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WMS: THEY’RE STILL TOO OPTIMISTIC

Street estimates continue to look high to me. WMS probably should’ve lowered 2009 guidance in their FQ3 earnings release, but they didn’t. I don’t doubt the success of WMS’s new games but there aren’t many new casinos or expansions in the pipeline. Replacement demand won’t make up the difference. I know the sell side wants to get behind a growth story (11 out 16 ratings are buys), but the casinos (and their creditors) are not cooperating. EPS growth in 2H F2009 and full year F2010 may only be flat to up low single digits.

The first chart details our industry wide projections for slots sales into new casinos and expansions and the year over year change. From the data, it’s pretty difficult to walk away with the conclusion that WMS has a lot of near or intermediate term growth, even if they resume market share gains. The numbers are pulled from our database of every new casino and expansion opening in North America over the next 2 years. The September quarter of 2009 is the only quarter through the end of 2010 where there is a positive delta in domestic slots to new/expanded casinos.

The second chart provides the projected growth by the Street. Currently, the consensus EPS estimates for 2H F2009 and full year F2010 are $0.81 and $1.63, respectively, representing growth of 19% and 14%. Meanwhile, we project total domestic slot unit declines for the industry of 44% and 22%, respectively, over the same period. That’s with a 25% increase in projected replacement demand! As can be seen in the first chart, slot unit sales to new casinos and expansions will be down even more. WMS would need to grow its market share by 10 percentage points to 32% to hit the Street’s domestic unit sales estimate of 19,000 slots in F2010, based on our industry assumptions.

Clearly, there is a big disconnect between the two charts. Market share gains and replacement demand won’t be enough to bridge the gap.


Significantly negative growth in every quarter except Q3 2009
Hard to reconcile this chart with the one above

RE-SHORTING JAPAN: Does Bernie Madoff sit on the BOJ’s board?

RE-SHORTING JAPAN
Does Bernie Madoff sit on the BOJ’s board?

Today was day 1 of the BOJ policy board meeting and the top issue on the agenda has been what to do to help prop up Japanese banks, which are straining under the weight of their collapsing stock portfolios in a vicious cycle that sends equities lower, in turn.

The banking sector rejected the opportunity to sell preferred stock to the government last December for fear that the stigma would cause a loss of confidence among shareholders and overtures by the central bank last month to purchase concentrated cross-holdings directly from the banks in off market transactions were rebuffed by CEO’s unwilling to publicly book losses (Japanese accounting practices are more opaque than those in the US).

After attempting to lead a horse to water but failing to make it drink on multiple occasions, the BOJ is now trying a new approach. A new program is being discussed which will provide up to $10 billion in subordinated loans to banks whose capital ratios have been decimated by declines in their equity investments.

The hope is that this measure will help maintain capital ratios to prevent spiraling liquidations in the stock market, but the modest size suggests that this is a “band aid” and the impact on domestic credit liquidity could be minimal. The bank is also expected to announce treasury buying to combat rising yield. As of this morning, the Nikkei had rallied 12.67% for the week into high expectations for these and other programs.

By our reckoning there may be good news here for the markets in the short term but not for the actual economy. Extending margin loans to levered banks to prevent them from being forced to sell stocks while buying debt to keep yields low strikes us as just delaying the inevitable. After decades of stagnation Japanese financials are living on borrowed time.

Into the strength associated with the recent market squeeze, we re-shorted the Japanese equity market rally via the ETF EWJ today. This is a tactical short; we expect the market there to pull back when reality sinks in over the coming weeks. We will leg into our virtual short position at higher levels if the rally continues. Everything has a time and a price.

Andrew Barber
Director

Shark Line 762: SP500 Levels, Refreshed...

I can assure you that AFTER making 17 consecutive shorts and long sales in our Virtual Stock Idea Portfolio this market’s resilience today surprises me. Being data dependent however, the math (refreshed for 3PM EST prices) is telling me a close above the 762 Shark Line (dotted white line) could get this short squeeze to 790 in the SP500 (dotted red TRADE line) in short order.

At 790, nothing from an immediate term TRADE perspective will have changed other than going straight up to the top of a trade-able range. The Bear Market’s intermediate TREND line remains overhead (solid red line) at 830.

I was first given the gun to manage a “carve-out” of a hedge fund in the year 2000. In the Baby Bear market of 2000-2003 the average trough-to-peak squeeze rally in stocks was just north of +17%. The 2009 SP500 closing trough price was 676 (we got bullish for a TRADE there); if we see that 790 print, that will have been a +16.9% move, trough-to-peak. I have seen this movie before.

TRADE and tread carefully as we push to the topside of the range. All of the Bulls have been Bearish, and you can bet your Madoff that they’ll get sucked into this at that immediate term top.
KM

Keith R. McCullough
CEO & Chief Investment Officer

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Korea: Damned If They Do, Damned If They Don't...

While other Economies face the threat of deflation, South Korea faces a rate dilemma driven by devaluation

The Bank of Korea (BOK) reported Monday that import prices grew 3.91% in February M/M, the first monthly gain since October when prices increased 4.1%. On a year-over-year basis, the increase in February registered at 18.03%, up from January’s 16.7%.

The weakness in the won is driving this import cost pressure. In 2008 the won declined 25.7% against the dollar, with the slide continuing into 2009. Despite the Won rally coming out of this weekend’s G20 meeting the expectation must be that import prices will continue to increase into March, driving consumer prices higher. CPI rose in February increasing 4.1% Y/Y, up from a 3.7% gain in January.

The one bright spot in import data was raw materials, which decreased 5.5%, Y/Y, following a 3.5% decrease in January, as aggregate commodity prices have continued the downward trend from last summer’s highs. This is a critical data point for Korea, the fourth largest oil importer globally which imports 97% of its energy needs. The rising price levels for crude so far this month suggest that this silver lining may soon disappear in the face of reflation.

Last week the BOK Monetary Policy Committee decided to maintain the Base Rate at 2.0%, after 6 consecutive rate cuts totaling 325 bps from October to February. The committee cited weakening domestic and export demand as downside risks to economic growth and a moderating factor in the run up in consumer price inflation generated by the won depreciation. YTD the won has weakened nearly 13% against the dollar, the largest depreciation among the region’s major economies, which has interesting ramifications for Chinese exchange rate policy.

The question is which effect will dominate the politics of policy going forward, the rate of increase in inflation driven by the collapse of the won or the contraction of Korean economic growth, as income and consumer sentiment continue to fall. We have a negative bias on the South Korean equity market and will continue to seek tactical opportunities to short into strength.

Andrew Barber
Director

2009 – THE ENDING TO A PERFECT STORM

In late November, I outlined my call that 2009 would be a better year for restaurant stocks (please refer to my November 30 post titled “Building a Case for Casual Dining in Early 2009”). Specifically, I highlighted five catalysts, including 1) lower gas prices, 2) a fiscal stimulus package, 3) reduced restaurant capacity, 4) a decline in commodity prices and 5) valuation. With these catalysts already starting to take hold, I am sticking with my call!

Throughout 2008, restaurant management teams repeatedly referred to the operating environment as the perfect storm as sales declined at the same time a majority of their input costs hit historical highs. These two factors alone crushed margins, particularly within the casual dining industry.

We have not yet seen an end to the pressure on restaurants’ top-line results, though according to Malcolm Knapp data, January casual dining trends were less bad than December. Commodity costs, however, should be less of a burden in 2009. Most management teams are expecting food cost increases to moderate on a year-over-year basis, largely in 2H09. As the table below shows, all but one of the most prevalent restaurant commodity inputs (chicken) are down on a year-over-year basis in 2009 (based on the average prices year-to-date in 2009 vs. 2008). And, the declines are rather significant, except for pork, which is essentially flat.

Higher gas prices hurt restaurant margins in 2008 from both a cost standpoint, as companies were forced to pay higher fuel surcharges, and from a revenue/demand perspective as higher gas prices deterred consumers from going out to eat. Although gas prices are up 20% year-to-date, they are still down over 40% on a year-over-year basis, which should benefit consumers and restaurant margins alike.

In addition to lower year-over-year commodity inflation, most restaurant management teams are now more prepared to cope with the current sales environment as they have pared back on new unit development and directed more focus to better managing costs. All of these factors combined should help mitigate the impact on margins from continued sales deleveraging. That being said, I would not expect to see any material improvement in margins until sales begin to improve.

On a number of different levels we are setting up to see some very bullish trends in 2H09. We have already established the commodity tailwind that most restaurant operators will see in 2H09. From a MACRO standpoint, the potential for the consumer to prevail, begging to feel “less bad” as we move through the summer is a real possibility. Like it or not, progress is being made to heal the country, especially as it relates to the health of the banking system. Whether it’s the stimulus package, bank bailouts or small business loans, the current administration is pressing ahead with a number of initiatives to restore consumer confidence. This is positive for restaurant stocks!

For the past three years, as the restaurant industry led the down turn in the economy, easy comparisons were meaningless. As we head into 3Q09 and 4Q09, the tailwind of easing commodity prices and a stronger consumer could lead to improving same-store sales and margin expansion. Easy comparisons will once again be investable.

US Housing Will Bottom In Q209'

EYE ON HOUSING – STICKING WITH OUR CALL – MARKING A BOTTOM IN 2Q09

Since the beginning of 2009, I have been very clear on my stance as it relates to the housing crisis - the worst of the housing crisis is behind us. I said in early January that housing could bottom (in terms of sequential price declines and inventory growth) in 2Q09. Forming a bottom in housing is a process, not a specific data point.

The bubble in residential real estate is the root cause for the problems we face today. Therefore, it is only fitting that residential real estate should become the leading indicator that the worst of times is over; or at the very least, that the bottom is near. Increased confidence in the real estate asset class will allow those assets, in addition to other asset classes (i.e. equities), to obtain higher prices and ultimately, a higher valuation.

Today we learned that housing starts in the U.S. surged in February from a record low number in January. February housing starts saw a 22% increase from January; the biggest jump since 1990. While we are not out of the woods, these numbers are a part of the bottoming process and provide some visibility that we may see housing starts reach a bottom in the 2Q09. At the very least, it should provide comfort that the end is near.

We understand that builders are facing record foreclosures that will keep prices down year-over-year for the balance of 2009. Importantly, we will see the deceleration in prices begin to slow, also in 2Q09.

Howard W. Penney
Managing Director

Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.

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