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LV LOCALS: THE MIRAGE OF A RECOVERY

At best, higher housing prices helped stabilize locals gaming revenue.  In the face of potentially lower prices going forward, gaming demand could dry up – not good for BYD and Station Casinos.

 

 

CALL TO ACTION:  DRY DEMAND IN THE DESERT

Las Vegas Locals gaming revenue have been stagnant for a while despite a pickup in home prices, but at least had stabilized.  It seemed attributable to a delayed wealth effect – housing prices proved to be the most statistically important driver of Locals gaming revenues during the boom.  However, falling sales volume – a demand indicator – since July may have been indicative of a weak overall housing environment despite higher prices.  Indeed, Q1 locals gaming revenues were disappointing after months of stability and the first 2 months of Q2 deteriorated further.

 

Our Hedgeye Financials Team sees downward pressure on home prices as they usually lag demand by 12-18 months.  The recent gaming revenue performance and declining prices would not be good for BYD and Station Casinos.  Historically, Vegas home prices have a 70% correlation with Locals gaming revenues.  At the very best, the upcoming housing environment should prevent any Locals casino recovery.  At worst, the already fragile Local customer will tighten her purse strings even more.

 

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EVIDENCE:

The Phoenix and Vegas housing markets have mirrored each other in the recent housing bubble and recovery.  While Phoenix home prices have remained relatively robust, home sales have declined since last July.  A number of comments from an ASU report on the Phoenix home market in May were quite disturbing:

  • Total single family homes sold fell 19% YoY with those under $150k plunging 37% YoY
  • The percentage of residential properties purchased by investors continued to decline from 16.3% in April to 16.1% in May.
  • Weak demand from 1st time home buyers
  • Outlook:
    • Some home sellers appear to be cancelling their listings and waiting for another time when buyers have a greater sense of urgency.
    • Many families are choosing to stay in their homes longer than they used to 10 to 15 years ago.
    • The mix of homes that are selling has changed a lot in the past 12 months. There are fewer distressed homes and far fewer homes priced under $150,000. This tends to push the averages and medians upward even if prices are stable.

Las Vegas home demand is not much better.   According to GLVAR, Southern Nevada total home sales (single family, condos, townhomes) declined double digits every month since January 2014.  Furthermore, in June, short sales – when lenders allow borrowers to sell a home for less than their mortgage obligation – spiked to 10.8% of all existing local home sales – up from 7.9% in May.  

 

LV LOCALS: THE MIRAGE OF A RECOVERY - LLL

 

CONCLUSION:

Housing is a critical component of the health of the Las Vegas Locals gaming market. With sluggish top-line gaming revenues thus far in 2014, more weakness may lie ahead for the Locals market as any support from rapidly rising home prices is taken out.  Of the publicly traded gaming operators, BYD is most sensitive to the Locals environment.


CHART OF THE DAY: Risk Happens Quickly (Cue Portugal)

Takeaway: Is Portugal the proverbial canary in the global market coal mine?

 

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Sleep Training the Markets

“And a young prince must be prudent like that,

giving freely while his father lives

so that afterwards in age when fighting starts,

steadfast companions will stand by him and hold the line.”

-Beowulf

 

As many of you know, I recently joined the ranks of fatherhood after a solid run as a bachelor. Fatherhood is great on so many levels, but also very intriguing intellectually. As my daughter emerges on her 6th week, her mother and I have started talking a lot about sleep training, or lack thereof.

 

It seems there are many different (and really divergent) views on how to encourage a baby to fall asleep on a timely basis and, also, how to to ensure she gets the right amount of sleep.  On one extreme, there is the "cry-it-out method," in which the infant figures out how to sleep on their own. On the other extreme is "attachment parenting" in which the infant is basically brought into the familial bed.

 

Sleep Training the Markets - baby1

 

After doing a survey of my friends, one suggestion that was most unique was to read Beowulf just before bedtime.  I’m not sure if we will employ the so called “Beowulf Method,” but admittedly if it didn’t put our little Emmy to sleep, it would certainly work with her parents.

 

Speaking of sleep training, global asset markets continue to be in deep REM sleep.  In our Q3 themes deck, we emphasized this with our theme: Volatility Asymmetry.  A few highlights from that theme include:

 

  • U.S. equity volatility is literally at an all-time low and well below the 20-year mean of 20.05;
  • Fixed income volatility is also literally at an all-time low and the current reading is 54.03, which is in the 1.5% percentile versus the long run mean of 99.7; and
  • Finally, the JPM Global foreign exchange volatility index is at 5.45 versus the long run mean of 10.6.

Yes, it is official -- the world’s central banks have lulled the markets to sleep, for now at least.

 

Back to the Global Macro Grind...

 

The interesting thing about global markets of course is that global risk can happen all at once.  Any of you that have invested and thrived over the last decade know this fact only too well.  As of late, so do those investors that have parked capital in Portugal.

 

No doubt most of you have been following the woes of Espirito Santo family of financial institutions in Portugal over the last month.  This morning the news actually got incrementally worse.  Specifically, Riforte Investments SA, a holding company in the Espirito Santo family, missed a $1.2Bn payment of commercial paper yesterday.

 

The Portuguese Central Bank Governor was quick to put on his super central banker cape and fly to the rescue.  In prepared comments, Carlos Costa indicated that shareholders of the parent were standing ready to inject more capital if needed.  In the short run, this has actually helped as Banco Espiritu Santo’s bonds and stocks have recovered a portion of their losses.

 

Nonetheless, as we’ve highlighted in the Chart of the Day below, Portugal has disconnected with Europe rather quickly in the last month or so.  Over the month, Portuguese equities are down more than 12% and are now down on the year just over 4.2%.  Of the major markets in Europe, only Russia is down more (for some obvious reason related to the Ukraine).

 

No surprise, Portuguese sovereign debt has seen a comparable spike in yields.  While the 10-year yield of Portugal is still at a reasonable 3.73%, the fact remains that this yield has widened dramatically versus its peripheral peers Italy and Spain.  We have also seen Portugal’s sovereign debt auctions have a much tighter bid-to-cover as of late.

 

The big question remains whether this is a canary in the proverbial global market coal mine, or, conversely, whether the bad news is priced in.  Our Financials Sector Head Josh Steiner likely put it best in his weekly Risk Monitor note when he wrote the following (emphasis mine):

 

“Portugal's Espirito Santo Group continues to dominate news flow on the banking front. Both EU and US global bank swaps are widening sharply, and TED Spread is beginning to widen as well. For now, there appears to be no reason to assume that Espirito Santo's problems are widespread, but there is a rising level of uneasiness as investors ask how could this bank, which was under so much scrutiny for the last few years, suddenly be now having such problems?”

 

His point is an astute one and time will tell whether this is the awakening of risk that seems to be broadly not priced into global asset classes.

 

Unfortunately for Europe, which remains under the strains of too much debt, the economic data coming out of Europe as of late, with the exception of the United Kingdom, has been less than robust.   Most telling this week was the reading from the German ZEW economic expectations index.

 

Expectations coming into the number were for a notable deceleration, but the actual number was much worse than expected. Specifically, July printed 27.1 versus expectations of 28.2 (29.8 prior).  In reviewing the leading indicators for May, industrial production fell for a third consecutive month, missing expectations, and factory orders also missed. The ZEW Current situation survey also fell sharply from June while consensus expected a slight deceleration. That gauge printed 61.8 versus expectations for 67.4 (67.7 prior).

 

Growth slowing and banks imploding . . . perhaps our call that the U.S. Federal Reserve will be more dovish than consensus (read Jan Hatzius) believes will happen sooner than expected.   But, hey, China just beat GDP by 0.1%, so there is that...

 

Our immediate-term Global Macro Risk Ranges are now:

 

UST 10yr Yield 2.49-2.58%

SPX 1

RUT 1140-1170

BSE Sensex 249

VIX 10.32-12.94

USD 79.86-80.46

Gold 1 

 

Keep your head up and stick on the ice,

 

Daryl G. Jones

Director of Research 

 

Sleep Training the Markets - 77


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RH Black Book - Real Estate Deep Dive (7/17, 11am ET)

Takeaway: Join us for a call to debate the key issue today facing RH – real estate. Our deep dive will show why we think this story is far from over.

Please join us on Thursday, July 17th at 11:00 am ET for a call titled RH: Real Estate Deep Dive. We’ll be releasing our 2nd  Black Book on Restoration Hardware, specifically outlining the key issues that we think are critical to the investment thesis and the stock at this point in the company’s growth trajectory.  The reality is that some of the key factors to this story deserve greater scrutiny today than they did just $30 ago. 

 

We’ll hit on several topics, but the key focus on Thursday will be real estate. The crux of our commentary will focus on the likelihood of success in RH’s build-out of its large format Full Line Design Galleries. We’ll outline the biggest opportunities, potential risks, and whether or not the company is set up to execute on this opportunity. Ultimately, we’re going to flush out the real estate profile and potential store growth in the same way and using the same tools many retailers use to analyze their own store growth opportunity.

 

KEY TOPICS WILL INCLUDE:

1) What does RH’s addressable market look like, and how will that evolve over the next 5 years?

2) How many markets in the US can support a Full Line Design Gallery at the sales productivity standards that RH is setting for its’ new stores?

  1. We’ll drill down on specific markets that have been announced, but will also analyze in great detail other markets that we think are likely candidates that the company has not yet announced.
  2. We’ll look quantitatively at the underlying economics of each FLDG market.
  3. We’ll break out ‘fill in’ markets versus new markets.
  4. The costs of the properties is evolving. How this is impacting RH’s ROIC?

3) A look at trends we’re seeing in anchor tenant space, and why we’re seeing more premium space available than most people might think.

4) Category expansion, and which categories present the biggest opportunities (and potential risks) at retail.

5) How much of a risk is a housing downturn to the RH story?

 

Participant Dialing Instructions

Toll Free Number:

Direct Dial Number:

Conference Code: 275779#

Materials: CLICK HERE

 


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BULLISH TRENDS

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BEARISH TRENDS

 

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A Castle-in-the-Air

This note was originally published at 8am on July 02, 2014 for Hedgeye subscribers.

“Dreams of castles in the air, of getting rich quick, do play a role – at times a dominant one – in determining actual stock prices.”

-Burton G. Malkiel

 

For the past several days, I’ve been reading a gem of a book recommended by my colleague, Howard Penney.  Malkiel’s A Random Walk Down Wall Street is a timeless, thought provoking piece that most curious investors would enjoy reading poolside on a beautiful summer day.  I certainly did.  After all, restaurant research isn’t limited to cheeseburgers and fries.  In fact, a large part of our job pertains to understanding both human and market psychology.  The castle-in-the-air theory, which concentrates on the psychic values of investors, serves as a constant reminder of this fact. 

 

For those unfamiliar with its origin, the castle-in-the-air theory was popularized by John Maynard Keynes in 1936.  While we tend to disagree with Keynes’ and his disciples on a number of economic issues, the notion that stocks trade off of mass psychology is widely appealing.  Accordingly, some investors attempt to front run this onslaught of groupthink, not by identifying mispriced stocks, but rather by identifying stocks that are likely to become Wall Street’s next darling.  All told, this can be a profitable strategy – until it’s not.  

 

A Castle-in-the-Air - castle

 

Back to the Global Macro Grind...

 

We believe we’ve identified one of Wall Street’s current darlings and recently added it to the Hedgeye Best Ideas list as a short.  Del Frisco’s Restaurant Group (DFRG) owns and operates three distinctly different high-end steak chains.  After coming public in July 2012, the stock has gained over 114%; quite impressive, by any measure.  More importantly, however, we believe cheerleading analysts and the subsequent madness of the crowd have propelled the stock during this time.  Is it reasonable to call a company whose adjusted EPS declined 7% in 2013 one of the greatest growth stories in the restaurant industry?  We think not. 

 

As Malkiel goes on to say:

 

“Beware of very high multiple stocks in which future growth is already discounted, if growth doesn’t materialize, losses are doubly heavy – both the earnings and the multiples drop.”

 

Beware indeed.


The truth is, the company currently screens as one of the most expensive stocks on both a Price-to-Sales and EV-to-EBITDA basis in the casual dining industry.  While we’re not insinuating DFRG is the beneficiary of a “get-rich quick speculative binge,” we are confident the stock is severely dislocated from its intrinsic value.

 

Part of the hype has been driven by the company’s positioning within the restaurant industry.  Del Frisco’s caters to the high-end consumer; a cohort that the stock market would suggest is doing quite well.  While this may be true, we believe the high-end consumer has been slowing on the margin as inflation in the things that matter (food, energy, rent, etc.) continues to accelerate.  Contrary to popular belief, high-end consumers can feel the pinch too and two-year trends at the company’s hallmark concept, Del Frisco’s Double Eagle Steakhouse, would suggest the same. 

 

Admittedly, the Double Eagle Steakhouse, though slowing, is a healthy concept.  But it’s only 25% of the overall portfolio.  The other 75% consists of a fundamentally broken concept (Sullivan’s) and an unproven growth concept (Grille).  Naturally, the Street is discounting an immediate turnaround at Sullivan’s and a flawless rollout of the Grille, neither of which we see materializing.  In fact, we continue to expect restaurant level and operating margin deterioration throughout 2014.  This has less to do with all-time high beef prices (32.8% of Del Frisco’s 2013 cost of sales) and the recent wave of minimum wage increases (25% of Del Frisco’s restaurants have exposure), than it does with the fact that the company is systematically growing at lower margins and, consequently, returns.

 

More broadly, there are a number of red flags that the Street is unwilling to acknowledge right now including decelerating same-store sales and traffic trends, declining margins, declining returns, increasing cost pressures, expensive operating leases, peak valuation, positive sentiment and high expectations.  We simply refuse to give the company credit for what it has not proven and while we can’t hit on all the minutiae of our thesis in this note, we do have a 67-page slide deck that does precisely that (email sales@hedgeye.com for more info).  In short, our sum-of-the-parts analysis suggests significant downside.

 

You can delay gravity, but you can’t deny it.  Needless to say, we don’t expect this particular castle-in-the-air to stay there much longer.

 

Our immediate-term Global Macro Risk Ranges are now:

 

UST 10yr Yield 2.50-2.59%

SPX 1949-1976

RUT 1169-1208

VIX 10.61-12.74

Brent Oil 111.51-115.43

Gold 1310-1330 

 

Stay grounded,

 

Fred Masotta

Analyst

 

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