO Keith McCullough appeared on The Kudlow Report tonight to discuss currency devaluation and the election.

 

As it stands, currency devaluation reaches a tipping point where people lose it. You've seen it in Argentina and now you're seeing it in Iran. When people can't feed their families and put gas in their car, they get angry. The US has been busy devaluing the dollar for four years - how much longer can they take it?


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Hyperinflation !

Takeaway: We don’t see hyperinflation as imminent, but historical context is telling.

Below we’ve highlighted the tables from a recent academic paper from the Cato Institute that outlines examples of hyperinflation that have occurred over the past couple of centuries.  The paper was written by Professor Steve Hanke from Johns Hopkins.  He found 56 examples of hyperinflation. 

 

In the paper, hyperinflation is defined as a price-level increase of at least 50% per month.  The most extreme case of hyperinflation on record was in Hungary in 1946.  In July of that year, Hungary had a monthly inflation rate of 4.19 x 10^6.  (As far as we know, Chairman Bernanke was still in diapers then!)

 

Even as we’ve been sounding the inflation risk horn due to the aggressive monetary easing that is occurring around the globe, we certainly aren’t predicting prices to increase at more than 50% per month.  But as Mark Twain famously said:

 

“History does not repeat itself, but it does rhyme.”

 

 

Indeed.

 

Daryl G. Jones

Director of Research

 

Hyperinflation ! - 1

Hyperinflation ! - 2

Hyperinflation ! - 3


G2E: WMS NOTES

Some detailed notes from meetings with WMS at G2E

 

  • The new product is performing at a better level than their old product.  Have more new products.  Over 100 new titles.  80 of them are on the new platform.
  • When will they produce cash?  They took the time to invest in their business.  This year, they are investing in interactive.  Have an opportunity to provide more transparency and milestones on how much they will invest in interactive on the call.
  • Five cabinet configurations now and launching five new ones on their new operating systems.  5th cabinet is their poker platform launching at STN's and CZR's.
  • How do they fill the gap between now and when the new cabinet comes out?  Pricing discounts - G2E specials targeted at bridging the gap.  Took four quarters after BB2's launch to reach 50% of sales.  In theory, ASPs will go up after the launch of the new cabinet.
  • No product sales guidance for FY13': "could be lumpy" because of IL and Canada which have lower price points
  • Where is WMS in IL?  Gaming control board going through beta test phase.  Once that's over, operators can place games at approved locations.  Have an agreement with Betsson and going direct with others.  Betsson units will be for sale.  Others will be operating leases.  Thinks that they can get upper teens/ low 20s share when it's all said and done.  
  • Canada:  Alberta - ordered 2000 units - WMS got 500 of those - will be in the September Q
  • Manitoba and BCLC (got an award) 
  • Oregon state lottery - will be at the proposal stage soon
  • Class II:  teamed up with Blueberry technologies initially to service class 2.  They now have integrated that system with their CPU Next system. 
  • Consolidation?  Unidesa is selling their slot ops to Novamatica.  Doesn't think that there is anything imminent among the Big 5.
  • Blade I - March 2013 release initially - will have 15 titles
  • Aladdin is doing well for them.  Super Team hasn't done as well.  New Lord of the Rings is doing well.  New Wizard of Oz is doing well.  
  • The Kiss games get approved this Q 
  • Spiderman in March and Willy Wonka in June Q. 
  • Thinks that participation yields have stabilized 
  • Wizard of Oz was performing very well, though not where it was 
  • Macro view on WAP/Participation market:  % of their install base that's remained WAP is still 36-38%.  Have turned the tide on the declining install base.  Have more participation titles in their booth than IGT at this year.  They are making some headway.  Doesn't think that they have hired anyone from IGT.  At this show, IGT did more internal vs external development.
  • CPU 2 strategy:  will still create content for the next 3 years.  If you buy a BB2 now, then you get a free upgrade to the CPU3 in a year.  They stripped down their games to bring them back to the basics that worked before.  Stripped out the noise from the games.  Took out the "bank" strategy with a new look so every game has a new look.  These games are targeted towards the gamer.  The WAP games are for the more casual player that wants to enjoy time on device.
  • Have double money burst (similar to IGT's DUO).  Very volatile experience. 
  • Colossal Reels did well out of the gate.  Now when they have a hit, they "fast track" new content for those boxes.
  • Spiderman is a follow up to Aladdin.  Hoping to capture a younger player with Spiderman
  • Willy Wonka - hope that this will be the next Wizard of Oz 
  • Monopoly refresh on the the xD.  Not too many original Reel 'Em Ins! on the floor - relaunching the brand.
  • Wheel on the Cheers game and Monopoly money.  Game of Life is doing really well - Craps-like features.
  • BBxD for their poker game.
  • How big will the poker launch be at CZR and STN?  Licensed names from Double Double Poker (IGT) and Deuces Wild.  Launching in September with Stations.  Stations is committed to keeping them on the floor for a year.
  • The new game field cabinet.  Looks like a pinball machine.  First games are progressives.  No buttons.  Available in FY4- May 2013 and Wizard will come out on this platform in February.
  • Blade:  looks like the Veridian cabinet.  Addressed some customer complaints:  wager saver (when customers are down to small change- they can get one last spin- win or lose or just cash in).  When there is petty cash left on a ticket, it's a pain for customers.
  • Bonus Guarantee:  guaranteed to give players a 10x on their win.  Giving players a small win even if they lose.
  • The participation stuff looks good but are very back end loaded (Q4)
  • Everything on the floor is ready to go this fiscal year
  • Have a 25% increase in mathematical product that is unique.  Only a handful of clones for the fast track games that are hot (can get out in 4-6 months).
  • Gamefield xD (pinball game):  can do more with the game because there is more within the players' line of vision
  • Sensory immersion 2.0 cabinet/chair:  Willy Wonka and Spiderman
  • MyPoker:  working on it for 3 years.  Comfort of the game is really unique.  Players can also save their configuration.  When the player puts their card in, they are automatically logged into Player's Life.
  • Blade:  aside from a new look; the fluidity of play is second to none.  Had multiple repeat visits from their customers to see the product again, which is a good sign.

WMS Product Details from the G2E Booth

  • All of the Blade stuff is CPU NXD 3 system
  • KISS game:  can change songs while playing.  They are trying to do more music themes in general since Michael Jackson is such a hit. 
  • Yahtzee: Q1 2014
  • New Lord of the Rings:  42" top screen.  Very successful license for them.  These are entertainment products - i.e. more time on device.
  • Gamefield xD: everything on the machine in players peripheral view.  32". Thinks that this is the key differentiator for WMS. Also really comfortable. First games come out March time frame. Wheel bonus feature
  • Cheers: new franchise for them. Also a wheel topper. 80/20 pricing.
  • Monopoly Legends:  integrated 4 themes of Zeus, Reel 'em In!, Jackpot Party, and Goldfish for the bonus round.  Also has a wheel.  Q4 release.
  • Willy Wonka:  thinks that this is the best game they've made in a long time.  Should appeal to the Wizard of Oz crowd.  Lots of motion on the chair.  Graphics were really great.  WAP game.  Q4 release.
  • Spiderman:  brand new license for them.  For any spin, you can get up to 8 wheel arrays.  Q3 release.  WAP game.
  • Price is Right:  they learned that they put too much into the first 2 versions.  Just focus on the singular game in Price is Right.  In each bonus, you are guaranteed to win one of the progressive bonuses.  Plinko is doing well - out the last few months.  This is the follow up to Plinko.  Q4 release.
  • Godfather:  second product in this line.  3 reel mechanical:  can also go as a video.  Clone of Lord of the Rings-The Fellowship.  Lord of the Rings that is out on the floor is one of their better participation WAP titles.  Original didn't do well.
  • MyPoker:  multi-game video product.  One of the reasons that IGT players stop playing is because they get tired of sitting - games not comfortable. 
  • For sale:  Colossal Reels:  this one has been a big hit.  Have five more versions out.  The math is just good.  High volume game.  8 total titles.
  • Portal applications:  still supporting it.  Not doing well.
  • Networked gaming: 
    • Remote configuration and download /portal app
    • They have 60 installs in NA and some international ones too
    • Sent companies a DVD with all the titles.  Allows customers to pay a subscription plan to their library.
  • Williams Interactive:
    • Partouche, Jadestone, Phantom EFX, and 888/Dragonfish alliance
    • Phanton has the #3rd best monetization and 5th largest Facebook play for fun game

IDEA ALERT: LONG JACK

Takeaway: $JACK is one of our better long-term TAIL ideas. The stock corrected, but held its TREND line, and our thesis is still intact.

We just added Jack in the Box (JACK) to our Real-Time Positions as the share price is at the low end of Keith’s immediate term TRADE risk range.  We like the stock from a fundamental perspective and stand by our Sum of the Parts analysis which suggests long term upside of 50%. For our most recent note on JACK, click here.

 

Fundamental View

 

Jack in the Box has been a strong performer within QSR over the past year, outperforming the S&P 500 by over 10%.  We believe that there is more to come from this stock.

  • Jack in the Box continues to perform well.  Management raised guidance on the last earnings release and we expect the refranchised and remodeled concept to continue to generate strong cash flows for the company. 
  • Qdoba is taking time to win over the naysayers.  It is difficult to know, but our take is that recent softness in the stock is likely related, at least in part, to David Einhorn of Greenlight Capital making comments on the new Taco Bell “Cantina Bell” menu and how the initiative is set to take share from Chipotle.  Clearly, the implication is that this new menu at Taco Bell will have a similarly negative impact on Qdoba.  Given the AUV’s and restaurant-operating margins Qdoba stores have achieved during Chipotle’s incredible same-restaurant sales growth over the last couple of years, we are confident that Qdoba still represents a compelling growth play for investors, even with Taco Bell becoming more competitive.
  • The stock is valued at 7.2x EV/EBITDA, lower than WEN and SONC and higher only than GMCR.  Given the growth prospects, future cash flow generation, and asset base behind company, we believe that JACK should be valued more richly.  At 7.2x EV/EBITDA, with EBITDA growth accelerating ahead of expectations, we believe that JACK could see two-to-three turns of multiple expansion.  On this basis alone, Jack in the Box has $10-15 in upside from the current stock price.

Quantitative View

 

Keith added JACK to our Real-Time Positions at $27.33.  The immediate-term TRADE range is $27.31-$28.33.

 

IDEA ALERT: LONG JACK - jack levels

 

IDEA ALERT: LONG JACK - JACK SOTP

 

IDEA ALERT: LONG JACK - qsr ev to ebitda

 

Howard Penney

Managing Director

 

Rory Green

Analyst

 


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