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FRIDAY'S EARLY LOOK

On Friday, we were given the chance to pen Hedgeye's Early Look.  This product is usually written by our CEO, Keith McCullough, with his take on markets, the economy, and politics.  If you do not receive the Early Look, and would like to, please email sales@hedgeye.com.

 

Our stab at the Early Look for 1/4/13 is below.

 

FOOT SOLDIERS OR GENERALS?

 

“His outward appearance seemed indifferent and unconcerned over the wretchedness of his soldiers…although French and Allies shouted into his ears many oaths and curses about his own guilty person, he was still able to listen to them unmoved.”

-Jakob Walter, German soldier under Napoleon

 

Two hundred years ago, following one of the most brutal military campaigns in history, thousands of young European men traipsed through the snow of East Prussia, half-dead. The Diary of a Napoleonic Foot Soldier, by Jakob Walter, is a harrowing but thoroughly enjoyable account of what it was like to serve in Napoleon’s Grand Armée during the ill-fated invasion of Russia in June 1812.  Given that one is as likely to be born in one country, at one time, as another country at another time, I am particularly grateful I was not one of the 600,000 Napoleonic soldiers that crossed into Russia in mid-1812.  Of the 140,000 that were left to retreat from Moscow, only 25,000 actually crossed back over the border in December 1812 to begin the long walk home.

 

Few individuals have left as indelible a mark on history as Napoleon Bonaparte.   That he was born in Corsica of Italian heritage but went on to gain the title “Emperor of the French” is indicative of the strength of personality he possessed.  All of his courage and decisiveness meant little without the contribution of his subjects.  Napoleon understood this; it is estimated that between 1800 and 1815, he raised approximately two million conscripts, or 7% of the population, in France alone.   Was the future of 18th Century France (or 1930’s Germany or Russia) dictated by the common man’s wishes or a charismatic leader dragging a country toward his vision?  This question has no definitive answer but it can serve as a loose metaphor for policy versus demographics in our contemporary economy.  While demography is concerned with the passive role people play in economies, the roles of the common man and policy maker in driving economic growth are important to consider in 2013.  Harry Dent, author of several books on demographics and its importance states: “it’s Homer Simpson that drives our economy, not Ben Bernanke or Barack Obama!”

 

I recently did some long overdue reading on demography.  While my understanding of the subject is tenuous at best, it is clear to me that understanding the role of demographic and technology cycles is key to understanding what drives our economy over the long term.  Hedgeye Healthcare Sector Head Tom Tobin and his team have produced some excellent research that anchors off these topics.  Recently, his work has suggested that household formation, maternity, and pet ownership (WOOF) rest on a similar age demographic and are likely to see corresponding strength.  While the increasingly short-term nature of our industry has marginalized such thought processes, we continue to believe that identifying investment themes that deviate from consensus but are supported by long-term cycles can lead to highly actionable ideas.

 

Considering some of the key demographic trends pertaining to the consumer economy offers interesting long-term insights.  In terms of the sector my team covers, restaurants, the core demographic of casual dining companies tends to be the 45-65 YOA cohort.  For any consumer industry executive, decelerating population growth among age cohorts with a high propensity to spend money on your goods or services will act as a top-line headwind.  Pertaining to the restaurant industry, it is clear that for many years executives’ lives were made easier by a rising demographic tide.  We believe that casual dining is facing a painful adjustment due to excessive unit growth.  Trading opportunities on the long side will remain, on immediate-to-intermediate-term bases, but we see casual dining as a group that will experience consolidation for a number of years.  It is no coincidence that the management teams that are most demonstratively aware of the demographic headwind are running the companies whose shares we are relatively positive on (EAT – at a price).  Darden Restaurants (DRI) is one company that we became bearish on in July.  One of the key issues we took with management’s strategy was its growth trajectory and we continue to believe that it is overly aggressive relative to the fundamental performance of its chains and the overall health of the industry.  The quote, below, from Brinker (EAT) CEO, Guy Constant, highlights the reality of the situation facing his industry and his company’s awareness of it:

 

“…We've had to deal with those questions internally because as a company that's only ever been in a growth space, it's been an adjustment for us to adjust to running a business in a more mature space now than we did before. But knowing then that history, we believe, is repeating itself, that helps you understand what you need to do in order to survive in this space.”

 

While long-term demographic and technology cycles dictate economic growth, from an investment perspective, it is self-evident that policy has a significant impact on market prices as well as the duration and amplitude of economic cycles.  The market, after all, is not the economy.  Previously, I have wondered if forming an opinion on government policy is a worthwhile exercise.  Long-term cycles seem to bear out over time regardless of government policies (give or take a few years).  In recent times, our macro team’s process of focusing on Growth, Inflation, and Policy has proven effective in identifying key inflection points in markets, globally.  Moreover, the level of government intervention in markets implores investors to form an opinion on policy and to update it, regularly.  For example, investors in gold that have ignored policy, and the expectations around it, have had a difficult time of late. 

 

Our view of policy makers in the US (and almost everywhere else) has been decidedly negative.  Keith wrote in yesterday’s Early Look: “What if Bernanke is what he usually is – wrong on his growth forecasts? What if unemployment rate expectations start to fall towards 6.5% in 2013 instead of in 2017? Inquiring Bond and Gold bulls would like to know…”  Yesterday we saw gold and bonds get crushed on the expectation that Bernanke could be forced to call back his troops if expectations of employment growth improve sufficiently.  Every general meets his Waterloo.  The only question is when.

 

Timing, as always, is the critical factor in investing but even more so in life.  After all, if not for timing, we could have been Napoleonic foot soldiers.

 

Rory Green

Senior Analyst

 

FRIDAY'S EARLY LOOK - Chart of the Day


All Is Calm

This note was originally published at 8am on December 24, 2012 for Hedgeye subscribers.

“All is calm, all is bright.”

-Garth Brooks

 

One of my favorite holiday history songs is Belleau Wood, by Garth Brooks. It’s a song about a truce between US and German soldiers in 1918. The first WWI Christmas truce came between British and German soldiers in 1914.

 

“Through the week leading up to Christmas, parties of German and British soldiers began to exchange seasonal greetings and songs between their trenches; on occasion, the tension was reduced to the point that individuals would walk across and talk to their opposite numbers bearing gifts.” (Wikipedia, Christmas truce)

 

Then across the frozen battlefield another’s voice joined in…

Until one by one each man became a singer of the hymn.” (Garth Brooks)

 

Back to the Global Macro Grind

 

I’ll keep it relatively tight this morning – just economic data and risk management levels.

 

But first, here’s how I’d summarize our GIP (Growth, Inflation, Policy) model right now:

  1. Globally (across countries in our model), growth has been stabilizing now for almost a month
  2. Inflation continues to deflate, providing the real-time tailwind to this shift from growth slowing to stabilizing
  3. Both Treasury Bond and Gold prices do not like this (they like #GrowthSlowing)

Global Macro Economic data:

  1. Taiwan printed its highest Industrial Production number in 9 months this morning (+5.9% NOV vs +4.8% OCT)
  2. Singapore reported a 2-yr low in Consumer Price Inflation (CPI) this morning (+3.6% y/y NOV vs +4% OCT)
  3. CFTC Futures & Options net long contracts hit a 6 month low (-5.6% wk-over-wk to 758,256 contracts)

That last point is one of the most critical we have been focused on since making our Bubble#3 (Commodities Bubble) call - 1 of our Top 3 Global Macro Themes @Hedgeye for Q42012. It’s also what’s driving the shift in our model from growth slowing to stabilizing.

 

To put the market’s expectations for lower commodity prices in perspective:

  1. Total net long contracts are -43% below their all-time (Bernanke Bubble) peak of September 2012
  2. Gold net long contracts (down -13% last wk to 112,421) hit their lowest level since August 2012
  3. Corn contracts are getting cobbed, down another -22% last week to 175,631 (lowest since July 2012)

Now maybe the Policy to Inflate thing gets plugged back into your life in January, but the probability of Qe6 superimposing new all-time highs for commodity inflation versus those that have been bubbling up for the last decade is relatively low.

 

Across the board, our risk management signals concur:

  1. CRB Commodities Index = 294 (flat last week in an up tape for Global Equities) remains in a Bearish Formation
  2. Gold = down another -2.2% last week to $1657/oz, snapped our long-term TAIL risk line of $1671
  3. Silver = down another -7.1% last week led losers in the commodities complex, followed by Palladium at -4.8%

Yes, this is me pushing my thesis for Strong Dollar = Strong America. With the US Dollar making a series of higher long-term lows (up for 9 of the last 13 weeks), that’s the most bullish thing I can tell you this Christmas. Let free-market prices win the day.

 

But for just one fleeting moment, the answer seemed to clear…

Heaven’s not beyond the clouds, it’s just beyond the fear.” (Garth Brooks, Belleau Wood)

 

Our immediate-term Risk Ranges for Gold, Oil (Brent), Copper, US Dollar, EUR/USD, UST 10yr Yield, and the SP500 are now $1640-1671, $106.20-109.59, $3.52-3.58, $79.09-79.99, $1.31-1.33, 1.70-1.85%, and 1419-1450, respectively.

 

Merry Christmas and Happy Holidays to you and your loved ones,

KM

 

Keith R. McCullough
Chief Executive Officer

 

All Is Calm - Chart of the Day

 

All Is Calm - Virtual Portfolio


A Tax Increase We Can Sink Our Teeth Into

On Friday, the FDA published two rules (broad descriptions copied below from the FDA website) with the goal of reducing the risk of food-borne contamination in both processed food and farm food.  The rules are out for public comment for a 120 period.

These two rules (and three others to follow, below as well) are at the core of the Food Safety Modernization Act signed into law by President Obama in 2011.

  • Preventive Controls for Human Food: This rule sets safety requirements for facilities that process, package or store food for people. (There is a separate, upcoming rule for animal food.) The rule will require that food facilities implement “preventive controls,” a science-based set of measures intended to prevent food-borne illness.
  • Produce Safety: The food-safety law requires that science-based standards be set for the production and harvesting of fruits and vegetables, and FDA is proposing such standards for growing, harvesting, packing, and holding produce on farms.

Rules yet to come:

  • Foreign Supplier Verification for Importers: This program will require importers to verify that foreign suppliers are following procedures that provide the same level of health protection as that required of domestic food producers. About 15 percent of the food consumed in the U.S. is imported, including about 49 percent of fresh fruit and 21 percent of vegetables.
  • Accredited Third Party Certification: The accreditation of third-party auditors would help ensure that food producers in other countries comply with U.S. food safety laws.
  • Preventive Controls for Animal Food: This is the implementation of preventive controls at animal food facilities that are similar to those proposed for human food.

As with everything in life, there is a cost, and we have seen estimates ranging from $500 million to just over a billion in terms of annual costs to be borne by farmers and food manufacturers.  I doubt that anyone knows for certain and initial estimates are almost certainly hopeful guesstimates.  Ultimately, as is the case with most regulation of this type, the cost will be passed on to the consumer.  When examining the cost, keep in mind that there has been a substantial expense over the course of the past decade in terms of voluntary recalls, lost sales and even legal expenses in the wake of food-borne illness in with products ranging from cantaloupes to refrigerated dough to spinach to peanut butter.



The Centers for Disease Control and Prevention estimates that approximately 48 million people in the United States each year get sick, 128,000 are hospitalized and 3,000 die from food-borne illness.  The calculus then boils down to this – are Americans willing to spend $4 per year, per person (assuming an annual cost of $1.2 billion) to avoid a 1 in 6 chance of getting what is usually a pretty nasty illness, and a chance, although significantly less, of succumbing to something much, much worse?  It makes sense to us and we appreciate the need to move food safety standards in this country out of the 1930s.

 

Have a good week.

 

Robert  Campagnino

Managing Director

HEDGEYE RISK MANAGEMENT, LLC

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TAP – Keep Your Eye on the Puck

Shares of TAP (Molson Coors Brewing Company) may get a lift with the news that the NHL owners and players have reached a tentative agreement on a CBA framework.  With short interest at 2.4 days to cover, it wouldn’t be a surprise to see some weak shorts cover on news that represents a volume benefit to the company’s operations in Canada.  Further, the stock is cheap – 10.8x P/E and 9.1x FCF - making it one of the least expensive stocks across our consumer staples coverage.

 

However, it is inexpensive for some very good fundamental reasons, as outlined below.  While we aren’t a fan of shorting cheap stocks, neither are we fans of buying cheap simply because it is cheap – we prefer to wait for the right signals, so we would caution investors not to get caught offside if TAP sees some short covering.  Comfortable that we have gotten Hedgeye off to a good start in terms of weekly hockey references, we expand on our view on the fundamental issues facing Molson Coors below.



Volume weakness in Canada as a result of the NHL’s protracted labor dispute is only one of the issues facing the company at this point.  In the company’s most recently reported quarter (Q3 2012, back in November) we saw a decline in consumer demand across multiple geographies.  In the United States, for example, distributor inventories are simply too high as the company has shipped ahead of consumption, a condition that will have to correct itself beginning in Q4.  In the company’s newly acquired Central European business, weak economic conditions drove a 1.5% volume decline in the quarter that appears to have only accelerated toward the end of the quarter and through the start of Q4.  Further, the business, when acquired, had a very healthy margin structure that we view as likely unsustainable.  The United Kingdom has been a basket case as a beer market for a time as a weak economy, rising taxation, a smoking ban in pubs and competition from other alcoholic beverages (cider, for example) have hurt beer trends.  While estimates have come down to reflect these factors, we believe that further negative revisions to consensus estimates ($3.97 in ’13) are likely.



One last point we need to mention - Molson Coors CEO Peter Swinburn mentioned back in November that Molson Coors would be seeking financial compensation from the NHL to cover the impact the lockout has had on the company.  The validity and potential amount of that type of claim is unknown at this point, but it is certainly clear to us that Molson Coors lost a good chunk of an important cold weather driver of beer sales in Canada.

 

Have a good week.

 

Robert  Campagnino

Managing Director

HEDGEYE RISK MANAGEMENT, LLC

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MACAU MODEL UPDATES

Q4 estimates going higher

 


Following the receipt of the December detailed numbers for Macau, we are adjusting our Q4 property estimates higher for Galaxy, LVS, MPEL, MGM, and WYNN as follows:

 

MACAU MODEL UPDATES - d1

 

Certainly, hold played a big role in the estimate hikes.  In December, MPEL was the only company that held below its normal level.  Nevertheless, Mass growth was strong across the board in Q4 and Mass drives profitability.

 

We’ve updated the consensus as best as we could but you resourceful buysiders probably have a better consensus estimate than we do.  Nevertheless, we believe we are above consensus EBITDA estimates for all of the Macau operators with the exception of Wynn.  MPEL looks like it will generate the largest beat in percentage terms.

 


HIGH HOLD A BIG CONTRIBUTOR BUT DECEMBER STRONG ON ALL LEVELS

Takeaway: December was never the issue for us but hurdles remain for Q1

December was never the issue for us but hurdles remain for Q1

 

 

As we suspected, high VIP hold contributed significantly to December’s strength.  Rather than the 20% actual YoY growth, we estimate that if hold was normal, GGR would’ve gained a still strong 13-14%, slightly above our original 12% projection.  We have to estimate Direct VIP play so hold % is also an estimate.  Mass growth was once again impressive – up 32% and in-line with the recent trend.

 

Every operator held above normal on their VIP business.  We also suspect that Mass hold % was above normal for the market and particularly for MGM.  With the exception of Wynn, each operator also generated significant YoY growth in GGR.  Wynn’s VIP rolling chip and VIP revenue both fell YoY although the property eked out a 4% gain in Mass.  Not surprisingly, Sands China’s properties generated the best YoY growth at 52% but MGM’s 34% growth was surprising although certainly hold-aided.

 

Here are some observations before we put out our more detailed note:

 

Direct play adjusted hold was 3.18%

  • The highest since we have been tracking direct play #s (May 2010). 
  • If hold was 2.85%, then growth would have been 13-14% vs. 20%

Actual numbers came in better than projected

  • Mass:  +3% better
  • Slots:  +10% better
  • RC volume:  +3% better- actually improved almost 5% YoY – best growth since Feb 2011

Company Observations

  • Sands China
    • Gained 20bps of share.  We estimate that they held at 3.14% - high but in-line with the market this month
    • Unlike last month, the driver behind share gains was VIP RC share.  Mass share declined MoM.
    • For the 6th month in a row, Sands YoY GGR growth led the market at 52% led the market.  Mass grew 48%, which is impressive, but only earned LVS 4th place behind MGM, MPEL, and Galaxy this month.
    • VIP growth was the strongest among all 6 concessionaires for the consecutive month at 55%, and VIP RC growth also led the market for the 7th consecutive month at 46%
  • Wynn Macau
    • Wynn continued to struggle this month with GGR 10%- the worst performance of the 6 concessionaires
    • Estimated hold was 3.1%, below the market but above normal
    • Wynn was the biggest loser in term of market share this month losing 1.8% to just 10.3%
    • The loss in market was driven by losses in the VIP RC share which fell to just 10.8% - the lowest point since November 2007
  • MPEL
    • MPEL had a pretty good month, considering that they were the only concessionaire that held below 3% this month. 
    • GGR growth was 13% and market share only dipped 20bps to 13.5%.
    • Impressively, MPEL’s Mass revenues grew 56% YoY - just behind Galaxy for the top spot
  • MGM
    • A very strong month, party driven by high hold of 3.55%
    • GGR growth was 35% which earned them 2nd place behind LVS
    • Mass revenues grew an impressive 51%, coming in 3rd place behind Galaxy and MPEL.
    • VIP chips grew 10% YoY, ahead of the 9% market growth
    • Market share bounced back to 10.9%, above the company's 6-month and 2011 average
  • Galaxy
    • Galaxy’s share increased to 18.2%, up 2% MoM, the largest market share gainer in December
    • Galaxy held high in December, at an estimated 3.39% across their two properties
    • However, December marked the 5th month in a row where their VIP RC growth was negative. Galaxy was only one of two concessionaires that experienced YoY declines in VIP RC growth in December.
    • Galaxy took the top spot for Mass growth at 59%, with strong growth across both of their owned properties
  • SJM
    • Held their ground with GGR growth of 18% and normal hold of 3.03%
    • Mass growth was 9% YoY and VIP RC growth was 12%

HIGH HOLD A BIG CONTRIBUTOR BUT DECEMBER STRONG ON ALL LEVELS - table1

 

HIGH HOLD A BIG CONTRIBUTOR BUT DECEMBER STRONG ON ALL LEVELS - mass1

 

HIGH HOLD A BIG CONTRIBUTOR BUT DECEMBER STRONG ON ALL LEVELS - rc1


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