According to Bloomberg Businessweek, CCTV has reported that the ice at a KFC restaurant in Beijing was found to be unsanitary.  Initial reports indicate that the ice contained 20x more bacteria than the national limit and 13x more bacteria than toilet bowl water.  The stock is down 90bps on the day.


We view this as a minor setback to YUM and maintain our bullish view on the long-term prospects of the company.  However, it is important to note that the turn we foresee in 4Q same-store sales is at risk if this turns into a real public relations nightmare.  


You can read the full story here:




Howard Penney

Managing Director




Regional gamers are in for a tough earnings season if PENN is any indication. The problem is deeper than just market softness.  



The table below details the soft quarter just posted by PENN.  The quarter met recently reduced Street estimates but guidance was well below consensus.  As we wrote about in our 07/15/13 preview, we expect an ugly earnings season from regional gaming companies.  Might this earnings season finally be the negative fundamental catalyst we’ve been waiting for?  We think so.  Valuations have expanded, rightfully so given the real estate angle to which these companies are now viewed.  However, estimates are clearly too high and massive long-term headwinds remains – that is, market saturation and a declining base of slot players.  Baby Boomers are passing on and younger generations refuse to embrace slot play as a leisure pursuit. 




We disagree with management that their issues are not something to worry about over the long-term.  US same store gaming revenues may continue to be under pressure for years to come due to the demographics.  Management also dismissed the impact of saturation yet many of their properties are facing new competition.  That would at least partially explain why trips are down – demographics also contributes.  And there is more to come.  We think we will continue to see new markets open in the US as states continue to face long-term budgetary issues.




We’ve reduced our 2013 and 2014 EBITDA estimates to $825 and $867 million, respectively, pre-split.  Note that we remain slightly above PENN’s new guidance for 2013 of $805 million.  Following the drop in stock price and estimates, PENN now trades at 8.5x 2014 EV/EBITDA which seems fair.  On a sum of the parts valuation basis, post-split, we value OpCo and PropCo combined at a range of $39-54.  The midpoint of our valuation range falls a little below where PENN currently trades.  


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




  • WORSE:  A big cut in guidance confirms our regional gaming thesis. It's not just the economy.  Demographics are a big headwind. Our model predicted a tough June but a flattish July. With management portraying July as similar to June, underlying demand is actually getting worse.




  • WORSE:  While spend per visit hasn't changed much, visitiation count has decreased a couple of % points.  Consumers are more conservative with their discretionary spending.  July trends are similar to June's.
  • PREVIOUSLY:  "Most of our data suggests that the weather had a big impact on visitation. We didn't see much change in spend per visit at our core properties year-over-year. Most of the effect was admission trends and visitation trends that I think were either impacted by new competition in our markets or weather-related. It doesn't seem to be any change in consumer spending when they do visit our properties. It's been more of the same, generally flat."


  • WORSE:  Horseshoe Cincinnati has been very aggressive with discounting, pressuring Hollywood Columbus results, which has significantly underperformed expectations.  Cleveland is another market that is highly promotional.
  • PREVIOUSLY:  "I would continue to characterize overall the promotional activity across these regional markets as fairly stable."


  • WORSE:  Mgmt says margins and market share at its Columbus facility are below their expectations.  Its Toledo property's top line results have met their expectations though operating margins were weaker than they anticipated.  
  • PREVIOUSLY:  "I think you're going to see another build that will start in the July-August timeframe as we hit the summer months as well. We're still working on marketing activities to continue to expose our new property to customers for the first time, and that's gone very well. Our repeat visitation has been very, very strong; our database growth continues to be very, very strong. So, this is very typical what we've seen in how Penn National opens a property in both Toledo and Columbus."


  • SAME:  Received approval from the Ohio Racing Commission for the relocation of Beulah Park in Columbus to Austintown in Mahoning Valley and for Raceway Park in Toledo to move to Dayton.  Both facilities expected to open 2H 2014.  PENN will be conservative with the slot count.
  • PREVIOUSLY:  "The two next projects are Youngstown and Dayton racetracks. Capital spend, which includes $125 million for license, basically a relocation fee and a gaming license. And so we're looking to $267 million and $257 million of cap spend, which will happen over the course of the next year and a half. We expect to open sometime in 2014." 


  • SAME:  No changes to financing costs.  Mgmt sees no obstacles to completing the spin-off.
  • PREVIOUSLY:  "Next steps, we have to finalize the Carlino Group agreement. We need to finalize our financing agreements with our banks. We also have to start the process of refinancing of all of PENN's existing debt and putting in place the bank agreement, as well as the bonds for the transaction going forward. And then we would expect that in the fourth quarter that we'll complete the spin and the E&P purge will happen hopefully in the first quarter of 2014, at which point in time, we'll make our REIT election."


  • SAME:  Governor has given cafe operators 90 days to collect their signatures. Senate legislation has passed a bill enforcing the ban.  Mgmt is hopeful the House will come back in early September and support the bill.
  • PREVIOUSLY:  "My expectation is once the internet cafes do get contained, we will see improved business volumes, and it's just going to be a wait and see approach on how we address the overall count in the Columbus operation. But I would expect at this point that the 2,500 count that we have there today will get us through 2013."


  • SAME:  Had significant construction disruption in 2Q.  Remains on schedule with 5 months left of construction and on budget.  $61MM have been spent with $32.8MM remaining on capex.
  • PREVIOUSLY:  "We're planning to spend roughly $61 million in total to rehab the property. One of the things about purchasing an asset from Harrah's was we recognized that there have been some deferred maintenance and also that the property needed to be refreshed and obviously the slot product needed some updating."

Early Look

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[VIDEO] #RatesRising: Q3 Macro Theme #1


‘POP!’ goes the bubble as interest rates start to rise, reversing the most asymmetrical set of relationships on our Macro screen. Hedgeye CEO Keith McCullough goes out a macro limb and says we are not likely to see the 2012 lows on 10-year bond yields ever again. Moreover, McCullough shows that as the slope for interest rates turns up, so much that has been tied to declining rates will unravel.


PENN in line with recently reduced estimates but guidance far worse than consensus. Demographic headwinds continue to pressure revenues.



 “Given the trends from the first two quarters, results thus far in July, and a lack of visibility on factors that would improve national regional gaming revenue trends, we are guarded in our outlook for the remainder of the year. 


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




  • 2Q was disappointing 
    • General softness through most of the properties
    • Cannibalization effect was already taken into their guidance
    • Missed expectations mainly due to slow Ohio ramp
  • Lower trip visitation across mature properties; a different trend from spend per visit weakness in the past
  • Hollywood St. Louis:  tornado impacted 1st couple days in June; facility had some damage but nothing long-term. Significant construction disruption in 2Q as they rebrand to Hollywood.  About 5 months of construction left.
  • Lawrenceburg:  impacted by Horseshoe Cincinnati's aggressive promotional discounting. PENN views the promotions as 'insane'.
  • Toledo:  margins continue to get better but below mgmt expectations.  Expect year 2 to be better than year 1. Worried about Greektown ownership and potential to be Cincinnati-like.
  • Maryland Live! operators have been rational.  Charlestown in-line with expectations.
  • Columbus:  performance below expectations - had expected to be market leader.  50/50 share with Scioto Downs even though they outspend PENN 2:1
  • Ohio will take time to ramp
  • Ex all the noise, 2Q was really a miss of $15MM.  Previous guidance had priced in a much better 2nd half of 2013.
  • Confident Columbus will eventually get to cash-on-cash 20% return
  • Level of construction disruption have been higher than expected
  • Baton Rouge/Maryland have suffered from cannibalization but mgmt have expected those

Q & A

  • July trends:  looking like June
  • Reduced trips trend:  customers visitation patterns have lessened (down a couple of % points); consumers more conservative with their discretionary spending
  • Lower guidance breakdown:  $15MM Ohio EBITDA guide downs each for 3Q and 4Q (assume Ohio market share and margins to remain constant), bonus/legal costs are a couple of million due to Sioux City, St. Louis expectations brought down.
  • Penn National will have a 3Q report
  • Borrowing costs have not been changed
  • 2Q Cash: $235MM; bank debt $2.137BN, capital lease: $13MM, bonds: $325MM - total debt $2.476BN
  • 2Q capex $53.9MM ($23.9MM Maintance capex, $30MM project capex (Columbus-- little less than 1/2 the balance, Hollywood St. Louis spent $9.4MM) 
  • 2013 capex guidance: $196MM project capex
  • Dayton/Youngstown: will be conservative with slot count;
  • Slot licene Massachusetts: still speculative stage; 1,250 slot units 
  • Diversify outside regional gaming? Highly focused on gaming
  • Should compare Columbus to Kansas City, Missouri
  • Conservative guidance? It's realistic.
  • Lowered cash component of E&P distribution to $294MM - came to conclusion of similar debt leverage for both companies; to reduce amount of borrowing, they had to reduce cash.
  • PropCo dividends:  if they lose Sioux City, it will have a minor effect on dividends; expect to see increase in Toledo/Columbus rent in 2014
  • To fund acquisitions, they will use secondary equity offerings that will be accretive to shareholders
  • Promotional activity: Cleveland/Cincinnati are high. Are reinvesting with VIP slot players, particularly female ones
  • No obstacles with REIT spin-off process
  • Columbus: can get to 30% margin
  • 2014 EBITDA should be 'clearly higher' than the 2013 guidance of $805MM
  • Internet Ohio cafe ban:  Governor has given cafe operators 90 days to collect their signatures. Senate legislation has passed a bill enforcing the ban; hopeful the House will come back in early September and support the bill.
    • In PENN survey, 10% of respondents have been to an Internet cafe


Takeaway: CPS household formation data has been a good leading indicator for housing's momentum. This morning's June data is the strongest YTD.

This note was originally published July 16, 2013 at 16:04 in Financials

One of Housing's Leading Indicators Grows Increasingly More Positive

The latest household formation data is solid - a sequential acceleration. The Census Bureau just released its June household formation survey data, which showed that at the end of June there were 122,881,824 households in the United States. This data comes from their monthly phone survey of 50,000 households, which is statistically representative of the country as a whole.


The proper contextualization is to look at the rate of year-over-year growth since the data is not seasonally adjusted. On that basis, the U.S. added 1,507,553 net new households vs. June 2012. This is a rate in excess of the 2011-Present average of 1,391,889. In the charts below we present various snapshots of the trends in household formation. Most of the data is self-explanatory, however, the hatched red line in the second chart, for clarification, shows the rolling 12-month average rate of YoY growth. That figure currently stands at 1,655,470 through June. 










We wrote a note recently (May 15) entitled "Housing: A Double From Here?", in which we argued that the rate of building construction could double from present levels to ~2 million starts/year over time. For the detailed take on why we think that's likely, refer to our note. The executive summary, however, is that by applying the JCHS ratio of 1.35-1.39 new housing units to net new household formations (see the table above), and using the current rolling average rate of household formation, we find that we would need (1.655 * 1.35) =  2.2 million new starts. Using just the June data, we find a need for (1.507 * 1.35) = 2.03 million new housing units. For reference, this compares with the 0.914 million starts rate for May. We'll get the June data tomorrow. This morning's NAHB HMI builder confidence reading of 57, a 6 point month-over-month increase, also concurs with the trends we're seeing in HH formation.


The ratio of single-family/multifamily is open for debate, but we looked at this issue in our note (June 5) "Housing: Are Rising Rates a Big Deal", and concluded that a) ownership remains highly compelling vs. renting at the national level in spite of the recent back-up in rates, and b) the ratio of single family to total has averaged 72% since 1960 and is currently at 72%.


Last month we cautioned that in light of the recent run-up in rates, it would be more instructive to watch HH formation trends in June/July. Now, with the June data in hand, we think there's growing evidence that the rise in rates thus far hasn't derailed the housing recovery's momentum.


Joshua Steiner, CFA



Jonathan Casteleyn, CFA, CMT



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