If I had a nickel for every time I've heard that BYD is not cheap and the locals LV market is horrible, I'd own a lot more BYD stock.  Of course, I'm restricted from buying stocks I write about but you get my point.  I honestly don't know where BYD is going over the near term.  Research Edge is a bit negative on the US market, gaming has a high beta, and I'm increasingly cautious on gaming operators overall.  However, from a long-term perspective, the stock is actually dirt cheap, and the Las Vegas locals market is a growth market.  The company's incredibly valuable credit facility rounds out the positive thesis.  It is this final thesis point that I will focus on this note.


As a refresher, BYD's credit facility does not mature until May 2012 and its 2% spread above LIBOR is unmatched in the industry.  The effective interest rate is under 3%.  BYD currently has $2 billion of borrowing capacity remaining on the facility. The other operators (MGM, WYNN, LVS, ASCA, PNK, PENN) have all refinanced at significantly higher rates or will do so soon.


So what is this valuable asset worth?  We see value in two ways.  First, in terms of straight interest savings, the differential between BYD's interest rate and the "going rate" is approximately 6%.  This differential multiplied by BYD's outstanding borrowings on the line is about $67 million per year.  On a present value, tax-effected basis over the remaining 3 year life of the facility we estimate there is $114 million, or $1.30 per share in value.


Second, the additional liquidity gives BYD an incredibly cheap cash source to make an acquisition at near trough EBITDA and a low multiple.  The assets of Station Casinos come to mind.  Assuming a $1 billion acquisition at 8x EBITDA, above current public trading multiples, we estimate BYD could generate $2.50 per share in equity value, as shown in the following table.  Please note that these are not wild assumptions.  We are only assuming the market gives BYD a 5x multiple of the free cash flow accretion generated by the hypothetical acquisition.


BYD: THE VALUE OF A GREAT CREDIT FACILITY - BYD hypothetical acquisition


BYD's free cash flow yield is currently north of 20% (highest in the sector), which is not sustainable in our opinion.  The valuation doesn't appear to reflect the appropriate value ($3.80) of the credit facility nor does it reflect the 87 acres of Strip acreage.  We value the land at $3.50 per share so potentially $7.30 of real value is not being reflected in a $9.30 stock that is already supporting a huge free cash flow yield on current operations alone.


McDonald's reported global May same-store sales of 5.1% vs. consensus of 4.2%. The notable standout was MCD USA which was significantly below consensus 2.8% vs. consensus at 3.6%. Europe reported a solid 7.6% vs. consensus at 4.3% and APMEA 6.4% vs. consensus of 5.4%.


With MCD running 4%+ pricing (including the change to the $$ menu) the 2.8% is disappointing. The early read on MCD's coffee strategy is not good! Given the coffee push the traffic trends should be much better.


MCD - USA MAY SALES Trends Slow - mcdussss


MCD - USA MAY SALES Trends Slow - mcdeursss


MCD - USA MAY SALES Trends Slow - apmeasss


Barking At Consensus

"One dog barks because it sees something; a hundred dogs bark because they heard the first dog bark."
-Chinese Proverb
I was in New York meeting with investors last Wednesday. When I started going through the second derivative effects of a US Dollar moving into crisis mode, and walked through how this story ends (with the US Federal Reserve eventually being forced to raise rates), I had some interesting looks at me from across the table.
On Thursday morning, Bloomberg TV's Erik Shatzker and I walked through the implications of what Bernanke had to say about quantitative easing (reigning it in) combined with the yield curve being at an all time peak. I said current US monetary policy was unsustainable, and that the next Fed move would be up.
This morning, a top 3 story on the Bloomberg box reads "Treasuries Fall as Traders Bet on Higher Fed Rate; Stocks Drop"...
I'll stop barking now.
On a percentage basis, Friday's move on the short end of the US Treasury curve was one of the most explosive one-day moves we have ever seen. Two-year treasury yields remain elevated at 1.34% this morning - that's a full +41 basis points above where they were at this hour of the morning last Monday when I was writing credit market factors down in my notebook.
As a result of the short end exploding to the upside, the yield curve (the spread between 10 and 2-year US Treasury interest rates) has come in from its all time highs. When I was talking about last week's "peak in the yield curve", I meant that the spread between 10's and 2's was +277 basis points wide - that was a PEAK, as in the widest the yield curve has been, EVER...
Ever, is a long time. For a risk manager, EVER is where we look for things to change on the margin. This morning that, thankfully, has. The spread between the 10 and 2-year yield has come in by a full +26 basis points to +251 basis points wide. Yes, in the land of rates and spreads, these are huge moves in compressed periods of time.
So what does it mean? It means that the Piggy Bankers will have less of a spread to chow down on as we move into Q3. Apart from a nauseating calendar of investment banking secondary issuance in Q2, another point that we made last week was that the bankers are having a blockbuster Q2 on that yield curve.
The way that this works is that the Goldmans and Morgans scare the living daylights out of Washington into believing that we are going into a Great Depression - then they borrow American moneys for free and lend it out to America's commoners for a piggish spread. I know - isn't that an America we can all trust!
The New Reality remains - as the US Dollar continues to trade in the crisis zone, the Three Little Pigs are getting paid: Bankers, Debtors, and Politicians. Since 53% of the world's foreign currency denominated debt is in Dollars, collapsing its value reduces debt obligations and allows Timmy Geithner to tell the Chinese that all has been corrected in the land of Wall Street Oz.
Obviously this is a joke, and that's why the Chinese laughed at tiny Tim. But make no mistake folks - the other side of 2-year rates shooting higher is that holders of those bonds (China and Japan) get smoked.
The other somewhat meaningful constituency who cares about this thing called cost of capital is the American public. If they weren't getting paid ZERO on their savings accounts in order to facilitate this pigging out on the trough of their yield curve, they might actually believe CNBC's narrative on this too... but, once again, betting that the hard working people of America are stupid, is a bet reserved for Washington and Wall Street.
Main Street pays for Bernstein to upgrade Goldman ahead of the quarter alright - they pay for it via higher mortgage rates and at the pump.
Pumps matter, especially when they start to feel like pump and dump. I know, I'm barking again.
Best of luck out there this week,


EWC - iShares Canada- We want to own what THE client (China) needs, namely commodities, as China builds out its infrastructure. Canada will benefit from commodity reflation, especially as the USD breaks down. We're net positive Harper's leadership, which diverges from Canada's large government recent history, and believe next year's Olympics in resource rich British Columbia should provide a positive catalyst for investors to get long the country.   

XLE - SPDR Energy- We bought Energy on 6/05. We think it works higher if the Buck breaks down.  Bullish TRADE and TREND remain.

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.

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.

XLU - SPDR Utilities - As long term bond yields breakout to the upside, Utility investments are the relative yield loser.

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.

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WSM: Getting Tough To Ignore

We continue to warm up to Williams-Sonoma (WSM) as a way to play two themes in the retail space.   


  • First, we are comfortable with the gradual, but increasing momentum in the home furnishing sector.  We know that big-ticket items remain under pressure but we are seeing encouraging signs in soft-home, cookware, and accessories.  Importantly, any pick up in non-furniture will be positive to WSM on the gross margin line as these categories tend to carry higher IMU's.  Consumers are spending more time in their existing homes which results in higher home-related capex.  


  • Second, in the wake of the severe downturn in the commercial/retail real estate market, we are becoming bigger fans of companies with large, scalable e-commerce businesses.  This is not only because it gives these companies a competitive edge vs. others who are levered to real estate values and dysfunctional/bankrupt landlords. More importantly, we think that companies with superior, e-commerce, and consumer-direct businesses will command a higher premium as we emerge from this cycle as strong companies without such platforms realize that they either need to build them (costly and risky) or buy 'em.


Despite recent sales woes and an expectation embedded in Street estimates that revenues will continue to be challenged for 2009, WSM derives 40% of its revenues from its online/catalog operation.   WSM's heritage as a direct marketer makes it a rare brand that actually understands the direct relationship with its customers and has profitably built a business around it.  Today WSM is the 20th largest ecommerce business in the U.S. 


Importantly, the company continues to de-emphasize its catalog mailings (down 30% in '08; down 17% in 1Q09) in favor of more cost-effective brand and targeted online advertising.  The benefit from a shift away from paper to a virtual world will not entirely accrue overnight, but there are few retailers with as a great an opportunity to cut costs and improve margins in this area.  Currently, the e-commerce business is the most profitable of all the WSM channels, and has the opportunity to produce an even higher ROI driven by shifts away from the catalog to the internet.  WSM has relied almost exclusively on the catalog (85-90% of total marketing spend) as its main advertising vehicle which has historically cost 10% of sales.

WSM: Getting Tough To Ignore - wsm catalog


We have heard for years about how catalogs are going away, consumers prefer to shop online, and call centers are a way of the past.  However, the reality of the market has been that most direct marketers were a bit wary to embrace these changes and were even reluctant to dial back catalog circulation for fear that sales would plummet.  Currently, WSM direct and retail sales trends are both tracking down in low to mid twenty percent range and within expectations.  Now is the time for companies such as WSM to become more aggressive as they seek to cut capex, cut costs, and to preserve and even grow cash flow in the wake of a topline that remains more sensitive to the overall environment.  We are seeing this same process unfold at J Crew where catalog circulation has also been cut dramatically as the company shifts it investment towards ecommerce. 


We're the first to admit that a company is never going to cut its way to prosperity. It's gotta grow to ultimately have any kind of earnings stability and sustain a reasonable multiple. But we think that the inefficiencies in the existing operation combined with the underlying strength in the brands and the consumer-direct platform should allow the company to pull away costs without meaningfully impacting either the brands or the top line - a rarity in this business.


While this pronounced shift in the direct business is occurring, it's also important to look at WSM's retail business in the wake of planned square footage growth slowing in '09 to only 1%.  Importantly, future lease obligations are properly aligned. Near-term obligations outweigh future obligations by a healthy margin - and they have improved in each of the past three years.  We view this as a positive sign in terms of the company NOT trading future margin for near-term benefits.

WSM: Getting Tough To Ignore - wsm leases


Combining the .com opportunity with a clean balance sheet ($100mm cash and no debt), substantial capex and inventory cuts planned for '09, and weak financial performance expectations, and high short interest at 14% of the float, we like how this story sets itself up..

WSM: Getting Tough To Ignore - wsm sigma


Eric Levine


On the Road: The Dollar, Interest Rates and Gold


"Everything has its limit - iron ore cannot be educated into gold." -Mark Twain


"We turned at a dozen paces, for love is a dual, and looked at each other for the last time." -Jack Kerouac, On the Road


Keith and I were on the road this week and had some of the most interesting conversation we've had since I joined the firm nine months ago and we started accepting macro clients.  Two key areas of discussion were the US Dollar and interest rates.  On the former, the discussion centered around whether this "dollar crisis", as we are calling it, is really anything more than a trade into more risky assets globally.  That is, investors are just selling the safe haven US dollar and shifting into riskier asset classes like emerging market and small capitalization equities. 


The second debate centered around the next move of the Federal Reserve.  The most contrarian point we heard was that the Fed may not raise rates for more than a year and a half from now.


As in the Mark Twain quote above, everything has its limits, even the US dollar.  With the US dollar down dramatically in the last 3-months and the U.S. stock market one of the worst performing global equity indexes, the facts clearly suggest that what is going on globally is a vote against the U.S. economic system.  That statement may sound unpatriotic, but it is simply a fact. 


While we have seen the appetite for risk assets increase over the past couple months, it is difficult to attribute the decline in the U.S. dollar to this asset shift.  There is clearly something else going on as investors have been buying gold in that period as we outline in the chart below, which is considers a safe haven in periods of heightened risk.  In fact, global political rhetoric is almost as much evidence as we need to convince ourselves this is not the case.  Over the past few days, there have been some public statements by Russian President Dmitry Medvedev, in particular, which highlight this point.  His quotes are below:


"The dollar is not in a spectacular position, let's be frank, and its prospects cause various questions as do the prospects for the global currency system.''


And as it relates to a new global currency Medvedev said:


"This idea has potential, even though some of my G-20 colleagues aren't actively discussing it at the moment.  However, for example, in the opinion of our Chinese colleagues it is quite a possible step. The most important thing is not to walk away from discussions on this topic.''


In the last statement, Medvedev is obviously appealing to The Client (China), who have voiced similar concerns as recently as this week with Treasury Secretary Geithner's visit to China.   Over the past 9 - 12 months this call by the Chinese has been getting louder and louder.  In a April 17th note entitled, "Is China Advocating for the Bancor?", we quoted Dr. Zhou Ziaochuan, a primary player in determining Chinese fiscal policy, who wrote the following in an essay:


"Though the super-sovereign reserve currency has long since been proposed, yet no substantive progress has been achieved to date. Back in the 1940s, Keynes had already proposed to introduce an international currency unit named "Bancor", based on the value of 30 representative commodities. Unfortunately, the proposal was not accepted. (Emphasis is Research Edge's.)"


We can theorize about why the dollar is crashing and whether it is a crisis or not, but I don't think any of us can ignore the drum beat of the people that are buying US dollars and Treasuries.  A key catalyst in this political rhetoric will occur on June 16th, when Russia meets with Brazil, India, and China in the Russian city of Yekaterinburg, which is in the Ural Mountains.  The Russians and Chinese have already played their cards and they will only turn up the volume on the rhetoric during and post this conference and encouraging their Indian and Brazilian "colleagues" to do the same.


Jack Kerouac, who is of course the famous beatnik author, wrote the line at the start of this note in his novel, On the Road; likely he did not intend that quote to be used as a euphemism for the global currency markets, but the quote is an apt description as any of the global currency dual that is going on.  To consider this merely a shift to a higher risk assets, would be very shortsighted indeed. 


We make our calls based on the facts in front of us and don't have a specific view on when rates will increase, but ultimately if the voices from abroad continue their heightened anti-dollar rhetoric this will also become a political issue in the U.S.  Clearly, in the short term anyways, one of the quickest ways to strengthen the U.S. dollar is for the Fed to raise rates.  To some extent, their hand will likely be forced on the inflation front in that regard as well.  That is, if the U.S. dollar continues to break down, reflation will turn into inflation, and the Fed will start raising rates.  As the yield curve is signaling (outlined in the chart below), this could happen much sooner than many equity investors expect.  After all, as most global macro fundamental analysts already know, bond markets are not lagging indicators.


Daryl G. Jones
Managing Director


On the Road: The Dollar, Interest Rates and Gold - dj1


On the Road: The Dollar, Interest Rates and Gold - dj2

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