DDS - Debunking DDS at $155. We Like The Short Side.

Takeaway: DDS at $155 seems ridiculous. The asset play is maybe $50 on a great day. If people value DDS like a retailer again, the stock’s in trouble.

Conclusion: DDS with a $9-handle, or even an $8-handle, was enough to land a spot on our bench of short ideas. But with the spike in the wake of comments by Marcato Capital saying that the stock ‘may be worth $155’, we simply had to weigh in with what ludicrous assumptions you need to make in order to reach that value. We think the property value is maybe $50 per share – on a great day. Let’s not forget about the underlying business, which is looking toppy. We'll take the short side of this debate any day.



The comment that sparked yesterday’s rally was grounded in what could happen to DDS stock price if the company spins out its internal REIT. We absolutely agree that there is real estate value at DDS. The company owns 245 of its 296 stores outright,  or about 42mm square feet of retail anchor tenant space throughout the South. There’s another 19 stores where it has equity ownership through hybrid and ground leases.


But let’s consider a few things.

In January 2011, DDS first announced that it would spin off its real estate into a wholly owned REIT. But at the time, it failed to monetize its assets to the public. Three considerations…

  1. DDS had a sizable NOL that was set to expire at the end of its fiscal year (Jan 11). Proceeds from the internal REIT transaction were offset by the NOL, giving the company a $202mm tax credit in FY11. Because of the transaction assets were marked to fair value allowing the company to realize tax depreciation deductions by $5mm on annualized basis for the next 20yrs and $2mm for years 21-40. Simply put, this was a no-brainer at the time from a financial engineering standpoint. But it doesn’t mean that there’s a public market for DDS’ properties, even though the equity market thought so at the time.
  2. Typically one retailer would not account for more than 10% of a property owner’s income. The point here is that the pool of buyers out there is extremely limited for such a large number of stores.
  3. DDS’ current real estate portfolio is very heavily weighted towards B & C mall properties. These assets account for less than 20% of public mall REIT NOI despite their disproportionately high representation. The top 30% of mall properties for example account for 60% of public REIT NOI. Dillard’s presence at these premier properties is scant.



What About Value?

Let’s start with the only two assumptions that really matter here, which is a) the rent/foot for the portfolio and b) the cap rate (a de-facto discount rate – the expected rate of return based on the asset’s income profile).

a)    Most anchor tenants average somewhere between $4-5 per square foot. KSS is bottom of the barrel (strip malls are cheaper) at about $4.15, JCP is about $4.95, Macy’s at $5.15, and JWN at $6.30. On the properties that Dillard’s currently leases, it is paying around $4.90 per foot. But the catch here is that those are among the best properties in its portfolio. Our sense is that the properties in question (that could be monetized) are closer to $4.25.

b)   The cap rate is more theoretical, but no less structured. Usually it’s feast or famine. What we mean is that the lower rent-generating assets will command a higher cap rate (north of 10%), while the premium higher-quality properties will have a cap rate within 300bp of the risk free rate.  Given the preponderance of B and C malls in Dillard’s portfolio we suspect that we’d be looking at a cap rate of about 10%.

c)    Add those two assumptions together and you get a value of about $1.8bn, or about 38% of DDS’ enterprise value. That’s about $42 per share, about 55% below current levels. We’re not saying that this where the stock is going, but there’s another $3bn in Enterprise Value that needs to be supported by these things called Revenue and Margins. They sometimes get forgotten when people get overly pumped about real estate.

d)    Let’s assume for a minute that we’re totally wrong in our assumptions – after all, we have not had an independent appraiser visit each of the 264 properties owned by DDS. But where the stock is now, we don’t think we have to. Let’s assume that Dillard’s rent profile is an even $6.00 per foot – which is just a hair below JWN. Now let’s assume a cap rate of 6%, which is far better than you’ve got at Macy’s, and probably nearing the ballpark of what we might expect at Wal-Mart. That gets us to a $105 per share value. That’s within 10% of where the stock is trading today. You want to get to $155 in the stock? Use $6 per foot at the same yield we’re looking at today on a 30-year treasury. Good luck with that.   


DDS - Debunking DDS at $155. We Like The Short Side. - 4 22 2014 8 26 15 PM


And if the company does manage to pull off this public REIT, then ask yourself what it does with the proceeds. About 45% of it goes to pay off debt. So then it goes from having net debt to having net cash. That’s definitely a plus. But another thing people often forget to do when properties are sold is ask the question as to whether the company will remain a viable entity. If the answer is Yes for Dillard’s, which we suppose is the case (unlike the SHLD property debate), then we have to add back $200mm per year in rent. It has these properties now at a great rate (free), but when it sells them it has to pay to play.


The punchline for us on this one is that a $155 value is simply ridiculous. We have a hard enough time getting to $90. The asset play is maybe $50 at best – and that’s assuming there is liquidity (we’re uncomfortable assuming that one). More realistically, DDS sells off properties a few at a time, where the pool of buyers is far greater. That might help along the way, but shoots the big ‘public REIT’ call in the foot.  If people start valuing this like a retailer again, the stock is in trouble.


Declining participation installed base troubling but strong ASPs were the offset. We'll have more to say on IGT




  • Cost savings in $30MM in current fiscal year and $50MM on an annualized basis
  • Wheel of Fortune will be in DoubleDown at calendar year-end
  • Powerbucks:  expect NV and Canada to come online by end of FY
  • Avatar product:  performance surpassing Wheel of Fortune in 40% of locations where Wheel of Fortune and Avatar both exist; Avatar performing above mgmt expectations 
  • Crystal Core cabinet:  2nd Avatar game coming on new hardware platform - expectations similar to 1st Avatar game
  • Class II market:  next quarter, will release new titles in this market
  • South Africa:  2,000 terminals will come online in the next 18 months (IGT will secure 50% share)
  • International systems business:  in FQ2, deployed cloud product to UK.   Three casinos on our cloud product will expand to ten in the next coming quarters as well.
  • Replacing Aristocrat systems in South Africa (3 casinos)
  • Gaming ops yields increased sequentially in-line with seasonal trends.
  • Install base declined sequentially due largely to declines in MegaJackpots
  • Expect gaming ops gross margins for FY to be consistent with FY2013
  • Capex decreased to $15MM
    • Expect increase in 3Q/4Q  capex due to upcoming launch of new Crystal Core Cabinet but total CapEx lower than FY2013
  • International revenues declined 25% due to implementation restrictions in Argentina and soft demand in a few other markets
  • ASPs improved due to mix shift of higher priced units
  • Several of recent titles performing well in  the market, including Prowling Panther, high Volatility game designed for the gambler and Jade Fortune, a new Asian-themed game.
  • Launching Winners Choice in F3Q
  • Expect Doubledown revenues to be up 20% for FY
  • Tax rate elevated at 39.5% due to adverse impact of peso devaluation in Argentina.  Expect effective tax rate to be ~35% for reminder of year


Q & A

  • Working hard to protect yields; continues to expect  mid-single-digit decline in yields. Optimisitic on yields for F3Q, F4Q 
  • Non-gaming sales high:  higher than expected. Had IP settlement that timed in FQ2 rather than Q3.  Half of the increase is IP. Remainder of the growth is parts and conversions.
    • Normalized run rate probably average of last four quarters
  • Lots of noise in margins and product sales.  It's about flattish.  Upward pressure seen in ASPs.  Expect flat product sales margins to continue.
  • Non-box margins were pretty consistent with box margins
  • Cost savings come exclusively from SG&A
  • SG&A:  Still targeting 19-20% of revenue (excluding items); however, it can fluctuate given revenue trends
  • Class II similar to poker business.  Ready for an upgrade in that market. See good Class II growth in Mexico/South Africa.
  • Fierceness of the competition hasn't changed much
    • Competition coming from both price and product, esp MegaJackpot.  Another factor is the competition for operating expense $$ from their customers that is affecting both gaming ops and product sales.
  • #1 priority is to eliminate declines in installed base
    • Renovations at SLS and Cromwell have resulted in lower install base
  • Believe flat to down (more likely down) replacement cycle this year than last
  • Feel comfortable with R&D levels
  • DoubleDown is GAAP accretive now
  • On DD MAU, IGT focused on converting players into payers i.e. bottom line.  Not concerned about MAU decline
  • Continue to outperform expectations on ARP (average revenue per DAU); ARP is industry-leading
  • Need 30-60 days to quantify effect of Powerbucks
  • IL units in FQ2;  1,000 (pretty normal run rate).  Do not have ship share #
    • We think it was 44% ship share
  • South Africa is an expanding market.  Expect the market to be like product sales. May have a daily fee attached but more product sales than participation business
  • Making progress on the mobile product
  • Wheel of Fortune mobile will be out by end of calendar year too

MCD: Staying On The Sidelines

Takeaway: We continue to dislike MCD, but we're staying on the sidelines. Look for a stronger entry point on the short side post the 2Q catalyst.

In mid-February, we pulled MCD from our Best Ideas list as a short due primarily to easy comparisons and the likelihood of a future financial engineering event.  Despite this, we believe the McDonald’s business continues to have underlying issues that, at this point in the game, are not easily addressable.  This morning’s press release and subsequent earnings call validated our thoughts.


McDonald’s reported disappointing 1Q14 results this morning, missing top line and bottom line estimates by 25 bps and 222 bps, respectively.  Although system-wide same-restaurant sales beat estimates by 10 bps, the global business continues to be bogged down by the most important market – the U.S.  Europe and APMEA same-restaurant sales exceeded expectations, but both markets continue to have issues.  Overall, the McDonald’s system generated negative traffic in the quarter, driven by its four primary markets: U.S., Germany, Japan and Australia.  Until performance in these markets turn meaningfully, the system will be hard pressed to generate notable earnings growth.


System-wide same-restaurant sales were +0.5%, beating estimates of +0.4%


MCD: Staying On The Sidelines - 1



U.S. same-restaurant sales missed estimates by 30 bps, driven by negative traffic.  Management attributed most of the miss to unfavorable weather (note: CMG just put up a +13.4% comp) and, to a lesser extent, challenging industry dynamics (note: challenging for MCD).  As a result, company operating margins fell 10 bps to 17.3%.  Part of the margin compression can be attributed to higher commodity basket, led by proteins, that was up +3% year-over-year.  Management expects this commodity pressure to persist throughout 2Q, before easing in 2H14.  Guidance for the full-year grocery basket continues to imply a 1-2% increase.


MCD has identified several opportunities (enhanced marketing, enhanced customer experience, stronger core/promotional balance) to help strengthen the U.S. business.  While the opportunities are apparent, the plan to execute and capitalize on them is less clear.  We expect all domestic restaurants to have new kitchen equipment installed by mid-year, but the effect of the high density prep tables is largely unknown and franchisees have reported mixed feelings.  Domestic restaurants will also implement a reset in the first half of 2014, focusing on staffing and scheduling, which could benefit peak hour throughput.  A new, innovative marketing message could help the brand generate some modern day relevance and the company is hoping the new CMO will be able to deliver this.  Management emphasized the importance of its breakfast business and denied any claims of competitive pressures affecting the daypart in 1Q.


U.S. same-restaurants sales were -1.7%, missing estimates of -1.4%.


MCD: Staying On The Sidelines - 2



Europe same-restaurant sales beat estimates by 20 bps, driven by strength in the U.K., France and Russia.  Company operating margins improved 30 bps to 70.3%.  Despite this, negative same-restaurant sales and traffic momentum continued in MCD’s most important European market – Germany.  The brand continually struggles to offer affordability and connect with customers in this country.  We need to see this market turn before we become bullish on this region.  In accordance with Hedgeye’s Macro view, management acknowledged that economic indicators in the region appear to be stabilizing, but cautioned that quarter-to-quarter results could remain volatile. 


Europe same-restaurant sales were +1.4%, beating estimates of +1.2%


MCD: Staying On The Sidelines - 3



APMEA same-restaurant sales beat estimates by 30 bps, driven by strength in China, due primarily to a one-time benefit as the country lapped last year’s supply chain issue.  Japan and Australia, however, weighed down the overall performance of the region.  Company operating margins decreased 60 bps to 14%, as sales momentum wasn’t enough to fully mitigate cost pressures and the negative impact from new restaurant openings in China.  Management continues to believe this region offers the potential for significant growth.


APMEA same-restaurant sales were +0.8%, beating estimates of +0.5%.


MCD: Staying On The Sidelines - 4



On the earnings call, management highlighted four opportunities for improvement in their priority markets.  These initiatives, which could be applied to other markets as well, include:

  1. More effectively bridging consumer insights into the right plans and actions
  2. Delivering a stronger, more resonant marketing message
  3. Enhancing affordability platforms
  4. Better balancing focus on core menu items and LTOs

There’s nothing wrong with these initiatives.  In fact, we understand the basic rationale behind all of them, but that alone doesn't give us confidence in management's plan.  The issue is they are not easily achievable or measurable and will be difficult to tailor to each diverse market.  McDonald’s is not nearly as nimble as it used to be.  We like that management is acknowledged some of the concerns we have raised, but none of these initiatives offer game-changing solutions. 


As we cautioned several months ago, the real, more immediate opportunity for value creation is in the form of a future financial engineering event.  Management didn’t go into much detail, but they did reinforce that they are continually looking at ways to improve shareholder returns.  As CFO Pete Bensen briefly mentioned on the call, this could include optimizing the capital structure, re-franchising activity (particular in international markets) and reallocating general and administrative expenses. 


We’d rather not speculate at this point, but we assume this event will be a positive catalyst for the stock.  Management plans to release more details surrounding this development prior to the closing of the second quarter.  As it stands, we believe the stock remains disconnected from the fundamentals and until we see a material improvement in system-wide trends, particularly in the U.S., we continue to believe this event will provide another nice entry point on the short side.  For the time being, we remain on the sidelines.   


MCD: Staying On The Sidelines - 5


Howard Penney

Managing Director


Fred Masotta


Poll of the Day Recap: 70% Say Yes, Volume Matters

Takeaway: 70% voted YES; 30% responded NO.

Poll of the Day Recap: 70% Say Yes, Volume Matters - stock trading


Hedgeye CEO Keith McCullough wrote about the lack of recent buying conviction in today’s Morning Newsletter and has argued that volume matters because “stocks are making lower-highs versus the all-time-bubble highs; it’s extreme price versus volume divergences (from unprecedented prices).”

But we wanted your opinion in today’s poll: Does volume matter?

At the time of this post, the heavy majority went toward 70% voting YES; 30% responding NO.

As one YES voter explained, “It matters because it shows lack of participation by the broader market players. The broader market is likely positioned for a downside move and waiting for that catalyst can be painful and expensive.”

Other noteworthy YES comments included:

  • “Only in the very immediate term. Having been in secular decline, volume has held a near-perfect inverse correlation to the equity market over the past 5+ years. Better said, stocks pretty much only go up when volume is falling over longer durations.”
  • “Volume is only one of the many components that should be considered in gauging market up vs down days. Price action, VIX, sector rotations, bonds, currency action(s) are other major components. Albeit for this poll; Yes, volume does matter.”
  • “More importantly, [Dennis] Gartman is now Long of equities in equity terms.  Combine all factors and you get a major warning signal.”

Over in the NO group, however, one responder explained that volume “only matters if you’re on the wrong side of the trade,” while another believed volume “hasn't mattered for five years since the current rally began.”

Though one NO voter acknowledged that volume has been in secular decline since 2009, they specifically stated that it “will be even under more pressure with the rug being pulled out from HFT.”


Green Screen Macro: Flowers, Showers, Ticking Clocks & Back-Half Ramps

Takeaway: Is anyone not expecting a bounce in the reported March/April fundamental data?

Green Screen Macro:  Flowers, Showers, Ticking Clocks & Back-Half Ramps - Weak in the Dollar


Editor's Note: This note was originally sent to subscribers on April 17, 2014 by Hedgeye Macro Analyst Christian Drake. Follow Christian on Twitter @HedgeyeUSA.


  • Green Screen Macro: Paint whatever eco-growth picture you want. And remember, when in doubt, herd your point estimate for growth right on the current consensus and… always, always, bake in the back-half ramp.
  • Tracking the Bounce: Is anyone not expecting a bounce in the reported March/April fundamental data? We continue to think the 2014, growth-slowing playbook remains the relevant one.
  • Initial Claims -  April Flowers: A fourth week of accelerating improvement. The numbers for the month-to-date are supportive of a strong April jobs report.
  • #InflationAccelerating: Food, energy, and housing are all key cost centers for the consumer and with inflation in each currently running at a premium to wage growth, share of wallet for other discretionary purchasing will remain under pressure
  • #HousingSlowdown: The pervasive deceleration in housing activity to start the year has extended itself into March/April - across geographies. The West, not the Northeast, has looked the worst.   
  • Policy Thoughts: The Ticking Clock: The Fed needs to get out if only to allow themselves to (credibly) get back in. The clock is ticking on the current expansionary cycle.  

Macro’s Green Screen

Listening to Yellen’s remarks and the referencing of her now enigmatic “dashboard” while staring at consensus growth estimates for 2014 provided this year’s most potent reminder that professional macro forecasting remains very much a storytelling exercise.   


Indeed, for Fed tea leaf readers, the chess match that has become massaged messaging to markets under the Fed’s fledgling, increased transparency directive only adds another distortive layer to the storytelling.


For forecasters...remember, when in doubt, herd your point estimate right on current consensus (which at a round 3% is, itself, just an un-imaginative expectation for a return to pre-recession Trend line growth) and always, always, bake in the back-half ramp


Green Screen Macro:  Flowers, Showers, Ticking Clocks & Back-Half Ramps - GDP estimates Cons

Slope Stacking: Tracking the Bounce

With a host of domestic macro metrics recording some of the biggest sequential declines in history in the weather-distorted December to February period, is anyone not expecting a bounce in the reported March/April fundamental data?   


What we’d like to see, in short, is the slope of growth track back toward the levels that characterized the heart of the 2013 acceleration.   


Thus far, the March/April data has been mixed as most measures have shown sequential improvement, but haven’t exhibited a material, rebound effect that would be suggestive of deferred activity and certainly haven’t retraced the cumulative declines realized in the peri-new year period.   


With the dollar holding in bearish formation, 10-year yield is broken (and declining in the face of the last few, low volume equity rallies), and inflation still rising alongside increasingly harder growth/inflation comps through 3Q14, we continue to think the 2014, growth-slowing playbook remains the relevant one.   


Green Screen Macro:  Flowers, Showers, Ticking Clocks & Back-Half Ramps - Macro Slope Stack


Green Screen Macro:  Flowers, Showers, Ticking Clocks & Back-Half Ramps - Eco Summary Table 041714

Initial Claims: April Flowers for Labor

Initial Claims has been the notable positive diverger from a fundamental data perspective over the last month. 


This morning’s labor data extended the streak of accelerating improvement to four consecutive weeks as the 4-week rolling average in non-seasonally adjusted claims improved to  -12.1%  year-over-year  vs. -10.5% the week prior.    


The trend in headline, seasonally-adjusted claims was similar with the 4-week rolling average falling -4.25K week-over-week to 312K, the lowest level since August of 2007.


As Josh Steiner, our head of Financials research at Hedgeye, highlighted: 


The weather's turn, particularly in the Northeast, remains coincident with the turn in the claims data. Based on the numbers so far, it looks like the April job's report will come in quite strong.


Green Screen Macro:  Flowers, Showers, Ticking Clocks & Back-Half Ramps - 2


Green Screen Macro:  Flowers, Showers, Ticking Clocks & Back-Half Ramps - 1


Headline CPI inflation accelerated +40 basis points sequentially to +1.5% YoY while Core CPI  accelerated +10bps to +1.7% YoY in March. Under the hood, the existent trends extended themselves as food, energy, and shelter price growth all continued to accelerate.  


Green Screen Macro:  Flowers, Showers, Ticking Clocks & Back-Half Ramps - Core PCE vs Food   Energy Inflation March


Green Screen Macro:  Flowers, Showers, Ticking Clocks & Back-Half Ramps - CPI Housings Pull march


Green Screen Macro:  Flowers, Showers, Ticking Clocks & Back-Half Ramps - OER Contribution March


Real Hourly Earnings of Production & Non-Supervisory Employees grew +0.8% YoY in March according to BLS data released Tuesday – a sequential deceleration of 70bps vs. the +1.5% YoY growth recorded in February – and nominal spending continues to grow at a positive spread to incomes


Green Screen Macro:  Flowers, Showers, Ticking Clocks & Back-Half Ramps - Spending vs. Earnings Nominal 041714


Food, energy, and housing are all key cost centers for the consumer and with inflation in each currently running at a premium to wage growth, share of wallet for other discretionary purchasing will remain under pressure. 


Further, with household savings rates already at the low end of the historical range, consumer credit growth (ex-auto & student loans) tracking sideways, equities down YTD and housing slowing, the capacity for non-wage related factors (i.e. credit, reduction in savings, wealth effect) to support incremental consumption growth appears constrained.  


Core PCE inflation, meanwhile, continues to list at approximately +1.0% YoY.  Persistent, sub-2% PCE inflation gives the Fed latitude to further talk down the dollar which, in our view, will only perpetuate rising inflation and, by extension, a slowdown in domestic consumerism.  


Green Screen Macro:  Flowers, Showers, Ticking Clocks & Back-Half Ramps - Median Consumer Expenditures


Source: Hedgeye Financials

Green Screen Macro:  Flowers, Showers, Ticking Clocks & Back-Half Ramps - loan compendium chart


The pervasive deceleration in housing activity to start the year has extended itself into March/April - across geographies. The West, not the Northeast, has looked the worst.    


  • NAHB HMI:  Headline NAHB confidence increased 1 point month-over-month in April vs the downwardly revised March print. Notably, with the exception of the Northeast, builder confidence was flat or down across geographies. Confidence in the West region slid for a third consecutive month to 45, continuing its expedited drawdown from a peak reading of 71 just three months ago. 
  • Mortgage Applications: Yesterdays purchase application index rose 1.3% WoW  but remains -17% off the May 2013 peak.  Similarly, the composite index (purchase + refi) gained +4.3% WoW but remains in free fall at -58% YoY. We continue to believe the confluence of QM implementation, declining affordability, and a slowing consumer will drag on housing demand, with home prices responding on a lag.   
  • Housing Starts/Permits: Housing starts rose 26K MoM but missed estimates by a comparable amount while Building Permits went sub-1 million, declining -2.4% MoM to 990K.  On a relative basis, supply/demand/price dynamics in the new home market continue to compare favorably to those in the existing market.  Buyer demographics and the cumulative deficit in new housing units built since the recession should help buttress the relative downside in new construction activity.  

Green Screen Macro:  Flowers, Showers, Ticking Clocks & Back-Half Ramps - NAHB Regional


Green Screen Macro:  Flowers, Showers, Ticking Clocks & Back-Half Ramps - Mortgage Apps


Green Screen Macro:  Flowers, Showers, Ticking Clocks & Back-Half Ramps - Home sales by region NAR


Green Screen Macro:  Flowers, Showers, Ticking Clocks & Back-Half Ramps - San Fran Case Shiller

Quasi-random Policy Thoughts:
The Ticking Clock

By FOMC admission, the juice on quantitative easing (QE) has been largely exhausted and the risk/reward balance has shifted. If anything at this point, the Fed needs to get out if only to allow themselves to (credibly) get back in. 


A cessation of QE alongside decent macro data accomplishes two things. 


First, from a messaging perspective, it signals confidence in the ability for the private sector to carry the recovery forward. 


Second, stopping QE while the fundamental data is supportive implies that QE was (at least in part) effective in its objective.  Some measure of perceived effectiveness by the market allows them to come back to it should they need to.    


Perma-QE, however, is de-facto admission of its ineffectivenss, leaving it largely impotent as a forward policy tool.     


The line of thinking above isn’t necessarily new or novel but, as of April, the duration of the current expansion stands at 59 months – exactly the mean duration of expansions following recessions over the last 100 years. 


Sure, balance sheet recessions are defined by slower recoveries with lower amplitude, but do you think the Fed is completely unaware of the ticking clock?  


Green Screen Macro:  Flowers, Showers, Ticking Clocks & Back-Half Ramps - US Recession Cycle



Cartoon of the Day | Beware of (Low) Volume

Takeaway: Lower-highs on lower-volume doesn’t confirm a renewed bull.

Cartoon of the Day | Beware of (Low) Volume - Price Volume 04.22.2014

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