Morning Reads From Our Sector Heads

Todd Jordan (GLL):


China culls poultry as bird flu death toll reaches six (via BBC)


Brian McGough (Retail):


Versace Sees Full-Year Growth — and Perhaps an IPO (via WWD)


Josh Steiner (Financials):


U.S. Regulator, Bank of America Reach Mortgage-Loss Settlement (via WSJ)


Money Spigot Opens Wider (via WSJ)


Kevin Kaiser (Energy):


Europe to Shut 10 Refineries as Profits Tumble (via Bloomberg)


Jay Van Sciver (Industrials):


Boeing Girds for 787 Battery Fix as Teams Near Biggest Fleet (via Washington Post)


Rob Campagnino (Consumer Staples):


China Bird Flu Deaths Rise to Six, Poultry Markets Shut (via Bloomberg)


Howard Penney (Restaurants):


Fast Food Workers Call For $15 An Hour Wage, Union Protections (via NY1)


Rattling Sabers

Client Talking Points

Down With The KOSPI

Korea's KOSPI index dropped the most in five months as the Bank of Japan stimulus resonates throughout the country. 41% of the KOSPI is tech/industrial that competes head to head w/ Japanese Manufacturers and as the Yen continues to be debauched, the KOSPI continues to slip lower, down another -1.6% overnight.

Bear Oil

When crude oil drops in price, that's bullish for the economy. Americans hate high gas prices and an increase in consumption is a bullish catalyst for growth. Brent Crude oil is down -4.3% year-to-date and it's starting to look a lot like gold did three months ago as the US dollar continues to roar higher. Oil can still come down further from these current prices. Get the dollar right, you'll get oil right.

Asset Allocation


Top Long Ideas

Company Ticker Sector Duration

Darden stands to be a beneficiary from a housing recovery and an improved employment picture, which boosts casual dining trends. The company's net income declined on its recent earnings report but beat the Street's expectations


With FedEx Express margins at a 30+ year low and 4-7 percentage points behind competitors, the opportunity for effective cost reductions appears significant. FedEx Ground is using its structural advantages to take market share from UPS. FDX competes in a highly consolidated industry with rational pricing. Both the Ground and Express divisions could be separately worth more than FDX’s current market value, in our view.


HOLX remains one of our favorite longer-term fundamental growth companies given growing penetration of its 3D Tomo platform and high leverage to the 2014 Insurance Expansion from the Affordable Care Act.

Three for the Road


"@moorehn Well if recent history teaches us anything, basically no one in America gets how money works." -@KatherineMiller


"The cure for boredom is curiosity. There is no cure for curiosity." -Dorothy Parker


U.S. creates just 88,000 jobs in March; unemployment rate down to 7.6%.


Takeaway: We would fade the optimism

Tax rebates a positive for the regionals in March but revs will struggle to move into the black



Uncle Sam's late refunds may have jolted a very weak regional gaming environment – temporarily.  Sadly, same store revenues will still likely fall.  Our first peak into March involves Missouri, which we think declined only 2% on a same-store basis in March, much improved from the 9% average decline seen in the past 3 months.  


Overall, we expect SS riverboat revenues to decline 2-3% in March, much improved, but still down.  Down revenues with a favorable calendar and the tax refund catalyst is not cause for celebration, in our view.  Our projection model accounts for changes in seasonality factors, calendar differences and the tax refund. 




Before people get too pumped up about the sequential improvement in gaming revenues, we would note that SSS revenues may continue to post YoY declines until July, with July benefiting from an a easy comp from July 2012 (-7%).  With lower visitation and an older, smaller number of core gamers, we remain bearish on the regional fundamentals. 

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Persistent Illusions

This note was originally published at 8am on March 22, 2013 for Hedgeye subscribers.

“Reality is merely an illusion, albeit a very persistent one.”

-Albert Einstein


This has been an entertaining week at Hedgeye.  For those that have been reading the Early Look or following us on Twitter, you have noticed that we have been having some fun with a few of the old guard of Wall Street research.  One friend of Hedgeye actually wrote in and called Keith and myself: grumpy young men.


Candidly, that is probably more truth than illusion.  To be fair, though, getting up early and grinding hard throughout the week probably does rightfully make a guy or gal grumpy.   There is no doubt many of our subscribers can relate to this as well.  While we have the pressure of running a profitable business and making 50+ employees happy, the pressure that many of you have associated with the fiduciary responsibility of managing money is also no illusion.


Speaking of illusions, our Energy Analyst Kevin Kaiser actually identified a great one this week in the cash flow statement of a company called Linn Energy (LINE).  LINE is an upstream MLP, so in effect they use the tax advantage of a MLP structure to pay out large distributions.  This is fine for predictable and mature businesses.  Unfortunately, neither of those traits fit LINE.


In fact, LINE is an oil and natural gas producer.  So not only is it not a mature to slightly growing business, it is actually a business with natural decline rates that requires meaningful capital expenditures to maintain the cash flow stream.  In the Chart of the Day, we’ve included a slide from the presentation that looks at distributions paid from 2006 to 2012.


In that time period, LINE paid $2.2 billion in distributions.  Strangely, in the same period the company only generated $1.7 billion in cash flow from operations.  Moreover, if we look at free cash flow, which we define as cash flow from operations less capital expenditures, LINE generated a negative -$1.0 billion in cash flow.  Despite these cash flow deltas, LINE management has done a decent job pulling rabbits out of the proverbial cash flow hat and paying distributions, largely from financing cash flow.


So, as Kaiser summed up about the company at the end of his presentation:


The illusions:

  • LINN’s assets are mature oil and gas fields with low decline rates;
  • LINN’s cash flows are stable because of its hedging strategy;
  • LINN generates sufficient cash flow to pay and grow its distribution;
  • With an 8% yield, LINN is an attractive fixed-income alternative; and
  • LINN is creative and innovative.

The reality:

  • LINN’s base decline is 20 - 25% per year;
  • LINN’s cash flows are overstated because of its hedging strategy;
  • LINN does not generate any FCF, and must raise additional capital to pay its distribution;
  • LINN equity is more than 50% overvalued today; and
  • LINN is financially creative and innovative.

If Houdini were a hedge fund manager, he would likely be all over this company!


In the global macro world this week, the primary illusion has been in regards to the cash in Cypriot bank accounts.  Is it there? Will it stay? How much will the government take?  Coming in to the week, many pundits predicted that the arbitrary decision to “tax” money in bank accounts in Cyprus would lead to a run on the banks across the peripheral countries in Europe.  Much to the chagrin of alarmists, this hasn’t happened.


Of course, this is not to say that the EU decision to try and force a bank levy on Cyprus makes any sense.  The larger risk is not that the EU will do try to this in Greece, Portugal, or Spain next, but rather that the illusion is created that they will.  A run on banks across the peripheries is literally a worst case scenario for the EU.  Unfortunately, investor and depositor confidence erodes very quickly with seemingly arbitrary decisions.


The latest news flow suggests that the Cyprus situation will continue into next week.   Russians have a large amount of capital in the Cypriot banking system, but Cypriot Finance Minister Michael Sarris spent all week in Russia and returned with his hat in hand and no bailout monies.  The European Central bank has also said that effective this coming Monday they will cut off liquidity lines unless Cyprus gets a deal in place.  So yes, the illusion that ECB officials have the situation under control is alive and well.


As for the Cypriots, well as of this morning the statement the government was supposed to issue is now more than 60 minutes late, but according to Twitter they are working on it.  As for the average Cypriot, their bank withdrawals from ATMs are limited to literally a couple hundred Euros.  Talk about dysfunction!


The slow and steady recovery of U.S. economic activity continues to be solidly in the category of non-illusions.   The key data point we received this week was in the way of non-seasonally adjusted jobless claims, which declined by -7.5% year-over-year for the week.   In aggregate, the improvement in jobless claims is starting to mirror 2012. 


Our Financials Sector Head Josh Steiner has noted many times, improving jobless claims are one of the best leading indicators for housing trends, credit quality, and loan growth.  Even as the dysfunction in Europe percolates, the U.S. economy stabilizing is no illusion. This is a key reason U.S. equities remain one of our favorite global asset classes.


Our immediate-term Risk Ranges for Gold, Oil (Brent), Copper, US Dollar, USD/YEN, UST 10yr Yield, VIX, and the SP500 are now $1594-1620, $107.01-108.99, $3.39-3.49, $82.23-83.39, 94.12-97.08, 1.89-1.98%; 10.73-14.74, and 1542-1565, respectively.


Enjoy your weekends.


Keep your head up and stick on the ice,


Daryl G. Jones

Director of Research


Persistent Illusions - Chart of the Day


Persistent Illusions - Virtual Portfolio


The Macau Metro Monitor, April 5, 2013




Macau need not be worried about four confirmed human deaths on the mainland linked to a strain of bird influenza known as H7N9, said the government. And the outbreak has no impact on the decision to open the Gongbei border for two hours longer during the three days of the Ching Ming holiday, added Alexis Tam Chong Weng, head of the Chief Executive’s office.  “For the [H7N9] ‘flu this time, there is still not any case recorded in Macau,” Mr Tam told a press conference on Wednesday. “The cases are currently limited to the northern region of China so I think there will be no problem for us to open longer hours in the border in these three days.”



China has begun a mass slaughter of poultry at a market in Shanghai, after a new bird flu virus was detected there.  The H7N9 virus, a form of avian flu not before seen in humans, was discovered in pigeons being sold in the market.  Six people have now died from the virus, Chinese officials say.


It is not yet known how people are catching the disease, although the WHO says there is currently no evidence of human-to-human transmission.  The virus was discovered in pigeon samples in Huhuai market in western Shanghai, Chinese media said.  There have been 14 confirmed infections so far in eastern China, including in Shanghai and Zhejiang province.



The Taiwanese government is proposing a 13% tax on gross gaming revenue for potential casinos built on its outlying islands.  In Macau, casinos pay a 39% effective tax on gross gaming revenue.



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