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Remember November

REMEMBER NOVEMBER

 

CLIENT TALKING POINTS

 

YESTERDAY’S PROOF

Our #EarningsSlowing theme kicked into gear yesterday as more companies continued to disappoint on earnings through not beating Street consensus and/or offering lower guidance for the rest of 2012 into 2013. This is one thing that can’t be easily fixed by actions from the Federal Reserve. Thus, investors are realizing how bad things are actually getting out there and that is one of the explanations for yesterday’s sell off. Expect more reports to come in looking less-than-perfect over the remainder of the week.

 

REMEMBER NOVEMBER

With the election less than two weeks away, the polls and major media feedback show that Romney and Obama are tied with Romney making the occasional jump ahead. But the fact of the matter is the race is too close to call right now. There’s still plenty of time for bombshells to come out and hit each candidate hard and Donald Trump may be doing just that today. Just keep in mind that whoever is elected will have a major impact on the market on the long-term side of things.

 

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ASSET ALLOCATION

 

Cash:                UP

 

U.S. Equities:   Flat

 

Int'l Equities:   Flat   

 

Commodities: Flat

 

Fixed Income:  DOWN

 

Int'l Currencies: DOWN  

 

 

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TOP LONG IDEAS

 

BRINKER INTL (EAT)

Remains our top long in casual dining as new sales layers (pizza) and strong-performing remodels (~5% comps) should maintain sales momentum. The company is continuing to enhance returns for shareholders through share buybacks . The stock trades at a discount to DIN (7.7x vs 9.3x EV/EBITDA) and in line with the group at 7.3x.

  • TRADE:  LONG
  • TREND:  LONG
  • TAIL:      LONG            

 

PACCAR (PCAR)

Emissions regulations in the US focusing on greenhouse gases should end the disruptive pre-buy cycle and allow PCAR to improve margins. Improved capacity utilization, truck fleet aging, and less volatile used truck prices all should support higher long-run profitability. In the near-term, Paccar may benefit from engine certification issues at Navistar, allowing it to gain market share. Longer-term, Paccar enjos a strong position in a structurally advantaged industry and an attractive valuation.

  • TRADE:  LONG
  • TREND:  LONG
  • TAIL:      LONG

 

HCA HOLDINGS (HCA)

While political and reimbursement risk will remain near-term concerns, on the fundamental side we continue to expect accelerating outpatient growth alongside further strength in pricing as acuity improves thru 1Q13. Flu trends may provide an incremental benefit on the quarter and our expectation for a birth recovery should support patient surgery growth over the intermediate term. Supply costs should remain a source of topline & earnings upside going forward.

  • TRADE:  NEUTRAL
  • TREND:  LONG
  • TAIL:      LONG

  

_______________________________________________________

 

THREE FOR THE ROAD

 

TWEET OF THE DAY

“over capitalized over produced and under incomed -too much everything” -@fearlicious

 

 

QUOTE OF THE DAY

“The cure for boredom is curiosity. There is no cure for curiosity.” -Dorothy Parker

                       

 

STAT OF THE DAY

Germany's PMI down in October to 45.7 vs 47.4 last month.


Materials for today's call: "VIEW FROM THE BATTLEGROUND STATES"

Today at 1:00pm EST the Hedgeye Macro Team and Healthcare Team will be hosting a View From the Battleground States Expert Call. 

 

Materials: View From the Battleground States

Please dial in 5-10 minutes prior to the 1:00pm EST start time using the number provided below:

  • Toll Free Number:
  • Direct Dial Number:
  • Conference Code: 496674#

 

 

"Based on our forecasting model, it becomes clear that the president is in electoral trouble"

-Ken Bickers     

 

Professor Kenneth Bickers of the University of Colorado will be featured on the call. Bickers and his colleague, Michael Berry, have created an economic forecasting model that has accurately predicted the outcome of the last eight presidential elections.

 

Topics will include: 

  • Electoral College vote set-up, impact and the importance of swing states 
  • Discuss Forecasting Model Factors: including state and national unemployment figures and changes in real per capita income
  • Factors that will make this election different 
  • Voter expectations and turn out
  • Economic impacts following the election (healthcare, fiscal cliff) 

Bickers' Background

  • Joined faculty at CU Boulder in 2003
  • Received his Ph.D. from the University of Wisconsin-Madison and his BA from TCU in Fort Worth
  • Published articles in numerous journals, including the American Journal of Political Science, Journal of Politics, Public Choice, Administration and Society, and the Journal of Conflict Resolution
  • Current research includes;
    • The consequences of devolution of federal policy activities to states and local communities
    • Local Government Elections Project, an ongoing investigation of the recruitment and campaigns of local office holders who populate local and state offices
    • Exploration of the relationship between residential mobility and local politics 


Early Look

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269 – 269

“A tie is like kissing your sister.”

-J.C. Humes

 

How about if America woke up on November 7th and “269 – 269” was the headline on the front of major newspapers? The implication would be that the Electoral College was effectively tied.  This is actually a somewhat plausible scenario in 2012.  It could occur with Obama winning all of Kerry’s states from 2004 and adding New Mexico and Ohio.  Currently, both New Mexico and Ohio, albeit marginally, are in the Obama camp.

 

In the event of an Electoral College tie, the decision gets handed to the House of Representatives.  Given that the Republicans hold a majority in the House, Romney would then become the next President.   Just as many moderates think that the Tea Party has hijacked the Republican Party, they would now be arguably the key reason that the Republicans gained the Presidency.  After all, if it weren’t for the Tea Party insurgency (for lack of a better word) in the midterms, the Republicans would likely not currently control the House.

 

Regardless of whether you believe my 269 scenario, it is beyond argument that this race is getting too close to call.  The averages of the major national polls are basically within 0.5 points, favorability ratings of the candidates are basically tied, and neither candidate has a definite edge in the Electoral College. 

 

There are some credible outliers related to predicting the outcome of the election.  One of these is Professor Ken Bickers from the University of Colorado. He has done an analysis that looks at state level economics as a predictor for the Electoral College.  Currently, his analysis suggests that Romney and Ryan may win up to 330 seats.

 

We will be joined by Professor Bickers today at 1pm today for a conference call to discuss his analysis.  For institutional macro subscribers, the materials and dial-in will be circulated this morning.  If you are not an institutional macro subscriber, ping to inquire about access.

 

Politics matters as it relates to future economic policy, so we have been and will continue to focus closely on this election.  In fact, we would postulate that some of the stock market weakness over the last few days, though largely driven by #EarningsSlowing, is being amplified by increasing uncertainty in political outcomes in the United States. 

 

Globally, the bigger concern continues to be tepid economic growth.  This morning HSBC’s flash PMI for China came in at 49.1 versus expectations of 47.9.  Even if marginally better than expected, the number remains below 50.  In Europe the numbers were bleaker as the Eurozone Flash PMI came in at 45.3 versus an estimate of 46.5.  The German IFO business climate indicator also disappointed marginally coming in at 100.0 versus expectations of 101.6.  Not surprisingly, the Euro is weak and Spanish yields are backing up this morning, as result.

 

It is a major policy day today in the United States with an announcement coming from the Federal Reserve.  The FOMC rate decision will be held at 12:30pm today with a Bernanke press conference at 2:15pm. Even though the stock market basically peaked on the day of the last Fed announcement, it is unlikely that even Chairman Bernanke adds more fuel to the fire at this point.  Although if the Fed were to signal they are going to take the money printing press up a gear, that would be the ultimate October surprise.  It may even be bigger news than the October surprise that Donald Trump is purportedly going to reveal on Twitter today. 

 

Our friends at Bespoke Investment Group actually did an interesting analysis looking at the return of the stock market on the days of Fed announcements in this period of zero interest rate policy.  According to their analysis, the SP500 showed a positive return on 21 out of 31 of those days with an average gain of +0.71. 

 

Even as history is a guidepost, we would suggest that investors are getting much better at front running the Fed.  This is actually born out in the numbers as in the last year the return on a Fed day is closer to +0.30.  Yes, this is still a positive return, but only marginally so.  Today the setup seems more poised to disappoint as Chairman Bernanke will likely not have much new positive news on the economy, and is also unlikely to further ease.  But, we’ve been surprised by the Fed before . . .

 

The broader issue with the Fed’s long-term zero interest rate policy is that extreme levels at which certain asset classes are getting priced.  One example is the high yield market.  As one high yield investor emailed me yesterday:

 

“Our basic premise is that there is massive technical support in the search for yield for the broader HY and leverage loan market driving yields to historically tight levels.  There is such appetite in the loan market that terms are reverting back to 2007 peak levels…new issue spreads are being compressed and covenants are being pulled (45% of new issue is now ‘cov-lite’ vs. 10% last year).  To a large extent this has been driven by the return of the clo…back from the dead…or at least from 2007.  CLO issuance will be $40bn this year, which is more than the last 4yrs combined.”

 

Now we aren’t ready to make a big call on high yield market just yet, but the red flags raised above are well worth pointing out.  After all, it’s not a tie if you are long high yield at the top.

 

Our immediate-term risk ranges for Gold, Oil (Brent), US Dollar, EUR/USD, UST 10yr Yield, and the SP500 are now $1, $107.48-110.71, $79.58-80.16, $1.29-1.31, 1.71-1.82%, and 1, respectively.

 

Keep your head up and stick on the ice,

 

Daryl G. Jones

Director of Research

 

269 – 269 - Chart of the Day

 

269 – 269 - Virtual Portfolio


MGM: A HOLD-ADJUSTED MISS LIKELY

We qualify the miss since someone held well in July.  Despite at least 4 sell-side downward revisions in October, we’re still below consensus EBITDA by 4%.

 

 

Thanks to Big Ben, this asset heavy, debt-laden company’s stock has held in pretty well.  Meanwhile, management has done a good job refinancing its substantial debt and saved some dough on interest expense.  Ah, but those pesky fundamentals.  The Strip is going backward, not forward.  Slot volume and non-Baccarat table play are moving in the wrong direction. 

 

The slots have us particularly concerned as you may have noticed.  We don’t agree with the commonly held perception that the Strip is stable.  Slot revenue is high margin and the trend is down, not up.  Q3 RevPAR will be down which was supposed to be an anomaly.  We fear, MGM’s Q4 commentary will turn that anomaly into a trend. 

 

The Street looks too high for 4Q 2012 and 2013.  We are currently 13% below the Street in EBITDA for Q4 2012 and 10% below for 2013.  Our below Street numbers are predicated on our cautious macro outlook, way too aggressive Street growth estimates, inflationary cost pressures, and the unfavorable demographic picture we’ve highlighted over the past 6 months.

 

MGM will report Q3 earnings on October 31st.  We estimate $2.3BN of net revenue and $446MM of consolidated property level EBITDA.  We also look at wholly owned EBITDA plus MGM’s pro-rata share of MGM China and City Center, less corporate expense which produces EBITDA of $395MM.  Our net revenue estimate is in-line with consensus while our comparable EBITDA is 4% below consensus.

 

 

Q3 DETAIL

 

We project MGM’s Strip properties to produce net revenue of $1,196MM and EBITDA of $248MM, in-line and 7% below Street numbers, respectively:  average RevPAR declines of 4%, low single digit casino and other growth, and low single digit operating expense increases.

  • Bellagio:  $286MM of net revenue and $76MM of EBITDA, 1% above and in-line with consensus, respectively
    • 1% decline in RevPAR
    • 4% growth in casino & other
    • 4% expense growth
  • MGM Grand:  $239MM of net revenue and $34MM of EBITDA, 4% above and 9% below consensus, respectively
    • 2% decrease in RevPAR
    • 3% growth in casino & other
    • 2% YoY expense growth
    • Last year and last quarter both suffered from low hold, so this quarter has a low bar
  • Mandalay Bay:  $190MM of net revenue and $40MM of EBITDA, 3% and 4% below consensus, respectively
    • 4% decrease in RevPAR
    • 5% decrease in casino & other
    • 5% decrease YoY expenses
  • Mirage:  $144MM of net revenue and $23MM of EBITDA, 1% above and 13% below consensus, respectively
    • 2% YoY decrease RevPAR
    • 4% increase in casino & other
    • 5% increase in expenses
    • This quarter should have an easy comp as 3Q11 casino and other revenue declined 14% YoY due to MGM’s comment that Mirage experienced “very low hold”.  MGM also commented that hold was low in 2Q12.

Other U.S:

  • MGM Detroit net revenue of $139MM and EBITDA of $41MM, in-line and 2% above consensus, respectively
  • Mississippi net revenue of $126MM and EBITDA of $34MM, 3% below and 6% above consensus, respectively

We’re estimating that MGM Macau will report $688MM of net revenue and $172MM of EBITDA (the street is at $668MM and $165MM, respectively.)  Our assumptions in HK$MM’s are as follows:

  • Net casino revenue of $5.3BN and total revenue of $5.3BN
    • Net VIP win of $3.4BN
      • VIP Turnover: 173,300 assuming 9% direct play
      • Hold of 2.93%
      • Rebate rate of 35% or 1.01%
    • Mass table win of $1,430MM
    • Slot win of $503MM
  • Variable expenses of $3,245MM
    • $2,765MM of taxes and gaming premiums
    • $451MM of commissions to junkets
  • Fixed expenses of $715MM
  • $93MM of branding fees

We estimate that City Center will report $48MM of EBITDA on $264MM of net revenues:

  • Aria:  $214MM of net revenue and $40MM of EBITDA
  • Mandarin Oriental:  $11MM of revenue and $0MM of EBITDA
  • Crystals:  $14MM of revenue and $9MM of EBITDA
  • Vdara:  $21MM  of revenue and $5MM of EBITDA
  • $6MM of development and administrative expenses

Other stuff:

  • D&A:  $235MM
  • Corporate & other:  $39MM
  • Stock Comp:  $9MM
  • Net  interest expense:  $276MM
  • Income from unconsolidated affiliates & non-operating items from unconsolidated affiliates of ($24MM)
  • $34MM of tax credits
  • Minority interest of $67MM

Smell The Truth

This note was originally published at 8am on October 10, 2012 for Hedgeye subscribers.

“Keep it simple. Tell the truth. People can smell the truth.”

-Steve Wynn

 

If you’re looking for Steve Jobs like thought leadership, product innovation, and job creation in this country, look no further than Steve Wynn. The guy gets what most of us who have built something from nothing get – he has vision.

 

If you and your spouse and/or business partners are really going to build something on your own in this good life, you have to, deep down in your bones, believe that people will side with the truth.

 

If what you deliver is better than what they currently use, both you and your customers win. If you believe that people are dumb – and that they’re generally not smart enough to Smell The Truth, you’ve already lost. Politics might be a better career path.

 

Back to the Global Macro Grind

 

Whatever central planners want to throw at us this morning, I say bring it. The only certainty I have in my life is that the sun will rise in the East and, God willing, I will be sitting right here at my post, preparing to play the game that’s in front of me.

 

Yesterday, we got long again. We bought Apple (AAPL), Michael Kors (KORS), and Taiwan (EWT). We started the day with 7 LONGS, 8 SHORTS and closed the day with 11 LONGS and 3 SHORTS. Progress embraces change. So that’s what we do.

 

I’m not saying that our Top 3 Global Macro Themes for Q4 2012 have changed this morning. In fact, I’ll reiterate Theme #1 this morning (#EarningsSlowing) as that remains the market’s most important risk. That risk, however, gets overbought and oversold, fast.

 

The most important driver of the market’s daily beta isn’t AAPL. It’s the US Dollar. If you get that right, you tend to get a lot of other things right. Here’s the refreshed immediate-term TRADE correlation between the US Dollar Index and stocks:

  1. SP500 = -0.95
  2. EuroStoxx600 = -0.97
  3. MSCI World Index = -0.97

Those are wicked high correlations. So, you can either run around like a chicken with his 50-day Moving Monkey cut off on AAPL… or, you can just build a model that probability-weights where the US Dollar is immediate-term TRADE oversold/overbought, and then buy/sell AAPL (or whatever it is that you really like in the US or Global Stock market) using those signals as your headlights.

 

At the house of Marcus Goldman (when it was private and Partner Capital was on the line every day), they used to evaluate talent by asking themselves if their players could make money if locked in a “dark room” (by themselves) with only their process.

 

While they may have not put it that way precisely, I just did. Because I think that’s a great way to think about risk management and what it is, precisely, that you do. When everything goes straight down like it did yesterday, what do you smell? Buy or sell?

 

As a risk management process, smelling buy/sell opportunities should go both ways. That’s why I have had no problem changing my mind in the last 4 weeks. This isn’t politics – in real life business, flip-flopping your opinion is critical to success.

 

In the immediate-term, in particular for the beta implied in US stocks, there are always positives and negatives to consider.

 

POSITIVES:

  1. USD immediate-term TRADE overbought at $80.16
  2. EUR/USD immediate-term TRADE oversold at $1.28
  3. SP500 Immediate-term TRADE oversold at 1434
  4. VIX immediate-term TRADE overbought at 16.74
  5. UST 10yr yield holding 1.64% support
  6. II Bull/Bear Survey compresses by 1,000 basis points to the bear side

NEGATIVES:

  1. Equity Volume is as dead as a doornail, nowhere to be found on last week’s bounce
  2. Tech (the market leader up until 3 weeks ago) is leading the decline
  3. S&P Sector Studies just saw 4 of 9 Sectors snap immediate-term TRADE support (XLK, XLI, XLY, XLB)
  4. KOSPI (South Korea) broke its immediate-term TRADE line again overnight
  5. Oil (Brent) is back above its TAIL risk line of $112.69/barrel
  6. Bernanke and Geithner are still gainfully employed

But, like any risk manager of any professional game, you have to make a call at some point on which way to lean. That’s why I have built a model that removes most of the emotion that I used to have when making those decisions. An emotional Mucker fights too much.

 

I don’t want to fight you. I want to help you. I don’t always lean, but when I do, I go with the process that most often tells me the truth.

 

My immediate-term risk ranges for Gold, Oil (Brent), US Dollar, EUR/USD, UST 10yr Yield, AAPL, and the SP500 are now $1761-1792, $112.69-115.01, $79.69-80.16, $1.28-1.30, 1.64-1.76%, $630-642, and 1434-1464, respectively.

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Smell The Truth - Chart of the Day

 

Smell The Truth - Virtual Portfolio


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