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JOBLESS CLAIMS - ARE WE MOVING IN THE RIGHT DIRECTION AGAIN?

Takeaway: Don't believe what you read. While claims appeared to deteriorate significantly WoW, they actually improved slightly. Here's why.

A Quick Walk Through What's Really Happening & What the Market Thinks is Happening ...


Let's start with the perception of what's happening. The perception is that initial jobless claims rose 38k to 368k from 330k WoW. This is being regarded as bad, which is not a surprise. First, let's put this morning's headline number in context. As we flagged two weeks ago, we're simply seeing the reversal of very poorly adjusted number from two weeks prior. Two weeks ago claims dropped by 37k, their largest one week drop since the same week last year. Last year's drop of 46k was followed by a 23k bounce, which was in turn followed by a 4-week drop of 20-25k. This year, we saw claims drop 37k two weeks ago, drop a further 5k last week and this morning rise by 38k. In other words, we're right back where we started 3 weeks ago; actually, we're still 4k lower.

 

Initial claims should trend steadily lower from here over the next four weeks as the final phase of Lehman's Ghost kicks into the seasonal adjustment factors. Thereafter, beginning in March, we'll begin to see the strength in the labor market cool off, and ultimately give way to weakness as April progresses to August.

 

Now, let's take a look at what's really happening. Rolling NSA claims improved year-over-year by -4.8% this week, that's an improvement vs. the prior week's -4.3% change. This may not sound significant, but it is because it marks an inflection from what had been two straight weeks of deterioration. Remember that a more negative number is better, as we're measuring the YoY change in jobless claims.

 

This series has consistently been the best read on the underlying labor market condition. Bear in mind that tomorrow's payroll report suffers from the same seasonality problems as jobless claims. Tomorrow's report, by the way, should be very solid (partly because it's benefiting from an imaginary tailwind).

 

Given this dynamic, we continue to expect Financials to push higher through February and likely into March (high beta, value names continuing to lead the way), though as the labor data cools in March/April we expect to see the same pullback we've seen over the last three years. However, we think this year's pullback will be smaller than in years past, partly because Lehman's effect is shrinking, but also because the housing data should partially offset the perception of weakening labor dynamics.

 

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Yield Spreads, Meanwhile, Are Solidly Improving

The 2-10 spread rose 13.7 basis points WoW to 172 bps. 1Q13TD, the 2-10 spread is averaging 162 bps, which is higher by 20 bps relative to 4Q12.

 

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JOBLESS CLAIMS - ARE WE MOVING IN THE RIGHT DIRECTION AGAIN? - JS 13

 

 

Joshua Steiner, CFA

 


PENN 4Q12 CONF CALL NOTES

Very weak quarter underscores our negative domestic gaming call. Full value of REIT conversion still not recognized in stock price even with lower 2013 numbers

 


"Fourth quarter operating results fell short of our guidance targets as our newer facilities have taken longer than expected to ramp up and industry-wide regional gaming revenue trends softened during the period. Consolidated results reflect a number of factors, including lobbying expenses, development costs associated with new greenfield opportunities, transaction costs associated with our proposed REIT transaction, and litigation accruals."

 

- Peter M. Carlino, Chairman and Chief Executive Officer of Penn National Gaming

 

CONF CALL NOTES

  • 4Q softer than what PENN anticipated.  October was particularly tough, ahead of the fiscal cliff decision.
  • Higher taxes have affected the middle class
  • Ohio continues to ramp up, but slower than anticipated slot volumes especially in Columbus.  Table games/F&B revs, however, has been ahead of goals.
  • Slot volumes in Columbus will improve sequentially in January 
  • REIT making significant progress. 
  • St. Louis:  Breaking up casino floor in chunks; 400 slot machines will be offline during construction work in Phase I which will be done by December 2013.
  • New supply in gaming markets affecting about half of its properties.  Average quality of its customer database has improved a bit but attendenace has declined.  
  • 4Q: 170bps improvment in EBITDA margin
  • January gaming volumes have been similar to 4Q

Q&A

  • Feel comfortable with 2013 guidance.  50/50 range of changing expectations as 2013 progresses
  • Central Ohio market: primary issue is penetration, not saturation.
  • Corp expense run rate:  should normalize around $80 million
  • 2013 revised EBITDA guidance:  combination of what PENN saw in NOV/DEC/JAN and base levels for Columbus/Toledo and construction disruption from Hollywood St. Louis
  • Columbus market:  CZR spent 4:1 in slot promotional spend in December
  • Toledo market:  will be prudent in any reinvestment
  • 2 OH racetracks:  confident on reaching ROI goals
  • 4Q end: Total cash: $260.5MM (higher than usual given calendar was broken out); bank debt: $2.394 billion; capital leases: $2.1MM; bonds: $325MM, other: $10MM. Total debt: $2.730; total capex: $108MM ($87.8MM capital ($77MM Columbus/Toledo, $8.9MM St. Louis); $20.3MM maintenance)
  • 2013: $175MM project capex; $97.9MM maintenance capex;
  • 1Q 2013: $49.4MM project capex; $27.2MM maintenance capex
  • 4Q Southern Plains margin weakness:  St. Louis pre-opening had some impact on margin;  Gulf Coast has been under pressure and also Baton Rouge underperformance due to new PNK property.
  • PENN undergoing 'egregious' lawsuits on higher real estate taxes
  • PROPCO spin:  Financing is going well; may lower interest expense expectations;
  • Financing new acquisitions for PROPCO: will have a nice revolver; there will be equity raises; 
  • Lower end consumers are taking less trips
  • New competition (Cincinnati/ Northfield Park):  will not affect Central Ohio businesses
  • Illegal internet cafes impact in Ohio:  over 800 internet cafes with slot machines; it is having some effect.  Bill HB7, hearing next week, will crack down on these illegal cafes. PENN expects a positive outcome from this bill.
  • PROPCO leverage levels:  no change from guidance; expect PROPCO to stay at 5.5x.

 

HIGHLIGHTS FROM THE RELEASE

  • PENN reported 4Q revenues $744MM, Adjusted EBITDA of $152MM, and EPS of $0.19.  All 3 metrics missed company guidance, our estimates and consensus. The miss was concentrated in the Midwest & Southern Plains segments. Other contributors to the miss included: 
    • Maryland lobbying expenses were $2.2MM in 4Q
    • Cherokee County litigation accrual of $6.4MM
  • "While full year 2012 regional market revenue trends and customer visitation levels proved to be largely stable, quarterly visibility and performance was impacted by volatility that did not follow historic trends. Due to this volatility as well as the still challenging economic environment, we are approaching 2013 with caution as consumers continue to adjust to lower discretionary income levels related to higher taxes and other factors. In this environment, we continue to vigilantly address operating efficiencies while maintaining a disciplined approach to marketing spend and promotional activities." 
  • "We remain focused on expanding the EBITDA contributions from all facilities as we rationalize operating costs, fine tune the slot floor and table game mix, build our customer databases at newly opened facilities, improve player marketing efforts and adjust food, beverage and entertainment offerings."
  • "With our Zia Park Casino benefiting from a healthy economy in its feeder markets, we anticipate commencing construction of a hotel at the facility in the second half of 2013, which would feature 150 rooms with six suites, a board/meeting room, exercise/fitness facilities and a breakfast venue. The new hotel, budgeted at $26.2 million, will allow the property to become more of a destination location enabling us to build relationships with key customers from eastern New Mexico and western Texas as the new integrated hotel, casino, and racing facility will far surpass any of the limited options currently in the market."

Hedgeye Best Ideas: Starbucks (SBUX)

Thank you for the feedback last week related to the revised format we're considering for the Hedgeye Hot Sheets (to be renamed Hedgeye Best Ideas). For those who have not responded, please take a moment to review the revised format of the stock report and let us know what you think. For a preview of the email, please click here.

Please send your thoughts to feedback@hedgeye.com

 

Starbucks is the premier roaster, marketer, and retailer of specialty coffee in the world, operating in more than 50 countries. The company sells drip brewed coffee, espresso-based hot drinks, tea, cold drinks, a variety of food items, as well as mugs and similar products.

As of October 2, 2011, there are more than 17,000 Starbucks locations across the globe, 53% company-owned. During fiscal 2011, company-operated stores accounted for 82% of total net revenues. Risk factors for Starbucks' business include costs for commodities that can only be partially hedged, such as fluid milk and high quality Arabica coffee, labor costs such as increased health care costs, and other variables beyond management's control. Trading Starbucks today, it's all about the duration.

 

 

INTERMEDIATE TERM (the next 3 months or more)

We are positive on the intermediate-term for Starbucks as the company should continue to post stable revenue growth thanks to the ongoing expansion of its CPG business, alongside other drivers mentioned above. If the US employment picture continues to improve, that would give investors further confidence in Starbucks achieving its targets.

 

LONG-TERM (the next 3 years or less)

The long-term TAIL for Starbucks is attractive; the company has plenty of white space to grow through several channels and geographies with ample expertise and capital to execute its strategies. The company must retain focus on the core business and, we believe that managemet is acutely aware of this following prior ('07/'08) experience.

 

 

Hedgeye Best Ideas: Starbucks (SBUX) - he bi SBUX chart

 

 

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Jobless Claims: Hidden Improvement

This week’s jobless claims numbers appeared to deteriorate significantly week-over-week but in reality, they actually improved slightly. The perception is that initial jobless claims rose 38k to 368k from 330k week-over-week. While poor in performance, we’re actually right back to where we were 3 weeks ago. In March, we’ll see the strength in the labor market cool off and give way to weakness as April progresses to August.

 

Jobless Claims: Hidden Improvement - 1

 

So where’s the hidden gem? The positive ray of hope? Rolling NSA (non-seasonally adjusted) claims. They improved year-over-year by -4.8% this week versus last week’s -4.3% change. The more negative the number, the better as we're measuring the year-over-year change in jobless claims. The seasonality distortion that we’re beginning to experience is perfectly normal; the labor market is not about to fall off a cliff or anything just yet. 

 

Jobless Claims: Hidden Improvement - 2


JOBLESS CLAIMS - ARE WE MOVING IN THE RIGHT DIRECTION AGAIN?

Takeaway: Don't believe what you read. While claims appeared to deteriorate significantly WoW, they actually improved slightly. Here's why.

A Quick Walk Through What's Really Happening & What the Market Thinks is Happening ...

Let's start with the perception of what's happening. The perception is that initial jobless claims rose 38k to 368k from 330k WoW. This is being regarded as bad, which is not a surprise. First, let's put this morning's headline number in context. As we flagged two weeks ago, we're simply seeing the reversal of very poorly adjusted number from two weeks prior. Two weeks ago claims dropped by 37k, their largest one week drop since the same week last year. Last year's drop of 46k was followed by a 23k bounce, which was in turn followed by a 4-week drop of 20-25k. This year, we saw claims drop 37k two weeks ago, drop a further 5k last week and this morning rise by 38k. In other words, we're right back where we started 3 weeks ago; actually, we're still 4k lower. Initial claims should trend steadily lower from here over the next four weeks as the final phase of Lehman's Ghost kicks into the seasonal adjustment factors. Thereafter, beginning in March, we'll begin to see the strength in the labor market cool off, and ultimately give way to weakness as April progresses to August.

 

Now, let's take a look at what's really happening. Rolling NSA claims improved year-over-year by -4.8% this week, that's an improvement vs. the prior week's -4.3% change. This may not sound significant, but it is because it marks an inflection from what had been two straight weeks of deterioration. Remember that a more negative number is better, as we're measuring the YoY change in jobless claims. This series has consistently been the best read on the underlying labor market condition. Bear in mind that tomorrow's payroll report suffers from the same seasonality problems as jobless claims. Tomorrow's report, by the way, should be very solid (partly because it's benefiting from an imaginary tailwind).

 

Given this dynamic, we continue to expect Financials to push higher through February and likely into March (high beta, value names continuing to lead the way), though as the labor data cools in March/April we expect to see the same pullback we've seen over the last three years. However, we think this year's pullback will be smaller than in years past, partly because Lehman's effect is shrinking, but also because the housing data should partially offset the perception of weakening labor dynamics.

 

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Yield Spreads, Meanwhile, Are Solidly Improving

The 2-10 spread rose 13.7 basis points WoW to 172 bps. 1Q13TD, the 2-10 spread is averaging 162 bps, which is higher by 20 bps relative to 4Q12.

 

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JOBLESS CLAIMS - ARE WE MOVING IN THE RIGHT DIRECTION AGAIN? - 13

 

 

Joshua Steiner, CFA


SGMS ACQUISITION OF WMS CONF CALL NOTES

Borrow cheaply, buy cash flow and profitability at a reasonable multiple, utilize NOLs - worked for PNK and should work for SGMS.

 


"The acquisition of WMS is transformational for Scientific Games, enabling us to offer a complete portfolio of lottery and gaming products and services to both new and existing customers around the world.  We expect to combine our game content, technology, operational capabilities and respective geographic footprints to create an enterprise poised to capitalize on significant growth opportunities around the globe." 

 

-A. Lorne Weil, Scientific Games' Chairman and Chief Executive Officer

 

 

CONF CALL NOTES

  • Opportunity of a lifetime for both companies
  • Faster growth of their business has been outside the US but for structural reasons all of their interest expense and most of their operating expenses are inside the US. Therefore their EPS has lagged revenue growth.  They have racked up a huge NOL inside the US. 
  • WMS is almost a mirror image of their situation - 75% of WMS's business comes from within the US and they have a pristine balance sheet. Also have a large tax bill in the US
  • The merger will give them huge EPS growth and a significant number of investors care about P/E multiples. So at last they will look attractive on that valuation basis. This acquisition will allow them to reap huge cash flow savings as a result of utilizing their NOL.
  • Feel confident that SGMS's existing international footprint can help WMS cross sell their products. 
  • Feel that there will be more expansion by the lotteries (internationally) into traditional slot related product. 
  • Greek lottery is expected to create a national network of thousands of machines and SGMS is partners with OPAP, so that puts them in a unique position
  • The financial engineering rationale isn't the only reason for this acquisition. They have a lot of industrial logic.  They have virtually no competitive overlap between the WMS & SGMS businesses. However, the businesses are complementary.
  • Think that there is a huge revenue synergy from being able to cross sell each other products and create new products, systems and services that neither company is currently offering to the market
  • Think that that there is an opportunity for cost savings since they are both in the business of manufacturing, designing, acquiring 3rd party content, and expanding into the online world... therefore, there should be cost syngeries and scale benefit here.
  • The two companies have a high degree of cultural compatibility (that's a little scary...)
  • Need regulatory and government approvals to complete the transaction
  • SGMS: 
    • 50% of their revenue comes from their instant ticket business
    • 25% is from their traditional lottery systems business
    • 25% from providing machines and systems supplying to VLT markets with just a few devices per location vs. casino operators
  • In IL they are going to be providing the monitoring system for VLTs
  • Feel like WMS's business is on the verge of a turnaround 
  • Like WMS's game server intergration business and will complement their similar business. Together they can have a leading business.
  • Both companies are leaders in using licensed brands to promote their respective products. Have a few brands where they overlap and can help each other acquire developing content.
  • Thinks that the lottery distribution channel will be a huge opportunity for WMS
  • Feel like the US economy is in the beginning of a recovery, albeit perhaps a slow one.
  • Combined leverage with no synergies will be 5x on an LTM basis and 4.4x with synergies compared with current leverage of 4.0x

Q&A 

  • WMS is the best possible partner for SGMS with no close second.  
  • Integration with WMS: Expect to have 2 operating sectors with a lottery one and a gaming one
    • Regarding Barcrest: They will intergrate Global Draw with Barcrest and move that over into the "gaming sector"
    • They intend to keep the WMS brand and the senior management team to continue to manage the gaming sector - including whatever SGMS has
  • Term loan that they will use to finance the deal has a 7-year term and they will have a $300MM R/C
  • Do not believe that they will have to exit any businesses as a result of the combination
  • There are a number of lottery jurisdictions that are either run by a private operator like OPAP, where WMS's content can help them on the VLT side
  • Wouldn't characterize that WMS is in the midst of a turnaround, nor would WMS
    • huh?
  • Competitive implication of this combination is not likely to help the other gaming suppliers
  • The interactive opportunity? Thinks it's a big opportunity given SGMS's view that online gaming will proliferate through the government/lottery channel vs. federal legislation in the US. Their relationships with lotteries and foreign governments and WMS's content and efforts in that arena could be hugely synergistic.

 

HIGHLIGHTS FROM THE RELEASE

  • SGMS and WMS have "entered into a definitive agreement under which Scientific Games has agreed to acquire WMS for $26.00 in cash per common share or approximately $1.5 billion." 
    • Includes assumption of $85MM of debt and $55MM of cash
    • Price translates to a 6,0x TTM EBITDA multiple (looks low but this is just because WMS's cash flow conversion is terrible. They have always had a low multiple)
    • Acquisition is subject to WMS shareholder approval
    • Expected closing by end of 2013
    • SGMS has committed financing 
  • The combined company will have revenue of approximately $1.6BM and EBITDA of $579MM based on TTM results ended September 30. 
  • The transaction was unanimously approved by both company Boards
  • "We view this transaction as the next logical and strategic step in offering continued innovation in gaming. Shareholders will enjoy a meaningful premium for their shares and employees will have expanded career opportunities as part of a larger, broader and more diverse organization"
  • "Scientific Games expects to achieve synergies through revenue growth, shared costs and larger scale, as well as by monetizing its significant U.S. tax attributes. The combined company will also be able to efficiently utilize shared manufacturing, engineering, software, field maintenance and customer service to drive growth and cost savings"
  • Other reasons for the combination: 
    • Complementing businesses leveraging core competencies
      • "Scientific Games and WMS will draw on each organization's core strengths to broaden offerings, bring gaming products to new sectors and geographies, accelerate key growth initiatives and offer enhanced capabilities, systems, field service and content. Scientific Games' strong global footprint, including its position in server-based gaming, should help accelerate WMS' international development initiatives."
    • Diversification of revenues
    •  Strengthened position in interactive gaming
      • "The combined iLottery/iGaming platform and content will significantly expand the scope of the combined company's interactive products.  WMS has a well-developed iGaming platform, including social and mobile gaming, while Scientific Games has an advanced platform for iLottery, sports book and loyalty/rewards. Scientific Games expects significant opportunities to cross-sell these products to the companies' respective customers"

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