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Kentucky Fried Politics

This note was originally published at 8am on October 11, 2012 for Hedgeye subscribers.

“The American people do not think the system is fair, or on the level.”

-Joe Biden


Forget #BigBird. The world’s tweeters will shift to whose political chicken gets fried tonight in Danville, Kentucky. It’s a good thing there’s no bubble in partisan US politics.


In terms of political ironies, the aforementioned quote is a beauty. It’s how MSNBC’s Chris Hayes kicks off Chapter 3, “Moral Hazards”, in the most recent book I have been reviewing, “Twilight of The Elites.”


While I’d love to debate Hayes and/or my boy Biden on their respective concepts of “fairness”, here’s something Hayes wrote that I completely agree with: “ … we cannot have a just society that applies the principle of accountability to the powerless and the principle of forgiveness to the powerful. This is the America in which we currently reside” (page 102).


Back to the Global Macro Grind


With the SP500 down for the 4th consecutive day, we got longer yesterday, for a trade. To be clear TRADEs (3 weeks or less) in our model are not to be confused with TRENDs (3 months or more). TRADEs get overbought and oversold. TRENDs (like #EarningsSlowing) last longer.


Some people don’t like the whole Duration Agnostic thing. Some people love it. I don’t wake-up every morning looking for love or loathing. I focus on doing what I can do to make our risk management process more dynamic and repeatable, across durations.


From an immediate-term TRADE perspective, at $630 AAPL was evidently oversold on Tuesday. What was oversold on Wednesday?


1.   Tech (XLK) – First, understand that this S&P Sector ETF is 1/5 AAPL, so buying XLK yesterday gets me more of what I really want - in a slowing growth scenario, I want to buy the cheap growth that I can find.  


2.   Utilities (XLU) – If I am going to buy what’s getting smoked in October (Tech), I also want some asymmetry on the long side in owning something that works if Tech doesn’t. Utilities are one of the top performing S&P Sectors since The Bernanke Top.


3.   Gold (GLD)Hedgeye Playbook long, for a trade, here as the US Dollar Index moves to immediate-term TRADE overbought. Remember, get the US Dollar right, and you’ll get a lot of other things right.


Yes, one of our intermediate-term TREND Themes for Q4 is Bubble #3 (Commodities), but that doesn’t mean I can’t fully embrace understanding what people do with bubbles (they chase them when they are green), and trade the risk of the position both ways.


Gold’s long-term TAIL risk (3 years or less in duration) is much more daunting than its intermediate-term TREND risk. Why?

  1. TAIL risk = lower long-term highs from the $1900/oz zone (2011 all-time highs) make a bubble look like a bubble; look backwards
  2. TREND support = Gold has recently proven to test its YTD highs established in February ($1794); that keeps mo mo bulls in it
  3. TRADE range = $1758-1792; you don’t have to be bullish or bearish to understand that; it’s just math

Agreed. It’s a lot harder to keep countervailing thoughts, across durations, in your head than being perma – but that’s precisely why I think about risk that way. The market doesn’t care about your politics or your positioning.


So, if I sell Gold at $1792, it will probably be because it’s immediate-term TRADE overbought, the USD is immediate-term TRADE oversold, and Romney’s momentum in the polls keeps firing Bernanke in play (no Bernanke is not good for Gold).


Back to Tech…


I’m not a techie, but I have built a #WallSt2.0 firm that’s been able to monetize Twitter. So you can just call me social. Risk managing Tech (XLK) is not for the faint of heart, but where it closed yesterday illustrates the Duration Mismatch of price momentum quite well:

  1. Tech (XLK) = down -2.5% for the month of October is the worst performing Sector of the 9 in the S&P Sector Model we track
  2. Tech (XLK) = up +18.1% YTD is the 3rd best performing Sector in the S&P for 2012
  3. Tech (XLK) = has a heavy weight in AAPL (20.73% of the ETF) and AAPL is up +58.25% YTD

So, if you want to get Tech (XLK) right, you probably have to get AAPL right. That’s why timing and factoring your position risk matters.


Now some people pay a lot of attention to what is up for the YTD. I personally couldn’t care less. My net wealth (and most people who don’t measure it on Old Wall’s calendar bonus schedule) compounds or is drawn-down, daily.


If AAPL is up +58.25% YTD, but down 10% in a straight line (from The Bernanke Top in September) from where your money manager bought it for you, you need to be up +11.1% (from the down 10%) to get your money back to break-even. That’s not Kentucky Fried Politics. That’s just risk management math.


My immediate-term risk ranges for Gold, Oil (Brent), US Dollar, EUR/USD, UST 10yr Yield, Tech (XLK), and the SP500 are now $1758-1792, $112.54-115.05, $79.43-80.03, $1.28-1.30, 1.68-1.76%, $30.02-30.69, and 1429-1448, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


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“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


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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


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."

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