“Not this week, thank God.”
-Dwight D. Eisenhower
That’s what the President of The United States said to one of his senior advisors “with beads of sweat on Eisenhower’s forehead during the tense debate over whether and when to intervene” in Vietnam in 1954. (Ike’s Bluff, pg 131)
As many of you know from your risk management experiences, it’s what you don’t do under pressure that often defines your performance. “Eisenhower was an expert in finding reasons for not doing things recalled Andrew Goodpaster.” (pg 130)
That’s why I study the history of great leadership. It helps me empathize with and learn from what Teddy Roosevelt called “the struggle” of other men and women when they were under pressure. It also gives me confidence in making decisions. That doesn’t always mean I’ll make the right call. It just means I’ll have known why I made it.
Back to the Global Macro Grind…
Eisenhower’s legacy is that he didn’t let the French suck US casualties into Vietnam in 1954. He also avoided playing the end of the world card (releasing the bomb) during a time when plenty of Americans had US politicians (LBJ) freaking them out about outer space.
If the world ended this morning, I am pretty sure A) I wouldn’t be writing this and B) you wouldn’t be reading anything else. So, with that in mind, and the entire manic media focused on what is so 2010-2011 (Italian Bond auctions), what happened?
- Italian Bond Auction was better than “expected”, so bond yields fell, making another lower long-term high
- Italian Equities stopped going down right at our immediate-term TRADE oversold signal of 15,511 (MIB Index)
- US Equity Futures held onto yesterday’s gains; the 2nd up day in the last 3 (+4.9% YTD)
I’m not trying to be complacent about Italy’s economic risks (just don’t be long Italy, and get over it). I’m well aware of what Eisenhower himself coined as The Domino Theory. We made this call on Europe around this time in Q1 of 2010 don’t forget. It’s 2013, and we don’t see Italy being the domino that knocks down our bull case for Asian and US Equities right now.
That could change. The plan is always changing. And when it does, I’ll be the first to let you know. But, for now, let’s focus on doing more of what we did when people were freaking out about Congress at the end of December:
- Buy Asian (China and Singapore) and US Stocks (EWS, CAF, XLF)
- Short US Treasuries (TLT)
- Short Japanese Yen (FXY)
Why buy American instead of Italian?
- US #Housing is ripping (New Home Sales shocked the bears to the upside yesterday with inventory falling, again!)
- US Employment #GrowthStabilizing (our rolling non-seasonally adjusted jobless claims model continues to be bullish)
- If you have to choose between a criminal, comedian, and Congress, I’d actually choose Congress
Yep, that’s how sad and embarrassing Italy’s #PoliticalClass has become. And neither France nor Japan are too far behind them.
So, if you are shorting Treasuries, can’t buy European or Japanese Sovereign Debt, and have to buy something else, why not Asian or American stocks? To be clear, I don’t have to buy anything. But when I do buy something, both the signal and research back it.
The last point I want to make this morning is about volatility expectations. I get the front-month VIX is different than the term-structure of volatility’s curve. Looking at expectations, across durations, will amplify my point:
- VIX (front-month) TREND resistance = 17.18, and that was only violated to the upside for ½ a day
- VIX topped on Monday at another lower long-term-high (on DEC28, 2012 the lower-high = 22.72)
- VIX was at 40 in Q1 of 2010 after we were legitimately concerned about European Dominos
As you can see in the Darius Dale’s Chart of The Day, front-month Volatility (VIX) continues to make a series of long-term lower highs as the volume of the manic media’s freak-outs make higher-highs. Think they’ll make the call on the end of the world, together?
If this is just a mini-mania of what you saw in November-December (substitute Italy for US Congress), what is it, specifically, that you have a as a catalyst that would stop the VIX from going straight back down to 12 from here?
It’s not going to 12 this week. I get that. But the VIX is probably not going back to 22.72 or 42.96 (the SEP2011 freak-out) this week either. If I see anything real developing that changes my view on this, I’ll just change my mind. I don’t have to do that yet, thank God.
Our immediate-term Risk Ranges for Gold, Oil (Brent), US Dollar, USD/YEN, UST10yr, Shanghai Composite, and the SP500 are now $1, $112.55-116.12, $81.12-82.23, 91.55-94.49, 1.84-1.96%, 2, and 1, respectively.
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
The Macau Metro Monitor, February 27, 2013
MGM CHINA SEES MACAU CASINO VIP BUSINESS PICK UP Bloomberg
VIP business has seen a “strong comeback” after the festival that ended on Feb. 17, Bill Hornbuckle, chief marketing officer of MGM Resorts, said in Macau today. MGM China said it hasn’t seen any sign of a Chinese crackdown on the junkets. “There’s never any real, concrete indication or direction from the government,” said Pansy Ho, chairman of MGM China and daughter of Stanley Ho. “Although the growth rate of VIP business may slow, I’m not aware of any crackdown.”
Pansy Ho said she has no plan to cut her 27% stake in MGM China.
EMPLOYMENT SURVEY FOR NOVEMBER 2012-JANUARY 2013 DSEC
Macau unemployment for November 2012-January 2013 held stable at 1.9%. Total labor force was 358,000; the labor force participation rate stood at 72.5%, up by 0.1%. Total employment increased continuously, reaching 351,000 in November 2012-January 2013, an increase of 1,400 from the previous period.
LAWMAKERS CALL FOR FULL CASINO SMOKING BAN Macau Business
Legislative Assembly members yesterday urged city officials to review the partial ban on smoking inside casinos as soon as possible, making them completely smoke-free. The most vocal assembly member was Angela Leong On Kei, who is also an executive director of SJM.
A regular review of the ban is scheduled for 2015, but assembly members want it to be pushed forward. However, the head of the Health Bureau, Lei Chin Ion, said yesterday the review would only take place in 2015 as scheduled. Lei said yesterday that the bureau detected 118 violations of the partial smoking ban in casinos between January 1 and February 20, 60% of which involved tourists.
VISITOR DROP TO HELP EASE INFLATION: TAM Macau Business
Secretary Francis Tam said that consecutive monthly declines in visitor arrivals could help ease Macau’s strong internal demand and consequently slow down inflation. Tam said that strong purchasing power of tourists is the “main factor” pushing up the city’s internal demand.
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This note was originally published at 8am on February 13, 2013 for Hedgeye subscribers.
"On the road we're somebody else's guests - and we play in a way that they're not going to forget we visited them."
- Knute Rockne
With Keith and Daryl on the road across the pond I've been tapped to pen this morning's Early Look. In doing so, I'll bring an alternate angle to the morning missive compared to my hockey colleagues since my foundation was forged on the gridiron.
In 1924, the Four Horsemen as they were coined comprised Notre Dame's spirited backfield under legendary football coach Knute Rockne. During their three year run together ('22-'25) they only lost two games. They weren't the biggest, nor the fastest, but together they were dominant.
At Hedgeye, we have our own spirited foursome who delivered on our Best Consumer Ideas call on Monday. With the most recent addition to the team, Rob Campagnino, launching Consumer Staples coverage in December, the records have yet to be written, but that's precisely the spirit of Hedgeye's new Best Ideas product - we'll be keeping score real-time with #timestamps. Later I'll hit on four (IGT, JCP, KMB and BKW) of the nine Best Consumer Ideas presented.
First, let me highlight two new process improvements we introduced to Institutional Hedgeye clients on the call, our Best Ideas Product and new Consumer Coverage initiative that I will be spearheading personally. In brief, the Best Ideas Product will highlight only the Best Ideas from each sector firm-wide (4-8 per year). Clients will be notified of changes and additions to this list through Black Books and research notes.
Our Consumer Coverage offering provides a customized approach to conveying our top calls across all of Consumer, beyond just the Best Ideas. Drawing on my experience covering the Retail sector over the last 4+ years, I am working alongside each of our Four Horsemen infusing original content, analysis and risk management (quant/factor overlay) to select clients. For more information on either of these new offerings, please contact us at firstname.lastname@example.org.
Back to our horsemen. Similarities can be drawn between each consumer sector head and Rockne's horsemen - quarterback (Harry Stuhldreher), fullback (Elmer Layden) and two halfbacks (Jim Crowley and Don Miller) by comparing sector beta (not physiques).
We have Rob Campagnino (Consumer Staples) representing the lowest relative beta - our 'three yards and a cloud of dust' fullback, two halfbacks in Howard Penney (Restaurants) and Brian McGough (Retail), and our high-beta quarterback in Todd Jordan (Gaming, Lodging and Leisure). A sorted bunch indeed, but I look forward to taking the field with these guys. Before we hit on some Ideas, let's cover a little ground on where we stand on the consumer and sectors.
Our view on the consumer here is one of concern of slowing demand from lower-to-middle income earners and underperformance of the companies over-indexed to this demographic. Meanwhile, the latest results out of Hermes and Michael Kors suggest the higher-end consumer remains resilient. Among the factors at play here include payroll tax increases of 2%; at the same time we're seeing a surge in gas prices over the last 3-weeks to historic February highs. The reality is that a pinch on consumer wallets near-term from both ends does not improve sentiment nor spur spending.
Another factor on the horizon to consider is the wealth effect of an improving housing market. As highlighted in our Q1 Macro Themes call, our #HousingsHammer theme suggests that house prices will increase due to lower supply, rising demand and stabilizing mortgage purchase application activity. This is positive indeed, but it will take time to manifest after which point it will take more time for people to actually feel better about their financial position. The timing here will more likely be measured not in months, but years.
As for sectors, regardless of what duration you pull over the last year, the Staples Sector SDPR ETF (XLP) and Consumer Discretionary (XRT) have consistently outpaced the S&P 500. Year-to-date alone the XLP and XRT are up +7.3% and +8.7% respectively versus the S&P's encouraging +6.5% start.
A look at the chart below reflects this recent performance. Interestingly, yet not surprisingly, the move in price has not been supported in kind by a corollary move in upward earnings revisions with investors seeking yield. This is reflected in a valuation premium in likely sectors (Utilities, Health Care and Staples) 1.4x-2x standard deviations above recent history. The next closest sector? You guessed it, Consumer Discretionary clocking in with a 0.8x STD premium.
While these levels suggest peaky valuations, we're not trying to call a top, but simply recognize that it may be prudent to look beyond fundamentals alone when considering long positions at these levels. As a result, our list of longs consists of largely event/catalyst-driven stories. Fortunately, there are plenty of stocks that fit that criteria for those committed to playing Consumer.
Here are four callouts among the nine Best Ideas discussed Monday, which also included CAG, CAKE, and ASCA (long) and PNK and UA (short):
IGT (Long) - After refocusing on game content and digesting several poor acquisitions to establish online gaming, the stock is at an inflection point with a rebound expected in ROIC. Growing replacement demand and new domestic and international markets should drive multi-year bull slot market. In addition, substantial share repurchase activity expected to continue with accelerating FCF. Bearish sentiment and 11x EPS multiple do not reflect the 20%+ earnings growth we expect. One of the better looking long-term longs as its nowhere near 5yr or all time highs = bullish formation with TREND breakout line of 14.26.
JCP (Long) - Near-term sentiment is too bearish at a time when the delta in top-line is likely to get better. We think improving sales trajectory with comps turning positive in 3Q and improving dot.com will drive the stock higher. Liquidity remains a concern, but we don't see it surfacing over the intermediate-term. TREND breakout above $20.41 is when the long works quantitatively, below that is all storytelling.
KMB (Short) - Top-line growth is masking deteriorating earnings quality at peak valuation. EBIT growth is largely derived from unsustainable restructuring savings and a slowing commodity benefit that swings to a headwind in 2013. Notably, the stock closed at $89.90 flirting with quantitative TRADE support at $89.81 - below that is where you press.
BKW (Short) - Never 'fixed' during its stint as a private company, the outlook for the U.S. and Canada (60% of total) is deteriorating. Some North American franchisees are tracking well below expectations. Decelerating comps are likely to compress BKW's industry high multiple. The stock is breaking down through both TRADE (17.45) and TREND (16.78) lines of support - short it here.
With the calls on the board and #timestamped, the Four Horsemen are off and running. For a replay of our Best Consumer Ideas call and slides, contact email@example.com
Our immediate-term Risk Ranges for Gold, Oil (Brent), US Dollar, USD/YEN, UST 10yr Yield, and the SP500 are now $1641-1667, $116.98-118.91, $79.71-80.31, 92.78-94.46, 1.96-2.01%, and 1510-1526, respectively.
We are off to a strong start YTD, however, as my Hall of Fame coach Dick Farley liked to remind this Eph, "keep your head on a swivel."
Director of Consumer Research and Sales
- FY 2012: Mass market revenue grew 13% and slot revenue increased 3% and VIP revenue increased 1%
- They are particularly encouraged by the QoQ growth in the 4th quarter which grew 11% sequentially on the back of strong VIP growth
- Their Cotai site will be combined with the adjacent site (amusement park)
- Planning to create more space at Grand Lisboa on the main floor and the 3rd floor for premium mass. They are dedicating more of their tables to the premium mass segment.
- They are constructing a bridge and renovating the Jai Alai building
- Grand Lisboa: isn't EBITDA margin down QoQ despite adding more tables? Yes, the margin is down. VIP grew 15.8% QoQ but the mass was down 1%. So some of it was mix - 80% VIP mix. Additional margin decline due to junkets performing well and getting higher commissions. They also had to absorb higher bonuses and accrued compensation in the 4Q. They should have a little north of 14% EBITDA margins or 24-25% on a US GAAP basis going forward.
- They are going to get some additional revenues from Jai Alai to re-allocate to Grand Lisboa
- Down about 2% QoQ on slots and mass. They took some slots offline to make room for more table games.
- They are going to be negotiating a lease with Angela on the adjacent land. They can only build non-gaming facilities on that land but will complement their gaming asset on that site. Looking to add 6,000 more rooms on that site in addition to the 1,700 that their site can support. Phase I should open in 1Q16. The rest of the towers will open as they reach certain occupancy levels.
- Trends in Febraury, soft CNY and then the rebound afterwards: Hard comparisions YoY because of the calendar shift. But if you combine the months of Jan and Feb their business is up 20%.
- They don't think that there is really anything going on politically.
- Their 1Q is usually the weakest Q of the year [for VIP]
- Jai Alai: In November, they wanted to lease the entire building. Capex would be HK$600-700MM. For 2013 they are budgeting HK$400MM. They are going put in better retail etc to complement Oceanus. They will have table space at Jai Alai once the renovations are complete but the tables won't come back from Grand Lisboa.
- They think that their current dividend payout ratio is sustainable around 76% but they can't guide to that because the Board needs to approve it
- Theme Park & rooms on Cotai: They are still negotiating with Angela. The capex on Angela's site will be roughly the same as what's on their adjacent site.
HIGHLIGHTS FROM THE RELEASE
- Adjusted Group EBITDA grew by HK$7,631MM and gaming revenue grew by 4.5% to HK$78.9BN
- Market share of 26.7%
- Grand Lisboa 2012 revenue: HK$29.2BN, up 28% YoY and Adjusted Property EBITDA of HK$4.5BN
- Mass market table gaming revenue increased by 11.5% and VIP gaming revenue increased by 34.4%, while VIP chips sales increased by 16.6%.
- Grand Lisboa Hotel’s occupancy rate increased by 2.4% to 95% for the full year, and average room rate increased by 3.6% to HK$2,129.
- Visitation to Grand Lisboa grew during the year, from an average of 34,733 visitors per day in the first quarter, to an average of 40,770 visitors per day in the fourth quarter
- During 2012 Casino Grand Lisboa expanded its VIP gaming operations from 134 tables at 1 January 2012 to 175 tables at 31 December 2012. Two areas of the property were converted for VIP gaming, on the 31st floor (since February) and on the 9th and 10th floors (since September). Mass market table gaming grew during the year due to increased numbers of visitors and greater spending at gaming tables, particularly by high limit mass market customers
- If calculated under US GAAP, the Adjusted Property EBITDA margin of Casino Grand Lisboa would be approximately 25.8% for 2012
- As at 31 December 2012, Casino Grand Lisboa operated a total of 175 VIP gaming tables, 240 mass market gaming tables and 731 slot machines.
- Cash: HK$24BN
- Besides growth of gaming revenue, other factors that contributed to higher Adjusted EBITDA in the year were improved operating results at Ponte 16 and Grand Lisboa Hotel.
- The Group’s Adjusted EBITDA margin for the year was 9.6%... If calculated under GAAP, Group’s Adjusted EBITDA margin would be 16.9% for 2012
- VIP gaming operations accounted for 67.5% of the Group’s total gaming revenue in 2012, as compared with 69.9% for the previous year
- SJM had 587 VIP gaming tables in operation with 36 VIP promoters, as compared with 609 VIP gaming tables and 32 VIP promoters at 31 December 2011. At 31 December 2012, SJM operated VIP gaming in 14 of its casinos.
- As VIP chips sales for the year decreased by 4.0%, the increase in VIP gaming revenue of 1.0% resulted from a higher hold rate for the year. The hold rate for SJM’s VIP operations increased in 2012 to 3.03% from 2.88% in 2011.
- SJM had 3,532 slot machines in service at 31 December 2012 as compared with 3,910 slot machines at 31 December 2011. Slots were operated at 14 casinos and 2 slot halls.
- At 31 December 2012, Casino Lisboa operated a total of 48 VIP gaming tables, 131 mass market gaming tables and 72 slot machines.
- At 31 December 2012, Casino Oceanus at Jai Alai and Casino Jai Alai operated a total of 188 mass market gaming tables, one VIP gaming table and 648 slot machines.
- Operating results for the Sofitel at Ponte 16, in which SJM’s interest is 51%, improved during 2012 and contributed $184 million in revenue to the Group, compared with a contribution of $162 million in 2011. The occupancy rate of the 408-room hotel averaged 80.8% for the full year 2012 as
compared with 72.8% in 2011, and the average room rate increased by 0.7% to $1,210.
- In 2013, SJM is continuing to expand gaming capacity at Casino Grand Lisboa by making more space available for tables on the ground floor for mass market gaming and on the first floor, adjacent to the current high-limit gaming area, for premium mass market gaming. Further space for expansion of premium mass market table games is under consideration involving relocation of food and beverage outlets. SJM is currently working with contractors to determine the actual added capacity, expenditure requirements and timetable. In the first quarter of 2013 additional VIP gaming
tables were added on the third floor and on the 31st floor.
- Casino Lisboa is currently upgrading its table capacity and in 2013 will devote more tables for premium mass market gaming in special high-limit gaming areas. In addition, Casino Lisboa has opened a new area for multi-station electronic games and will add 150 slot machines adjacent to the
main gaming areas by the second quarter of 2013.
Takeaway: Need meaningful EPS upside for M to work from here. With margins at new peak, and competition coming off trough, that’s unlikely.
Conclusion: We’re bearish in light of a great quarter. A lousy secular story that a) is at peak margins and b) had a breakout year that temporarily pushed returns above its cost of capital, and c) is about to see a major competitor comes back online. The stock seems cheap, but not for a department store at peak margins and competitive threats looming. We think that anyone buying it here can at best be playing for a 10-11x pe on $4.25, or about 15% upside. On the bear side, we think you’ve got 8x $3.50 (our 2014 estimate). That’s 29% downside from current levels.
We find it hard to step up and be an incremental buyer of Macy’s here today. It has nothing to do with the quarter that the company posted, but rather, what Macy’s has to do from here to give us confidence in earnings upside.
As it relates to the quarter, there was hardly anything to criticize. M put up a solid 3.9% comp and leveraged that to 8% EBIT growth and 17% growth in EPS. We’ve often said that if we were given only one operating statistic about a retailer in a given quarter, we’d pick e-commerce sales. And Macy’s blew the doors off with 47% growth in dot.com. In the end, when we look back to guidance at the beginning of the year, Macy’s has done virtually everything it said it would do – and then some, winning some clear credibility in our eyes for a business that has hardly warranted much in the past.
We want to stay transparent and accountable on this one in that we’ve had it on our list of top three fundamental retail shorts throughout 2012, and the stock has worked against us over that time (+18% vs +24% for the S&P Retail Index). The part of the story that we missed was the acceleration in dot.com off of a larger base driving both comp and EBIT margin higher. We fared far better from a risk management perspective, going 5 for 6 in our Real-Time Alerts over the past nine months.
There are several reasons why we’re sticking with our short call.
1. Margins Are Toppy: First and foremost, Macy’s closed out this year with an EBIT margin of 9.6%. It touched that level in 2000, and then flirted with it again in 2004/05. Those were far better periods for the consumer than we’re seeing today. Admittedly, this was when it was a smaller and far less efficient organization (Federated and its predecessors). But even M mgmt noted that margin upside from here will be more difficult – in that weaker Gross Margins will be offset by SG&A leverage. Margins have gone from 5.6% to 9.6% over the past four years. That’s what made this stock go from 6 to 39 (yes, a 6-bagger). Margins might have a few basis points to go, but we don’t think Macy’s is a business that can sustain margins over 10%.
2. The JCP Factor: We think that another reason the stock worked in 2012 is because of the share gain from JC Penney. It’s kind of funny to hear M mgmt talk on the conference call that “the overlap isn’t 100%, and many of our customers are well above shopping at Penney.” We agree that the average Bloomies customer wouldn’t be caught dead in a Penney. But take a look at the chart below. It is the cumulative sales change for JCP vs M over the past three years. Can anyone really say with any iota of intellectual integrity that there has not been a material share shift? We’ve been big bears on JCP for 1.5 years, and turned positive on Dec 31. We think that the key at JCP this year will be turning the tip line. Even if they buy it – we think they’ll begin to close the competitive gap. Macy’s will still likely get their comp too, but we think they’ll take it on the chin with Gross Margin when all is said and done.
REVENUE DOLLARS HAVE CLEARLY SHIFTED BETWEEN JCP/M
3. Dot.Com: Again, hats off to M on this front. But by our math, dot.com now accounts for about 7% of total sales. That’s about in line with some specialty apparel retailers that offer a mono-brand experience directly to consumers – a model that presumably plays into e-commerce more easily. As M takes the number of stores that can fulfill orders from 292 up to 500, does that mean that dot.com should go up proportionally to 12%? It might, but it says nothing about their ability to continue to drive people into the stores. Also, part of Macy’s dot.com strategy is to allow consumers to order online and pick up merchandise in the stores. Seriously? Short of buying a 300-lb snowblower at Home Depot online and picking it up a few miles away, we can’t think of a single retail model where the ‘order online and pick up locally’ concept is additive. That might sound like a punitive statement, but we simply think that the big upside in omnichannel -- net of store sales -- has probably past. As a sidenote, management will no longer breakout dot.com from store sales. We've seen other retailers do this as well. And in fairness, it's probably the right move. But also means that its getting more mature and evolved.
4. The Big Picture: We all know that department stores have zero square footage growth. That’s no revelation. But longer-term, doesn’t the company need to find a way to make more people shop there? Ultimately, the more powerful brands (that currently sell wholesale inside Macy’s and other department stores) are incrementally going direct, and the ‘proprietary’ brands that Macy’s has are sub-par. Its boxes are massive – averaging 180k+ square feet – the largest out of its peer group. Also, it owns 55% of its stores, and some of the stores it does not own are on 100-year leases. The point here is that it needs to find ways to entice the next generation of shoppers to shop at its stores. We’re not sure if what we’ve heard of its Millennials strategy is enough.
Ultimately, we simply don’t like how this story is packaged. This is a lousy secular story with no unit growth that is at peak margins and just had a breakout year that temporarily pushed returns above its cost of capital. It has a major competitor that is coming back online after a disastrous year, and it will impact the competitive landscape whether it succeeds or fails in hitting its own goals.
Yes, the stock is cheapish at 10x management’s guidance for 2013. But it does not take a whole lot of historical fact-checking to see that department stores have traded at much lower multiples in the past. We think that anyone buying it here can at best be playing for a 10-11x pe on $4.25, or about 15% upside. On the bear side, we think you’ve got 8x $3.50 (our 2014 estimate). That’s 29% downside from current levels.
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