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 “Never allow a crisis to go to waste” – Rahm Emanuel

An ever expanding list of states look to expand gaming. In the unlikely event of a v-shaped economic recovery, a state(s) of fiscal desperation will still prevail. We’re entering an extended bull market for slots.

Hopefully, the slot companies are heeding Mr. Emanuel’s advice and pushing their lobbying efforts at maximum effort.  There are plenty of dominoes yet to fall while many are already tilting.  Prospects for expanded gaming in Ohio, Iowa, Illinois, and Pennsylvania look decent.  With the pressing need for cash, states may step on the accelerator.  Long timelines experienced in Pennsylvania and Maryland are unlikely in these desperate times.

Here’s the state by state summary:

  • Ohio - Governor Strickland signed a directive instructing the director of the Ohio Lottery to immediately begin the process of implementing VLT’s at racetracks.  More details will become available today as the budget is released.  The approved legislation permits a maximum of 2,500 video lottery terminals at each of Ohio’s seven racetracks.  Requirements for each of the racetracks include a $100,000 application fee, a $65 million licensing fee, 50% of all net revenue being retained by the state, and capex requirements of at least $80 million in the first five years of operation with at least $20 million of that in the first year.  The proposal to open the door to four new casinos in downtown Cincinnati, Columbus, Cleveland, and Toledo could be back on the table. The Ohio Jobs and Growth Plan (OJGP) petition to have casinos voted on again in November collected more than twice the necessary amount of signatures required by the state government (400,000).  The Secretary of State is expected to give a final ruling on whether there is a sufficient number of valid signatures on the petition.  Despite the racetracks directive from Gov. Strickland, the OJGP plans to continue its campaign for four new casinos in Ohio.


  • Illinois - The Video Gaming Act was signed into law as part of House Bill 255.  The Act creates a new video poker market under the control of the Illinois Lottery Commission.  The Illinois Coin Machine Operators Association believes the number will end up being around 45,000 to 50,000 units.  The machines will be placed in licensed establishments (bars, taverns), licensed truck-stops, licensed fraternal establishments, and licensed veteran establishments.  The Illinois Gaming Board anticipates that it will be at least a year before gamblers in the Prairie State can legally play video poker.


  • Iowa - In light of Illinois approving video poker, Iowa is trying to decide how best to maintain its gaming market. The Iowa Gaming Commission held a public meeting on Thursday and, after some public comment, unanimously agreed to consider licensing new casinos.  Commissioners’ comments seem to indicate that they will be protective of casinos that are already open and that this process for granting new licenses will be more complicated than it was in the past.   The deadline for applications for licenses is October 1st and the commission is expecting five applications.  Press reports indicate that it could take up to a year for the commission to make any final decision.  Lyon County, in northwestern Iowa, could have a strong chance; the market is underserved and so cannibalization of other casinos’ revenue would not be an issue.  It would also draw from the Sioux Falls, South Dakota, market.  It seems likely that at least two new casino licenses will be granted with 2,000-3,000 slots.


  • Pennsylvania - A Pennsylvania state House panel has approved, on the second attempt, a bill that would legalize and tax video gambling machines in bars.  The proposal is designed to generate grants for tuition costs at one of the fourteen state-owned universities or the fourteen community colleges in Pennsylvania.  Some of the votes for the bill were more tepid than others.  Rep. Curtis Thomas voted yes but still wants to make major changes to the bill when it comes up for action on the House floor.  Even if the House passes the bill before the summer break, Senate action is unlikely before the fall. 


IGT is the obvious play on new gaming jurisdictions since it is the largest slot provider in the world and tends to garner a larger market share in new casinos and expansions (60% vs 40% in replacements).  IGT generates about $0.015 in EPS per 1,000 slots sold.  Indeed, the stock has performed well recently due in part to the potential for new markets.  The long term takeaway is that there will be expanded gaming, the fiscal crisis will dictate that.  The only question is which states and when?  The right trading strategy might be to fade optimism of new legislation and buy into pessimism.  Either way, slots could be at the cusp of a huge bull market as replacement demand is troughing and state fiscal desperation opens new markets across the country.

Casual Dining - June Knapp Track

Malcolm Knapp reported that June same-store sales declined 7.7% with traffic down 7.2%.  For the second consecutive month, comparable guest count results were better than sales, which points to the significant discounting in the industry.  Even with companies trying to drive traffic at the expense of average check and margins, traffic trends decelerated sequentially from May on a 1-year, 2-year and 3-year basis. 

These June numbers do not reflect the same level of decline that we witnessed back in December, but the Q2 numbers overall are worse than Q1.  Same-store sales declined 6.6% on average in Q2 versus -4.2% in Q1.  We will learn more about company-specific Q2 results over the next couple of weeks and the winners will be those companies that have been able to offset these soft sales results with continued cost cutting.


McDonald’s plans to release its June same-store sales figures as part of the second-quarter earnings release, which is scheduled to be published before the market open on Thursday, July 23.

The latest proprietary McDonald’s Franchisee Survey asked respondents about their June same-store sales results. For the 35 domestic franchisees -- representing roughly 227 restaurants -- who responded, the aggregate June same-store sales figure is 2.7%.

This survey marks the 39th time that a McDonald’s Franchisee Survey has been published. In the prior 38 times, the actual U.S. same-store sales number reported by McDonald’s has been within 100 basis points of the survey results on 26 occasions, and within 200 basis points of the survey results on 33 occasions. 

The average magnitude of the difference between the survey and the actual result reported by McDonald’s is about one percentage point.

Assuming about 4% pricing, MCD continues to experience negative traffic trends.  Given the extreme discounting we are seeing from MCD, margin pressure can only follow at some point.

These numbers support out favorable position on SBUX and cautious stance on MCD.


Kids Who Commute to High School on the Company Jet

Ripples in Russia

This year we've been cautious in pointing out the risk premium associated with owning Russia, yet assertive that Russia's commodity based economy stands to benefit greatly from commodity reflation, a major theme of ours in the first half of this year. 

The Russian stock market (much like other countries that are paid in petrodollars) has followed the price of oil like a hawk year to date, with a correlation coefficient (R squared) of .94 between the RTSI and the continuous front month light sweet crude contract (see chart). This year we've frequently commented on Russia's performance as it vied for the best performing global market with the other BRIC components, until it began pulling back in concert with oil.  Starting June 1st the RTS declined 28.5% with oil down 12.0% in the same period, before catching a bid this week, up 10.6% on oil's 6.4% run.

While the price of energy commodities and metals remain the central catalyst for the Russian market, we're equally watching the country's underlying economic fundaments as we believe they'll drag down performance on an intermediate and TAIL (3 years or less) basis, especially should oil stay under our TAIL resistance level of $67.78/barrel.

This week the Russia's Economy Ministry updated its economic forecast. Whether the information is completely creditable or not is a matter of discussion in itself, however the Ministry reported that GDP may decline 8.5% this year, after contracting 9.8% Y/Y in Q1 (the most in 15 years) and that Russia may not match last year's growth until 2012.

On the ground industrial production was down 17% in May, with the IMF forecasting unemployment at 13% this year.   Wage arrears rose 10.8% and according to a study by Moscow's Higher School of Economics--and not surprisingly--Russia is seeing a rise in labor unrest with a recorded 99 labor disputes in the first five months (nearly the same level as in all of last year). 

While the data may be questionable, the country's demographics support a grim picture for future growth.  The World Bank reported that by the end of this year 17.4% of the population (24.6 Million) will live beneath the subsistence level of $185 per month, about 5% more than before the crisis. Additionally the Economy Ministry said Russia's working population will annually decrease by ~1 Million every year over the next three, and the population will continue to decline, as it has over the last 14 years; last year the population stood at 141.9 Million.

From a fiscal and monetary perspective Russia is certainly trying to weather the storm, but we'd argue that the Kremlin is not doing enough. The country issued a stimulus package of more than 2.5 Trillion Rubles ($80 Billion -a puny amount in context), and has reduced interest rates to stem the blockage in credit lending. Over the last three months Bank Rossii has cut interest rates three times, shaving off 50bps to 11% in its last cut on July 10th.  

The chart below helps to frame the USD-RUB dynamic along with the price of oil. Certainly the Central Bank has played a large role in manipulating the Ruble's value over the last year, having drained some $200 Billion (1/3 of the country's foreign-exchange reserves) from August to January to stem the Ruble's slide versus the dollar as oil came down off its summer highs. Most recently, the bank reported that international reserves slid by $8.4 Billion to $400.7 Billion last week, the largest decline in almost in six months, as the Bank attempts to strengthen the Ruble. 

All of this action begs the question: to what extent the Central bank is willing to support a strong Ruble policy (and ensure it trades below the high side of its trading band of 26 to 41 against a basket of Euros and Dollars) if oil continues to fall? On one hand, Russia has the reserves to support currency, yet the bank has no control over investors who may flee due to the volatility of a economy levered to energy prices.  

Make no mistake, the Russian stock market is focused squarely on Oil and Gas, yet our work in global macro has taught us that a country's fundamentals drive market performance in the long run. As outlined, on the TAIL there are real risks in the Russian economy and, perhaps more importantly, real political risks to investing there.

In the immediate term, we will continue to analyze all data points -large or small,  made up or not, as we look for signals on the margin that may change our stance.

Matthew Hedrick

Ripples in Russia - russia


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