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GALAXY: CONF CALL HIGHLIGHTS

The Galaxy call was fairly optimistic (when is it not?). Most of the issues we see are on the Mass Market side – supply growth and discounting – which shouldn’t affect the VIP centric Starworld much.

 

Galaxy 2Q09 Earnings call:

  • Improving but more competitive Macau market
  • Continuing with the development of Galaxy Cotai but at a slower pace
  • Added 16 VIP tables in June and 6 more in July at Starworld
  • 50% of their Mass table area was closed during the quarter due to renovations
  • Cotai shell is due to completed end of 2009 and will align the opening with a recovery in the market
  • Maintained 12% market share in Q2 in the face of supply growth
  • Annualized ROI of 26%
  • Net cash positive at end of June, retired $250MM of debt at .50 on the dollar
  • Confident that they can deliver the $200MM of operational efficiencies that they have already announced

 

Q&A

  • Did have 50% of the Mass gaming floor out of operations for at least 50% of the quarter
  • Very diligently managing their costs
  • Are they able to take on additional debt under their current credit agreements?
    • At the corporate level there are no restrictions think they need to get lender approval
    • Doesn’t sound like they have an issue here
  • Seeing positive trends in Cotai with the opening of City of Dreams – gaining critical mass needed to succeed
  • Commission Caps?
    • “Momentous occasion” the commission cap has been on the table for over a year.  They are cautiously optimistic that there will be a cap implemented by year end
    • Don’t think it will have a large impact on VIP volumes
    • We remain skeptical that the y will be enforced and are concerned with the number of loop holes – more on that later
  • How do they feel about 2010?
    • Fairly positive
  • Any other trends they can highlight?
    • VIP volumes were up around 10% in the 2Q
    • July was pretty solid as well
    • Added 6 new tables in July and relaunched the Mass gaming area this past Sunday
  • Cotai Project – remaining capex?
    • Spent HK$4BN already, have another HK$1-1.5BN left for 2009 and then another HK$4BN
    • Leverage post project will be 35-40%, and should decline once the property gets up and running
  • Mass Market strategy
    • Cash rebate programs are very competitive with the market – we are concerned with the potential for shrinking Mass Market margins
    • Volumes in July are pretty healthy
    • June was the best month for VIP volume
  • Starworld ROI – 26%, hope high teens ROI at the Cotai project and eventually break 20%
  • Tax gain was from the bond buyback – HK$800MM ($100MM US)
  • Areas for operational improvement, future for the company/ strategic direction
    • Pleased with the new marketing programs
    • Working on efficiencies
    • Focused on opening an “Asian Centric” Cotai resort
  • Will be prudent and opportunistic with debt buyback now that the paper is trading in the 90s
  • May & June visitation numbers have been very weak, despite decent revenues
    • Hasn’t affected them as much because they are VIP focused
    • Once they  re-opened, the majority of the Mass space their visitation has improved
  • Bank debt: only a few hundred million HK
  • Restatement of Mass and VIP revenues in their reporting
    • Reporting is consistent with the way they pay their commission and the DICJ practice
  • Where is the cash coming from on their balance sheet?
    • Working capital –have had inflows/deposits from new VIP room junkets
  • How will the HK$5.4BN of cash on hand be spent?
    • Mostly on Cotai – another HK$5-5.5BN to spend
    • Construction materials / city clubs/ Starworld cash flow will help fund that
    • Not unreasonable to think that they will do a new debt offering in the future given the recent repurchases - Will be opportunistic – but have no plans for a buyback right now
  • VIP/ Mass split with the capacity additions:
    • VIP – 140
    • Mass- 100
  • Cotai – spend about HK$300-400MM in 1Q09 and a few hundred MM in 2Q09
  • City Club- Declining EBITDA contribution – reorganized the business – they switched from a profit share to a top line agreement – they actually lost money in the 2H08. Think they will contribute around HK$100MM per year
  • Lots of questions on where all the cash balances came from – VIP promoter deposits and R/C draw as well…  Cash balances will obviously decrease going forward as they develop Cotai
  • Bank debt – was HK$200-300MM … now they repaid it.  I don’t understand why they just don’t disclose their debt balances – ie net cash
  • Seeing HK$50MM per quarter of savings
    • Starworld focused on managing labor and marketing.
    • Reducing work week from 48 to 40 hours. 
    • Directing investment of marketing more productively
  •  The commission cap will definitely benefit their margins, commission caps are north of 1.25% now
  • VIP volumes aren’t growing so why is everyone so upbeat?
    • Added 16 tables in June and another 6 in July
    • Over time- visa restrictions, swine flu, economy… just feels better

Bernanke's Bananas

"There is nothing more deceptive than an obvious fact."
-Sherlock Holmes
 
The global macro fact of the matter remains - when the US Dollar goes up, everything priced in those dollars goes down. That's what happened yesterday. Let's eliminate that from our minds and focus on today.
 
Today, the US Dollar is trading down again. And guess what? Oh yes dear leading indicator investors, those US Futures like that don't they! The fact of the matter remains - when the US Dollar goes down, everything priced in those dollars goes up.
 
At one point yesterday, the inverse correlation was a perfect 1:1. The US Dollar Index was up +1% and the SP500 was down -1%. Perfect is as perfect does, so in Forrest Gump fashion I simply re-shorted the US Dollar (UUP) and started getting "long of" things that would augur well to a reversal in that one-day move (US Technology ETF and the Australian Equity ETF). While one day performance always matters, it does not a TREND make.
 
Never mind intermediate term TREND, across all durations in my macro model, the Buck is Broken. We have 3 Macro Themes that we issue at the beginning of every quarter here at Research Edge, and one of them has been "Burning The Buck". Cramer, please stay in your cage. This banana is mine.
 
I have beaten this theme to a dead pulp in 2009, and I will continue to until the facts change. The fact of the matter remains - we are witnessing the most politicized directive that US monetary policy has ever seen. Don't fight it folks. Capitalize on it. There are no incremental buyers of significance for the American compromise anymore. The US Dollar will not find a sustainable bid until Ben Bernanke raises rates.
 
Since the professor of Great Depression storytelling outlined his economic outlook at his Humphrey Hawkins testimony last week, the short end of the US Treasury yield curve has gone straight up. Straight up? Yes, straight up into the right hand corner of the chart - get one of the 50-day Moving Monkeys to give you their read on it. Throw them a banana and they'll say "bullish." Since July 22, the yield on 2-year treasuries have gone from 0.93% to 1.18%. By my math, that's a +27% move in just over a week.
 
The Economist had a great one-liner in their Future of Economic Theory feature a few weeks back: "real scientists don't leaf through Newton's Principia Mathematica to solve problems!" Mr. Bernanke's rear-view considerations of what he learned in the library stacks about 1929 aren't going to help you risk manage your finances either. Let's seriously get with the program here Mr. Chairman. Mr. Market is embarrassing you.
 
Real-time markets are leading indicators. GDP, unemployment, and the history of Goldman blowing up levered long Investment Trusts in 1930 are lagging ones. For those who continue to manage other people's moneys using Bernanke's economic outlook as their leading indicator, all I can say is Godspeed.
 
Back to that Buck that Bernanke is Burning... here are the price levels and durations I am considering when I say that its broken:
 
1.      TRADE (3 weeks or less) resistance = $79.74

2.      TREND (3 months or more) resistance = $81.68

3.      TAIL (3 years or less) resistance = $82.77

 
I get to my numbers using these little mathematical monsters we fact oriented sleuths in math call fractals. I know, I know - these aren't the kinds of things like a 200-day moving average that my 2-year old can plug into Yahoo Finance and belt over the box at Merrill. My levels are born out of a global macro multi-factor investment process. A mathematician would call it complexity or chaos theory.
 
I know, I know - that sounds like being a quant. So what? It's better than sounding like a monkey. But if you throw my quant boys a banana over here, they'll eat them too ... and then they'll smile, reminding you that complexity theory may be the most relevant scientific discovery since relativity. It matters.
 
The global market place is an interconnected and complex system with dynamically changing inputs/outputs. When "smart" people told me that spending so much time on macro was "style drift" 3 years ago, I actually had to grind my teeth and listen. Today, some of those people have closed their almighty funds.
 
Today is one more day where we have an opportunity to recognize that we have a wonderful opportunity in modern day finance. We have the opportunity to evolve.
 
We have an opportunity to quantify our decision making processes rather than qualify them. After all, this is a tidy way of auditing all of Washington and Wall Street's storytelling. While fiction is entertaining, don't forget that the stories theoretically make sense because they are made up.
 
Today is the first day this week where the immediate term reward in the SP500 outruns the risk. I have immediate term resistance/support at 995 and 965, respectively. If Bernanke's free money bananas are on the table again today, eat'em.
 
Best of luck out there today,
KM


LONG ETFS

EWA - iShares Australia
-EWA has a nice dividend yieldof 7.54% on the trailing 12-months.  With interest rates at 3.00% (further room to stimulate) and a $26.5BN stimulus package in place, plus a commodity based economy with proximity to China's reacceleration, there are a lot of ways to win being long Australia.

EWG - iShares Germany - We bought Germany on 7/28 on a pullback in the etf. Chancellor Merkel has shown leadership in the economic downturn, from a measured stimulus package and budget balance to timely incentives such as the auto rebate program. We believe that Germany's powerful manufacturing capacity remains a primary structural advantage; factory orders and production as well as business and consumer confidence have seen a steady rise over the last three months, while internal demand appears to be improving with the low CPI/interest rate environment bolstering consumer spending. We expect slow but steady economic improvement for Europe's largest economy.

XLK - SPDR Technology - Tech got smushed for the 2nd day in a row on 7/27. Buying red.

QQQQ - PowerShares NASDAQ 100 -With a pullback in the best looking US stock market index (Nasdaq) on 7/24, we bought Qs. The index includes companies with better balance sheets that don't need as much financial leverage.

CYB - WisdomTree Dreyfus Chinese Yuan
- The Yuan is a managed floating currency that trades inside a 0.5% band around the official PBOC mark versus a FX basket. Not quite pegged, not truly floating; the speculative interest in the Yuan/USD forward market has increased dramatically in recent years. We trade the ETN CYB to take exposure to this managed currency in a managed economy hoping to manage our risk as the stimulus led recovery in China dominates global 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 - Buying back the GLD that we sold higher earlier in June on 6/30. In an equity market that is losing its bullish momentum, we expect the masses to rotate back to Gold.  We also think the glittery metal will benefit in the intermediate term as inflation concerns accelerate into Q4.


SHORT ETFS

UUP - U.S. Dollar Index - With a +1% move in the USD on 7/29 we shorted the greenback. This is how you earn a return on the socialization of the US Financial system's risk. We believe that the US Dollar is a 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 US dollar.

XLI - SPDR Industrials
- We don't want to be long financial leverage, which is baked into Industrials.

EWI - iShares Italy
- Italian Prime Minister Silvio Berlusconi has made headlines for his private escapades, and not for his leadership in turning around the struggling economy. Like its European peers, Italian unemployment is on the rise and despite improved confidence indices, industrial production is depressed and there are faint signs, at best, that the consumer is spending. From a quantitative set-up, the Italian ETF holds a substantial amount of Financials (43.10%), leverage we don't want to be long of.

DIA  - Diamonds Trust
- We shorted the financial geared Dow on 7/10, which is breaking down across durations.

EWJ - iShares Japan -We're short the Japanese equity market via EWJ on 5/20. We view Japan as something of a Ponzi Economy -with a population maintaining very high savings rate whose nest eggs allow the government to borrow at ultra low interest levels in order to execute stimulus programs designed to encourage people to save less. This cycle of internal public debt accumulation (now hovering at close to 200% of GDP) is anchored to a vicious demographic curve that leaves the Japanese economy in the long-term position of a man treading water with a bowling ball in his hands.

XLY - SPDR Consumer Discretionary
- As Reflation morphs into inflation, the US Consumer Discretionary rally will run out of its short squeeze steam. We shorted XLY on 7/9 and again on 7/22.

SHY- iShares 1-3 Year Treasury Bonds
- If you pull up a three year chart of 2-Year Treasuries you'll see the massive macro Trend of interest rates starting to move in the opposite direction. We call this chart the "Queen Mary" and its new-found positive slope means that America's cost of capital will start to go up, implying that access to capital will tighten. Yields are going to continue to make higher-highs and higher lows until consensus gets realistic.


BUZZKILL

Last night’s 5% pullback in the Shanghai Composite was a jolt to the system of bubble watchers like myself who have been following the trajectory of a market that appears to have come too far too fast in recent weeks -driven by a cocktail of optimistic first-time investors, easy credit and raw momentum.  5% does not a correction make however, so the price action in the next two sessions will provide us with a critical signal.

Currently, the quantitative model that Keith uses as part of our portfolio process has identified a SSEC index TRADE resistance level at 3,488 and a TRADE support level at 3,123. On a longer duration, 2776 is setting up as a TREND support line.

BUZZKILL - abchina1

In the here and now, Chinese equities are not being driven by fundamentals and only two forces are poised to force a reckoning:

  1. The IPO Calendar: In the wake  of the 12 billion share State Construction initial offering there are a slew of additional companies lined up to begin trading now that the 9 month new issue moratorium  has ended. Presumably, even with the billions of dollars that Chinese households have in savings accounts, the impact of increased supply will be felt eventually.
  2. Credit: Last night saw a 57 basis point spike in 1 month repo rates to 2.23% on speculation of tightening by the central bank. The trend in short term rates in recent weeks has been pronounced as more stock and commodity speculators enter the short term money markets (see chart below).

BUZZKILL - abchina2

On this second point, Ken Fisher was quoted today saying that Chinese regulators have “zero incentive” to curb lending since the nation’s economy is “going gangbusters compared to the rest of the world, so why would they try to kick that”. Now I know that Ken has been doing this for longer than I have, but to my mind the decision by the central bank to keep the loosening policy in play doesn’t necessarily mean that they won’t try to curb speculative excess.  Beijing doesn’t want to have volatile stock market fluctuations create discord among the new retail investors flocking to the markets so, I think that it is entirely possible that they could take steps to reign in margin lending and proprietary speculation by banks ( a growing factor in the equity markets there –see chart below) without impacting the access to credit for consumer spending on durable goods and industrial expansion.

BUZZKILL - abchina3

Andrew Barber
Director


Early Look

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Apparel: Small, but improving trend for the week

Despite total sports apparel sales being down again, sporting goods and family retailers had positive weeks. Total sports apparel was strong on the West Coast in all channels, but considerably weaker in the Mid-Atlantic region, especially for family retailers.  New England was soft with negative mid to high single digit declines across all channels with the exception of family retailers which increased 1.5% for the.  Columbia and The North Face were the outliers on the upside, with 43% growth in the outdoor apparel category for the week.  Hanes Brands had another slow week.  Under Armour’s decline for the week was driven primarily by weakness in compression, which recorded a  9% decline for the entire category.  Market share gainers on the week were Nike, Adidas, Columbia, and The North Face while Hanes, Russell Athletic, and Under Armour lost share.

Apparel: Small, but improving trend for the week - Sports Apparel Table

Apparel: Small, but improving trend for the week - SPorts apparel dollar chart

Apparel: Small, but improving trend for the week - Sports Apparel ASP chart

 


PNRA - Standing Apart

Going into Q2, I was having difficulty seeing how PNRA would achieve the high end of its $0.62-$0.64 EPS guidance range.  Well today, PNRA reported $0.69 per share excluding $0.04 of one-time charges.  On the high quality side, PNRA’s company same-store sales came in at -0.7%, which was better than my expectations, particularly considering the 6.5% comparison from 2Q08.  PNRA’s same-store sales improved rather significantly throughout the quarter, posting -1.9% in April, -1.6% in May and +1.6% in June.  The favorable June sales trends continued into July and even improved, running up 2.8% for the first 27 days of Q3.

On the low quality side, however, G&A expenses declined nearly 15% YOY, marking the first time this expense has decreased on a YOY basis in at least 5 years, never mind the magnitude of the decline!  This significant cut to G&A costs accounted for $0.04 per share relative to what I was modeling.  Management stated that it is not cutting G&A, but rather the quarterly decline can be attributed to the general lumpiness of projecting G&A costs as a result of timing differences for overhead expenses.   Specifically, management said that bonus accruals were lower in 2Q because relative to certain performance metrics, the company had underperformed relative to Q1.   Given that restaurant margins declined 110 bps YOY in the quarter (before the one-time charge related to the roll out of new china), the timing of such a significant reduction to G&A expense does not seem coincidental.  Instead, it seems that management needed to cut G&A to save operating margins. 

Even with PNRA maintaining such impressive top-line numbers, it is going to become increasingly more difficult for the company to maintain margins.  Unlike most restaurant companies, PNRA is still growing.  I am forecasting 4% company unit growth in 2009, which means that PNRA is still incurring growth related costs.    And, these costs are only heading higher next year because management stated today that it expects to increase its company-owned unit growth by 50% in 2010.  PNRA is only expecting modest cost inflation in 2010 as higher labor and occupancy costs are expected to be largely offset by lower food costs, but increased development costs will creep into the P&L as the company aggressively ratchets up its unit growth targets.

PNRA - Standing Apart  - PNRA Restaurant level margin 2Q09

PNRA - Standing Apart  - PNRA G A 2Q09


AS GOOD AS IT GETS

First, to state right up front, it’s been well over a year since we have shorted the financials.  Currently, the XLF is the only sector in the market not trading above the TAIL line (three years or less).    As steep as the yield curve looks right now and as good as the ted spread looks – this is, by definition as good as it gets for credit and the financials.   

On top of all this, the dollar is teetering on a major breakdown below the 78 line.  The dollar is currently down 12% since March – we call that a crash.  We view the XLF as the most politically compromised sector in the market because financials have the most political dependence, which helps to fix the earnings power of the industry.  What the government giveth, it can also take away! 

Last week, Ben Bernanke proved to the world that he is staying with his politicized strategy by keeping the low end of the curve at 0%.  As the rest of the world moves on from the financial crisis, there are many countries that may not invest in the politically compromised U.S. Financial services industry.  This fits our thesis of “buy what china needs and not what we want them to need.”  The US government wants China to buy US dollars and US treasuries, but our belief is that China’s central bankers will decide that they need to diminish their exposure, a conclusion that will be made easier by the politics of the situation. 

Provided that we keep the low end of the curve at 0% in the US, there is no incentive to save in this country, and economics 101 has taught us that savings need to equal investment over time.  Investment is perpetuated by a country that has cash and savings – think China (although it’s easy to hoard when all property and income belongs to the state).

The bulk of the XLF is made up of the Diversified Financials (55%), which include the industry heavy weights JPM, BAC, GS and MS.  Banks make up 20% of the ETF with Insurance and Real Estate companies accounting for the balance. 

The earnings trends for the Real Estate and insurance companies have been disastrous all year and did not find much support going into 2Q earnings season.  The Banks, those best levered to taking advantage of the steep yield curve, have shown the most positive earnings revisions trends of the past week and month.  Overall however, earnings revisions for the XLF continue to be negative.

AS GOOD AS IT GETS - hp12

Since the XLF bottomed on March 5th, 2009 at $6.24, we have seen a generational short squeeze that most investment managers missed.  The XLF has rallied +102% largely on the back of a massive recovery in earnings sponsored by the US taxpayer.  As you can see in the chart below, earnings for the XLF declined significantly in 2H08, have since recovered in 1Q09 and continue to improve in 2Q09.  While 2Q09 was strong for the financials, it appears that the bulk of the earnings recovery is behind us as there was a sequential deceleration in improvement.  Going forward, the pace of sequential improvement in the XLF EPS will continue to slow, declining to 9% in 4Q09.  These estimates are based on a compromised yield curve.  If our 4Q inflation call proves to be correct, interest rates are headed higher.  What will happen to Q4 numbers if the yield curve flattens? 

AS GOOD AS IT GETS - hp34

It is our conclusion that things can only go downhill from here for the majority of the financial sector for the immediate and intermediate duration. As always, we are data dependent and will be testing our thesis as new data emerges.  

Howard W. Penney

Managing Director


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