IGT addressed some major concerns with a high quality and substantial beat.  Higher FY2013 guidance a nice bonus.



IGT was our favorite name heading into earnings and though we were projecting a beat this quarter and calling for higher 2013 estimates, even we were surprised how good the quarter was.  In fact, this is the first time in recent memory where we’re writing a positive review of IGT’s results.  The momentum looks sustainable as fiscal 2013 guidance was introduced at $1.20-1.30 vs. the Street at $1.18.


FQ4 was a very high quality quarter almost across the board.  EPS of $0.38 beat our estimate by $0.04 and the Street by $0.06.  Moreover, IGT addressed a couple of major issues that had been hurting sentiment:  Interactive performed very well and slot ship share grew substantially.  Maybe the Interactive acquisitions weren’t such a disaster after all?  And as we pointed out in our 10/1/12 note “IGT: IMPROVING 2013 VISIBILITY,” a significant capital deployment shift toward stock buybacks amid an improving fundamental backdrop is a pretty powerful long thesis for a cheap stock.


We will have some more insight after speaking with management today but here are some preliminary takeaways.


The Positives

  • North American product sales and margins were better than we expected
    • IGT shipped over 1.6k more units than we expected.  Most of the upside came from better ship share on replacements.
    • ASPs were significantly higher given the high percentage of Canadian units shipped in the quarter
    • IGT shipped 4,100 units to Canada but only 3,300 of those were VLT units.  Last year, IGT shipped 700 units to Canada in F4Q11.
    • IGT did not recognize any VGT units shipped to IL
    • Based on our calculation, IGT’s ship-share was 42% this quarter vs. 40% last year and 34% in the June Q.  The September Q is usually IGT’s best ship share quarter.
    • Product margins likely benefited from lower discounting and higher volume.  Higher IP payments likely also helped since those carry a 100% margin.
  • Non-box sales were better
    • We initially thought that perhaps IGT’s system business was gaining some traction, but it sounded like most of the bump was due to the settlement payments from BYI.
  • Interactive revenues and margins were a lot better than we expected
    • We thought that with the reorganization at Entraction that IGT’s revenues would take a hit, instead they look like they grew several MM QoQ
    • Double Down revenue was $2MM above our estimate due to bookings per user increasing more than we projected
    • Margins were just plain better
  • Guidance was above the street and the mid-point was higher than our $1.20 estimate
    • Interactive looks like it’s on track to deliver approximately $230MM of revenue at over a 60% gross margin
    • 10% growth in product sales seems achievable and IGT should be able to leverage some of that growth to produce better margins

The Negatives

  • International unit sales fell short of our expectations - though IGT backed away from guidance given earlier in the year of double-digit unit growth in international, during our last conversation with the company, they still insisted that international unit shipments would be up high single digits.  Instead, we saw a 2% YoY decline.
  • While the shipments to Canada were impressive, IGT also saw a huge increase in their receivable, largely as a result of monies due for the Canadian VLTs shipped
  • While ahead of us and the Street, core gaming operations continue at a flattish pace
    • The install base was disappointing, especially in light of the incremental units in Maryland.  IGT’s WAP base saw a fairly large sequential decline.
    • Yields in WAPs were down again YoY


TODAY’S S&P 500 SET-UP – November 09, 2012


As we look at today's setup for the S&P 500, the range is 46 points or 0.98% downside to 1364 and 2.36% upside to 1410



















YIELD CURVE – as of this morning 1.34 decreased from prior day's trading at 1.36 

BONDS – We’ve gone back and forth with clients on this one all yr and maintained that the most obvious bull market remains in bonds, provided that we remain right on both US/Global Growth surprising on the downside; at 1.61% on the 10yr, UST’s finally give us the immediate-term TRADE overbought bond signal here (German and Belgian Bonds overbought as well).



MACRO DATA POINTS (Bloomberg Estimates):

  • 8:30am: Import Price Index M/m, Oct. est. 0.0% (prior 1.1%)
  • 8:30am: WASDE agricultural data
  • 9:55am: U. of Michigan Conf., Nov. est. 83.0 (prior 82.6)
  • 10am: Wholesale Inventories, Sept. est. 0.4% (prior 0.5%)
  • 10am: Fed’s Duke speaks in Chicago
  • 11am: Fed to buy $1b-$1.5b TIPS due 1/15/19-2/15/42
  • 1pm: Baker Hughes rig count


  • SEC Enforcement Director Robert Khuzami speaks in N.Y., 9am
  • National Committee to Preserve Social Security & Medicare holds conference call briefing on proposed benefit cuts, with Sen. Bernie Sanders, I-Vt, 11am
  • IRS holds a public forum on proposed regulations relating to branded prescription drug fee imposed by Affordable Care Act


  • CME Group sued CFTC, challenging cleared-swaps reporting requirements imposed under Dodd-Frank legislation
  • President Obama expected to issue statement today on his plan for spurring economic growth, reducing deficit
  • To hold first post-election news conference early next week
  • NY federal judge to consider arguments today over whether to give Visa, MasterCard’s proposed $7.25b settlement of merchant fee price-fixing case prelim. approval
  • BP, plaintiffs ask judge to approve $7.8b spill accord
  • BofA’s Merrill Lynch unit must face lawsuit by FHFA over mortgage-backed securities sold by the bank
  • Whistle-blower helping U.S. mount $1b fraud lawsuit against BofA accused of fraud by investor in financing co. he co-founded
  • BNY Mellon reached deal to end lawsuit accusing it of defrauding state pension funds through forex transactions
  • China passenger-vehicle sales rose in Oct., beat est.
  • Lockheed’s F-35 jets may cost $1.26b for fixes
  • U.S. Fiscal Cliff, China Exports, Cisco: Week Ahead Nov. 10-17


    • Alliant Energy (LNT) 6:00am, $1.30
    • Enerplus (ERF CN) 6:00am, C$0.06
    • TMX Group (X CN) 6:00am, C$0.74
    • Covidien (COV) 6:00am, $1
    • GMP Capital (GMP CN) 6:00am, $(0.03)
    • JC Penney (JCP) 6:00am, $(0.07)
    • HeartWare (HTWR) 6:30am, $(1.52)
    • Foster Wheeler (FWLT) 6:45am, $0.45
    • Stella-Jones (SJ CN) 7:00am, $1.26
    • GenOn Energy (GEN) 7:00am, $0.03
    • MGIC Investment (MTG) 7:00am, $(0.74)
    • Warner Chilcott (WCRX) 7:00am, $0.79
    • Apollo Global Management (APO) 7:08am, $0.76
    • Laredo Petroleum Holdings (LPI) 7:26am, $0.13
    • EW Scripps (SSP) 7:30am, $0.11
    • Brookfield Asset Management (BAM/A CN) 8:00am, $0.30
    • Telus (T CN) 8:01am, C$1.07
    • Ameren (AEE) 8:15am, $1.41
    • Emera (EMA CN) 9:48am, C$0.36
    • Medivation (MDVN) 4:09pm, $(0.10)


  • Gold Set for Best Week Since January on Stimulus Prospects, ETPs
  • Gold Traders More Bullish After Obama’s Re-Election: Commodities
  • Sugar Declines in London on Brazilian Supplies; Cocoa Rises
  • Gold Demand in India Seen Rebounding on Festivals, Price Decline
  • Copper Heads for Fifth Weekly Decline on European Growth Concern
  • Corn Top Commodity Pick at Morgan Stanley as U.S. Supply Shrinks
  • Rubber Gains, Paring Weekly Loss, on Signs of Economic Recovery
  • Indonesia Palm Oil Group Wants Tax Changes to Counter Malaysia
  • Oil Trades Near Four-Month Low on Demand Concern, Supply Growth
  • Copper Inventories in Shanghai Climb to Highest Since April
  • Canada’s New Corn Belt Attracts Hot Money to Bargain Farmland
  • California Carbon ‘Crippled’ by Buyer Hesitation: Energy Markets
  • China’s High-Cost Aluminum Producers Limit Output Declines
  • Gold Traders More Bullish After Obama’s Win
  • Sugar Fee for Thailand Climbing as Futures Slump to Two-Year Low





EURO – euro $1.27 is ugly, but also immediate-term TRADE oversold; get the EUR/USD right, you get a lot of things big beta right; so today’s currency signal, like our bond signal, says buy stocks that can deliver on the numbers (yes, there are far fewer of those today than 2 months ago). Top 3 Ideas from here: IGT, SBUX, FDX (long).










CHINA – unfortunately, for team “China has bottomed”, China is not the reason for us being more bullish than we have in 2 months this morn – everything has a time and price, but Chinese stocks were down for the 5th consecutive day and remain in a Bearish Formation as China refuses to deliver the Western hope for stimuli.









The Hedgeye Macro Team




Major Changes

This note was originally published at 8am on October 26, 2012 for Hedgeye subscribers.

“An economic model conditioned on the notion that nothing major will change is a useless one.”

-Nate Silver


I’ll reiterate Hedgeye Risk Management’s top Global Macro Theme for Q4 of 2012 this morning: #EarningsSlowing. We are finally seeing Major Changes to buy-side expectations for revenue and earnings. The sell-side’s estimates remain in lah-lah land.


As Nate Silver writes on page 193 of The Signal And The Noise, “anticipating these turning points is not easy.” But I fundamentally believe that if you study history, do math, and believe in the probability of mean reversion occurring, it’s certainly less hard.


“So we should have some sympathy for economic forecasters. It’s hard enough to know where the economy is going. But it’s much, much harder if you don’t know where it is to begin with.” (Silver, page 194). Since March, Global #GrowthSlowing has caught most consensus economists off-sides in 2012. Now #EarningsSlowing (which happens on a lag versus revenues) has analysts off-sides too.


Back to the Global Macro Grind


Flying back from California yesterday, I was watching Amazon (AMZN) and Apple (AAPL) earnings roll across my tweet-tape, and I couldn’t help but think, ‘gee, wouldn’t it have been nice if all the bulls warned us that both companies would miss and guide down?’


The risk that needed to be managed in AMZN and AAPL isn’t what you’ll see when the stocks open today - we’re already 5 weeks into what’s turning into a very serious draw-down in Tech (XLK) overall.


From the Bernanke Top (September 2012):

  1. Technology (XLK) = down -10%
  2. Apple (AAPL) = down -14%
  3. Amazon (AMZN) = down -15%

Remember, AAPL represents 20.6% of the Tech Sector (XLK) ETF. So Tech is outperforming AAPL at this point (and the SP500 is outperforming Tech). That means that anyone who was outperforming being long AAPL until September is probably now underperforming. Typically when this kind of rotation starts to happen in your portfolio, beta starts to eat your alpha.


Overall, beta (the SP500) is outperforming both Tech, AMZN, and AAPL. Since the Bernanke Top, the SP500 is in what we call a correction (down -4.2%). A draw-down is different than a correction. When you have double digit losses in a position, the next question isn’t “what is the stock down on the open?; it’s will this position start to crash?”


We define “crash” as a peak-to-trough price decline of 20% or more. Russia is teetering on moving back into crash mode this morning (RTSI down -1.8% on the session; down -18.3% from the March global #GrowthSlowing top). We’ll give the ole Bernank some credit for that one too – Russian stocks have everything to do with Petro-Dollars – and now we have Strong Dollar, Down Oil.


Away from the market’s leaders missing, that’s the other Big Beta thing going on out there this morning – remember, get the Dollar right, and you get a lot of other things right. Looking at Global Equity risk, the current 60-day Correlation Risk between the USD Index and the broad indices are as follows:

  1. SP500 = -0.87
  2. EuroStoxx600 = -0.95
  3. MSCI World Index = -0.91

So, you can look at risk from a bottom’s up stock perspective and/or from a top down (SECTOR, COUNTRY, or ASSET CLASS) beta risk factoring perspective, and you’ll learn a lot more about what’s really going on out there.


Keynesian economists have been saying that the Fed’s Policy To Inflate has not been causal to Correlation Risk. I say that’s a crock. If Romney wins the election (on that risk factor, probabilities in your conditional Bayesian model should be rising, not falling), there is a very good chance that the most asymmetric risk in all of Global Macro (Strong Dollar) busts a big move to the upside.


If that happens, the aforementioned correlations are probably going to keep moving towards 1.0, and we’ll probably be really right, in the immediate-term on Hedgeye’s 2nd Global Macro Theme for Q4 of 2012: Bubble#3 (Commodities).


I re-shorted the Gold Miners ETF (GDX) with that causal relationship in mind yesterday. I also re-shorted the Industrials Sector ETF (XLI) on green yesterday too.


Jay Van Sciver’s bearish thesis was very cogent in yesterday’s Early Look. If you believe there’s a bubble in Mining Capex, you’re probably in agreement with us that the revenue and #EarningsSlowing risk to pro-cyclical Industrials like Caterpillar (CAT) and Komatsu (KMTUY) remains to the downside as well.


Major Changes aren’t always underway in markets, but when you can get in front of the big ones you can save yourself, family, and clients from losing a lot of money.


Our immediate-term risk ranges for Gold, Oil (Brent), US Dollar, EUR/USD, UST 10yr Yield, AMZN, AAPL, XLK, and the SP500 are now $1694-1728, $105.98-110.66, $79.64-80.25, $1.28-1.30, $217-228, $591-613, $28.44-29.14, and 1395-1419, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Major Changes - Chart of the Day


Major Changes - Virtual Portfolio

Early Look

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TUMI: Buy It Lower

Takeaway: For those buying into this 10.1mm TUMI secondary, keep in mind that it just fell below a critical quantitative support level.

For those of you buying into this 10.1mm TUMI secondary, keep in mind that it just fell below a critical quantitative support level and has little support until the high $17s. It might be a great story, but every story has a time and a price.

TUMI: Buy It Lower - 11 9 2012 6 51 05 AM

KSS: Cheap and Built To Stay That Way

Takeaway: The setup here looks tempting over the immediate-term, but we think KSS is in for another tough year in 2013.

The setup here looks tempting over the immediate-term, but we think KSS is in for another tough year in 2013.


KSS may appear to be a cheap stock, but we think it’s built to stay that way. Our bias is to the upside this holiday given the abysmal performance it went up against last holiday, and the fact that it does not really begin to feel pressure from JC Penney coming back on line until 2013.  


We need to keep in mind that KSS is quickly becoming a zero square footage growth retailer slowing from ~3%+ in 2010 and 2011 to +1.7% in 2012 and +1% next year. More aggressive repurchase activity can and likely will be used to grow earnings, but that doesn’t warrant ‘historical multiples’ from the days when KSS was aggressively growing its footprint productivity, and efficiency. As we pointed out in yesterday’s note on Macy’s, zero growth retailers have no problem trading at 6x forward earnings. KSS has never really gotten there, but it has also never been as mature as it is today.


Let’s keep in mind that it’s planning for a 3-4% comp in what it already thinks will be a highly promotional holiday. We already know that Macy’s is planning for a 4% comp, and while it has the benefit of JCP which will likely comp down at least 10-15 points below last year, there’s still potentially not going to be enough for everyone to go around.


That said, we’re less concerned with comp on what we’ll call ‘planned-promotion’ merchandise. In reality, it is a number we cannot forecast. No one can. Retailers themselves cannot do it other. It’s not as much a function as the actual number as the level of comp they are PLANNING. Then they execute on a marketing plan, and either a) convert at planned price, b) clear at heavier than expected discounts, or c) let comps lag, but keep margins high while letting inventories grow. (Note: Those are listed in order of attractiveness for the stock.)


Who are we to doubt that they can get the 3-4% comp given their more aggressive and better assorted inventory position compared to last year, but we do cast doubt on gross margins. While we see risk in 4Q EPS, however, our real concern is looking out to 2013.


2013 is when we expect the mid-tier to become severely promotional, and the fact that KSS is off mall does not isolate it from JCP (on-mall) regaining share. Growth in e-commerce (+220bps) and new stores (+140bps) has helped offset KSS’ contracting core business this year (-150bps), but we see slowing new store contribution, further erosion in core (comps down -3.5%), and anniversarying a 53rd week leading to a 3%-4% sales deceleration next year. This is illustrated in the first chart below.


The best bull case is that consumer spending rebounds, and KSS’ off-mall presence proves to insulate itself from increased competition between JCP, M, and GPS. In addition, technology investments continue to drive 40%+ e-commerce growth and the new merchandise team gets the kids business back on track driving +3%-4% comp growth. With modest gross margin expansion and SG&A leverage you get $5.25 in 2013 earnings – suggesting 10x earnings and ~5.3x EBITDA. That’s cheap enough for us to get interested in KSS, presuming there was a fundamental catalyst we could identify to get it there.


A number between $4.00-$4.25 suggests that  the stock is closer to 12x-13x earnings. This might not be expensive, but mature department stores – with better content – have traded at half that multiple in the past. The simple fact that KSS hasn’t comped while the rest of the mid-tier has benefitted from JCP hemorrhaging nearly $3Bn in share requires a high degree of trust to assume a meaningful rebound just when JCP’s top-line reaccelerates. We don’t see enough differentiation at KSS to bet against this risk/reward setup. While not at the top of our short list, it’s a name we think will work headed into 2013 (we like Macy’s and GPS better on the short side).

KSS: Cheap and Built To Stay That Way - KSS Grwth Comp


KSS: Cheap and Built To Stay That Way - KSS S






Takeaway: Improving fundamentals and more stock buybacks leading to higher estimates going forward

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



OVERALL:  BETTER - IGT put up a big quarter and provided guidance above the Street.  The strength of the quarter was mainly in product sales (pricing and margins) and the Interactive division - a pleasant surprise given the negative sentiment surrounding these acquisitions.  However, gaming ops also beat us and the Street so the overall quality of the quarter was quite high.




  • LITTLE WORSE:  Game ops gross margins ex interactive was 61% while interactive gross margins was 62%.  IGT expects margins to improve in FY 2013.
  • PREVIOUSLY: For the fourth quarter, we are assuming consolidated gaming operations gross margin of approximately 62%, including our interactive businesses.


  • MUCH BETTER:  Product sales gross margin came in at 56%.  IGT expects more improvement in margins especially in their international business.
  • PREVIOUSLY: For the fourth quarter, we are assuming consolidated product sales gross margin to be approximately 52%.


  • SAME:  FY 2012 diluted share count was 290.4 million.  IGT returned $550 million to shareholders in FY 2012.
  • PREVIOUSLY: "We expect our fully diluted weighted average shares outstanding to be 291 million shares for fiscal 2012. Inclusive of dividends, we anticipate returning over $0.5 billion to shareholders in fiscal 2012, a clear indication of the strength of our cash flows and confidence in our strategies."


  • BETTER:   Double Downs showed solid growth in revenues, gross profits, and bookings per user in F4Q. Even though the daily and monthly active users didn't change much, bookings per user came in better than expected.
  • PREVIOUSLY: "I think Double Down is the same. Double Down, we have a couple new products launching in August."


  • BETTER:  While IGT has yet to confirm, we're pretty confident that Canadian shipments were closer to 4,000 than a couple of thousand this quarter. 
  • PREVIOUSLY: "We have a couple thousand, I think, coming in the next quarter, but it's coming into new provinces where we have to get through the compliance process, so those things are in the balance.


  • BETTER:  IGT expects NA replacement ship share expected to be 48%. Of course this includes their Canadian shipments
  • PREVIOUSLY: "We always hear very optimistic things about the intent to purchase. I think it has been less predictable. You can see in our North American replacements there were very strong shipments this quarter. We felt very good about the replacement market, so I think that that's an indication of confidence. We'd like to see that trend continue. The things that we hear from operators would indicate they'd like to continue to put capital to work, so we just have to get a little help from the economy."


  • BETTER:  Gaming ops margins were significantly higher YoY and international product sales margins was down slightly YoY.
  • PREVIOUSLY: "We're obviously handily beating last year on the revenue line, but we're having challenges on the margin associated with game ops and then some of the international product sales, and we expect that those will continue to a degree."


  • SAME:  SG&A and R&D increased 3% and 8% QoQ, respectively.  D&A was flat QoQ.  IGT expects to continue to invest in the interactive business but at a rate than the revenue growth in that business going forward.  For the base business they expect low single digit SG&A growth. 
  • PREVIOUSLY:  [3Q SG&A, R&D, D&A good run rates?]  "I think you're going to continue to see some level of growth there as, for example, advertising and selling continue to factor into the Double Down model. But we will continue to make those investments as long as they're accompanied by growth in revenue, which we are seeing."

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