“You can boil down what we're thinking about 2013 to a short statement, and that goes both for economic environment and sales, and that statement is steady-as-she-goes, not much change from 2012.”

– Michael DeWalt, Caterpillar, 10/22/12


This morning, Hedgeye ran a proprietary P/E screen to identify a couple of bargains.  JDS Uniphase (JDSU) is trading at only 3x its 2000 EPS.  Lennar (LEN) is at only 4.5x its 2005 EPS.  Multiples were much higher when those earnings were reported, so today these names are on a big sale.   OK…probably not.  However, those “bargains” highlight the problem with using the peak margins and a simplistic framework to value companies.


The Industrials sector is loaded with mini-bubbles.  Capital equipment goes through replacement cycles, driving sales and margins to very high levels only to have them drop-off following the boom.  Our favorite cycle is shipbuilding.  After World War II, war tonnage was converted to commercial use.  Ships only last for about 30 years, so there was a replacement boom in the mid-1970s.  Tonnage deliveries were nearly three times higher in 1975, at the peak of the boom, than they were in 1980, after the bust.  The industry just had another replacement cycle with deliveries peaking in 2011. The group looks like a promising short today and should be a great long around 2035.    Mark your calendar.


We joke that mining is the world’s second oldest profession and that there is a reason the iron-age was called the iron-age.  Mining is a highly mature industry with long-term cyclical growth slightly below global GDP growth.  It should not boom.  When it does, you know something interesting is going on. 


Mining capital spending is an obvious bubble.  For example, global iron ore output went from ~1 billion tons in 2005 to ~3 billion tons last year.  Capital spending above depreciation at the eight largest miners went from about $10 billion in 2004 to $56 billion in 2011.  And 2004 was a fantastic year for mining capital spending.


Today, Caterpillar is best defined as a manufacturer of mining and resource-related capital equipment.  Among its largest customers are BHP, Rio Tinto, and Vale.   Typical of companies caught up in a boom, CAT has made overpriced acquisitions and added excess capacity to meet peak demand, in our view.  Investors who hold CAT through the down-cycle may end up paying for management’s investment errors in addition to their own.  Buying CAT today is similar to buying Lennar in 2005 or JDSU in 2000.  The peak $9.20/share or so that CAT will likely earn in 2012 may prove just as irrelevant for valuation as any other bubble-driven profit.


The Hedgeye Industrials team hates P/Es.  Extreme profit cyclicality leaves multiples useless in the Industrials sector. We prefer to build DCFs to estimate (wide) valuation ranges.  We forecast reasonable longer-term growth rates, margins, capital needs, and other factors, making assumptions explicit.  November 5th, we are presenting on the Express & Courier Services industry, including Fedex.  Fedex may grow at 2% or 6%, but it isn’t going to grow at 15% in the long-run.  Similarly, global iron ore production is not going to keep tripling every 5 years.  To value CAT by extrapolating recent trends in mining capital investment would be to assume the surface of the earth ends up covered in ferrous rocks.  A normal peak multiple applied to recent profits implicitly makes that assumption.


To note that there is a bubble in many commodities is different from explaining why.  The narratives that drive bubbles tend to be very persuasive and contain much truth.  The internet will revolutionize commerce.  Check.  Home prices rise over time and will be supported by the government.  Check.  A rising middle class in the developing world will need more appliances and cars.  Check.  Narratives allow investors to feel better about applying absurdly simplistic valuation ratios to companies serving highly complex markets. 


We’ll throw out a narrative to explain the commodity bubble to allow CAT short sellers to feel better.  We suspect that the commodity bubble has been driven by world’s second largest economy pegging its currency to the world’s largest economy while the world’s largest economy engages in highly simulative and largely experimental monetary policy.  The peg contributes to inflation in China, which drives savers in China to protect real wealth by investing in property and other hard assets.  Maybe check. Maybe not.


Narratives aside, our view on CAT is straight-forward.  Don’t be the investor who buys a cyclical at a multi-decade peak in margins.  We may well come back to CAT when it hits our proprietary P/E screen in a few years.


Our immediate-term risk ranges for Gold, Oil (Brent), US Dollar, EUR/USD, UST 10yr Yield, and the SP500 are now $1, $106.63-110.71, $79.69-80.25, $1.29-1.31, 1.71-1.89%, and 1, respectively.


Jay Van Sciver, CFA

Managing Director Industrials


Steady-As-She-Goes? - aa. JAY EL


Steady-As-She-Goes? - aa. Real Time


The Macau Metro Monitor, October 25, 2012




By October 2013, all slot machines at the two Singapore casinos must display the odds of a punter hitting winning combinations.  The Casino Regulatory Authority (CRA) implemented this requirement earlier this month to highlight how unlikely it is to end up with such combinations - in a move to deter people from over-exuberant gambling.  So far, about 20% of the 5,000 slot machines in the casinos have complied with the rule.



The Sy group has formally entered into an agreement with casino billionaires James Packer and Lawrence Ho for a US$1-billion gaming venture in Manila.  Belle Corp said it and its wholly owned subsidiary, PremiumLeisure and Amusement Inc., signed a cooperation agreement with MPEL for the development of a casino and entertainment resort within the 120-hectare Entertainment City.  The cooperation agreement makes Belle a co-licensee and owner of the resort project with Melco, while Melco will be co-licensee and operator of all of the project's facilities.  The deal will also bring in an additional investment from Melco of "no more than $580 million over the course of the project." 



Hundreds of Japanese tourists are cancelling trips to Macau.  Tourism agents quoted by Jornal Tribuna de Macau said several Japanese tourists have cancelled their trips.  Information requests about Macau have also dropped by half.  Industry insiders said tourists from Japan are scared of coming here after the violent protests in the mainland against Tokyo following the territorial dispute with Beijing over the Diaoyu/Senkaku Islands.  Visitor arrivals from Japan decreased by 0.9% YoY in September, to 35,300, official data shows.




Galaxy delivered another beat on in-line revenues driven by surprisingly strong margins at their flagship property. We are finally seeing the benefit of mix-shift? 




Looking ahead, GEG remains very confident in the growth prospects for the industry and Macau as a whole as major infrastructure projects come on stream which improve access to Macau.



  • Increase in margins at Galaxy Macau is attributable to a shifting mix towards more mass business which carries a higher margin
  • QoQ decrease in VIP turnover at GEG was due to the economic slowdown and moderation of activity before the government changeover
  • GM Ph2 has 900 workers on site currently and is on schedule to complete pilings at the end of this year
  • Acknowledge that VIP has paused but still remains very healthy.  The pause is natural given the changeover in government and economic conditions.



  • They are very focused on segment specific marketing and hotel yield management.  Yield their 2 properties as a portfolio rather than individual properties.
  • Average length of stay at GM is 2 days - one of the highest in Macau.  More than half of their hotel guests are gaming customers vs. FIT. As they increase length of stay that has a huge benefit for their business since they capture more play.
  • Pavilion high limit slot lounge is doing very well at GM
  • How much room for margin improvement is there at GM?
    • Primary factor of the improvement was the shift towards more Mass revenue.  Still think that there is upside in margins as they manage costs and yield their product
  • Hold rate on Mass? 
    • High 20s is normal given their premium mass focus. Thinks that high 20s/ low 30s are normal for their business mix.
  • GM:  modest hold adjusted HK$35MM benefit - held very high in premium mass last quarter which had a benefit of HK$100MM in 2Q (total - not just from premium mass)
  • Uses of cash? Spending on GM Ph2 will ramp up next year.  That's not to say that at some point in the future they won't consider a dividend.  Think that the highest and best use of cash given their ROI is reinvesting in their property. 
  • Thoughts on Phase 3 plans? They are very excited for Ph3 but right not they are focused on developing PH2.
  • Haven't seen any slowing collections from their partners.  Their partners are very healthy. They do believe that the VIP market will start growing again just at a slower pace then in the past. The VIP market just feels better now.
  • Spent about HK$600-700MM on capex, most of which was on PH2.
  • How do they feel about getting enough labor post all the other project approvals? They are confident that they will get the labor they need.
  • Galaxy Macau: Still have about HK$2BN unpaid capex balance
  • Their receivables balance in 3Q is very stable
  • VIP at GM used to be in the high 60s on revenue contribution and now it's in the low 60s
  • Smoking Ban:  Meeting with the government to understand how to meet the new standards. They are confident that there will be minimal impact on their business. 



  • "The Macau gaming market continues to evolve with VIP gaming revenues moderating from
    historic highs and higher margin Mass revenues growing as a proportion of total gaming
  • GEG Adjusted EBITDA of HK$2.6BN, up 46% YoY and revenue of HK$14BN
  • Galaxy Macau: Adjusted EBITDA of HK$1.8BN, reflecting an increase in Mass revenue
    • Adjusted EBITDA margin of 21% and 29% under US GAAP
    • Revenue of HK$8.3BN
    • Annualized ROI of 42%
    • Hotel occupancy of 97%
    • VIP turnover: HK$173.3BN; 3.3% hold
    • Mass drop: HK$6.3BN; hold of 29.9%
    • Slot revenue: HK$5.3BN; hold of 5.8%
    • Non-gaming revenue of HK$391MM
  • Starworld: Adjusted EBITDA of HK$843MM
    • Mass revenue grew 43% YoY
    • Annualized ROI of 99%
    • Implementing new growth initiatives with target completion of Q213
    • Occupancy of 99%
    • VIP turnover: HK$147.1BN; 3.0% hold
    • Mass drop: HK$2.6BN; hold of 23.1%
    • Slot revenue: HK$882MM; hold of 6.7%
  • City Clubs Adjusted EBITDA of HK$39MM
  • Construction materials Adjusted EBITDA of HK$113MM
  • Cash: HK$12.6BN (including HK$2BN restricted cash) & net cash position HK$1.5BN
  • Galaxy Macay Ph2: on schedule for mid-2015 opening

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Management seemed a little more upbeat about Macau, and Las Vegas had a surprisingly strong quarter in terms of volumes and revenues.




  • Had a good performance in Las Vegas this quarter.  Volumes are satisfactory, improving ever so slightly. They have enjoyed the advantages of being a niche operator so their room revenues are better.
  • In Macau, they are basically flat YoY YTD.  Considering all the new capacity being added this year, Steve is heartened by that.  Feel the strain of competition on the high limit slots. They will be improving their high limit slot room shortly. The level of competition in Macau is terrific. 
  • Confident that Wynn Macau will continue to garner more than their fair share of the business. 
  • If business continues to ramp up and improve, then, as economic conditions allow, they will increase their regular dividend.  It will also allow them to become attractive to yield focused investors 



  • Collections in Macau?  Credit has tightened in the market place so they have been more prudent than in the past so their collection rates have not been impacted
  • Plenty of cash in the US today to fund their dividends.  Their board will meet to discuss Wynn Macau's dividend.
  • Cash in Macau: $1.4BN post dividend (Wynn Macau), $500MM post dividend (Wynn LV) 
  • Going forward their dividend policy will be conservative to allow them to provide for their employees and money for projects, so long as the government policy remains favorable to dividends
  • Had some junket space, F&B, and retail out of service this quarter.  Have a brand new junket space (taken back from International group) opening on November 1st. Should see some improvement in 4Q and 1Q13. 
  • Lost some of their high limit slot business - not the very high end but the meaty part - should open a new room to compete better by CNY.
  • They give away as much in promotional allowances as they can afford to.  Would rather lose some top line than lose bottom line. So Steve doesn't know if their share in Macau has stabilized. 
  • They are worried about the labor issues but not so much about the other projects but also all the infrastructure projects that are ongoing.  The other project announcements do not impact their project thinking at all.  Government is taking a more relaxed outlook on labor importing as well. Currently, they have enough labor for foundation. Don't see any issues over the next 12 months.  Beyond that, it depends on all the other projects under construction, not just gaming.
  • Any change in the decelerating VIP trends in Macau?  Things have stabilized in Macau and credit has loosened. 
  • They build a rendering of the Cotai project in Macau in real scale, which you can see if you go over there. Should be finished before Christmas.
  • Finished drainage work by November. Think that they can start pilings after that.
  • 60% of the project cost is already financed. Most (75%) of the spending will take place between mid 2014 through 2016.   Want to open by CNY 2016. Doesn't think that they will have a labor problem constructing it. 
  • How are WYNN's small business customers in the US and China feeling? Hopes that the uncertainty in the US will be resolved during the elections which will occur in the next few weeks. In China, there are some feelings that more businesses need to be privatized and liberalized (i.e. decentralization) in response to the country's rapid expansion. 
  • Does not think that the VIP market is tapped in Macau
  • 2,000 SQFT- getting paid $6MM/year for a retail location in Wynn Macau
  • Their goal in Cotai is to be everyone's first choice
  • In Macau - they had pretty much the same hold in direct and junket play
  • In Macau they had some retail space under construction and the rest of subpar performance was just less super high-end watch sales
  • Everyone got nervous during the summer and there was some tightening of credit; since then, things have loosened.  Things really feel better today then a few months ago
  • Generally speaking, they think that the market is terrific in Macau



  • Net revenues were $1,298.5 million and Adjusted property EBITDA was $402.6 million 
  • "Wynn Resorts also announced today that the Company has approved an $8.00 cash dividend, which includes the $0.50 per common share quarterly dividend. This dividend will be payable on November 20, 2012, to stockholders of record on November 7, 2012 and the stock will begin to trade ex-dividend on November 5, 2012. Additionally, the Company plans on increasing its quarterly dividend to $1.00 per share in 2013."
  • Macau: Net revenue of $910.5MM and Adjusted EBITDA of $292MM
    • "Gross non-casino revenues decreased 5.3% during the quarter to $97.2 million, primarily due to an 8.5% decline in retail revenues resulting from lower sales in some of our watch stores."
  • Wynn Cotai: "The Company currently estimates the project budget to be in the range of $3.5 billion to $4.0 billion. The Company expects to establish a guaranteed maximum price for the project construction costs in the first half of 2013."
  • Las Vegas: Net revenue of $388MM and adjusted EBITDA of $110.4MM
    • Gross non-casino revenues increased 5.3% YoY "due to increases in hotel and food and beverage revenues, which were partially offset by lower retail and entertainment revenues."
  • Cash and investments: $2.7BN
  • Total debt: $5.8BN ($3.1BN at Wynn Las Vegas, $749MM at WYNN Macau and $1.9BN at the parent)
  • "On July 31, 2012, Wynn Macau amended and restated its credit facilities and increased the availability under its bank facility to approximately $2.3 billion, consisting of an approximately $750 million term loan facility and an approximately $1.55 billion revolving credit facility." 
  • "On September 17, 2012, Wynn Las Vegas terminated its credit agreement."
  • "In connection with amending the Wynn Macau credit facilities and the termination of the Wynn Las Vegas credit agreement, we expensed $19.7 million of deferred financing costs and third party fees"
  • In 3Q12, WYNN "spent approximately $24.0 million on our Cotai Project."


Takeaway: Solid quarter and positive forward commentary about Macau.

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




  • SLIGHTLY BETTER:  Management seemed a little more upbeat about Macau, and Las Vegas had a surprisingly strong quarter in terms of volumes and revenues.


  • BETTER: The special dividend of $8/share is a nice surprise given that some analysts were expecting it post-election.  Also, WYNN will increase its regular quarterly dividend from $0.50/share to $1.00/share starting in 2013.
  • PREVIOUSLY: [Update on special dividend, annual dividend or share buybacks?] "I can't resolve that question in absolute terms. I can tell you that that is the order of business before the Board when we get together and it comes up at this time. The Board was naturally waiting to see how the financing would go."


  • SAME:  WYNN has given out as much promotional allowances as they can.  WYNN will not risk the bottom line.  
    • "We have been able to hold the percentage we pay the junket operators to 40% plus 3% or so for complementaries, and our competitors are about 5 points ahead of us in terms of what they give the junket operators."
    • "The price war has extended into the mass end of slot markets....we always focus on how much junket commission that's given out, but we are actually giving out a lot more incentives now in slots and mass market to also buy back business."


  • BETTER:  Continued its prudent philosophy.  As a result, collections haven't suffered. The feeling is things have stabilized.  Junkets are giving more credit recently.
  • PREVIOUSLY:  "We are very conservative about credit....we don't use a rolling's 15 day credit on the 15th of the month."


  • SAME:  75% of the Capex will be spent in mid-2014 to mid-2016.  WYNN Cotai is aiming for a Chinese New Year opening in 2016. 
  • PREVIOUSLY:  "~$150 million on foundations over the next nine months to 12 months."


  • SLIGHTLY BETTER:  Opex came in around $1.2 million a day in 3Q.  This is a pretty steady run rate.
  • PREVIOUSLY:  "We're running between $1.3 million and $1.4 million per day before we take into account commissions or bad debt or anything like that. I expect that to continue. But, there will be continuous cost pressures, primarily driven through the pressures on payroll."


  • SAME:  New junket room will open at the 1st week in November; one of the major Chinese operators will move in.
  • PREVIOUSLY:  "We built a new junket room that's going to be open for Christmas. Another retail space -  a small one for jewelry at the entrance of the casino."

Trade Of The Day: EAT

Today we bought Brinker International (EAT) at $30.00 a share at 12:57 PM EDT in our Real Time Alerts. Hedgeye Restaurants Sector Head Howard Penney is saying that the conference call confusion is why the stock is getting hammered, so Keith bought it in the Real Time Alerts on red. Pretty straightforward as the EAT hold's its long-term TAIL line of 29.11 support. 


From our Alpha Sheet:


"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 Of The Day: EAT - EAT