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IGT: MGM, CREDIT MARKETS, AND REPLACEMENT DEMAND

MGM gets it done.  Good for MGM management, MGM's bondholders, and those investors who played the deal.  And good for IGT.  IGT you say?  MGM will probably be IGT's number one customer over the next year.  Anyone who has walked through MGM's Strip properties lately will notice a little bit of rust on the slot machines.  Bellagio still has a lot of the original slots from the Bellagio opening in 1998.

 

MGM is probably the most important cog in the wheel, but it is not the only one.  The recent opening of the credit markets has allowed companies to short up balance sheets, improve liquidity, and avoid covenant breaches.  The following casino companies could be more aggressive in the replacement market:

 

  • BYD: The company has dramatically cut back on maintenance capex the past year, including replacement slots. With the big Q1 and ability to buy back discounted bonds BYD is unlikely to breach its leverage covenant. Remember, BYD maintains $2 billion in liquidity on its credit facility and is already free cash flow positive.
  • ASCA: Raised $500 million in debt in May which effectively cures any potential senior leverage covenant breach. Company will be free cash flow positive this year.
  • PNK: Will likely issue bonds soon given the credit environment. There will be no limitations on PNK's ability to replace machines.
  • Harrah's Entertainment - A leading bankruptcy candidate a few months ago, the world's largest slot machine operator has restructured its balance sheet and cut costs. The regional markets are performing better than expected and the fire at PENN's Joliet Empress has given the company an EBITDA boost. If Harrah's starts buying machines again, look out.
  • Station Casinos - Once this company goes into bankruptcy, pre-packaged or not, it will have more liquidity to buy much needed replacement machines. Station is the third largest slot machine operator in the US.
  • LVS - Not a huge operator but cost cutting and asset sales could put LVS in a much better situation vis-à-vis its covenants.

 

We predict a V-shaped recovery, not for gaming revenues, but for slot replacement demand.  The timing is still uncertain but could it come as soon as 2010?  Maybe.  The good news is that a recovery is not in the estimates, at least not for IGT.  While all the suppliers would benefit from re-accelerating replacement demand, IGT could capture the lion's share due to the mix of the "old" machines.  More on that in our next slot post.

 

Yes IGT has had a great run since it announced its Q2 last month.  So what?  So has every other gaming stock.  That was simply a "the world is not ending" move.  The next move will be fundamentally driven.  On that front, there has been a lot of good news lately.  The simple fact is that IGT's customers are improving their balance sheets, liquidity, and taking covenant issues out of play.  Bottom line:  Casinos will start buying slots again.  As we discussed in our 4/21 note, "IGT: PLENTY OF EARNINGS POWER FOR PATIENT INVESTORS", IGT could earn $1.40 in a normal replacement market and potentially even more for a few years assuming a V-shaped recovery.

 

IGT: MGM, CREDIT MARKETS, AND REPLACEMENT DEMAND - slot replacement demand


NKE: Don't Read Into Headcount Announcement

Don't read too much in to Nike's announcement last night of another 1% headcount reduction (from 4% to 5%). It is not due to another downturn in biz nor is it a response to Adi being on the ropes.

 

It is simply the end of their fat-tailed process to evaluate and drill down who is being let go as part of the broader restructuring.  In actuality, it looks like any stress internally regarding who will be let go will finally come to an end, and there will be more of an SG&A pad.

 

I still would not touch the stock here, but I also want to get the unbiased facts to you before Mr. Market makes up its own narrative and takes on a mind of its own.


GREAT EXPECTATIONS

Chinese Retail Sales data for April was great, while Industrial Production was merely good

Research Edge Position: Long Chinese Equities via CAF


At 7.1%, year-over-year Industrial output data released by the National Bureau of Statistics On Tuesday evening came in lower than anticipated by most observers. While in light of collapsed external demand the lessened output growth is not surprising, it was still disappointing for bulls like ourselves to see lagging components like electricity which declined 3.5% Y/Y, and Telecommunications/Computers which grew by just 1.1% Y/Y.  We were hoping to see a broadening of production increases beyond just components directly tied to stimulus infrastructure investments like transportation equipment and cement up 9.6% and 12.9% Y/Y respectively.

 

Retail sales data for April also released by the NBS on the 13th provided better support for the bullish long term domestic demand thesis. At 934 billion Yuan, total retail sales grew at a 14.8% Y/Y -a massively bullish number even if the figures have not yet had the impact on the manufacturing sector we were looking for. While stimulus rebates have helped sales of big ticket items (as expected after last week's CAAM sales data, automotive figures crushed it with Motor Vehicle production up 17.9% y/y and sales up 18.5%) , retail shoppers have not appeared to abandon their taste for small luxuries either, with discretionary components like cosmetics and furniture showing healthy double digit y/y growth.

 

Put in contrast with yesterday's disappointing US retail data, the growth rate of China's consumer spending underscores the changing nature of global consumption. If the individual consumer in China continues to spend money with confidence, ultimately it will translate to imports beyond just cotton and iron ore and production growth beyond just rebar and concrete.

 


Andrew Barber
Director

GREAT EXPECTATIONS - retailsales


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More confident in MAY

 

Tomorrow the University of Michigan will report that consumer confidence is much better than expected.

 

Despite general employment concerns, declining home prices, retail sales, the H1N1 virus and the general feeling that things are still bad, the Oracle of Obama and the Dow at 8,300 appear to be bolstering consumer sentiment in May.  Tomorrow we will learn that consumers are becoming more confident that there is a chance for a strong economy over the next six months. 

 

The preliminary May reading of the University Michigan will suggest that confidence has risen to the highest level in six months.

 

Going into University of Michigan report we are long the XLY and have been buying some select consumer discretionary names (see www.researchedgellc.com) for our entire long and short positions.  On the flip side, yesterday we noted a significant increase in PUT activity in the XLY.  Clearly, somebody smells the fear that we don't!

 

With consumer confidence on the rise it's likely that consumers could also ease back on prioritizing needs over wants.  While the trend in April retail sales suggests that the majority of consumers maintain a needs-based bent when buying, an increase in confidence measures could suggest that consumers may wade back into the "want" spending pool.

 

Howard Penney

Managing Director

 

More confident in MAY - consumer


Russia’s Monetary Bandwidth

 

Russia's central bank cut its refinancing rate 50bps to 12% yesterday, the second cut in the last month. 

 

We've had our EYE on Russia this year and have been in and out of the Russian etf RSX on the long side. (We currently do not have a position). The Russian stock market (RTS) has now moved to +50% YTD, overtaking China as the best performing stock market YTD across the globe.  

 

This year we've been cautious in pointing out the risk premium associated with owning Russia, yet assertive that Russia's commodity based economy stands to benefit greatly from commodity reflation and its ability to supply China with the resources it needs for domestic growth. Further we believe that Brazil, Australia, and Canada share in this thesis. Yesterday we bought Brazil via the etf EWZ and Australia via EWA. Last week Andrew Barber noted in his post "Meet The New Boss: China" that Brazil's total exports to China exceeded those to the US for the first time in March, with iron ore leading the charge. Clearly getting long countries that can feed China's appetite has worked this year. Brazil is up 30% YTD and Russia (especially mining companies) will push higher from increased Chinese demand, which is now being confirmed by copper shipments. 

 

And there's continued confirmation that Russia understands who the client is.  Yesterday President Medvedev met with Wu Bangguo, chairman of the National People's Congress, to discuss their "strategic partnership" and a number of meetings are scheduled for the two nations this year.

 

Yesterday's interest rate cut will help to arrest the deflationary environment Russia is experiencing and in theory decrease the cost of borrowing.  In the case of Russia, it is worth noting that the central bank has room to cut, unlike major economies such as the US, UK, Japan, Switzerland, Sweden, and ECB-countries, all of whom are hovering at or around zero percent.  For the commodity levered Russia, inflation is a double edged sword. On the one hand it increases the price of its commodity exports that drive growth, yet on the other puts extreme pressure on domestic prices. By some estimates, inflation could slow to 9% this year, down from the central bank's target of 13%. In any event, Russia enjoys the ability to cut rates due to the stability of the Ruble versus the USD and Euro in the last months.

 

Look for use to get in on the long side of Russia via RSX at the right price.

 

Matthew Hedrick
Analyst

 

Russia’s Monetary Bandwidth  - russia


Bear Hunter Claims

 

This morning's jobless claims report was what it was - fundamentally bearish, on the margin.

 

Bearish for what? is the question however. If this acceleration in both the week-over-week and 4 week moving average (see chart below) is bearish for the US Dollar - then you know what that means for stocks - its bullish.

 

If this entire blow-off of the peak February Fear Factor on unemployment was a "head-fake", I will be surprised. That said, based on the latest fact, that probability is now back in play, and I'll call that for what it is. The only thing I can do from here is wait on next week's report.

 

One week doesn't a legitimate Depression redo make, but the Bear Hunters have every right to be back on the field here, armed with this chart and data point in hand. Bearish for what, will remain the question. Mr. Market is forward looking, and in early trading response telling us so far that Bear Hunters are better served being short volatility (VIX) and the US Dollar (UUP), rather than US Equities.

KM

 

Keith R. McCullough
Chief Executive Officer

 

Bear Hunter Claims - employ


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