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WILL BRAZIL HOLD THE LINE?

Takeaway: Watch Brazil closely here. A TREND-line breakdown is likely a very dour signal for the Brazilian economy and other risk assets broadly.

SUMMARY BULLETS:

 

  • All told, if the Bovespa holds its TREND line here, we are looking to use the recent weakness as an opportunity to increase our allocation to Brazil on the long side of equities and the BRL.
  • If the index breaks down, however, that would be a signal to us that our bullish fundamental bias on Brazil is not yet a probable outcome and we’d suspend that view until further notice.
  • Additionally, the aforementioned breakdown would likely be a leading indicator for weakness across risk assets broadly over at least the next few weeks. Our analysis of previous cycles and the key drivers of the Brazilian economy is supportive of this conclusion.

 

WHAT NOW?

Brazil’s benchmark Bovespa Index is literally dancing on its TREND line right now; if it holds, we’re buyers. If it snaps, that’s likely a very bad leading indicator for “risk assets” globally. We hate using that colloquialism, as every asset holds some degree of risk (like US Treasury bonds in the YTD; are those also risk assets?), but it works for now.

 

WILL BRAZIL HOLD THE LINE? - 1

 

To quickly recap why we’re bullish on Brazilian equities  – particularly the consumer and industrials names – we think the combination of continued currency appreciation will help promote domestic purchasing power and inflows of international capital, on the margin, and historically-low interest rates will reinforce penned-up demand for capital outlays (World Cup and Olympic Games preparations are generally well behind schedule).

 

It helps that Brazil’s non-seasonally adjusted unemployment rate also just ticked down to a record low on a monthly basis (DEC) and on an average annual basis (2012).

 

WILL BRAZIL HOLD THE LINE? - 3

 

On the bearish side of the ledger (there’s always disconfirming evidence in Global Macro research; you just have to figure the appropriate weight to assign to it in your fundamental reasoning), inflation continues to be a major headwind to Brazilian economic activity and with the recent strength in global commodity prices, inflationary pressures continue to bubble up in Brazil.

 

WILL BRAZIL HOLD THE LINE? - 2

 

That’s why we continue to anticipate outsized gains in the Brazilian real over the intermediate term. Because President Rousseff has all but officially prohibited the central bank from hiking interest rates, Brazil must reverse course on capital controls and allow its currency to strengthen dramatically, or the inflation monster will strike the final nail into the coffin of Brazil’s once-ballyhooed “BRIC” status.

 

Make no mistake, Brazil’s recent spate of Big Government Intervention has threatened to make investing in Brazil a structurally taboo activity. On the strength of continued investor-friendly reforms (like the recent gasoline and diesel price hikes for PBR), however, we’re anticipating a revival in international investor sentiment towards Brazil in 2013, but are necessarily married to the idea. Rousseff and Mantega need to deliver.

 

For more details behind our bullish bias on Brazilian equities (TREND), please refer to the following two research notes:

 

 

WHY BRAZIL BREAKING DOWN WOULD BE A BAD SIGNAL

On 10/24, we published a note titled, “IS BRAZIL’S RECENT BREAKDOWN A HUGE RED FLAG FOR RISK ASSETS?” in which we forewarned of pending weakness across “risk assets” across the Global Macro universe. From the publication of that note to the 11/15 bottom in the SPX, the following price deltas were recorded:

 

  • S&P 500: -3.9%
  • MSCI World Index: -3.5%
  • CRB Index: -1.6%
  • JPM EM FX Index: -1.2%
  • RWR (SPDR REIT etf): -3.9%
  • US Junk Bond YTM (FINRA-BLP Index): +44bps

 

As detailed in the aforementioned note, we find merit in using Brazil as a stealth, short-cycle leading Global Macro indicator because, since late 2008, the Bovespa Index has generally led global equities on nearly every major intra-cycle rally and correction.

 

Specifically, we think Brazil’s unique setup from a capital markets and economic perspective exposes it to getting pulled aggressively in both directions of global inflation expectations (reflation and de/dis-inflation). 

  1. On the way up, the Bovespa Index is heavily weighted to reflation with 65.7% of its market cap having direct exposure to top line and margin leverage that stems from rising prices of commodities and risk assets (Energy, Basic Materials and Financials sectors).
  2. On the way down, the Brazilian economy is heavily weighted towards domestic consumption, so the tailwind of disinflation and/or falling inflation expectations tends to become a demonstrable tailwind for Brazil’s growth outlook and supportive of speculation around easier monetary and fiscal policy in Brazil. It’s worth noting that consumption accounts for 81% of Brazil’s GDP by expenditure (household = 60.3%; government = 20.7%).

 

WILL BRAZIL HOLD THE LINE? - 4

 

WILL BRAZIL HOLD THE LINE? - 5

 

All told, if the Bovespa holds its TREND line here, we are looking to increase our allocation to Brazil on the long side of equities and the BRL. If the index breaks down, however, that would be a signal to us that our bullish fundamental bias on Brazil is not yet a probable outcome and we’d suspend that view until further notice.

 

Additionally, the aforementioned breakdown would likely be a leading indicator for weakness across risk assets broadly over at least the next few weeks. Our analysis of previous cycles and the key drivers of the Brazilian economy is supportive of this conclusion.

 

Darius Dale

Senior Analyst


PENN 4Q12 REPORT CARD

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 

  • WORSE:  Tough quarter and guidance.  2013 guidance does look aggressive to us but the reality is that even on our 2013 estimates, we estimate there is more value to PENN post-REIT conversion than the current value of the stock.

TOLEDO & COLUMBUS  

  • WORSE:  Ramp in slot volumes has been slower than anticipated, leading to a reduction in 2013 EBITDA guidance.  PENN sees Columbus slot volumes to improve sequentially in January.
  • PREVIOUSLY:  “We have over 200,000 accounts signed up in Toledo since we've opened and we're still very encouraged about the prospects as we move into 2013 there.  “We're right now very pleased with the flow-through coming out of Toledo and expect similar kind of results in Columbus as that property now is – today is day 10. The early results in Columbus are very much in line with what we would expect in a market of that size.”

OVERALL BUSINESS TRENDS

  • WORSE:  PENN is seeing the lower end consumers taking fewer trips.  Ohio is underperforming expectations.  Gulf Coast market also has been under pressure. 
  • PREVIOUSLY: “I characterize our businesses that have not been impacted by new supply as generally flat. We're seeing visitation trends year-over-year flat and spend per visit generally flat in markets that are stable. Really not seeing anything different than what we saw in the second quarter.”
  • “Toledo is doing a little bit better than we thought and I think Charles Town is doing a little bit better than we thought and then there's some offsets to both of those in different markets across the United States. Clearly, the – I call it the Gulf Coast area is a bit challenging, and clearly not exactly as healthy as we would hope, but that's obviously – those are relatively small properties.” 

2013 BUSINESS OUTLOOK

  • WORSE:  EBITDA guidance was lowered to reflect a very challenging demand environment.  PENN is also seeing more volatile market conditions.
  • PREVIOUSLY: 2013 outlook: “I think the initial feedback is most people seem to think that we're in a pretty stable environment, nobody is projecting or feels comfortable that we're going to get a hockey-stick recovery, nor do they feel like we're going to see any kind of significant downturn… Our thinking too, as we go into the fourth quarter and into next year that the promotional environment is going to be – going to remain stable”

PROGRESS ON REIT CONVERSION

  • SAME:  PENN received a Private Letter Ruling from the IRS relating to the tax treatment of the separation and the qualification of PropCo as a REIT.
  • PREVIOUSLY:  “We are effectively finished with the IRS. That doesn't mean that some facts and circumstances couldn't change that might require us to go back, and I have to say that for attorney's purposes, but for all intents and purposes relative to the IRS, we're finished. We just need to get our gaming approval and get some financing done to obviously accommodate the spin.”

MARYLAND LOBBYING EXPENSES

  • WORSE:  $26 million is $2 million higher than PENN's November guidance.
  • PREVIOUSLY:
  • Q: “Is the Marlyand lobbying expense projection in your EBITDA guidance for the balance of this year”
    • A: “No, the amounts that we're spending in Maryland are decisions made on the day-to-day basis as the tactics of the campaign unfold. And so, therefore, what we are not doing is trying to project exactly how much we're going to spend, nor do we want to forecast how much we're going to spend for obvious strategic reasons”
    • “Just to be clear on the $20 million lobbying that is in your current guidance, but the $11  million October to-date and whatever you go above that is not in the guidance? Correct”

IMPACT OF PNK’S NEW PROPERTY ON BATON ROUGE?

  • WORSE:  Increased pressure from L'Auberge Baton Rouge.  Baton Rouge had weaker margins than seen historically.  Baton Rouge 4Q revenues were down 27% YoY.
  • PREVIOUSLY: “I would generally say, so far so good, slightly less than we expected, but there's a lot more that has to evolve before we can make any conclusions on what our new business volumes will be at our Hollywood Baton Rouge property”

OHIO RACETRACK UPDATE

  • SAME:  Dayton and Austintown racetracks on track for 2014 opening.
  • PREVIOUSLY: ““We are waiting for the approvals from the lottery and racing commissions to relocate our tracks. We need to get that before we get this started, hopefully, that'll occur before the end of the year. We hope to break ground end of the year, early 2013, and we're talking about a first half of 2014 opening, if all goes well right now.”

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.

 

JOBLESS CLAIMS - ARE WE MOVING IN THE RIGHT DIRECTION AGAIN? - JS 1

 

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JOBLESS CLAIMS - ARE WE MOVING IN THE RIGHT DIRECTION AGAIN? - JS 6

 

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JOBLESS CLAIMS - ARE WE MOVING IN THE RIGHT DIRECTION AGAIN? - JS 8

 

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JOBLESS CLAIMS - ARE WE MOVING IN THE RIGHT DIRECTION AGAIN? - JS 10

 

JOBLESS CLAIMS - ARE WE MOVING IN THE RIGHT DIRECTION AGAIN? - JS 11

 

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.

 

JOBLESS CLAIMS - ARE WE MOVING IN THE RIGHT DIRECTION AGAIN? - JS 12

 

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

 

 

Joshua Steiner, CFA

 


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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 normal

 

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 normal


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