Monsters, Inc.

This note was originally published at 8am on October 25, 2013 for Hedgeye subscribers.

"Whoever fights monsters should see to that in the process he does not become a monster.  And if you gaze long enough into the abyss, the abyss will gaze back at you."

- Nietzsche 


Yesterday I was flying out to San Francisco and the United Flight I was on lacked two key things: access to the Internet and/or a choice in movies.  As a result, I was stuck watching Monsters, Inc. 


For those of you that have progeny perhaps you've seen it already? I'm still in the bachelor camp, so don't regularly watch Pixar cartoons.  I also have to sadly report, it wasn't all that scary, though it was cute and funny. 


The movie did, however, make me think about a few things that currently scare me about the U.S. economy. In no particular order, my biggest fears are:


1) The Federal Reserve - We certainly harp on the Federal Reserve and rightfully so as an un-elected and largely unaccountable body with the power to influence the global economy is very scary.  Our biggest concern is the excesses that are being built into the system because of elongated, extreme monetary policy. 


The economy is growing and the unemployment rate is in decline, but we remain at the zero bound in interest rates.  Admittedly the policy has helped to inflate some asset classes, such as housing, that were a major anchor on the banking system.  Unfortunately, this extreme monetary policy has created an economy and set of markets that are highly sensitive to central bank actions. 


In the chart of the day, we highlight this point by looking at the volatility that is occurring in the interest rate market. As an example, rates on the 10Y spiked ~37% in 3Q13.   This is as substantial a move we've seen on a percentage basis in fifty years. Further, in the wake of Bernanke’s confused policy communication on Sept 18th, we’ve seen a marked reversal in 10Y treasury yields with rates declining -17% off peak levels. 


2) Macro Data - Admittedly it's odd for a macro analyst to be scared of macro data, but I am and here's why - it is often grossly inaccurate. 


An example from our research earlier this week was a note I wrote on gold (somewhat of a meaningful asset class). The note took a deeper look at a letter gold bug Eric Sprott wrote to the World Gold Council on supply and demand in the global gold market. 


Sprott's thesis is that the global supply and demand numbers for gold grossly overstate the excess supply of gold in the world. In fact, Sprott thinks that in the year-to-date we are running at a supply deficit of some 503 tonnes.


Meanwhile the World Gold Council's projections for the year-to-date suggest the world is over supplied by a tune of 217 tonnes.  If we annualize both sets of projections, the difference between them is a notational value of some $50 billion dollars.  Not exactly chump change !


If you are one of those people that like to invest based on concrete date, like me, you must be scared of some macro data at times as well.  If you believe Sprott, then you should be buying gold hand over fist, and if you believe the World Gold Council, you should be selling. 


While we do like it when we get concrete data that informs us, as it relates to gold we'll stick with our sneaky correlation models, which show a very tight correlation to the Federal Reserve balance sheet and prevailing, forward policy expectations.  Interestingly, for the first time in a year, gold is actually looking like a buy in our quant model.  Scary indeed!


3) U.S. Economy - Coming out of the Great Recession, the U.S. outperformed many of its western peers in both labor market and broader economic improvement.  From here, though, there a few reasons to be scared. 


The equity markets domestically have been on a tear and are literally registering new all-time highs – but, of course, with highs in equities and expanding multiples come high expectations for forward fundamentals.  A few things that might not be so rosy on the U.S. over the next few months include:


1)   Debt and debt ceiling - The uncertainty on the recent debt ceiling debacle led to a meaningful decline in consumer confidence and a slowing in economic activity.  There is now a series of dates from December to February, that investors will be watching to see if there will be another debt ceiling scare or government shutdown.  In markets, confusion breeds contempt.

-  December 13th – the date when a House-Senate committee will report back on negotiations on a longer term budget deal;

-  January 15th – the date on which the government is now open until subject to another budget agreement being reached; and

-   February 7th – the next debt ceiling.


2)   Corporate earnings – The results from U.S. corporate this quarter haven’t been terrible, but they certainly haven’t been gangbusters either.  As of yesterday, 52% of companies are seeing sales accelerate, 51% are seeing earnings accelerate, and 47% are seeing operating margins expand.  That sounds good, but the translation is that over half of corporate America is seeing earnings, revenue and margins decelerate.


3)   Financials – We’ve already become more cautious on the financial sector over the last couple of days as we’ve taken Franklin Templeton off our Best Ideas as we see the outflow from bond funds slowing.  More broadly, as the yield curve narrows, this is negative for banks generally.  Borrowing short and lending long doesn’t pay in a narrow yield curve environment.  In the year-to-date, financials has been a market leader up 26%, the second best sector after consumer discretionary.  If this reverses, it will be hard for the SP500 to march higher.


Halloween is only six days away, so I don’t want to scare you too much . . . Boo! Or do I?


Our immediate-term Global Macro Risk Ranges are now as follows:


SPX 1733-1754

VIX 12.02-15.01

USD 78.81-79.74

Euro 1.36-1.38

Yen 97.06-98.63

Gold 1320-1363


Enjoy the weekend.


Keep your head up and stick on the ice,


Daryl G. Jones

Director of Research


Monsters, Inc. - 10Y Yield CoD


Monsters, Inc. - Virtual Portfolio


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:  Despite management's effort to focus the call on what they accomplished in FY2013 it was hard to mask the fact that there wasn't much to be "extremely pleased about" in FQ4 or guidance.



  • SLIGHTLY WORSE:  Results missed expectations, but part of the miss was due to some non-recurring issues related to temporary delays in payment processing on Facebook and some disruptions related to the rollout of Apple's iOS7 platform.  Trends in October were at record levels.  IGT continues to expect DD to finally be GAAP accretive in F1Q 2014. 
    • We are pleased with our success at DoubleDown and we expect that the transaction will be accretive on a GAAP basis in the first quarter of fiscal 2014.
    • I think those (new) markets will develop perhaps a little bit slower than we thought, though my comment last period was in anticipation of multiple quarters. As we enter new markets, we do expect that there may be some downward pressure on ARPU as DAU picks up, and we did see a pickup in DAU. I think the positive surprise for us this quarter is that it didn't damage ARPU, and actually we're seeing incredibly strong conversion rates continue in our domestic markets.  Over time, I still expect that there may be some pressure on that ARPU number as we further penetrate the international markets, but we didn't see that materialize in this quarter which was a great surprise.


  • LITTLE WORSE:  Yields and installed base both declined 4% YoY.  IGT touted a QoQ increase in yields, although part of the lift was due to the conversion of lower yielding leased games and normal seasonality.  Gross margins were better though and capex remained disciplined.  Gaming ops margins and yields for 2014 are expected to be in-line with 2013.  
    • PREVIOUSLY: Gaming operations capital expenditures are expected to decrease year-over-year as we remain focused on disciplined capital deployment. 
    • We are striving to improve yields through a variety of initiatives.
    • We're holding up on margins which again is what we were focused on


  • BETTER:  Captured 40% share in Canadian/Illnois VLT market and increased North American ship share in FQ4. Although gains came at the price of lower ASPs and margins. IGT shipped over 4,700 units Video Poker units to CZR this Q
  • PREVIOUSLY:  We are confident that we maintained our industry-leading ship share in the replacement market this quarter.


  • IN LINE:  For the first time in 4 quarters unit sales were actually up YoY.  That said, they likely got a lift from some leased games converting to sale 
  • PREVIOUSLY:  I think we are starting to see some signs of improvement.  Despite ongoing challenges in certain regions, there is still significant potential in our international business as we leverage our investments in localized content and infrastructure improvements.



  • SAME:  Revenues increased 29% YoY primarily due to an expansion of our on-line desktop and mobile partners excluding the impact of our former European on-line pokeer network and a one-time bad adjustment in the prior year.  In 2014, they expect modest growth at IGTi as they launch on-line casino style wagering in US.
  • PREVIOUSLY:  We continued momentum in this business, both in our existing markets where we attracted 15 new partners since a year ago and are excited about new markets like New Jersey, where our prospects to partner with some of our land-based customers, we're working on now.


  • SAME:  Has entered into $200MM accelerated share repurchase agreement.
  • PREVIOUSLY:  We have about $520 million remaining on our board-authorized repurchase. We continue to target using that authorization over the next two to four years, which is consistent with what we've said in the past.


  • SAME:  Expect "modest" pick up excluding Canada & IL. Hoping that the CZR's deal will be a catalyst for video poker demand
  • PREVIOUSLY: We haven't really seen a significant change in the tenor of those conversations.  The volume has not picked up as far as the volume of the voice from the customer on concern about their budget. So I would say the volume is there. The people we're hearing from are different than they were a year ago or different than they probably even were a quarter ago.


Conference call didn't provide much comfort.  2014/2015 headwinds remain



"We are extremely pleased to report our fiscal year 2013 financial results. We continue to drive significant revenue and earnings per share growth through the successful execution of our strategy and disciplined approach to capital allocation.  Our goal, as always, is to maximize our returns to shareholders through targeted share repurchases, consistent dividends and robust earnings growth." 


- Patti Hart, CEO of IGT




  • Systems revenues were up 39% YoY for the year
  • Excited about the momentum in game sales
  • 2014 product line up created a lot of interest at G2E
  • Expect modest growth in product sales in 2014, excluding Canada and IL.  Anticipate stable gross margins as higher ASPs offset lower non-machine revenue.
  • Increased cash flow through lower capital expenditures in gaming operations
  • Install base was partly down due to a conversion to sale of lease games
  • 2014 Gaming operations: expect margins, yields, capital expenditures and install base to be in line with 2013 results
  • 4Q  results in DD: temporary delays and some disruptions with the rollout of OIS 7. Despite this, DD was still the top grossing app in August.  October was also a record month for them as they rolled out a new Monopoly game.  They expect that the acquisition will be GAAP accretive by 1Q14.
  • IGTi: expect modest growth as they continue to launch casino style wagering in the US
  • Expect SG&A in 2014 to return to a normalized range of 19-20% of revenue and R&D to return to 10-11% of revenue
  • Argentina was also a 1 cent impact per share
  • Expect to take out the convertible notes due in May with R/C capacity and the proceeds of their notes issuance
  • 2014: weighted average share count of 250-255MM
  • Remain focused on disciplined capital investment
  • It's all about content for them, expanding and managing their distribution network, and maximizing value by generating cash flow and returning cash flow



  • 1,500 Canadian units shipped this Q and about the same in IL
  • Expect modest growth in the game sales market excluding IL & Canada for 2014
  • On a mix adjusted basis, ASPs were relatively flat.  Not seeing any unusual promotional activities.
  • Lost 1-2 cents in SG&A which was one time, lost a penny in bad debt and lost a penny on FX. 
  • Gaming operations install base: Some leased units converted to sales. Had some closures in the Mexican market. Pleased with the QoQ increase in yields.
  • They shipped about 2/3rds of the Video Poker units to CZR. The shipment to CZR was the first major replacement of video poker that they have seen in a while. This will pressure ASPs.
  • Going forward they expect margins to return to more normal levels in 2014 in product sales. Feel like the CZR replacement of their video poker machines will be a catalyst for more replacement of the VP install base
  • Guidance includes share reduction as a result of the ASR
  • International yields were up
    • I'm sure as a result of the conversion of the leased units to sales and the closure of the Mexican locations
  • September was a 1 month anomaly where they had to adjust for temporary delays in payment processing on Facebook. October was a very good indication of that rebound - record bookings, record new and revised players, and launched their most successful game. 
  • Expect to see flat to slightly (1-2%) increase in US GGR. 
  • Think that the year will be back end weighted
  • Feel like they are in process of becoming a much bigger/strategic phase of DD's life
  • Facebook platform revenue down slightly, but mobile was up 11%
  • Saw growth in their European real wagering 
  • Monetization is lower in Europe, as expected. It hasn't materially impacted their overall results, though. 
  • Most of the lease conversions are opportunistic. It's very hard to predict since it's contingent on customer liquidity.

Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.46%
  • SHORT SIGNALS 78.35%

Get Long The British Pound

Long GBP/USD (via the etf FXB)


Our bullish call on the British Pound vs the US Dollar was strengthen this morning with the ECB unexpectedly cutting its main interest rate by 25bps to 0.25%.  In our minds, it’s now anyone’s guess how the central bank currency wars between the USD and EUR will play out.  However, anchored on our Q4 2013 Macro theme of #EuroBulls (presented on 10/11/13), we continue to like British Sterling.


The Bank of England was also out this morning and announced no change to its interest rate (anchored at 0.5% since March 2009) and kept its asset purchase program target (QE) unchanged at £375B. 


Here are the main factors underpinning our bullish GBP/USD Call:

  • Regime:  we are bullish on the regime change at the BOE, replacing Mervyn King with Mark Carney – we believe Carney has fresh ideas and a focus to use forward guidance to direct the economy to stable growth
  • Fiscal Policy:  we expect (and are already seeing signs of) the country’s decision to issue austerity before its regional peers during the global recession as paying off in spades via accelerated growth over its European peers. We’ve seen steady improvement in the country’s deficit (as a % of GDP), from -11.4% in 2009 to -6.1% last year and is forecast to hit -4.4% in 2014
  • Monetary Policy:  we do not expect rate cuts or additional QE over the medium term. In the last policy meeting (October), the BOE voted (9-0) to keep rates on hold and the asset purchase program unchanged
  • Economic Data:  we believe that the health of an economy is reflected in its currency – the data suggests continued improvement (more below) which should bolster the GBP versus major currencies
  • Vs the USD:  we see a very favorable comparison versus the U.S. Dollar as Bernanke/Yellen burn the Greenback via delaying the call to taper (likely pushed out to March 2014)


By the Charts:


  • GBP/USD – the cross is trading comfortably above over our intermediate term TREND level of support

Get Long The British Pound  - zz. gbp usd


  • GDP – we expect outperformance versus most of its European peers, built largely on choking down austerity first during the great recession.  The European Commission in its autumn report this week raised UK GDP expectations, to +1.3% in 2013 from +0.6% and to +2.2% in 2014 versus a previous estimate of +1.7%.

Get Long The British Pound  - zzz. uk gdp


  • PMIs – UK Services and Manufacturing PMIs continue to outperform continental Europe.  UK Services PMI for October hit a 16 year high at 62.5! (above 50 = expansion). The UK PMI Construction also rose to 59.4 OCT (exp. 58.7) vs 58.9 SEPT


Get Long The British Pound  - zz. pmi


  • Confidence– Below we show business and consumer confidence, both trending higher since mid 2012

Get Long The British Pound  - zz. uk confidenc


  • Manufacturing and Retail Sales – confidence is a huge piece of the consumption puzzle; we see the trend in manufacturing and retail sales moving positively over the intermediate term. UK Industrial Production popped to 2.2% SEPT Y/Y (exp. 1.8%) vs -1.5% AUG

Get Long The British Pound  - zzz. retail sales and manufacturing


  • CPI – Inflation remains sticky and high, however we expect a #StrongCurrency to increase purchasing power by deflating imported inflation

Get Long The British Pound  - zz. uk cpi


Matthew Hedrick



Takeaway: The labor market deterioration observed over the last few weeks was largely optical as we revert back towards trend-line improvement.

The Initial Jobless claims data is taking a backseat this week to the advance estimate of domestic, 3Q13 GDP  (3Q13 GDP: Juiced By Inventories) and the surprise ECB policy decision - ECB Cuts, EURO Plunges! – which is serving as the lead driver of risk assets globally today. 


However, this week’s claims data provides important confirmation that the deterioration in the labor market observed over the last few weeks was largely optical and should reverse over the coming weeks as we revert back towards trend-line improvement. 


Below is the detailed breakdown of this morning's claims data from the Hedgeye Financials team.  If you would like to setup a call with Josh or Jonathan or trial their research, please contact 


-  Hedgeye Macro





The Jury is Back and Has Reached a Verdict (on the labor market)

Last week we lamented the inability to conclude whether a negative inflection in the labor market was occurring based on lagged CA state level data. This week can speak more definitively. The labor market remains strong. The chart below shows the Y/Y trend in NSA initial claims nationally. The red line highlights the trend rate of improvement prior to CA's IT-related fiasco. The data has now resumed that pre-CA trend rate of improvement.


We won't belabor the point other than to say that the labor market appears not to have skipped a step as we had potentially feared. One thing we will call out, however, is that consumer confidence/comfort has fallen to a new YTD low. We include a chart later in this note illustrating that. The chart shows the 4-week rolling average of the weekly Bloomberg consumer comfort survey, but the weekly data is no less reassuring. It's unusual to see a divergence between the labor market and the consumer comfort survey data. We'll take a closer look and report back with any worthwhile findings next week.




Nuts & Bolts 

Prior to revision, initial jobless claims fell 4k to 336k from 340k WoW, as the prior week's number was revised up by 5k to 345k.


The headline (unrevised) number shows claims were lower by 9k WoW. Meanwhile, the 4-week rolling average of seasonally-adjusted claims fell -9.25k WoW to 347.25k.


The 4-week rolling average of NSA claims, which we consider a more accurate representation of the underlying labor market trend, was -6.2% lower YoY, which is a sequential improvement versus the previous week's YoY change of -3.4%










Joshua Steiner, CFA


Jonathan Casteleyn, CFA, CMT



We’re stunned by the valuations we are seeing in the casual dining industry.  Is anyone even willing to buy casual dining names at these levels?



2013 Year-To-Date Casual Dining Statistics:

YTD Performance

  • Casual dining stocks are up +47% versus +24% for the S&P 500


YTD Macro

  • Conference Board Consumer Confidence is up +21.9%
  • The US Unemployment Rate has improved from 7.9% to 7.2%
  • US Initial Jobless Claims SA have improved from 373 to 340
  • Daily National Average Gasoline Prices are down -1.8%
  • US Disposable Income Per Capita is up +2.9%


YTD Fundamentals

  • On average, casual dining EPS revisions are down -2.9%
  • On average, calendar year revenue growth for companies in the Hedgeye Casual Dining Index is estimated to be +3.7%
  • On average, calendar year EPS growth for companies in the Hedgeye Casual Dining Index is estimated to be +8.6% on a normalized basis (excludes RT and RUTH)
  • On average, same-store sales for companies in the Hedgeye Casual Dining Index have declined from +1% in 1Q13 to +0.5% in 3Q13
  • According to Knapp Track, casual dining traffic is down -2.6% through September
  • According to Black Box, casual dining traffic is down -2.6% through September


YTD Valuation

  • On average, the EV/TTM EBITDA multiple for the Hedgeye Casual Dining Index is up +58.9%
  • On average, the P/TTM E multiple for the Hedgeye Casual Dining Index is up +48.9%
  • On average, the P/TTM CF multiple for the Hedgeye Casual Dining Index is up +50.5%

The late 1990s marked the beginning of a decade of growth for the casual dining industry.  During this time, the average cash flow multiple was 7x.  Today, we estimate the average cash flow multiple to be around 10.7x, as the majority of large, mature names have little to no growth.


Declining traffic, coupled with an earnings miss, used to instill fear in restaurant investors, often sending valuations for those companies to trade closer to 5x cash flow.  This has not been the case lately.  It is our view that the casual dining sector is in secular decline due, in large part, to the increased competition from fast casual restaurants and grocers.  Valuations are stretched and appear to be approaching peak levels.  We believe that the charts below are beginning to resemble a bubble.











*The Hedgeye Casual Dining Index includes BOBE, BWLD, CAKE, CBRL, DRI, EAT, RRGB, RT, RUTH, TXRH.




Howard Penney

Managing Director