Client Talking Points


Dr. Raj continues to pound the pig right up the middle with rates at 18 month highs – stronger currency deflates the inflation tax on the people, and consumption growth accelerates. The BSE Sensex is up +0.3% to +17.8% year-to-date. #Winning policy.


The yield bounces to lower-highs yesterday but who cares? They’re back down this morning and remain in what we call a Bearish Formation with the TAIL risk line of resistance up at 2.61%. US #ConsumerSlowing alongside Housing.


The Russell 2000 is down -0.5% on Friday. Down another -0.7% (with the SPX up on no volume) again yesterday to -6.6% since March and -3.1% year-to-date. Stay with the process and short that US domestic growth proxy instead of consensus-crowded SPY.

Asset Allocation


Top Long Ideas

Company Ticker Sector Duration

Hologic is emerging from an extremely tough period which has left investors wary of further missteps. In our view, Hologic and its new management are set to show solid growth over the next several years. We have built two survey tools to track and forecast the two critical elements that will drive this acceleration.  The first survey tool measures 3-D Mammography placements every month.  Recently we have detected acceleration in month over month placements.  When Hologic finally receives a reimbursement code from Medicare, placements will accelerate further, perhaps even sooner.  With our survey, we'll see it real time. In addition to our mammography survey. We've been running a monthly survey of OB/GYNs asking them questions to help us forecast the rest of Hologic's businesses, some of which have been faced with significant headwinds. Based on our survey, we think those headwinds are fading. If the Affordable Care Act actually manages to reduce the number of uninsured, Hologic is one of the best positioned companies.


Construction activity remains cyclically depressed, but has likely begun the long process of recovery.  A large multi-year rebound in construction should provide a tailwind to OC shares that the market appears to be underestimating.  Both residential and nonresidential construction in the U.S. would need to roughly double to reach post-war demographic norms.  As credit returns to the market and government funded construction begins to rebound, construction markets should make steady gains in coming years, quarterly weather aside, supporting OC’s revenue and capacity utilization.


Legg Mason reported its month ending asset-under-management for April at the beginning of the week with a very positive result in its fixed income segment. The firm cited “significant” bond inflows for the month which we calculated to be over $2.3 billion. To contextualize this inflow amount we note that the entire U.S. mutual fund industry had total bond fund inflows of just $8.4 billion in April according to the Investment Company Institute, which provides an indication of the strong win rate for Legg alone last month. We also point out on a forward looking basis that the emerging trends in the mutual fund marketplace are starting to favor fixed income which should translate into accelerating positive trends at leading bond fund managers. Fixed income inflow is outpacing equities thus far in the second quarter of 2014 for the first time in 9 months which reflects the emerging defensive nature of global markets which is a good environment for leading fixed income houses including Legg Mason.

Three for the Road


UK Home Prices +11% y/y in May vs +10.9% in April (rate of change still beating USA in 2014) #StrongPound @KeithMcCullough


"The greatest mistake you can make in life is to be continually fearing you will make one." - Elbert Hubbard


The Seattle City Council unanimously passed an ordinance that gradually increases the minimum wage in the city to $15, which would make it the highest in the nation.

LEISURE LETTER (06/03/2014)

Tickers: LVS, 1928.HK, MPEL, BEE, LHO


  • Tues June 3: Goldman Sachs Lodging, Gaming, Restaurant and Leisure Conference, New York
  • Tues June 3: NYU Int'l Hospitality Industry Conference, New York
  • Tues June 3: Midwest Gaming Summit, Rosemount, IL
  • Tues June 3 - Thurs June 5: REITWeek, New York, NY
  • Wed June 4 - Thurs June 5: Russian Gaming Week 2014
  • Thurs June 5 - Todd in Vegas for slot suppliers mgmt meetings
  • Thurs June 5 - 4:30 pm MTN earnings
  • Tues June 10 - HLT lock-up expiration
  • Tues June 10 - Thurs June 12: Bally Systems User Conference
    Mohegan Sun


1928:HK & LVS – The Dragon's Palace High Limit Area is now open at Sands Cotai Central.  This newest prestige area at Himalaya Casino features 74 baccarat tables, two Sicbo tables and four private gaming rooms. Minimum bets are HKD 1500/3000/5000/10000 (depending on tables), with a maximum bet limit of HKD3Million.  In addition, The Dragon's Palace provides daily pass-around canapés, refreshments and a dining area with a comprehensive menu.

Takeaway:  Widely anticipated and recently discussed on LVS's Q1 earnings call, the newly built premium mass area is now open. 


MPEL – confirmed on Tuesday a hotel management agreement with Hyatt for the hotel at City of Dreams Manila.  Melco Crown Philippines said the Hyatt would feature 365 guestrooms, two food and beverage areas, a fitness centre, VIP lounge, and outdoor swimming pool and is targeted to open in October 2014 to coincide with China's Golden Week holiday. 

Takeaway:  As expected 


BEE – increased guidance for full year 2014 Comparable EBITDA and Comparable FFO/fully diluted share to reflect the closing of the common equity offering, the acquisition of the remaining 63.6% interest in the Hotel del Coronado (expected to close in early June), and the redemption of the 8.25% Series C Cumulative Redeemable Preferred Stock (expected to be completed in early July) -- comparable EBITDA $230-$250M vs prior guidance $210-$230M and comparable FFO $0.59-$0.68 vs prior $0.57-$0.67.

Takeaway:  The upward revision was expected but the magnitude of the positive revision was larger.  The company is finally on the road to stronger financial results. 


LHO – entered into a definitive contract to sell the Hilton Alexandria Old Town for approximately $93 million with proceeds from the transaction used to reduce borrowings on the Company's Senior Unsecured Credit Facility. The Company acquired the hotel in May, 2004 for $59 million. The Company expects the transaction to close during June 2014. The transaction is subject to customary closing conditions.  Additionally, LHO initiated the process to redeem its $58.7 million, 7.25 percent Series G Preferred Shares. Official notice of redemption will be given at a later time. The redemption is expected to close early July 2014.

Takeaway:  Generating positive returns for shareholders both with asset sales and paying off preferred debt. 


MSC Cruises - Boosts commission pay to 25% (Seatrade Insider)

MSC Cruises USA's has announced a 60-day Balcony Bonanza Cash-Back booking incentive for all MSC Divina Caribbean seven-night and 10-night sailings between Aug. 2 and Dec. 20.  Effective today, MSC Cruises USA is paying 5% commission on all pre-paid special services pre-booked by agents on behalf of their clients.  In addition to the current commissionable shore excursions, hotel packages, transfers and airfare, this now includes spa treatments, specialty restaurants, beverage packages and stateroom celebration packages, among others.  MSC will continue to pay 10% commission on pre-paid cruise insurance coverage.


Takeaway:  This follows Celebrity's temporary commission incentive yesterday.  While good for agents and maintaining good relationships, we wonder if these actions could be attributed to Caribbean pricing pressures to some extent.


May GGR - (DSEC, GGR Asia)

Macau May GGR rose 9.3% YoY to MOP 32.354 billion (HKD 31.411 billion, USD 4.051 billion).  According to industry figures compiled by GGRAsia, market shares are as follows:  LVS (23.2%), SJM (23%), GALAXY (21.2%), MPEL (12.8%), WYNN (10.5%), and MGM (9.3%).

Takeaway: Disappointing May numbers well below our forecast. Please see our separate note today.


Japan – "Japan Industrial Revival Plan" the 60-page draft outline of Prime Minister Shinzo Abe's growth strategy promises to overhaul corporate governance, promote technology and attract private investment.  However, issues still not addressed in the preliminary draft include whether Japanese corporations will be allowed to own farmland, reforms to the labor arbitration process as well as a policy position regarding legalizing casino gambling.  The policy plan will form the basis of Abe's "third arrow" reform update due to be announced later this month.  

Takeaway:  Abe has endorsed casinos last week so we're not worried about the lack of gaming language in the "third arrow" policy plan. Timing remains elusive. 

Cambodian Border Casinos negatively impacted – Statistics from the Cambodian authorities indicate the number of people passing through the Thai-Cambodia border crossing per day has declined from an average of about 1,500 prior to the military coup to about 700 on Monday.  The Cambodia-based company called Crown Resorts Co with three casinos in Poipet receives more than 200 Thai visitors per day.  However, following the military coup, the number of Thai visitors has fallen to just over 100 per day. The drop in visitation is due to fears the Thai army may impose capital controls which would result in devaluation of the Thai baht similar to the 2006 devaluation.

Takeaway:  A potential headwind to NagaCorp's NagaWorld casino.


Amex survey – (Seatrade Insider) 

American Express travel counselors are booking more cruises this year than last and report demand or interest in river cruising is skyrocketing. However, clients are waiting for future price cuts and many ask for on-board credits. And most agents are focused on getting repeat customers to cruise, rather than drumming up new business. The most typical challenge to closing cruise sales is customers waiting for the price to drop (42%), less spending on vacations (36%), interest in land-based tours and vacations (34%), negative publicity surrounding cruising (34%) and customers booking online (29%).


Takeaway:  Not a good sign for cruisers' attempt to raise prices


Hedgeye remains negative on consumer spending and believes in more inflation.  Following  a great call on rising housing prices, the Hedgeye

Macro/Financials team is turning decidedly less positive. 

Takeaway:  We’ve found housing prices to be the single most significant factor in driving gaming revenues over the past 20 years in virtually all gaming markets across the US.


ZQK: Removing Quiksilver from Investing Ideas

Takeaway: We are removing Quiksilver (ZQK) from Hedgeye's high-conviction stock idea list.

Editor's note: Hedgeye retail sector head Brian McGough is removing Quiksilver from Investing Ideas. Please see his note below.


ZQK: Removing Quiksilver from Investing Ideas - Quiksilver LOGO


Conclusion: There’s only one take-away from this quarter for us – and it’s not about lower revenue out of PSUN or ZUMZ. It’s a serious ding to Team Mooney’s credibility. The company’s cavalier attitude towards pushing out revenue and profit targets, its lack of any clearly articulated building blocks of growth (even though we still think they exist), and what we think is lack of accountability to the financial community make it near impossible to tell our story – that was 50% based on management execution – without serious thesis-morph (which we won’t do). As such, we’re taking the black eye and are removing ZQK from our Best Ideas list. Our sense is that this will be an idea worth coming back to in another year as a) revenue growth reaccelerates (which we still think will happen), b) the company finds a way to actually tell what could be an interesting story, and c) it becomes a take-out candidate.  But none of those things will happen in this calendar year. If we get wind that the story is back on track when it is a few bucks higher, then so be it. But we’re not going to change our thesis and narrative just to fit in with where the stock is today.



I’ve been doing this for 21 years, and this is a first for me -- I’m yanking support of a stock AFTER a meaningful blow-up. When a stock I like faces a negative event (it happens to most of us), I like to step away from all the noise, recalibrate long-term earnings power with the stock, and see if it is an opportunity to double down, or best to just walk away.  Usually, we stick with the name. But the problem with ZQK is that the research changed as much, if not more than the stock. This goes far beyond #growthslowing. And we’re definitely not talking about weakness in PSUN, TYLYs or the US ‘teen space’ like so many people are talking about. Basing the investment on that would be nonsense, especially given that the US is only 38% of ZQK’s business. But our problem here is that management is simply not as effective as we thought it was. 


When we first got involved with this name about six months ago, we were attracted to what we thought was a far better management team than a company the size of Quiksilver probably deserved. With seven of the top eight executives coming from high-profile roles at employers like Disney, Gap, Levis, and Nike, we thought they were worth giving the benefit of the doubt on being able to fix this perennially mis-managed company. We did the digging on the individuals as well, and research came back positive. We also conducted extensive consumer research to see if the brands could still be saved. After all, even the best management team can’t fix a dead portfolio. Fortunately, the brands scored far higher than we expected in our surveys, and when it all came together we built up a model that arrived at over $1.15 over a five year time period.


Now, unfortunately, we struggle to get to $0.75, and our confidence level in that earnings power has all but evaporated. A higher discount rate on a lower earnings number is hardly comforting.


There are several factors that concern us. None of them is a smoking gun, but they add up to be enough when 50% of our thesis hinges on a management team….

1)      Lack of clarity surrounding financial plan. We keep hearing about the ‘profit recovery plan’ but there’s so little detail given about how they get there. All we hear about is how the Quiksilver brand is declining, Points of Distribution are shrinking, but yet sales will still accelerate to a high-single digit rate for the next three years. It would be so much easier for us all if they’d step up and say “we think we could add $300mm in revenue in 3-years…a) footwear is $150mm, b) China is $100mm, c) Roxy/Yoga is $50mm, etc…” There’s a problem when we think we can articulate a revenue story better than the CEO of the company (for what it’s worth, China and Footwear combined should account for a $500mm opportunity alone). Clearly, his information is better than ours. So either a) the growth is not there like we think it is, or b) the company will likely never articulate it as such until they hire someone who knows how to run a real IR effort.

2)      Very little sense of urgency.  We concur that this might be just a personality trait on the part of Andy Mooney, but when most CEOs talk about their business, they sound hell-bent on fixing existing problems as soon as humanly possible. Mooney comes across as way too accepting of certain problems as they are presented to the Street (like pricing pressure,  distribution closing, and the eventuality of growing emerging markets ‘over a few years’). Again, this might be part personality, and part lack of being trained by someone who knows investor-talk. But it is what it is.

3)      Should Mooney really have been on Mad Money on the final day of the quarter? Do you think that just maybe he knew the general trajectory of his business on the last day of the quarter? Either that was extremely poor judgment to be on financial media to promote his story when there was such a disconnect with expectations, or he simply did not know the numbers and his day-to-day command over the financials are not what they should be. We’d bet that it was poor judgment.

4)      Lack of accountability to Wall Street. This goes beyond the fact that it’s easier to get a call returned from President Obama than it is from ZQK management. But they don’t seem to acknowledge or care about what it takes to be a shareholder-friendly company. Maybe Apple and Nike have earned the right to be ‘tough to follow’ but a company like ZQK needs to make it as easy as humanly possible for an investor to cover the company.  There appears to be very little humility as it relates to the messages that they send to the investment community about financial targets, and how changing those statements impacts shareholder value. 

5)      There seems to be a new ‘issue’ every quarter. It was DC two quarters ago, then independent wholesale distribution last quarter. And now it’s wholesale apparel pricing.  As it relates to apparel pricing, this means that we won’t see any uptick in this busines until ’15. Our revenue estimates for the back half of ’14 were contingent upon the company’s ability to deliver fast-turn ‘fashion right’ product to wholesale accounts. Those systems, which we were led to believe were in place at the end of 1Q, won’t be ready until at least the 1H ’15. And, management has shown very little confidence in its ability and/or the willingness of retail buyers to invest in the ZQK brands. The company admitted that it was buying shallow into the Fall ’14 and Spring ’15 selling seasons due to fears about sell throughs – which doesn’t help the top line a whole lot.

6)      Product is behind schedule. Footwear pricing initiatives that were slated to take hold in the Fall of ’14 before full implementation in Spring of ’15. The changes which were to be part of the product relaunch in Fall of ‘14 were characterized as a  ‘band-aid’ operation by Mooney, which is hardly what we were led to believe last quarter. The team would have been given a much better reception had they articulated both the issues facing DC from a pricing perspective and the gigantic opportunity in the $45-$50 price range.  Price without product is a no win situation, and we think management failed in communicating this to the street. There still may be tremendous opportunity in the now 200mm canvas vulcanized market – but we had more faith yesterday in ZQK’s ability to deliver than we do today. 


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KKD: Concerns Are Overdone

KKD released disappointing 1QF15 results after the close yesterday, hitting bottom line estimates but missing top line estimates by 335 bps.  The company also lowered its full-year adjusted EPS outlook from $0.73-0.79 per share to $0.69-0.74 per share due to unfavorable weather and higher than expected costs associated with ERP implementation and management succession.  “Severe winter weather” negatively impacted on-premises and wholesale sales throughout the company-owned unit base in the Southeast.


Despite the disappointing headlines, KKD continues to look quite healthy under the hood.  The stock’s reaction to the headline is far from surprising.  The stock trades at a premium valuation and continues to have its fair share of doubters, but we believe concerns are overdone.  The truth is, not much has changed to deter us from our bullish thesis.  KKD is still one of the best growth stories in the restaurant space and will continue to leverage its operating model by investing for the future and building out smaller, higher returning stores.  The company plans to grow units by +10% this year and, even with the guide down, adjusted EPS in the +13-21% range.  When the dust settles, we believe people will be willing to pay for this, even if the double-digit comp story has passed.  KKD still has a strong financial profile with compelling unit economics, strong FCF generation and impressive returns on incremental invested capital.


To touch a bit upon executive management succession, we have faith that incoming CEO Tony Thompson will build upon Morgan’s success.  Thompson was a well-respected executive at Papa John’s International, where he served as President and COO and played an instrumental role in the company’s technological innovation and success.  Former CEO James Morgan is transitioning to Executive Chairman and will remain very much involved with the company.

What we liked:

  • Tony Thompson’s first official day on the job as the new CEO and James Morgan’s first day as Executive Chairman.
  • System domestic same-store sales growth of +2.3%.
  • Franchise domestic same-store sales growth of +4.5%, versus expectations of +4.2%, despite a near +12% comp last year.
  • With the new guidance, KKD is still projected to grow adjusted EPS by13-21% in FY15.
  • Plan to grow system-wide store count +10% this year.
  • Continue to focus domestic growth on small factory shops.
  • Expect additional franchisee development announcements over the next several quarters.
  • Repurchased just over $25 million of stock during the quarter and remain committed to returning cash to shareholders through share buybacks.
  • Focused on driving top of mind awareness with the introduction of its ready-to-drink bottled coffee, bagged coffee and K-Cups.

What we didn’t like:

  • Total revenues missed street estimates by over $4 million or 3.35%.
  • Company owned domestic same-store sales decreased -1.5% versus expectations of +1.1%.
  • International franchise same-store sales decreased -2.2%.
  • Guiding down full year adjusted EPS by $0.04-0.05 due to disappointing 1Q performance, higher than anticipated ERP investment and higher than anticipated costs for executive management succession.
  • Wholesale channel revenues, exclusive of the effects of refranchising, decreased -1.6%.
  • Company owned operating income of $4.4 million, down from $5.3 million a year ago.


Howard Penney

Managing Director


Fred Masotta



Weekly placeholders mask weakness, not strength. May fizzles, up only 9%.



Well, we were wrong about May growth.  The Hedgeye model had been stellar up to this point so what went wrong?  There are 3 possibilities: 1) hold percentage was very low, 2) VIP volumes contracting faster than we expected, 3) May was a statistical anomaly. 


We suspect that hold percentage was low in the month but not low enough to justify only a 9% YoY increase in GGR.  Lower VIP volumes likely played a role.  Despite all the negative headlines regarding VIP, we were aware of liquidity issues only with a couple of junkets.  It’s possible the issues were more widespread.  The reality is that one month is a short period of time and even volumes can be volatile month to month. 


In any case, the two “placeholder” weeks this month actually masked weakness and not strength like we saw in April and previous months.  Thus, the last week showed unusually soft numbers but was really a catch up softer than indicated weeks earlier in the month.


Going forward, our model was already projecting a soft June with YoY growth of only 9-11%.  If there is a systemic problem with VIP, there could be downside even to that number.  Either way, June was unlikely to spark the Macau stocks and that’s still the case now.  May was the last near-term positive for these stocks and that didn’t quite pan out.


The Hedgeye Macau model has had a great track record in projecting Macau GGR so we’re absolutely sticking with it.  With that in mind, we move to the sidelines on these stocks.  We remain favorably disposed over the long-term but, lacking catalysts, the stocks could be volatile with downward bias.  Given some unique levers to grow market share, WYNN remains our favorite stock over the near term and given its quality as an operator, might be the safest.  LVS is a close second.

The Old Smoke Wall

This note was originally published at 8am on May 20, 2014 for Hedgeye subscribers.

“You might as well hit a brick wall as hit that man on the head.”

-Yankee Sullivan


Yep. They used to settle things in this country the old fashioned way. More commonly called “Old Smoke” by NYC’s finest mid-19th century gang members, John Morrissey (Member of Congress), could deflate #MoBro Twitter muscles, fast.


In 1864, a crowd of con men from Manhattan (three-card-monte artists) stepped off the train at Saratoga. Morrissey sauntered up to them with his white flannel suit and quietly told them to leave town. They did.” (The First Tycoon, pg 399)


150 years later, the US stock market’s volume feels like that. After indicting some of our hedgies for insider trading and then going after the machines, central planners are quietly telling people to not trust a game they perpetuated. Evolution, baby.


Back to the Global Macro Grind


It was Victoria Day in my homeland yesterday, so I guess half of America decided to take another Monday off. Who needs to work full-time in an industry where losers who lie and cheat only have to pay a fine with other people’s money anyway?


Total US Equity Volume was down -21% and -41% versus its 1 and 3 month averages, respectively, yesterday. We’ve been hitting you with this DOWN-volume-UP-day thing square in the head this year. Contrary to popular “there’s been no volume for 5 years” thing, the complexion of 2014’s US stock market volume is signaling serious liquidity risk.


To review how we think about liquidity (volume) risk:


  1. Like most things we analyze, rate of change is what matters most
  2. When DOWN-day (down price) volume is accelerating and…
  3. UP-day (up price) volume is decelerating across multiple durations (1 month, 3 month, etc.)

That is not good.


There is a subtlety to analyzing a body of non-linear interconnected risk this way – it’s called hard work. You have to mundanely write down and/or register every day’s PRICE/VOLUME data, then overlay it with implied volatility assumptions across multiple durations.


I know. If you do math, it’s not as complicated as having a strategist tell you “but the market is up.” But we Street fighters on 2.0 weren’t born into just knowing what markets are going to do next, so we have to #grind for each and every data point. #process


“So” what if this PRICE/VOLUME signal is doing this and the market isn’t “up”?


  1. The Russell 2000 bounced on no-volume to yet another lower-high of 1114 yesterday
  2. At -4.3% YTD, the Russell2000 is still bearish on both our immediate-term TRADE and intermediate-term TREND durations

That’s really not good.


And if you dare saunter on over to the three-card-monte-perma-bulls and tell them that the Russell 2000 breaking down is a bearish growth signal, prepare for them to:

  1. Get a little uncomfortable as they rattle off lagging economic indicators
  2. Make a few snide remarks about what the market has done since they missed calling the last 10-20% decline
  3. Then leave the room before you show them a chart of bond yields

*hint (the charts of the Russell growth index and growth-slowing 10yr bond yields are the same)


Once we get rid of those guys, the real debate starts (the one between real-time market price, volume, and data). What is causal to driving slow-growth in both the Russell and bond yields? What’s causal and correlating? What is neither?


Almost 6 months into 2014, what is clearly causal to slowing US consumption growth is #InflationAccelerating. But if you live in the real-world, you already know that. What’s less obvious are the 6 month correlations between currency and commodities:


  1. CRB Commodity Index (19 commodities) inverse correlation to US Dollar Index is -0.77
  2. Soybeans have a 6 month inverse correlation to the USD of -0.75
  3. Corn and Wheat have 6 month inverse correlations to USD of -0.74 and -0.70, respectively
  4. WTI Crude Oil has a 6 month inverse correlation to USD of -0.66
  5. Gold has a 6 month inverse correlation to USD of -0.64

In other words, if you get the purchasing power of The People (USD) right, you’re probably going to get the rate of change in inflation/deflation right. And if you get the slope of inflation right, you’re probably going to get the rate of change in real-growth right.


As to why traditionally trained Keyensian economists who have missed calling every US consumption slowdown since Q1 of 2000 don’t get these very basic points right, no worries. You may as well bang your head against the Old Wall.


Our immediate-term risk ranges are now as follows (we have 12 of Global Macro ranges with a TREND signal overlay in our Daily Trading Ranges product):


UST 10yr Yield 2.47-2.58%

SPX 1865-1897

RUT 1089-1125

USD 79.31-80.21

Brent 108.60-110.45

Gold 1281-1305


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


The Old Smoke Wall - Chart of the Day

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