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DUSTING OFF THE GAMING EXPANSION THESIS

With the political shift over the last few years it looks like we are going to give Keynesian economics yet another shot at success.  We've got a view on how that will end but in the meantime, state governments need more cash.  Legalized or expanded gaming is a surefire way to raise cash for the states.  There are almost always winners and losers among the operators when a state legalizes or expands gaming.  The slot suppliers always win.

 

Here are some of the opportunities:

 

  • Illinois - 45,000 machines? Probably not, but 30,000 looks doable. The video poker bill that passed the Illinois Congress and is likely be signed by the Governor is underrated in terms of its impact to IGT. These are video poker machine, not video lottery machines. The difference is important because IGT's video poker market share is probably 80%. The quick math says 80% of 30,000 is 24,000 machines at about $0.01 per 1,000 would yield $0.24 in EPS to IGT. Not bad
  • Ohio - It will happen eventually. MyOhio and PENN are supporting a measure that would allow for 4 casinos in the state with 20,000 machines in total. The votes appear to be there in Congress but Governor Strickland may be opposed.
  • New York - Aqueduct and its 4,525 machines looks like a go again and could open as early as 2011.
  • Maryland - Cordish Company has a bid for 4,750 slots at Arundel Mills Mall in Arundel County. Baltimore City Entertainment is looking to use up the full amount, 3,750, of slots available by state law in their proposed Baltimore City slot parlor. There is a bid in for 800 slots at Worchester County, with an option to expand to 1,500. Penn National bid for 500 machines at Cecil County, with an option to expand to 1,500. We don't expect these slots to come on line before 2012.
  • Massachusetts - The Massachusetts Senate recently rejected a proposal to add slot machines at racetracks but we remain convinced that an expansion of gaming, in one form or another, is on the way in Massachusetts. There is a dire need for revenue and the departure of anti-gaming former House Speaker Salvatore DiMasi of Boston is another major plus for gaming. Current Senate President Therese Murray has given strong indications that the Senate will likely debate gaming in the fall and has been cited, along with other prominent lawmakers in Massachusetts, as supporting expanded gaming. Mohegan Sun is proposing a resort casino in Palmer, MA and welcomes the rejection of slots at racetracks. They hope to win the gaming debate this fall.
  • Texas - Not this year but a huge potential market.

 

Bottom line is that slots could and should become a growth industry again.  Illinois could be the catalyst.  IGT should be the winner.  IGT typically gets a higher market share in the new/expansion slot market than replacements.  Illinois alone could add $0.24 to IGT's bottom line.  Even over 2 years, that number is meaningful to the current sub $1 run rate.  Throw in the other states over time and a normalizing replacement demand and the slots business starts to look growthy again.


ROST: The Perfect Tailwind is Easing

There's been no better time to be an off-price retailer than the past 12-18 months.  We've seen retail bankruptcies accelerate, consumer demand shrink rapidly, and the entire apparel industry has scrambled to right-size inventories.  This has created the perfect storm of high quality goods in abundant quantities at great prices (i.e. supply) coupled with a value focused consumer (i.e. demand) seeking to save on apparel expenditures.  ROST is the poster child for the kind of company that benefits from this phenomena.

 

Over the years, the Street has been overly focused on the day when "just-in-time" manufacturing and ERP systems would finally wreak havoc on the off-price model.   If you listen to any conference call with either TJX or ROST, there is always the obligatory question asking about the "availability of goods".  The answer is also always, "there are plenty of goods for purchase".  This holds now even truer than ever.  As long as consumer demand remains subject to change without notice and factories seek to run at high capacity levels, there will be a viable market for the off-price business.  However, there will not always be a perfect storm like the one we are currently exiting.

 

There is no question that ROST has managed its business well against a very challenging backdrop.  Inventories have declined for the past six quarters and guidance suggests that they'll remain lean over the remainder of this year.  SG&A expenses have been in check, only rising 28 bps since 2005 despite inflationary pressures including healthcare, payroll, and energy costs.  Additionally, gross margins have expanded dramatically over the same period, up nearly 100bps while most other retailers have seen margins erode from peak levels.  In fact, ROST is now on pace to report its highest operating margin (8%) in six years! 

 

It's tough to knock this name right now given that they are seemingly doing everything right. In fact, ROST was the first company to meaningfully increase guidance with confidence in both the current quarter and remainder of 2009. (Betting that 'this is finally the end' has led to plenty a face-ripping for shorts over the past 2 quarters).

 

But this brings us to where we're focused for the remainder of the year as it pertains to ROST:

  • High expectations coupled with comparisons on the gross margin and SG&A line that become increasingly difficult.  GM's were up 128 bps in 2Q08 and 70 bps in 3Q08. Check out our SIGMA chart below.

 

  • Top line compares remain tough in the current quarter as ROST cycles last year's stimulus checks.  Same store sales were up 6% in 2Q08.  Keep in mind that annual same store sales for ROST have only ranged from -1 to +6% at any time over the past 6 years. 

 

  • CA, its largest market, just reported a 4% comp increase for 1Q vs. 3% for the chain.  We have been hearing more frequent discussions of a "relapse" in CA on the foreclosure front which may create a headwind in the coming months.

 

  • Management has been talking positively about the recent success of the lower-priced, lower-income targeted DD's Discount concept.  With all due respect, shouldn't this concept be doing great in the worst consumer downturn since the Great Depression?

 

  • I have no doubt that there will be an abundant supply of goods for ROST, forever.  However, I just don't see how the "quality" of the goods at very favorable purchase prices can be as beneficial in the next 3 quarters as it was in the prior three quarters.  Inventory metrics for both the manufacturers and retailers show that supply has diminished materially over the past year.  This should have an impact on gross margins going forward.

 

  • Year over year comparisons on gasoline and transportation costs are no longer as beneficial.  Additionally, prices at the pump have actually moved higher ($2.99/gallon over the Memorial Day weekend in NY) and may begin to impact both the cost and demand side of the equation.

 

At this point, the winds are changing and the extreme tailwinds that have favored ROST are easing.  With the stock within 10% of its all-time high, heightened earnings expectations, peak margins, and the unlikely scenario in which the inventory glut of 2008 is repeated anytime soon, the fundamental risk here far outweighs the reward at this stage. 

 

Eric Levine

Director

 

ROST: The Perfect Tailwind is Easing - ROST 1

 

ROST: The Perfect Tailwind is Easing - ROST SIGMA

 

ROST: The Perfect Tailwind is Easing - ROST 2


Fading Fast Money: SP500 Levels Into The Close...

 

For the past 3 months, I have been using Squeezy The Shark to amplify my point on levels for the pending short squeeze. Today, I'm putting Squeezy to bed and I'm going to start fading the Fast Money. I think the giant moves in this market (up and down) are behind us for now. Sorry.

 

Below I have outlined my new trading range. Be forewarned, it a boring one. I'm selling SP500 (dotted red) at or above the 916 level, and buying the 885 line (dotted green). Into month end, there are plenty of reasons for the bulls to support/defend 885 support. They better - it's the critical immediate term TRADE line. The Depressionista short seller of everything Q2 has plenty of explaining to do come Friday's close, and you can bet your Madoff that there will be plenty of window dressing before it's all said and done. There is no such thing as marking your shorts "to model" (at least not yet).

 

Note the lower-highs that we have seen in the last few weeks. The closing high of 929 on May 8th was an important one. That was a lower-high than the January 6th closing YTD high of 934. Be careful out there.

 

Keith R. McCullough
Chief Executive Officer

 

Fading Fast Money: SP500 Levels Into The Close...  - MC


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Peaking Sequentially?

 

When it comes to confidence, this is as good as it gets, for now...

 

For the past two weeks we have seen consumer confidence come in much better than the Depressionistas expected.  Last week the University of Michigan was better than expected and today's conference board index number reflects two months of significant improvement; the index is now at its highest level in eight months (Sept - 08, 61.4).

 

Markets are built on confidence - this round trip in US consumer confidence (see chart below) has equated to a generational short squeeze in the US stock market. But where does the market go from here, now that all of this is in the rear view?

 

While consumers are considerably less pessimistic than they were earlier this year, and the trends in the labor market are less bad, we have likely seen the bulk of the gains in consumer confidence. 

 

It appears that we are more likely to see the numbers begin to PEAK sequentially. This is a very important call for Research Edge to be considering, given that we were one of the few macro strategy firms who proactively predicted that things were going to TROUGH sequentially, back in February when they did.

 

The market reaction to today's numbers is obvious-early cycle stocks are rocking ahead.  We believe that we are headed to sequential peaks in our US Consumer MEGA Squeeze call from earlier this year.  The acronym MEGA - (M)oney (E)mployment (G)as and (A)ssets - is our metaphor for how we view the prospects for the consumer.  The trends in these MACRO factors help to influence consumer confidence, which appears to be peaking sequentially AFTER the factors have led them to.

 

This thesis is also being played out in the Case-Shiller home-price index where there was a slight month-to-month acceleration in the decline of home prices. Unfortunately, that data point is somewhat stale (it's a March number).

 

Everything that matters in our macro model happens on the margin. Sentiment peaks can occur at lower price peaks. Inclusive of today's US market strength, what you're observing here today is simply another lower high.

 

Howard Penney

Managing Director

 

Keith McCullough

CEO

 

Peaking Sequentially? - conf1

 

Peaking Sequentially? - conf2


PANDA BEAR HUG

 

Taiwanese export orders and industrial production improve sequentially on Chinese demand...

 

RESEARCH EDGE POSITION: Long China (via the CAF fund)

 

Tuan Tuan and Yuan Yuan, the two giant pandas which arrived in Taiwan in the last week of 2008 as a gift from the People's Republic to the Island they still consider a prodigal state; bear names that are a naked reflection of mainland desires. Smash the two names together and you get the word "Tuan Yuan" which translates to "reunion" in Chinese.

 

Mainland dreams of reunion have propelled negations forward rapidly year-to-date as last year's Panda diplomacy has given way to the newly opened floodgates of direct investment and direct trade  -all at a critical time when Taiwan desperately needs a friend. 

 

For the island nation, the collapse of export markets in North America and Europe has set them on course to get cozy with "The Client" (China) despite profound misgivings on the part of many leaders inside the KMT as well as the opposition DPP.

 

China has yet to make any concrete indication that it intends to respect the political or human rights of their own citizens (let alone those of subjugated territories) while continuing to expand its military strength; so it is easy to understand why a future as a satellite in its orbit is not a uniformly appealing thought.

 

In the here and now, the Panda's bear hug is propelling Taiwanese export industries back into motion in a big way, as evidenced by export order and output data released by the Ministry of Economic Affairs yesterday.

 

While Export orders for April declined by almost 21% Year-over-year, the numbers still reflected a sequential improvement and beat economists' forecasts significantly. Orders for Electronic goods, a critical component that accounted for just shy of 25% of total orders for the nation in April,  were even stronger at -14.76% as Chinese demand for consumer electronics continues to rise in the wake of stimulus measures aimed at rural consumers. Production data showed similar sequential improvements.

 

PANDA BEAR HUG - ch1

 

PANDA BEAR HUG - ch2

 

 

Yesterday also saw the debut of notebook-computer hardware manufacturer Ju Teng International on the Taiwanese Stock Exchange, which decided to launch its latest capital raise in Taiwan rather than Hong Kong as appetite for mainland investment opportunities increases with thawing relations.

 

This increased order flow is yet more confirmation of increasing consumer demand on the mainland, but it would be a mistake to read too much into it with respect to the Chinese economy: The true measure of Chinese recovery will come in the form of increased output domestically, not in orders for subsidized notebooks and flat screen TVs from abroad.

 

For the Taiwanese the political tightrope of increasing trade dependence without being forced to compromise politically will continue as economic ties draw the two nations closer. We have traded the Taiwan equity market on the long side in the past and we continue to believe that they will be among the primary beneficiaries of increasing demand for high tech goods on the mainland.

 

Andrew Barber
Director


American Survivor

"I'm trained in weapons, demolition, and unarmed combat. I'm a sniper, and I'm the platoon medic. But most of all, I'm an American."
-Marcus Lutrell, US Navy SEAL
 
For Memorial Day weekend, I re-read "Lone Survivor." If you're looking for a reminder as to what it takes to face real adversity for your country, that would be the required reading.
 
What we've had to deal with on a day-to-day basis in financial markets is not even in the same solar system as what Marcus Lutrell overcame in Afghanistan. To the lost heroes of SEAL Team 10, and all those who watch over this country while our families sleep - we can never Thank You enough. We get to wake-up and play this game every day because of you.
 
This game of REFLATION that I have been riding in the US stock market for the better part of 2009 became a materially riskier one to be invested in last week. I think the BIG move in the REFLATION trade is behind us, so I'm starting to get out.
 
What was the inflection point? That's simple - going from a proactively predictable exercise of Breaking The Buck, to crashing it. As the US Dollar broke what I consider emergency support (at the $81.48 line on the US Dollar Index), I opted to cut my Asset Allocation to US Equities and Commodities to 27% and 12% of my max exposures, respectively. Additionally, I made 20 consecutive sales in our virtual stock portfolio. I now have 18 long positions and 12 short positions.
 
What Tim Geithner and his boss have labeled a "Stress Test" pales in comparison to what lies in front of them if this US currency crisis starts to trend sustainably in its current direction. Amplifying this international economic problem is The New Reality that America's enemies (North Korea, Iran, the Taliban, etc...) are more than willing to use the weaponry of market-timing to their advantage.
 
Market timing? Who does that? I do - and apparently "they" do too. Does anyone in Washington think for one second that the timing of missile testing and insurgencies doesn't incorporate some level of marked-to-market sophistication?
 
C'mon guys, let's seriously wake-up and smell the Robusta beans this morning. Our enemies are more than happy to inaugurate President Obama into the real global macro stress testing that was always pending. Markets are where people in this world get paid. Geopolitical risk is a monetize-able weapon of considerable destruction.
 
These aren't my politics. This is my investment process. I'm trained in real-time market prices. But most of all, I am a Risk Manager. If you want to try and tell the guy sitting next to you that there is no basis for these concerns, ask him to pull up a live quote. Market's don't lie folks; people do.
 
Oil prices shot up +9% last week to $62/barrel. Gold prices were up another +3%, taking its 3-week cumulative run to +8%. Yields on 10-year US Treasuries busted out to new YTD highs at 3.45%. Treasury Bonds on the long end of the curve got smoked alongside the US Dollar. Yes, the aforementioned commodities are priced in Dollars. Yes, both of these commodities always reflect a level of implied geopolitical risk.
 
All the while last week, some of my favorite contrarian indicators (sell side strategists and economists) are explaining that this is the beginning of a bullish move, and that "reflation isn't inflation" - thanks for the revisionist memos from the national history society guys.
 
I have been talking about credit markets improving, on the margin, for almost 6 months. This morning, I am going to start talking about them looking too good. The slope of the US Treasury yield curve hasn't looked better. At almost 260 basis points, the spread between 10 and 2 year US Treasury yields is exceptionally wide. And the TED Spread (3month Treasuries, minus 3month LIBOR) is as narrow as it has been in a long time.
 
So what do we do? Do we parrot consensus and jump into the US Equity REFLATION trade with both feet? C'mon. Let's get as serious as this currency situation has become. It's time to get very serious about the risks that have mounted over the course of the last week. The US stock market, while up last week, is down for 4 consecutive days for plenty of reasons - and I think I have called out some big ones here this morning. A market that rallies to lower-highs is as bearish as a market making higher-lows is bullish.  
 
Where do we go from here? With the VIX (Volatility Index) down -60% from its October/November highs, and the TED Spread collapsing 400 basis points from that same time of real-world economic stress, my answer is not to higher-highs anymore. It's time to manage risk through the new game of Survivor that's developing, real-time.
 
In "Lone Survivor", Marcus Lutrell reflects on a veteran of six SEAL combat platoons, Eric Hall's, code of American conduct (Hall was one of Lutrell's instructors and stated to his prospective SEALs), "We don't put up with people who feel sorry for themselves... anyone lies, cheats, or steals, you're done, because that's not tolerated here. Just so we're clear gentlemen."
 
Just so we're clear, President Obama - it's time to step up and show the world what "I am an American" really means. Your country's currency is begging for leadership.
 
Best of luck out there this week,
KM
 

LONG ETFS

XLE - SPDR Energy- We bought Energy on 5/13 with the dollar up. We think it works higher if the Buck breaks down.  Bullish TRADE and TREND remain.

CAF - Morgan Stanley China Fund- A close end fund providing exposure to the Shanghai A share market, we use CAF tactically to ride the wave of returning confidence among domestic Chinese investors fed by the stimulus package.  To date the Chinese have shown leadership and a proactive response to the global recession, and now their number one priority is to offset contracting external demand with domestic growth.

EWD - iShares Sweden-We bought Sweden on 5/11 with the etf down on the day and as a hedge against our Swiss short position. From a fundamental setup, we're bullish on Sweden. The country issued a large stimulus package to combat its economic downturn and the central bank has effectively used interest rate cuts to manage its economy. Sweden's sovereign debt holds a strong AAA rating despite Swedish banks being primary lenders to the Baltic states. We expect Sweden to benefit from export demand as global economies heat up.

XLV - SPDR Healthcare-Healthcare looks positive from a TRADE and TREND duration. We've been on the sidelines for the last few months, but bought XLV on a down day on 5/11 to get long the safety trade.

TIP- iShares TIPS - The iShares etf, TIP, which is 90% invested in the inflation protected sector of the US Treasury Market currently offers a compelling yield on TTM basis of 5.89%.  We believe that future inflation expectations are currently mispriced and that TIPS are a compelling way to own yield on an inflation protected basis, especially in the context of our re-flation thesis.

GLD - SPDR GOLD -We bought more gold on 5/5. The inflation protection is what we're long here looking ahead 6-9 months. In the intermediate term, we like the safety trade too.
 

SHORT ETFS
 
XLU - SPDR Utilities - We shorted Utilities on 5/22 as it is trading below the TREND line. As long term bond yields breakout to the upside, Utility investments are the relative yield loser.

EWJ - iShares Japan -We re-shorted the Japanese equity market via EWJ on 5/20. We view Japan as something of a Ponzi Economy -with a population maintaining very high savings rate whose nest eggs allow the government to borrow at ultra low interest levels in order to execute stimulus programs designed to encourage people to save less. This cycle of internal public debt accumulation (now hovering at close to 200% of GDP) is anchored to a vicious demographic curve that leaves the Japanese economy in the long-term position of a man treading water with a bowling ball in his hands.

EWW - iShares Mexico- We're short Mexico due in part to the repercussions of the media's manic Swine flu fear.  The country's dependence on export revenues is decidedly bearish due to volatility of crude prices and when considering that the country's main oil producer, PEMEX, has substantial debt to pay down and its production capacity has declined since 2004. Additionally, the potential geo-political risks associated with the burgeoning power of regional drug lords signals that the country's economy is under serious duress.

IFN -The India Fund-We have had a consistently negative bias on Indian equities since we launched the firm early last year. Despite recent election results likely proving to be a positive catalyst, long-term we believe the growth story of "Chindia" is dead. We contest that the Indian population, grappling with rampant poverty, a class divide, and poor health and education services, will not be able to sustain internal consumption levels sufficient to meet targeted growth level. Other negative trends we've followed include: the reversal of foreign investment, the decrease in equity issuance, and a massive national deficit.

LQD  - iShares Corporate Bonds- Corporate bonds have had a huge move off their 2008 lows and we expect with the eventual rising of interest rates in the back half of 2009 that bonds will give some of that move back. Moody's estimates US corporate bond default rates to climb to 15.1% in 2009, up from a previous 2009 estimate of 10.4%.

EWL - iShares Switzerland - We believe the country offers a good opportunity to get in on the short side of Western Europe, and in particular European financials.  Switzerland has nearly run out of room to cut its interest rate and due to the country's reliance on the financial sector is in a favorable trading range. Increasingly Swiss banks are being forced by governments to reveal their customers, thereby reducing the incentive of Switzerland as a tax-free haven.


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