"It will be helpful if Geithner can show us some arithmetic"
From the lens of a global risk manager, this morning has to be one of the more fascinating that I have ever woken up to. At the same time as the US Government is setting themselves up to announce one of the largest bankruptcies in US corporate history, we have a squirrel hunting US Treasury Secretary telling the Chinese to "trust us" and America's currency. That a boy!
Providing leadership to the world's increasingly interconnected economy is by no means an easy task, and maybe that's why the world is voting against America holding the world's reserve Currency Conch any longer. Timmy Geithner's effectiveness with the Chinese translators overseas this morning is borderline laughable.
There was a time when the Wizards of Wall Street's Oz could fly overseas and make a comment like "we are committed to a strong dollar" and it would actually matter. Rather than getting on a plane and shaking hands with The Client (China) himself, President Obama opted to send the same guy that called the holder of $768B in US Debt "manipulators." Nice!
When it comes to financial market sophistication, other countries aren't as gullible as they used to be. An internet connection and You Tube screen have effectively changed all that. On the heels of Timmy's "reassuring" comments, the US Dollar is getting spanked again, trading down another -0.73% to lower-lows at $78.63. Rather than fading Geithner from my soapbox, now the world is - it's sad.
I understand that this is all doesn't matter yet because someone on CNBC is hopped-up about where the US futures ramped into Friday's close and look here on today's open. That manic behavior really helps America's reputation. At the end of the day, the US stock market could go up another 6% to 9% percent today, and it would still be amongst one of the worst performing stock markets in the world.
The Dollar moving into crisis mode matters. First, all of the REFLATION trades pay themselves out in full. Second, all of the global political capital associated with the almighty Petro-Dollar gets redistributed. And Third, well... rather than analyzing this as the said Great Depression Part Deux... how about another Third Quarter of 2008 in US Equities?
Nah, that's crazy right? Like they say in the Canadian Junior Hockey Leagues, "crazy is as crazy does"! There are loads of unintended consequences associated with a US Dollar crashing - the only other sustainable break we've seen in the US Dollar Index below the $80 level since 1971 (when Nixon abandoned the gold standard), was that one that led us to that 2008 Third Quarter...
After locking in another +5.3% month for May, the SP500 is up a whopping +1.8% for the YTD. Unlike most global equity markets that are charging to higher-highs this morning, the SP500 is still trading below its January 6th high of 934.
On the heels of another strong, albeit not herculean PMI manufacturing report last night (it decelerated slightly month over month), China's stock market charged to higher-highs, closing up another +3.4%. The Shanghai Composite Index is now +49.5% YTD, and we, as our British philosophy competitor likes to say remain "long of it."
From Hong Kong to Russia, stock markets are up +4 to +6% this morning. Why? Because, much like the ONLY other time we saw the US Dollar break down to these levels, everything that China needs REFLATES. Oil prices and the promises of a potentially empowering Chinese handshake have the Russian Trading System Index (RTSI) up +83% for 2009 to-date. Now that and the price of oil trading up +19% in less than 2-weeks is getting someone paid - and it isn't the American Consumer!
As she trashes her currency, America will continue to lose political capital both domestically and abroad. After all, a -12% three-month swan dive in the US Dollar has hacked over $90 Billion of value from the Chinese position in US Treasuries. Creditors and citizenry hush yourselves! All the while, 17 out of 23 Chinese economists polled are calling holding those Treasuries a "great risk" this morning.
I know, I know... an economist or a billion US Dollars aint what it used to be...
At some point, China's interpretation of the arithmetic is going to really matter.
Best of luck out there this week,
CAF - Morgan Stanley China Fund- A closed-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-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.
UUP - U.S. Dollar Index - We believe that the US Dollar is the leading indicator for the US stock market. In the immediate term, what is bad for the US Dollar should be good for the stock market. Longer term, the burgeoning U.S. government debt balance will be negative for the greenback. The Euro is up versus the USD at $1.4235. The USD is down versus the Yen at 94.6600 and down versus the Pound at $1.6393 as of 6am today.
XLU - SPDR Utilities - As long term bond yields breakout to the upside, Utility investments are the relative yield loser. TRADE and TREND remain bullish. We're wrong so far.
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.
"It will be helpful if Geithner can show us some arithmetic"
Demand for Las Vegas is indeed elastic. Drastic room rate cuts have improved visitation sequentially. The nightlife impact has been noticeable. In fact, anecdotal evidence suggests that the clubs are actually booming right now. Unfortunately, that is the only part of the business that is doing well, unless you count crowded buffets.
We know room rates are down. Lower visitation and gaming spend per visitor have driven down gaming revenues. Despite the higher club and buffet activity, restaurant covers appear to be way down. The best explanation I've heard is from a client following his recent visit. He speculated that younger adults are packing in 4 people to a room and spending what little cash they have on the necessities: buffet food (optional), club cover charges, and booze.
The following chart shows the departmental profit margin at Las Vegas casino hotels. The huge margin expansion experienced over the last 15 years has been driven exclusively by Food & Beverage and the Hotel, coinciding with the nationwide housing boom. Hotel pricing has been under the most pressure and given the falling demand, F&B may very well be too. We first introduced this chart way back on 06/22/08 with our post, "MEAN MARGIN MEAN REVERSION". The argument back then was that the most discretionary segments (hotel and F&B) were most at risk and Las Vegas margins had peaked.
The key then and now is housing and the wealth effect. Housing was already falling throughout most of 2008 and with a little statistical analysis we showed that rising housing prices were the number one macro driver of the gaming boom over the last 15 years. Housing prices are still falling and I'm not sure the housing related wealth decline has reached its full impact on consumer spending. The 4% national savings rate is high by the standards set during the housing boom, but very low relative to the high single digit rate averaged during the pre-1995 period.
Las Vegas was a prime beneficiary of the housing bubble both in terms of pricing and margins. Anyone who has consistently visited the city over the last decade can attest to the price inflation. I certainly can. Hotel rates and F&B pricing used to be "loss leaders". They may soon be again.
In looking at Tiffany's 1st quarter results there were no big surprises. Sales, margins, and expenses were all largely in-line with expectations. EPS was $0.20, a penny below the Street, but that really shouldn't matter at this point. This is a quarter to tuck away and forget about. Domestic same-store sales declined by 34%, a combination of a 42% decline in the NY flagship and a 32% decline for the remainder of the US. Anyone paying attention to the luxury segment and other big-ticket discretionary categories should not be surprised by such large declines. Instead, we're focusing on a few subtle changes on the margin that came out of the quarter.
- 73% of TIF's EBIT comes from the US and Japan and we're encouraged to see an uptick in the sales trend in these markets. It's always risky to call an exact bottom, but this certainly looks like one to us.
- With just under 50% of Tiffany's products containing a diamond of some sort, it is worth noting that diamond pricing has reversed dramatically in the past 6 months. We are now back to pricing levels of a couple of years ago. It will take some time for inventory turns to work through higher cost raw materials, but this reversal should help gross margins at the end of 2009 and throughout 2010.
- The recent and severe weakening of the U.S dollar should help TIF in the near-term, beyond the Street expectations. Let's be clear - the Dollar crashing does not end well for any of us, and we are not expecting tourists to return to 5th Avenue in droves, but this trend should help mitigate the fairly large FX translation impact we saw in 1Q.
- Consolidation has been a key theme of ours and the high-end jewelry market is a great example. With few national brands, if any that compare to Tiffany, there has been an increasing wave of store closures and bankruptcies. Inherent in the jewelry business is a high cost to fund inventory and only those with strong balance sheets will survive.
- Lastly, TIF's triangulation of sales, margins and inventories are improving on the margin. Check out the SIGMA chart below. 1Q is sitting in the lower left quadrant, and it is unlikely it will remain there for more than 1 more quarter. ANY move out of that quadrant is a positive stock move.
By no means are we out of the woods on the challenges facing the luxury retailer and consumer. In addition, we're not particular fans of the TIF business model (low margins and high inventory carrying costs). However, there is an increasing amount of certainty surrounding Tiffany. In our view the brand remains iconic in stature, expenses are being managed wisely and investments in the future remain in place where appropriate (store growth will be up 5-6% in '09). Importantly, management remains true to the brand and hasn't conformed to the environment. Has anyone seen the case of clearance engagement rings?
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Jack Lam, an accomplished junket operator, opened a VIP operation earlier this year at the Mandarin Oriental hotel in Macau under the Stanley Ho umbrella. By all accounts, Mr. Lam has been successful. We've heard he may have done almost $1 billion in VIP turnover in April alone. We've also heard that he could be retaining a commission of 1.4%, well above the much discussed "cap" of 1.25% and certainly even more above the rate Wynn Macau is likely paying him for his VIP room at that property.
With those respective economics, it should be pretty clear where Lam's priorities are. As can be seen in the following chart, Wynn Macau's market share began falling in February, and more rapidly in March and April. Some of the market share loss in April can be attributed to lower hold percentage. However, considering Lam's success at the Mandarin, most of Wynn's VIP market share loss is probably sustainable. Every 1% of VIP market share represents approximately $80 million annually in revenues or and $15-17 million in EBITDA.
On the Mass Market side, Wynn Macau's market share has fluctuated but the trend is pretty flat. However, that will likely change for the worse as well. City of Dreams opens on Monday with a high end Mass Market target market. This segment is Wynn's power alley. CoD is unabashedly going after the core Wynn customer. Wynn is the better operator but with visa restrictions in place, at least for a few more months, the Mass Market is unlikely to grow enough to offset the 17% capacity addition. Wynn could be the prime casualty.
There have been a few upgrades in the sector recently based, in part, on optimism about business getting less bad. This thesis has certainly played out in the gaming and cruise line sectors. While the same thesis will eventually play out in lodging - even a broken clock is right twice a day - we are not seeing any evidence of sequential improvement. Our 2010 estimates for HOT EBITDA and EPS remain 10% and 30%, respectively, below the Street.
YoY occupancy remains way down from last year. As we opined in our 01/07/09 post, "FILL 'EM AND THEY (INVESTORS) WILL COME", improvement in occupancy is a strong signal that there is indeed light at the end of the tunnel, even if lower rates are still driving overall RevPAR down. Lodging stocks typically do not sustain rallies until occupancy bottoms. Unfortunately, there is no visibility on that pivot.
As can be seen from the chart below, lodging fundamentals are not improving. We're not sure what data other sell-side analysts are looking at, but the STR data doesn't show any recovery or stabilization and our network of private hotel franchisees certainly doesn't see things getting any better. Just because the YoY decrease in RevPAR isn't accelerating doesn't mean that we've reached the bottom or that there is any improvement in sight. Occupancy fell 11% in April, and is tracking down 12.5% for the first 3 weeks of May. Given the lack of demand for rooms, the only way to fill rooms is by stealing share from your neighbor by dropping price. In order to change this you need real demand growth stimulated by job growth and income growth - things stabilizing at bad levels isn't enough.
We will give credit when credit is due. Starwood has done a great job cutting costs, but we do not believe that all of these cost cuts are sustainable, especially the ones at the capex level. We wrote about this in our 5/2/09 note "YOU TUBING HOT". Like the gamers, many hotel companies are simply deferring capital expenditures. The deferred maintenance capex issue is why many of the recent asset sales have come with mandatory investment requirements. We heard that the W New York - The Court & Tuscany is on the market for $100MM but the required capital improvements are almost as high as the ask price. Cuts on timeshare are only sustainable until the inventory on hand is sold, and then companies need to start investing again - otherwise we need to look at these businesses on a liquidation basis, not a multiple basis.
We understand the reflation trade. In fact, Research Edge was a big proponent of this thesis beginning in early March (thanks Keith), especially with the gaming and cruise lines sectors. That trade has worked. With cost of capital rising and valuations rising there needs to be more to keep this rally going. How about the fundamentals? Not quite yet.
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