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Let's Do This

“C’mon! Let’s do this.”

-Ray Lewis


If Japanese policy makers really want to get nuts, they should sign Ray Lewis for the 2014 Money-Printing season. After taking down the Patriots this weekend, the 13x Pro Bowler is going back to the Super Bowl. It’ll be his last game. If Baltimore wins, it will be epic.


“You’ve got to go out and show them that I’m a different creature now than I was 5 minutes ago, cause I’m pissed off for greatness. Cause if you ain’t pissed off for greatness, that just means you’re okay with being mediocre.”


Yep. That’s what I am talking about Japan – some ole school Raven rants in those BOJ pressers.


Back to the Global Macro Grind


Evidently, the global currency market didn’t get the BOJ’s marketing message overnight. The Japanese Yen rallied a full +1% on the “news”, and Japanese stocks snapped immediate-term TRADE support for the first time in months. Isn’t a #QuadrillYen fun?


PM Shinzo Abe called the BOJ’s “2% inflation” targeting and asset purchase plan both “bold” and “epoch making.” That might sound like some serious stuff, but the new asset purchases don’t start until January of 2014 – so there’s this little thing called timing that people short the Yen today are getting Taro Aso’d by in the meantime.


If you didn’t know the Global Currency War is on, now you know. The Russians and South Koreans talked about it last week, and the President of the Bundesbank (Germany) is calling it out, explicitly, in the FT (Financial Times) this morning. If you want to show the world you are a “different creature”, you’re going to have to one-up The Bernank’s 2012 performance.


That’s no easy task – neither is seeing the US Dollar stabilize alongside weekly US economic growth data:

  1. US Dollar Index closed up another +0.6% last week and continues to make a series of higher long-term lows
  2. US Housing Demand (MBA weekly mortgage applications) ripped a +12.9% move, taking the MBA series to 205
  3. US Weekly Jobless Claims dropped to fresh new intermediate-term lows at 335,000

If what’s bad for a country’s currency is eventually really bad for that country’s real (inflation adjusted) economic growth, the opposite should hold true when a country’s currency stabilizes.


What if a stabilizing US Dollar became a strengthening one? How about strengthening the US Dollar +15% (from here) and hammering energy/food inflation next? Didn’t the President of the United States say “we, the people, are all in this together” now?


Can you think of a more galvanizing, progressive, and uniquely American marketing message than Strong Dollar = Strong America? I bounced it off the Keynesians in the Romney camp, and they didn’t get it either. But you, The People can get this – Yes You Can!


In other major global #GrowthStabilizing news:

  1. Chinese monthly data for December (Industrial Production and Retail Sales) accelerated versus November
  2. Chinese Exports for December ramped by +14.1% (versus +2.9% NOV)
  3. Germany’s ZEW Index (reported this morning) just hit a 2.5 year high (31.5 DEC vs 6.9 in NOV)

It’s been a while here, folks – but, setting aside the economic disaster that is Japan for a minute, we have the other 3 major global engines no longer stalling/slowing (USA, China, and Germany). That’s better than bad. And so is sentiment.


The problem with sentiment, of course, is that it tends to turn after markets move. And right now that’s precisely what many of my key sentiment indicators are starting to flag:

  1. US Equity Volatility (VIX) = immediate-term TRADE oversold at a 5-year low of 12.46
  2. II Bull/Bear Spread (Bulls minus Bears) = 3,090 basis points wide (53.2% Bulls, 22.3% Bears)
  3. Fund Flows (to US Equities, ex-ETFs) = +3.8B last week (versus +7.5B in the week prior)

In addition to last week’s -6.7% drop in the VIX, we’re seeing aggregate short interest in US Equities fall fast from their late November highs (that was a bullish signal) at the same time that NYSE Margin Debt rips to the high-end of its 5-year range (perma bulls lever themselves up on the long side at the end of a move trying to chase performance).


So, it’s all out there – the economic data; the price action; the sentiment indicators – and, no, they don’t always signal that you should be doing the same thing at the same time. But that doesn’t mean you don’t have to get out there every morning and get it. As Japan’s new ‘let’s get nuts’ prospect, Ray Lewis, might add: “Effort, is between you, and you, and nobody else.”


Our immediate-term Risk Ranges for Gold, Oil, US Dollar Index, USD/YEN, UST 10yr Yield, AAPL, and the SP500 are now $110.75-112.35 (Oil is back above TAIL support, bearish for Consumption), $1, $79.75-80.17, 88.58-90.61, 1.84-1.91% (Bonds continue to signal #GrowthStabilizing), $482-561 (into Earnings tomorrow), and 1, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Let's Do This - Chart of the Day


Let's Do This - Virtual Portfolio


The Macau Metro Monitor, January 22, 2013




Paul Y. Engineering Group Ltd shareholders approved a deal allowing the company to hold land, raise share capital and sell bonds for a boutique casino in Macau.  Paul Y. Engineering Group – a unit of separately-listed ports and infrastructure business PYI Corporation Ltd – plans to raise funds for the US$800 million (MOP6.4 billion) casino hotel scheme by issuing shares on the Hong Kong Stock Exchange and by selling convertible bonds.

The casino property is planned to be located next door to the residential complex One Oasis, and will have 236 rooms and up to 66 live gaming tables.



Macau's inflation rate for 2012 stood at 6.11%.  The Composite CPI for December 2012 increased by 5.83% YoY and 0.85% MoM.


Soft Earnings

This note was originally published at 8am on January 08, 2013 for Hedgeye subscribers.

“Never have I seen a country so utterly unprepared for war and so soft.”

-Field Marshall John Dill


In one of the more poorly timed British central command comments during WWII, that’s what the Chief of the Imperial General Staff, Sir John Greer Dill, had to say about America just before December 1941 (The Last Lion, page 421).


Japan, of course, attacked the US at Pearl Harbor on December 7th, 1941. And, after President Roosevelt told Winston Churchill that “we are all in the same boat now”, America all of a sudden didn’t seem so “soft” anymore.


In his memoirs Churchill explained that he was quite happy about the whole turn of events. On the night of the Japanese attack he “slept the sleep of the saved and thankful” (page 423).


Back to the Global Macro Grind


After watching Notre Dame’s defense last night, I am still pretty sure that soft is as soft does. That’s also one of the Top 3 Global Macro Risks to being really long US Equities here: Soft Earnings.


Given our view of Global #GrowthStabilizing, that might confuse come people – but it shouldn’t. Veteran Risk Managers know that earnings are a lagging indicator, while growth is a leading one.


That doesn’t mean that #EarningsSlowing won’t matter. We introduced that Global Macro Theme in October of 2012, right before the worst US corporate earnings season since 2006. It too, didn’t matter, until it did.


One of the core takeaways from that theme was that this isn’t a ‘one-off’ where we’ll have 1 quarter of down earnings then straight back up again. That’s because US corporate margins are coming off all-time peaks. All-time is a long time.


I think #EarningsSlowing will matter, but so will the timing it:

  1. Alcoa (AA) and Monsanto (MON) kick off Earning Season tonight, but they aren’t driving the boat; Financials (XLF) are
  2. Financials Earnings Season starts on Friday, and we expect both Housing and Yield Spread to make that Sector bullish
  3. The biggest sector with #EarningsSlowing risk remains Tech (XLK); we don’t get those reports for a few more weeks

Yes, there’s a big difference between buying US stocks with the SP500 at 1400 and levering up long at a 5-yr closing high (1466). So be mindful of that. Be sector selective and stock specific.


Back to the Top 3 Global Macro Risks to being long overbought beta (Equities) here:

  1. #EarningsSlowing
  2. Japanese Policy To Inflate
  3. Rising Oil Prices

The 3rd risk in my Top 3 is the most trivial. Oil’s price, volume, and volatility is measurable within our TRADE/TREND/TAIL process, so as time/price changes, my fundamental research view of how that factor impacts our growth model does.


A far less obvious risk remains what could happen to Japan if they pull an Argentina in 2013. I think this old (but new) bureaucrat they have brought back as Japan’s Finance Minister is crazy. That’s not a typo – plenty of politicians are crazy. Especially Keynesian ones.


Last night Taro Aso (great name for the history books if he rips his country a new one) said Japan is going to print money and buy ESM debt (as in European Bonds) in order to devalue the Japanese Yen further. We’ll walk through what that means as Japan blows through their 44 TRILLION Yen debt issuance ceiling on our Q1 Macro Themes Call (January 15th). Key word score: Quadrill-Yen.


Away from all of that, there’s nothing to worry about out there…


“During the first week of December (1941), Churchill regularly telephoned Bletchley to ask about the disposition of the Japanese Combined Fleet (Kido Butai)… Each time Churchill asked, the Bletchley reply remained the same: No intelligence was forthcoming. The Japanese navy had vanished.” (The Last Lion, page 416)


I am sure some dude in Spain, Taro Aso, and Obama’s latest son-of-Summers US Treasury bureaucrat (Jack Lew) have all central economic command under control. Full debt printing and deficit spending ahead.


Our immediate-term Risk Ranges for Gold, Oil (Brent), Copper, US Dollar, EUR/USD, UST 10yr Yield, and the SP500 are now, $1639-1646, $110.19-113.06, $3.63-3.75, $79.99-80.49, 1.30-1.31, 1.84-1.96%, and 1438-1483, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Soft Earnings - Chart of the Day


Soft Earnings - Virtual Portfolio

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In preparation for IGT's F1Q 2013 earnings release tonight, we’ve put together the recent pertinent forward looking company commentary.






  • Under the terms of the accelerated stock buyback agreement, Goldman, Sachs & Co. will have delivered 30.3 million shares (27.8 million in the fiscal 2012 and 2.5 million in the fiscal first quarter of 2013) to IGT at an average price of $13.22 per share


  • IGT announced today its Board of Directors declared a cash dividend of $0.07 per share on its common stock, a 17% increase compared to the dividend paid in the same quarter last year. The dividend is payable on Dec. 31, 2012 to shareholders of record on Dec. 19, 2012.





  • “Gaming Operations gross margin increased in the 4Q by 400bps basis points to 61%. On a same-store sales basis, Gaming Operations gross margin was up about 100 bps. This is mainly driven by an increased percentage of standalone and fixed-fee games that carry higher gross margins than typical WAP games. It also reflects the success of our strategy to manage the turnover of capital in our MegaJackpot installed base”
  • “In 2013, we expect Gaming Operations revenue and installed base to be about flat with 2012, while gross margin and profit per unit are expected to show modest improvements.”
  • “For 2013, on a same-store sales basis, we expect our pricing to follow historical trends.”
  • “On the strength of our VLT business in Canada, Ohio, and Illinois, where we expect to enjoy leading ship shares, we anticipate our product sales revenue and gross profit to deliver double-digit increases, while gross margin may be slightly softer due to mix.”
  • “We have seen remarkable growth in the number of mobile users and a corresponding growth in revenue from those users. We remain very excited about DoubleDown's potential and still expect the transaction to be GAAP accretive by 2014.”
  • “Moving forward, we expect some additional costs and, in the short term, lower revenues and gross margin in our IGTi business as this restructuring plan is executed. On the positive side, these actions are anticipated to reduce annual operating expenses in our IGTi business.”
  • “For the year, adjusted operating expenses were about flat as a percentage of revenue, and we expect this trend to remain consistent into 2013.”
  • “We are extremely pleased with the rate at which our revenue is being converted into operating cash flow, roughly 21%. Over the past five years, on average we have converted 26% of revenues into cash flow from operations.”
  •  “Looking forward to 2013, we are initiating our adjusted earnings per share guidance at $1.20 to $1.30 per share, representing 15% to 25% growth over fiscal 2012. We feel this guidance reflects the positive momentum in our business as well as the current economic conditions globally and the improving sentiment of our customers toward our products and services. We expect to continue to grow the top line and grow operating income and adjusted earnings per share even faster.”
    • The guidance excludes $40MM of SG&A charges related to amortization of intangibles (DD) and earn-out mark to market.
  • “Historically we earn about 40% to 45% of our full-year earnings in the first half of the fiscal year and that the fiscal first quarter is usually less than half of that”
  • “We expect to stabilize our MegaJackpot revenues, improve our return on invested capital, and increase our product sales gross margin, especially in our international business.”
  • “At DoubleDown, the world's largest social casino, we expect to launch a more complete mobile product. We expect to add localized content for the international markets and to leverage even more of our proven IGT brands and game content.”
  • “At our IGTi group, we expect to see continued growth in our mobile real-money wagering business consistent with our past trends.”
  • “The vast majority of the growth in SG&A this year has been related to our Interactive businesses. That's the IGTi business and then, obviously, the acquisition of Double Down. In fact, the base SG&A has grown less than double-digit dollars. So we would expect to continue to invest in the Interactive business, but at a rate that's less than the revenue growth expectations going forward. And then in the base business, we'd expect again, low single-digit SG&A growth.”
    • Q: So if I think about that just empirically, maybe $30 million in incremental SG&A?
    • A: I think that's about right on the growth next year, recognizing that we have one more quarter of Double Down next year than we had in the prior first quarter.
  • “We are looking now expecting our North American replacement share to come in at around 48% for the quarter, a very strong quarter for us. There wasn't anything that we pulled in. Our guidance 90 days ago was to stay with our guidance range, which is exactly where we came in. So there wasn't an expectation; there was no moving here of shipments from one quarter to the other. We shipped what we had forecasted that we would ship that hit the guidance range that we confirmed last quarter”
  • “I think the margin, the gross margin on Canada is a bit stronger than Illinois, but not markedly so”
  • “The products that we have moved from the IGT game library into the DoubleDown Casino have had a significantly positive impact on that monetization. They're proven products. We were able to move them into the market in about half the time and with about half the cost of the other people we compete with in the social casino space.”
  • “I would say still cautiously optimistic on spending on the customer front. But as you can see this quarter and for the year, we continue to pick up ship share, even in a very restricted capital market, so we felt very good.”
  • “I would think about capital in the Gaming Operations business as flat to down slightly.”
  • “I would expect that there will be continued pressure on yield, so we're taking active steps in the quarter and have been for the last quarter.”

PG and KMB into Earnings

Kimberly-Clark (KMB) is set to report earnings on January 25th, and while it isn’t our thing to preview earnings, we think the timing of the KMB and PG earnings releases (also scheduled for the 25th) makes for an interesting short duration pair – long PG/short KMB.

KMB on the short side

KMB will report Q4 2012 EPS and provide an initial look at 2013 EPS – consensus for Q4 is $1.36 (we are modeling $1.34), bringing the full year 2012 EPS result to $5.23 versus company guidance of $5.15 to $5.25.  We see more risk to the $1.36 than upside.  The company will likely provide 2013 guidance consistent with its longer-term goal of EPS growth in the mid-to-high single digit range.  For reference, 2011 vs. 2010 was 6.3% EPS growth at the mid-point, while 2012 vs. 2011 was 5.7% growth.  Consensus for 2013 ($5.59) already contemplates 6.9% growth, so we don’t think a short position gets hurt with guidance.

Further, at 15.5x ’13 consensus, we don’t see much upside to the multiple, given our view of the company as a 3-4% top line grower.

We believe that the quality of KMB’s earnings have declined through 2012.  In Q1, $77 million of year over year EBIT gains were driven by cost saves ($60 million) and hurt by $10 million of input cost inflation, so operations accounted for $27 million of the year over year EBIT gains.  KMB reinvested $45 million in strategic marketing.  In Q2 and Q3, year over year EBIT gains slowed while cost savings increased and raw materials moved from a headwind to a tailwind and strategic marketing investments slowed.  As we move into 2013, raw materials appear to be set to move from a tailwind to a headwind once again.

PG and KMB into Earnings - KMB EBIT

Finally, the key commodities of crude and pulp have moved against the company over the last quarter of 2012.  Now, the company does have some flexibility year over year as we have seen increases in the strategic marketing spend through the first three quarters of 2012 (+$45 million in Q1, +$35 million in Q2 and +$25 million in Q3).  However, we are of the opinion that the company has seen its multiple expand precisely because it has increased investment and any reversal of that trend is unlikely to be greeted kindly by the market.

PG and KMB into Earnings - crude oil

PG and KMB into Earnings - pulp prices


PG on the long side


PG will report Q2 EPS on Friday, with consensus looking for $1.11 versus a guidance range of $1.07 to $1.13 - the growth versus 2012 is not heroic at all, with core EPS in the year ago quarter at $1.09.  Our estimate is $1.13 and we can model an increase to the full-year guide as well.  Our experience is that names that beat and raise go higher, particularly in the case of mult-year laggards such as PG.


While top-line trends at PG have been lackluster, the company has significant income statement flexibility from its restructuring program.  EPS stability sans top line momentum isn't likely to garner multiple expansion, but we at least have some comfort that the earnings base can be sustained while we wait to see what materializes on the top line for PG.  We may be waiting for Godot, but we don't think we are paying a substantial premium for the show.


PG's valuation isn't particularly compelling to us (16.9x calendar '13), but we think the name can be defended lower if our math happens to be wrong (just as we think investors can stick with the KMB short if Friday doesn't emerge as a catalyst).


Have a good week.




Robert  Campagnino

Managing Director




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