Moving Past The Noise

Client Talking Points

The Slowdown Continues

Corporate earnings continue to slow in addition to global growth. Moving into Q4, when companies report, expect a lot of misses. Any company that didn’t guide lower into the next quarter has to really prove they can beat the Street by a longshot. The market certainly has lost confidence in the ability of corporations to put up solid numbers, so testing 1300 on the S&P 500 soon isn’t some kind of crazy pipe dream. We can go a lot lower here so anyone screaming that stocks are “cheap” should realize that cheap can get a whole lot cheaper.

Political Dysfunction

President Obama meets with Congressional leaders today to kick off negotiations on the Fiscal Cliff. Obama won’t give wealthy Americans a break on taxes where as Republicans in the House want everyone to enjoy the benefits of a tax cut. Neither side is likely to budge, so you can imagine how well this will work out.

Asset Allocation


Top Long Ideas

Company Ticker Sector Duration

After a long downward slide, TCB has finally turned the corner. The margin has stabilized after the balance sheet restructuring. Loans are growing thanks to the equipment finance business. Non-interest income is more likely to go up than down going forward, a reversal from the past 18 months. Credit quality has a tailwind from a distressed housing recovery in TCB’s core markets: Minneapolis, Detroit and Chicago. On top of this, the CEO, Bill Cooper, is one of the oldest regional bank CEOs, which raises the probability that the bank will be sold. Expectations are bombed out at this point, so we think it’s time to move from bearish to bullish on TCB.


There is improving visibility on 20%+ EPS growth with P/E of only 11x with better content leading to market share gains. New orders from Canada and IL should be a catalyst. Additionally, many people in the investment community are out in Las Vegas at the annual slot show (G2E) and should hear upbeat presentations by management.


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.

Three for the Road


“Romancing The Fiscal Cliff” -@JohnBiggs


“If I had only known, I would have been a locksmith.” -Albert Einstein


Hostress Brands, maker of the infamous Twinkie, will close its doors and lay off 18,500 employees. The end of an era.

FL: Early Read

Takeaway: Solid Q confirming concerns over slowing sales were overstated. With $3 in EPS now squarely in view next yr we expect FL to work through YE.

Solid quarter out of FL coming in at $0.63 (adj) vs. $0.54E and our $0.59 expectation. Comps came in at +10.2% slightly higher than our +9.5% estimate and well above consensus (+7%). As always, we’ll get further detail on the call (at 9amEST), but we suspect domestic comps came in up low-to-mid double-digits offset by slower international growth of flat to slightly down. As noted in our 10/20 note ‘FL/FINL: Stealth Strength in Athletic Specialty,’ concerns over slowing sales were overstated due to a widening spread between the athletic channel and industry.

In addition, we’ll get the customary month-to-date comp update which we expect to be one of the least encouraging in recent quarters due to the impact of Sandy – this is not new news to investors. We suspect sales are likely running negative with weekly industry trends reporting sales down -6% November-to-date (see table below). While this sample consistently understates performance in athletic, we wouldn’t be surprised to learn that sales are down to start the quarter.


Gross margins came in essentially in-line with more modest SG&A spend accounting for the EPS upside. SG&A spend was flat yy leveraging 202bps. Taking into account $7mm in vacation pay accrual adjustments last year, SG&A was up +2%. With an estimated $2mm benefit from Fx and further growth in marketing investments, the spread between core SG&A and revenue growth continues to drive meaningful margin expansion.

Inventories marked the twelfth consecutive quarter of a positive sales/inventory spread though down 4pts to +6% which likely reflects some initial inventory build related to the storm at quarter end. This continues to put FL in a very good position to manage merchandise margin pressure near-term and gross margins through year end against easing compares.


FL is clearly continuing its momentum following a significantly more challenging 1H printing EPS 17% above expectations. Basketball continues to be a favorable tailwind given last year’s disruptions though we suspect that the company’s women’s initiatives are starting to play a more significant role in driving top-line in recent months as well. We expect plenty of air-time on the call to be allocated to the recently announced SIX:02 women’s only concept that will be tested this holiday season. This makes a ton of sense as the company looks to increase its women, kids, and apparel mix as well as growing the international store footprint (more productive that domestic base), and expanding digital platform to drive business over the next several years.


With a favorable setup through year-end, we expect more opportunity for further upside in performance. With $3 in EPS now squarely in view next year, we expect this one to rebound and work higher over the intermediate-term.



FL: Early Read - FL S


FL: Early Read - FW sales


FL: Early Read - FL FW sales chart






The Macau Metro Monitor, November 16, 2012




Contrary to widespread perception, Singaporeans are not taking advantage of annual levy passes into the casino to enjoy multiple entries at the fixed price of $2000.  Minister Iswaran said that of the total number of entry levies bought by locals last year, less than 1% of them were annual entry levies. The rest were daily entry levies.  He was responding to several Parliament members' suggestions during the ongoing debate on casino regulations, that the Government scrap the annual entry levies.  



According to the Trade and Industry Ministry, Singapore's economy is expected to grow by around 1.5% in 2012 (low end of 1.5-2.5% previous forecast range) and 1-3% in 2013.  Early estimates show that in 3Q, GDP grew 0.3% YoY and fell 5.9% QoQ.  Permanent Secretary at the Trade and Industry Ministry Ow Foong Pheng said: "Growth may come in slightly lower than forecast if the weakness in the externally- oriented sectors persists into the final quarter of 2012."



Roads across the Peninsula recorded heavy traffic and congestion as well as numerous accidents as the Grand Prix race got underway yesterday.   According to police and transport departments, congestion started as early as 7am in the Areia Preta zone after many roads were completely or partially closed to facilitate the annual event.  Road conditions were even more overloaded in peak traffic hours with long queues of vehicles seen in Avenida de Horta e Costa, the NAPE area and other districts near the racing track. 


real-time alerts

real edge in real-time

This indispensable trading tool is based on a risk management signaling process Hedgeye CEO Keith McCullough developed during his years as a hedge fund manager and continues to refine. Nearly every trading day, you’ll receive Keith’s latest signals - buy, sell, short or cover.

Fish Stories

“Many men go fishing all of their lives without knowing that it is not fish they are after.”

-Henry David Thoreau


The thing with fishing trips is they end more often with stories of massive fish that were on the hook, rather than actual proof of the whopper.  The best evidence of catching a trophy fish is of course taking a picture of it.  My colleague Keith McCullough and I went fishing off of Long Island more than a decade ago with some buds, back when we were hedge fund pups, and caught a whopper.  Being the accountable market operators we are, we actually took a picture of it and it is featured in today’s Chart of the Day.


Managing money is a little like fishing.  You can tell tall tales of your performance, but at the end of the day you need to be able to show the results.  In that sense, I’m pretty certain 2012 it is going to be a year of great tales but few whoppers reeled into the boat.  Simply, this has not been a year in which navigating the global macro waters has been easy.


All year we’ve been spinning the tale of both slowing growth and declining corporate earnings, but for much of the year the market shrugged off these concerns.  Now, of course, these concerns are front and center again.  As always, the most dangerous markets of all are those that go up in the face of declining fundamentals because ultimately those markets will have further to fall. 


In the global macro waters this morning, there are a number of key points to consider:


1.   Chinese leadership – After much speculation, the final names of the seven gentlemen (down from nine) that will run China was announced.  The conclusion is that they are more “conservative”.  The key takeaways are that we are likely to see fewer human rights reforms and likely a more tepid pursuit of economic growth.   Under the outgoing leaders, China experienced a decade of 10% growth and passed both Japan and Germany to become the second largest economy in the world.  At the very least, that growth rate will decelerate.


2.   Japanese easing – The Japanese equity markets are up almost 2% this morning, but don’t confuse that move with economic growth.   The LDP is widely expected to win in the December 16th election and LDP President Abe put his cards on the table and is calling for “unlimited easing” to achieve a 2 – 3% inflation target.  Ironically, or not, one of our top ideas yesterday was shorting the Yen.  Email if you’d like to get our Senior Asia Analyst Darius Dale on the phone to discuss this thesis.


3.   American political dysfunction – Today, President Obama is set to meet with key Congressional leaders as formal negotiations on the fiscal cliff begins.  Obama unofficially began the negotiations on Wednesday when he said in a press conference that he expects tax increases for wealthy Americans to be part of any deal.  This is a much more aggressive stance than the House Republicans were willing to accept in the prior negotiations, so it is unlikely to be accepted this time either. 


Of the three macro points highlighted above, the most pressing concern from a current and future growth perspective is clearly the fiscal cliff, or as we call it The Keynesian Cliff. Unfortunately, the election did not solve much in the way of giving either party a mandate to solve this issue.  At the table today, we have exactly the same cast of characters: President Obama, Senator Harry Reid, Senator Mitch McConnell, Congresswoman Nancy Pelosi, and Congressman John Boehner.  As Yogi Berra would say:


“It’s déjà vu all over again.”


To the extent that the participants get away from a grand plan, it may actually be a positive for the markets.  Simply, there is an immediate term catalyst.  In six weeks, dramatic spending cuts and tax increases go into effect, to the tune of some $500 billion annualized.  If this short term catalyst can be taken off the table it is likely to at least calm equity markets.  This would of course imply rational action from Washington, D.C. 


Since it is unlikely, based on recent history, that the elected officials in Washington act rationally, perhaps they will act in a more bi-partisan spirit.  Senator McConnell’s opening statement seems to suggest that, too, is unlikely.  As the Senator stated:


“I was glad to hear the President’s focus on jobs and growth and his call for consensus. But there is no consensus on raising tax rates, which would undermine the jobs and growth we all believe are important to our economy. While I appreciate and share the President’s desire to put the election behind us, the fact is we still have yet to hear an actual plan from the President for addressing the great economic challenges we face. What’s needed now is a realistic and specific proposal from the President that can actually pass the Congress.”


It’s pretty clear, so far, that tax hikes on the rich won’t pass Congress, so President Obama’s opening gambit may ultimately be a sign that we are in for a very volatile next six weeks.


Our immediate-term risk ranges for Gold, Oil (Brent), Copper, US Dollar, EUR/USD, UST 10yr Yield, and the SP500 are now $1, $108.19-111.10, $3.41-3.47, $80.58-81.33, $1.26-1.28, 1.53-1.68%, and 1, respectively.


Enjoy the weekends with your families and all the best to Yale Football up in Cambridge!


Keep your head up and stick on the ice,


Daryl G. Jones

Director of Research


Fish Stories - Chart of the Day


Fish Stories - Virtual Portfolio


The REIT/OPCO split certainly adds value and should create a new valuation paradigm for regional gaming operators.  ASCA – yes; MGM, CZR, LVS, WYNN – no.



In the making for a year, PENN’s blockbuster announcement last night should be a boon to regional gaming stocks, especially PENN.  When the transaction consummates in 9 to 12 months we currently project total value at $44-62.  The news is likely to propel all gaming stocks higher but we believe this structure is only possible for companies with lower leverage and high free cash flow.  Folks, it’s not happening with MGM and CZR and unlikely for WYNN and LVS so we would fade any strength today in those names.  Instead, we would focus on the regional gaming operators – specifically ASCA.  While we caution it would take 2 years for ASCA to pull something off like this, it’s a no-brainer for them.


The details of PENN’s transaction are complicated, the premise is quite simple.  REITs are much more tax efficient so instant value is created.  Moreover, the split capitalizes on the arbitrage card between how REIT investors value companies vs. how gaming investors value companies.  REIT investors value companies based on how much cash they throw off and hence how much they can return to shareholders via a dividend.  Gaming investors use an EBITDA multiple which gets adjusted based on the quality of a management team, growth prospects, and stability of underlying assets.   Using one methodology can get you a premium of 50% over the other, and hence the arbitrage. 


So what is this deal essentially doing?

  • PENN is putting roughly 50% of its EBITDA and guaranteeing it as fixed rent with annual escalators into a new REIT entity.  
    • The new entity will be structured as a triple net REIT, meaning that PNG (the operating company) in addition to paying fixed rent to the REIT would also be responsible for real estate taxes, insurance, some maintenance and utility expenses (basically most of the operating expenses). 
    • By setting the fixed rental payments at roughly 50% of the assets existing EBITDA, PENN’s REIT will have 2x coverage.  This means that EBITDA would have to drop by approximately 50% before the rental payments are endangered. 
    • Under PENN’s guidance, the REIT should be able to pay a dividend of $2.36/share in 2013.  Most triple net REITs are currently trading on a dividend yield of 7% or less.
  • Create an operating entity that will manage all of PENN’s wholly owned properties and own/manage PENN’s JV interests.  Given the high fixed rental payments due to the PROPCO REIT, the operating company will have a more volatile cash flow stream – akin to a highly leveraged gaming company (MGM/CZR) - and should trade at a lower multiple than PENN currently trades.
    • Regulatory risk (changes in tax rate, gaming legalization of neighboring markets), impact of new competition, and economic risk
    • Maintain the upside of the Ohio VLT facilities

We haven’t had time to go through all the numbers, but based on management’s guidance, we believe the new structure should create a value package of between $44-$62/share at closing.  Below are some of the key variables:

    • 1x special dividend of $1.4BN or $15.40/share ($487 million is cash)
    • 2013 base case dividend of $2.36/share that we think should be valued at a 6-8% yield or a 12.5x implied 2013 EV/EBITDA multiple ($30-$39/share).  Yes, we realize this is a discount to where most REITs trade, but this is justified given:
      • Unique asset class (i.e. of its own)
      • Single tenant risk
      • Regulatory and competitive risks
      • Less asset diversification than many truly “National” REITs
      • Lower value of underlying Real Estate assets compared to other asset classes
    • Based on today’s closing price, PENN trades at roughly 7x 2013E EBITDA
    • We believe that PNG OPCO should trade at a material discount of 5.0-6.5x ($10-$17/share).
      • When factoring in the rental payments and the 3x leverage, PNG OPCO will in-effect be a highly leveraged entity that bears the following risks:
        • New competition 
        • Regulatory 
        • Economic
      • Offset by some growth opportunities and still a fairly healthy FCF yield


So what are the implications for the other gaming operators and why wouldn’t other operators look at this structure if PENN’s stock reacts favorably to the spinoff?

  • The second question is actually easier to answer.  In order to pursue this kind of structure successfully, gaming operators need to have:
    • Low leverage is key and the largest barrier
      • Healthy REITs need to have good dividend coverage ratios – usually at least 1.75x.  So not only will a gaming REIT have to convince investors that its rental base is stable (“bond-like”) but leverage also needs to be reasonable in order to be able to pay a generous dividend yield.  The operating company will also have to have low leverage, given that they will already have a large fixed rental obligation that rating agencies take into consideration.
    • Diversified and stable cash flow stream
      • Given the regulatory and competitive risks inherent in the gaming business, coupled with the discretionary nature of the product, cash flow diversification is key to getting a good multiple/yield
    • Low cash needs
      • Since REITs pay hefty dividends, companies that need to save their cash for a development pipeline or that have heavy capex needs are not good candidates for this type of structure
  • At the very least, gaming investors should be forced to pay more attention to FCF yields vs. just slapping a multiple on to EBITDA

PENN maintained the lowest leverage of any gaming operator so it was the classic fit.  Given its high free cash flow, stable markets, and low capital needs following the opening of Lake Charles in two years, we think ASCA is the most likely pursuer of the PENN strategy.

investing ideas

Risk Managed Long Term Investing for Pros

Hedgeye CEO Keith McCullough handpicks the “best of the best” long and short ideas delivered to him by our team of over 30 research analysts across myriad sectors.