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BRAZIL: Getting Smoked

Brazil's BOVESPA Index dropped -2.1% yesterday and is down -13.4% year-to-date. One of the worst performing markets on the planet, the country just experienced a 0.25% rate hike to 7.5% on central bank borrowing rates by Alexandre Tombini, the governor of the central bank of Brazil. It's the first rate hike since July 2011 and has given investors plenty to worry about. We like staying short commodities and short Brazil through the iShares MSCI Brazil Index ETF (EWZ).

 

BRAZIL: Getting Smoked - BOVESPA


PENN 1Q 2013 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

  • IN-LINE: PENN's quarter was more or less in line with our expectations once you strip out some of the one time corporate charges and underperformance in the Southern Plains segment

 

PENN 1Q 2013 REPORT CARD - pa1

 

CONSUMER TRENDS/PROMOTIONAL ENVIRONMENT

  • SAME:  There has not been much change in spend per visit.  Any admission trends were impacted by cannibilization or weather-related.  Overall promotional activity across the regional markets have been rational.
  • PREVIOUSLY:  
    • "It certainly is more at the lower end with less trips, the retail consumers.  We are seeing some trip decline throughout all the segments of the business.  Some of that is due to cannibalization. But generally the big issue and the majority of our loss of business volumes have been at the retail end."
    • "March was clearly better than January and February, and we can talk about weather, we can talk about timing and tax returns, we can talk about the payroll tax. January and February clearly were not good months for our industry as a whole. And March, we saw a bit of recovery. Now, there couldn't have been pent-up demand from weather. Weather and timing of tax returns are two things that you would think would be just a timing issue and would come back in March. So I don't know that we're prepared to call March a consumer recovery, but it was certainly nice to see at the very least that some of the lost business from the first half of the quarter came back in March. From what I hear, we're not alone in saying that."

ST. LOUIS

  • SAME:  PENN remains on schedule and on budget with the re-branding and facility upgrade of Hollywood Casino St. Louis, which is expected to be completed later in 2013.
  • PREVIOUSLY: 
    •  "The acquisition there of Harrah's St. Louis I talked about earlier, that closed in November. We've decided to invest about $60 million in that property (this year); some new slot machines, some new carpets, facelift."

YOUNGSTOWN/DAYTON TRACKS

  • SAME:  Ohio State Racing Commission has a view of the racing environment is 'obsolete' and demand is slowing; thus, Penn is at an impasse until the Ohio commission agree to a rational amount of seating. As of now, no change in proposed 2014 opening.
  • PREVIOUSLY:   "Racing Commission has decided that they think we need more seats for the racing section of those businesses. So the process is a little bit on hold at this point. We're not changing the opening date from 2014, while we seek a resolution there."

OHIO/COLUMBUS

  • SAME:  March optimism is being extended into April.  Repeat visitation has been strong. PENN expects another build up in revenues in July/August time frame.  
  • PREVIOUSLY:  
    • "With Columbus, I'm not spending any time worrying about where Columbus is going to end up. It's going to be fine. It's showing sequential growth. It's showing increased visitation. It's showing improvements in the slot customer base. Clearly the fact that Scioto was out first in the market with very aggressive marketing upfront was not ideal. The reality is, over the long term – and I don't mean years, I mean a few more months, I think you'll see the Columbus property really come into its own in terms of getting an appropriate level of market share."

CORP EXPENSE

  • WORSE:  PENN raised corporate overhead guidance by $11MM due to higher development and stock liability expense (related to the higher share price). If we exclude development costs of $2.5 million and liability based stock compensation charges of $3.1 million, Q1 corp expense came in at $21.6MM. For Q2-Q4 2013, there will be $3.5-4MM development expenses and $5.5MM of stock liability charges.
  • PREVIOUSLY:  "I would expect corporate overhead to come back to a more normal level, probably on a normalized basis somewhere around $80 million would be our expectations."

CAPEX

  • SAME:  Q1 $62.7MM capex ($21.8MM maintenance capex, project capex: 1/2 wrap up costs at Columbus/Toledo, $6MM on tracks, rest on Hollywood St. Louis).  2013 capex will be $94.2MM maintenance capex and $277MM project capex.
  • PREVIOUSLY:  "Looking at 2013, we're expecting $275 million of project CapEx and roughly $97.9 million worth of maintenance CapEx for next year. Looking at the first quarter, I would break that down that we expect to spend roughly $49.4 million on project CapEx in the first quarter and $27.2 million of maintenance CapEx."

PENN 1Q CONF CALL NOTES

PENN’s quarter wasn’t too bad.  The underperformance of the Southern Plains segment could have negative implications for PNK.

 


“Our first quarter adjusted EBITDA results were approximately $4 million below our guidance. Despite the first quarter challenges, operating results at Penn National’s East/West and Southern Plains segments exceeded the results contemplated in our guidance while the Midwest segment results met our expectations."

 

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

 

 

 CONF CALL NOTES

  • 2012 was an especially good winter weather season.  While 2013 was "normal," there were 2x as many snow days. 
  • Happy with the way that they have managed costs in markets impacted by new supply
  • Iowa gaming commission just awarded a license to Hard Rock to build a casino in Sioux City despite them being the licensee in the city. They are mystified by the announcement. This is not the last word on this subject.

Q&A

  • Racing commission in Ohio discussions? Their current debate is down to seating.  They have a disagreement over what the state of racing is in 2013. They are trying to create an environment from day one that is not obsolete. Basically, the state of Ohio wants them to have more seats than Penn thinks is appropriate for market demand. They are hoping that the Ohio Racing Commission comes around to their point of view. Nothing more that they can do right now.
  • No changes on the proposed debt structure or interest expense
  • Expect incremental $9MM of corp overhead for 2Q-4Q--$3.5-4MM (development costs) and $5.5MM for stock price-related liability
  • Cash: $247.7MM, 
  • Total debt: $2.614BN - $2.276 BN was bank debt; capital leases of 2MM, 325MM bonds, 10MM of other. 
  • Capex: $62.7MM in 1Q13, $28.1MM was maintenance, 50% of the project capex was wrap up spending at Ohio and Toledo, $12.3MM Hollywood St Louis
  • 2013 capex: $94.3MM of maintenance, $277MM of project capex including Columbus/ Toledo ($36MM) wrapping costs, $173MM of Ohio track expenses. $13MM for the hotel at Zia and $47.8MM in St Louis. 
  • Hope that they will a few REIT approvals in the 2Q and a lot more in the 3rd quarter 
  • Slight reduction in revenue guidance? 
    • Took property level guidance up but offsetting with stock employee expenses of $9.1MM and higher development expenses
  • Think that the ramp in Ohio will resume this summer 
  • Gambling at internet cafes in Ohio are having a material impact on their operations at Toledo and Columbus. Have seen estimates that these cafes are can generate up to $500k of revenues. They want to see the cafes closed.
  • There has been a proliferation of illegal/ grey gaming in many states. It's happened in Florida as well as Texas. Ohio is the only jurisdiction where this is impacting their operations. 
  • Tables at Maryland Live has only been up and running for 7 days. Too early to know what the impact will be. 
  • Most of their data suggests that weather had an impact on visitation but they haven't seen a change in spend per visit at their properties. 
  • Won't say that properties hit by competition have maintained steady margins but they haven't been hit that badly
  • Removal of 500 slot machines in Columbus Ohio and reallocated them to other PENN properties. Feel that the 2,500 units are appropriate for current business volumes.  Do think that once the internet cafes are shut down, they will see better productivity on the slot side.
  • Shifts in OPCO/PROPCO guidance are just due to refining their view on the 2 entities. Still not 100% done there. There may be continued refinement in the estimates.
  • Expect the S-11 to be filed in the 2nd Q
  • Will be looking on an asset by asset basis for acquisitions for PROPCO
  • Have indications that there are other REITs looking at acquiring gaming assets. It's killing them that they cannot enter into conversations today with potential acquisition candidates. They are getting incoming calls that they can not entertain.
  • PROPCO rents changes for 2014: Ohio base rent will be set based on 2013 performance, new Ohio tracks coming online, 2% escalator on buildings if rent coverage is there
  • Continue to monitor online gaming as it unfolds state by state. Are keen to watch NJ unfold. Feel like it will negatively impact casino visitation but grow overall State revenues. 
  • They were the first property to open up tables games in March. Too early to predict the table run rate at Perryville and impact from Maryland Live
  • The philosophy of being rational marketers is an enterprise discipline applied on a market by market basis. Their competitors have been rational marketers too. 

 

HIGHLIGHTS FROM THE RELEASE

  • “The overall adjusted EBITDA shortfall for the first quarter is primarily attributable to the following higher expenses, specifically, $2.3 million of REIT transaction costs, $1.9 million of development costs for potential opportunities in Massachusetts, Philadelphia and Sioux City and higher expenses of $3.4 million associated with our cash settled employee stock appreciation rights and restricted stock units due to the increase in our stock price"
  • "We believe we remain on schedule to complete the tax-free spin-off of the REIT to Penn National shareholders later this year and to make the one-time taxable cash and stock dividend to Penn National shareholders in January 2014, concurrent with the REIT election"
  • [Agreement with the Jamul Indian Village to jointly develop a Hollywood Casino branded casino] "Based on the pace of approvals and construction progress, the facility could open by early 2016 and upon opening will generate management and licensing fees for Penn National."  
  • "We remain on schedule and on budget with the re-branding and facility upgrade of Hollywood Casino St. Louis, which is expected to be completed later this year, as well as the commencement of construction of a 150 room hotel at Zia Park Casino which is expected to open in the second half of 2014"
  • “In Ohio, we are in active dialog with the Ohio State Racing Commission regarding seating capacity at the two VLT facilities planned for Mahoning Valley and Dayton. As the nation’s leading operator of pari-mutuel racing facilities, we share the commission’s deep commitment to supporting horse racing, but believe our proposed seating plan more accurately reflects current market demand. We are hopeful that a resolution to this matter can be reached soon which will allow the facilities to open as planned in 2014"
  • "We are currently engaged in discussions with the City around the statutorily required Host Community Agreement and expect those negotiations to conclude by early May. Meanwhile, at the State level, we’re anticipating the Massachusetts Gaming Commission will complete its suitability findings by mid- to late summer."
  • “In Iowa, we await today’s decision from the Iowa Racing & Gaming Commission, related to our two proposed Hollywood branded gaming and entertainment development projects in Woodbury County" 



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INITIAL CLAIMS: A GROWING DIVERGENCE BETWEEN PERCEPTION & REALITY

Takeaway: So far, this year is following in the footsteps of the prior three years on both a seasonally and non-seasonally adjusted basis.

Below is the detailed breakdown of this morning's claims data from our head of Financials, Josh Steiner.  If you would like to setup a call with Josh or trial his research, please contact 

 

 

Back on Track

We realize there are a lot of charts in this note, so in the interest of everyone's time we'll direct you to the two that we consider most important: the first and second.

 

The first chart shows the illusion. You can see from the bottom right series that seasonally-adjusted initial jobless claims are beginning their steady rise that will continue through August, just as they have in the prior three years. In fact, the slope of the line is steeper than what we've seen in the last three years - a negative sign. As a reminder, we think this dynamic is one of the primary contributors to the recurrent pattern we've seen in the XLF over the last three years. For more on that see our note yesterday "Beware the Ides of April?".

 

The second chart shows the reality. The reality is that non-seasonally adjusted claims are 4.0% lower than last year, which is right in-line with the trend line of improvement we've been seeing since the recovery began in early-2009. You can see that the slope of the 2013 YTD change is nearly identical with what we saw in 2012.

 

The takeaway from this is that the market still focuses on the first chart when it should be focusing on the second chart. While we recommend battening down the hatches for the immediate term, we would view weakness as a buying opportunity so long as the second chart remains on track. 

 

The Numbers

Prior to revision, initial jobless claims rose 6k to 352k from 346k WoW, as the prior week's number was revised up by 2k to 348k.

 

The headline (unrevised) number shows claims were higher by 4k WoW. Meanwhile, the 4-week rolling average of seasonally-adjusted claims rose 2.75k WoW to 361.75k.

 

The 4-week rolling average of NSA claims, which we consider a more accurate representation of the underlying labor market trend, was -4.0% lower YoY, which is roughly flat with the previous week's YoY change of -4.4%.

 

INITIAL CLAIMS: A GROWING DIVERGENCE BETWEEN PERCEPTION & REALITY - JS 1

 

INITIAL CLAIMS: A GROWING DIVERGENCE BETWEEN PERCEPTION & REALITY - JS 2

 

INITIAL CLAIMS: A GROWING DIVERGENCE BETWEEN PERCEPTION & REALITY - JS 3

 

INITIAL CLAIMS: A GROWING DIVERGENCE BETWEEN PERCEPTION & REALITY - JS 4

 

INITIAL CLAIMS: A GROWING DIVERGENCE BETWEEN PERCEPTION & REALITY - JS 5

 

INITIAL CLAIMS: A GROWING DIVERGENCE BETWEEN PERCEPTION & REALITY - JS 6

 

INITIAL CLAIMS: A GROWING DIVERGENCE BETWEEN PERCEPTION & REALITY - JS 7

 

INITIAL CLAIMS: A GROWING DIVERGENCE BETWEEN PERCEPTION & REALITY - JS 8

 

INITIAL CLAIMS: A GROWING DIVERGENCE BETWEEN PERCEPTION & REALITY - JS 9

 

INITIAL CLAIMS: A GROWING DIVERGENCE BETWEEN PERCEPTION & REALITY - JS 10

 

 

Joshua Steiner, CFA


WWW: Adding to Best Ideas. 2-yr Double.

Takeaway: We're adding WWW to our Best Ideas. Accelerating grth + improving mgns + de-levering = 2-3 yr double. One of the few improving RNOA stories.

Conclusion: We're adding WWW to our Best Ideas list and think it's a 2-year double. We think that the prevailing bear case is weak and backward-looking, and that WWW has a little bit of everything that's needed for a long to attract new money and grind higher over a multi-year time period. Aside from having a high quality management team and a very consistent long-term track record, we think that new market share opportunity on a consolidated cost structure and asset base will accelerate organic growth, while taking incremental margins and returns higher. The ensuing cash flow will be used to de-lever, which provides a powerful kicker to propel earnings growth into the 20-30% range. Ultimately, we think that WWW has 3 to 1 upside/downside over the next 12/18 months. 

 

The outline below is a summary of our investment case. We plan to release a Black Book with a deep-dive analysis over the next two weeks.

 

DETAILS 

The bear case on WWW is simple. The company started to see a slowdown in its core footwear business, so it went ahead and did a transformational acquisition by paying a steep price for Collective Brands’ PLG division potentially near the peak of the cycle for its largest and most defendable brand – Sperry. Other brands like Saucony and Keds have upside, but are not in the 'great' category like Sperry arguably is. On top of that, the stock is trading at a high teens multiple on the company’s guidance. There are two realities associated with this bear case. 1) Most of it is correct.  And 2) all of it is irrelevant.

 

First off, let’s look at the sentiment on WWW and all agree that people are more bearish on the name than we’ve even seen in the modern history of the company (ie even in the years not displayed by this chart). We’re likely seeing some covering on today’s print, but it still leaves the name in record bearish territory according to our sentiment monitor.               

 

WWW: Adding to Best Ideas. 2-yr Double. - wwwsentiment

 

Secondly, we think that this bearish view is very backward looking and leaves out a big piece of the WWW story, which is that integration of these brands into the WWW portfolio will allow the former PLG group to achieve what it could not under its former owner (most notably – international growth, and leverage a more diverse selling infrastructure in the US). Furthermore it will grow without needing to add the capital we’d otherwise expect as a stand-alone company – especially given WWW’s consolidation from four divisions into three -- which improves asset turns and RNOA. Specifically, our math suggests that in the three years following the initial acquisition year (where there will be outsized accretion) we should see the following…

a)      The addition of over $700mm in revenue – split fairly evenly between the Performance and Lifestyle groups.

 

b)      $150mm in incremental EBIT (20% incremental margin on top of the 8.4% reported last year).

 

c)       The asset base should remain relatively flat over that time period at about $3bn. The cash cycle can, and should, come down 20-30% from 2012 levels.  There’s no reason why this business should have 115 days inventory and DSOs of over 60.

 

d)      Over that same time period, interest expense should come down by 40% as WWW uses free cash to repay debt. As a result we should see shareholder’s equity double from $644mm ($13 per share) in 2012 to $1.3bn ($27 per share) in 2016.

 

e)      Importantly, RNOA should climb from 10% up to 16%, with steady improvements each year.  Admittedly, the one catch is that this is a company that once had returns of 30%. The PLG deal changed that – likely permanently (or at least for a very long time). Nonetheless, returns have bottomed and are headed up systematically. It's very important to note that it's near impossible to find an example where a company's RNOA roadmap went up (margins improving) and to the right (turns improving) simultaneously without the stock meaningfully outperforming peers.

 

WWW: Adding to Best Ideas. 2-yr Double. - wwwrnoa

 

In the end, we’re modeling 30%+ growth in earnings over each of the next two years, and 20%+ at a sustainable rate for at least the next three years. Our estimates are only 5% ahead of consensus this year, but by the end of our modeling time horizon (2016) we’re 25% ahead of the Street.

 

WWW: Adding to Best Ideas. 2-yr Double. - wwwestimates

 

 

At the end of the day, this is probably one of the best managed and most consistent companies in retail. Accretion is ahead of plan, inventories are in very good shape, and though there is admittedly a permanent impediment to achieving asset turn levels WWW saw prior to the deal (acquiring as opposed to growing organically), WWW has a multi-year platform from which to grow. Add on accelerated cash flow generation and subsequent debt paydown, and we think that this story has legs (look at HBI over the past year – it’s the mother of deleraging stories. We’d put FNP in a deleregaing bucket as well – at least as it relates to expectations for proceeds from its asset sales.)  

 

The stock is hardly washed out – we get that. But the reality is that this for a high quality globally diversified portfolio that has consistent 20-30% EPS growth and improving returns we don’t think that arguing a high teens multiple is a stretch. 18x our 2014 estimate of $3.55 gets us to a $64 stock, or 36% above current levels. Take that out to 2015 and 2016 and we’re looking at $75 and $95, respectively. When we juxtapose that alongside 15x ehat we think is a worst case $2.50 in EPS power, we’re looking 3 to 1 upside/downside over the course of a 12-18 months.

 

 

WWW SIGMA: Inventories are extremely clean, which has continued bullish implications for gross margins.

WWW: Adding to Best Ideas. 2-yr Double. - wwwsigma     

 

 

 


Copper: Crash Mode

While gold is attempting to recover from its double digit percentage point crash on Monday, copper is having an even more difficult time as traders continue to sell the metal. The price of copper fell -1.1% this morning to $3.08/lb and is heading lower. Prices on the London Metals Exchange (LME) have fallen considerably since January as outlined in the chart below. With copper hitting a new six month low, we have no problem shorting stocks that have large exposure to the metal like Freeport-McMoRan Copper & Gold (FCX).

 

Copper: Crash Mode - LMECopper


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