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Europe on the Scale

Research Edge Position: Long Germany (EWG), Short Italy (EWI)

Today the European Commission reported that European confidence improved to 76 in July from 73.2 in the previous month, confirming the improvement in sentiment across many individual country indices that were released this week and adding a metric to compare the relative health of the region. We continue to hold that European countries will yield uncorrelated returns due to unique underlying fundamentals; we’re currently long Germany via the iShares etf EWG and short Italy via EWI in our model portfolio with the thesis that in aggregate countries with economic leverage will outperform those with financial leverage. [See our recent posts on the portal for more on our fundamental views on Germany and Italy.] 

This week we noted in our post ‘”Shoots” in Europe?’ that PMI improved in the Eurozone for the manufacturing and service industries, and that Germany and France, the region’s two largest economies, registered improved consumer and business confidence numbers in July, with sequential improvement over the last three months. These forward-looking data points from the economic heavyweights are positive as European countries are highly tied to the Union as a main trading partner, yet we still expect slow improvement across the region. It’s worth calling out that European retails sales (a lagging indicator) fell for a 14th month in July. Individually, German retail sales rose, while sales in France and Italy fell, according to Markit Economics. We continue to hold that German and French consumers will benefit from a low CPI/interest rate environment as we move out in the intermediate term, with June CPI at 0.0% in Germany and -0.6% in France, whereas inflation in Italy came in annually at +0.6% in June .

Noteworthy, today Germany released that the number of people out of work increased by 52,000, yet the adjusted jobless rate remained unchanged at 8.3% in July. While we expect this number to push out in the intermediate term, the stability of the number (though lagging) is bullish. As a long term risk we continue to highlight Germany’s depressed export picture, yet an increase in Factory Orders at +4.4% M/M in May and demand from China are early positive indicators. Further, we believe that the country’s powerful manufacturing capacity remains a primary structural advantage when compared to its European peers.  As of late there’s been increased speculation that lending in Germany could tighten as a result of the merger of the country’s big banks, Commerzbank and Dresdner Bank, due to obligations under European state-aid rules to shrink its balance sheet in return for the hand-out it received. We’ve seen no confirmation of this from the Bundesbank.

Our bearish view on Italy remains. Recently the Italian research institute Isae forecast the economy to contract 5.3% this year (matching an estimate by the OECD), from a previous estimate of 2.6%. Fundamentally we believe that Italy’s general government debt, which stands at over 100% of 2008 GDP as compared to 65.9% for Germany and 68.1% for France, will remain a stumbling block to its economic recovery. The spread on 10-year Italian Treasuries versus the German 10Y stands at 83bps, off from a high of 120bps for the month of July, but still suggest a risk aversion from investors.

And finally, UniCredit, Italy’s largest bank, may struggle to see a profit as it works through bad loans, which could have an adverse tail for lending. We’ll know more when the bank reports Q2 earnings on August 4th.  From a quantitative set-up, the Italian ETF holds a substantial amount of Financials (43.10%).

As we continue to monitor the European patient we’ll be focused on the individual performance of countries.  For now we’re paired off long Germany, short Italy. 

Matthew Hedrick

Analyst

Europe on the Scale - euromh

 


“DO I FEEL LUCKY?”

Dirty Harry’s memorable line may be the right question to ask, but it’s not the only one. When it comes to table hold, luck is not the only factor at play.

 

Lower than normal hold percentage is not always indicative of “bad luck”.  As we wrote in our 09/18/08 post, “HOLD % AS A HEDGE TO DROP IS BREAKING DOWN”, table hold is not a “statistically derived” metric like slot hold percentage.  Drop is the amount of dollars exchanged for chips – it does not account for how much is actually wagered.  When times are tough, players may buy in chips (drop) at the same level but are probably not gambling those chips at the same velocity.  Thus, the denominator (drop) is the same but the numerator (win or revenue) will be lower because the player is not actually gambling as much.

The following chart perfectly illustrates this phenomenon.  WYNN and LVS have both been experiencing declining hold percentages for many quarters now.  The “normal” hold percentage for Wynn’s Las Vegas properties is now looking more like 18-21% and not 21-24% as indicated in the company’s financial reports, including today’s Q2 earnings release.  Absent actual “luck” swings, average hold percentages are likely to stay in the lower range for quite some time.

 

“DO I FEEL LUCKY?” - wynn hold


Squeezy's Biting: SP500 Levels, Refreshed...

When I made the transition from being wrong on the top end of my Range Rover (954) to calling it for what it was – a confirmed breakout - I started giving you higher-lows of support and higher-highs of resistance. At 3PM EST today, I’m going to take up those levels once again.

My immediate term TRADE line of resistance (dotted red) is now 998, and my immediate term TRADE line of support is 971.

Don’t chase them higher here. Make some sales.

Provided that we continue to hold this pattern of broken volatility (VIX) and bullish price/volume, buy them when they are red and sell them when they are green. The big crash and squeeze moves are rear-view events. Now your daily risk management objective is to play the game that you see in front of you.

KM

Keith R. McCullough
Chief Executive Officer

Squeezy's Biting: SP500 Levels, Refreshed...  - kmsp


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WYNN: CONF CALL HIGHLIGHTS

Steve Wynn was more optimistic than the last time we heard from him. Cost cuts were very impressive in the quarter, revenues remain under pressure.  New Mass supply in Macau and high supply in Las Vegas are our major concerns.

 

WYNN 2Q09 Earnings call:

  • Things seem to be stabilizing in Vegas and China
  • Since March they felt a change in operations
  • They are feeling optimistic, still seeing Asian business in Vegas growing
  • They are as satisfied as they can be given that world is still so uncertain
  • More afraid of Washington than the economy
  • Mid week small business meetings are still off, but are benefitting somewhat with dealing with the high end customer
  • Encore – most beautiful building that they have ever built, on time and on budget for this spring

Q&A

  • Thoughts on lowering the gaming tax in Macau?
    • Government may or may not be in sync with Stanley Ho’s comments
    • Likes the new CE, “full-fledged doctor, a PHD”, will look out for the interests of the people of Macau and the businesses that create jobs… Sounds like Steve thinks that there is a good possibility that the tax rate gets lowered
  • Thoughts on VIP commission cap? Any benefit to Wynn?
    • Never went above 1.25%, and the fact that the market has realized that there is no benefit to destroying margins is a positive for the market as a whole.
    • Made some comment about not paying taxes – re: competitors
    • Question of enforcement remains
  • Areas where they cut costs, is there more to go?
    • FTE’s were down by asking for reduced work weeks, salaries and increased time off, they saved $65k per day here
    • Hundreds of other initiatives, related to operating supplies, promotional expenses, communication
    • In total recognized $140k per day of savings, and think that this is where they are going to be
    • $35MM behind on a run-rate basis from 2008 (revenue wise), but comparisons become easier going forward, thinks that the net effect will look softer going forward. Took out a $100MM of costs, which will benefit them as the market recovers
    • Let’s suppose they can take out another $15MM of costs, not sure if it makes sense because it will dislocate their employees… they think it is bad business to cut more costs.  It’s about the people not the money
    • Kicked off initiatives of cost savings in Macau, realized $50MM of costs savings there which can ramp to $66MM.  It’s not at the expense of employees or the franchise.  900 FTE’s lower than last year.
  • Strategy into the City Center opening? Any change in pricing strategy?
    • First people likely to try the new product will be Bellagio and also Wynn customers but the real test of whether they become loyal City Center customers will be guest experience
    • Thinks that City Center needs to charge Wynn/Bellagio/Caesar’s prices to make money
    • Only thing WYNN will do to compete is to keep the service at his property top notch, doesn’t think that price matters.  I’m not so sure, price matters when you have a corporate limit on what you can spend.
  • No reversal of bad debt provisions in Macau or Las Vegas
  • Promotional expense in Vegas being lower – reflection on being more focused on who should be at the hotel (more marketing-focused – hence occupancy was down)
  • Looking forward to the opportunity of developing Cotai … states that the Encore Macau is the most beautiful hotel in the world.  It should be at a cost of $1.6MM per key
  • Another Obama shot…
  • Growth plans, if they raise money in Asia, what will they use it for, can they bring it back to the US?
    • They are in a quiet period - can’t comment on filing
    • Growth plan commentary:  The policy of WYNN is to do one thing and do it well
      • Regarding Aqueduct, they want to do something completely different there.  Just finished presenting their plan this week. May not win, there is a very aggressive group of bidders. Schedule is unclear – decision needs to be made by multiple government bodies.  This Friday they conclude questioning all the applicants. How long they take to make a decision is unclear
      • Next move in Asia is Cotai
      • If Japan would be interested in a large scale resort they would be “on it” and Taiwan would warrant a look. Regrettably passed up Singapore because he was worried that he couldn’t commit to more than one project and give it the appropriate attention given what he had committed to in Macau
      • Love that he takes a shot at MGM & LVS getting into trouble by “losing focus” and biting off too much to chew on
  • Comment on what is happening on the promotional side in Las Vegas
    • Still heavily discounting rates and offering packages with lots of credits
  • Capital expenditures, how the $125MM breaks out, going forward?
    • $50MM was Encore Vas Legas
    • $55MM was Encore Macau 
    • Maintenance was approximately $25MM
    • Budget for Wynn Macau was revised down by $50MM to $650MM will start ramping up and then have the expenses that come 60-90 days post opening
  • Tax rate tutorial?
    • 42% effective tax rate
    • Quarterly tax provisions are hard to calculate because they are based on full year estimates that then get allocated quarterly
    • This quarter, taxes were high because results were better than expected
  • Impact from Danny Gans’ death? Who will they replace him with?
    • Beyonce is a special event
    • Danny Gans was basically break-even to slightly positive but generated a lot of traffic in the restaurants… Wynn basically said it’s an “immaterial” loss from an EBITDA standpoint. Looking to fill the spot now
    • Entertainment doesn’t move the needle anymore in Vegas, but rather F&B, hotel, service… explaining the 750-800MM of nightclub revenues the city makes – kind of “replaced” the “show” business
  • Are they capacity constrained at Wynn Macau?
    • No, feel like they are opening Encore at the right time
  • What else drove margins in Macau? 
    • The $15MM of quarterly run rate cost cuts, no difference between direct vs junket business

 


RESTAURANT INDUSTRY – COMMODITY UPDATE

The restaurant industry continues to benefit from significantly lower commodity prices versus last year.  Chicken is the only commodity that we track that is relatively flat year over year; though the prices paid by some restaurant companies are higher year-over-year. 

Earlier this week, BWLD noted that the anticipated average price per pound of fresh chicken wings for July and August is $1.67 versus $1.17 for the third quarter last year.   If the third quarter averages $1.67 per pound, the company expects to see a 50 bps increase in COGS versus last year (similar to the YOY impact in 2Q).

RESTAURANT INDUSTRY – COMMODITY UPDATE - bwld chicken

Over the last two weeks, cheese prices have moved up 12%.  It should be noted that even after this significant move, cheese prices are -42% YOY quarter to date versus -40% in 1H09.  Cheese prices are still favorable on a YOY basis but are worth watching, given the big move.

On the 2Q CAKE earnings call, management commented that COGS benefited by a good 50-plus bps from lower commodity costs, largely non-contracted items, such as cheese and dairy.  Looking to 2H09, CAKE will likely benefit from the same trends, but that is obviously going to be dependent on what commodity costs do.

RESTAURANT INDUSTRY – COMMODITY UPDATE - commpx


US Jobs: When Bad Is Good!

Since the US Dollar is the most dominant macro factor affecting US Dollar denominated stock and commodity prices, you can read this morning’s weekly jobs report as bad being good.

When is bad good? Well, when initial claims come in at 584,000 versus last week’s 559,000 AND climbs above the 4-week moving average (see chart), AND the stock market rips higher… I call that a bad jobs number being good.

Obviously a lot of people still look at the US stock market in a vacuum and those people won’t agree with my conclusion. That’s fine. That’s what makes a market. The New Reality of a country that devalues remains: what’s bad for the US Dollar is good for assets priced in dollars.

The US Dollar is down on the day – stocks and commodities are up. The longer Bernanke can justify this ridiculous “emergency Great Depression” policy of ZERO interest rates with negative (and lagging) economic data, the longer this REFLATION game carries on…

This won’t end well. But neither has this week for the short sellers of everything rear-view mirror.

KM

Keith R. McCullough
Chief Executive Officer

US Jobs: When Bad Is Good! - a1


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