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Germany Under Pressure: ZEW Tanks

Investment Recommendations:  short Eurozone equities (EZU) and EUR/USD (FXE)

 

Germany’s Expectations of Economic Growth (as surveyed by ZEW) tanked in today’s release of August data – the 6 month forward looking indicator fell -68% M/M! Similarly, Eurozone Expectations fell -51% M/M. The data further confirms our investment recommendations to be short Eurozone equities (EZU) and EUR/USD (FXE).

  • Germany - ZEW Survey Expectations 8.6 AUG (17.0 est.) vs. 27.1 prior
  • Germany - ZEW Current Situation 44.3 AUG (54.0 est.) vs. 61.8 prior
  • Eurozone - ZEW Survey Expectations 23.7 AUG vs. 48.1 prior

Germany Under Pressure: ZEW Tanks - z. zeww

 

The weakness in the survey mirrors declines/misses in more recent German high frequency data:

  • German Factory Orders dropped -3.2% in July M/M (vs expectations of +0.9%) and fell  -2.4% Y/Y (vs exp. +1.1%) and +7.7% in June
  • German IFO Business Confidence Expectations fell to 103.4 in July versus 104.8 in June
  • German Industrial Production rose +0.3% in June M/M (vs exp. +1.2%)

Germany Under Pressure: ZEW Tanks - a. Germany Factory Orders

Germany Under Pressure: ZEW Tanks - aaa. Germany IFO

Germany Under Pressure: ZEW Tanks - a. indust production

 

From a quantitative perspective, both the DAX and EUR/USD remain broken across our intermediate term TREND and long term TAIL lines.

Germany Under Pressure: ZEW Tanks - zz. dax

Germany Under Pressure: ZEW Tanks - z. eur usd

 

We believe our investment recommendations are grounded in a few key points:

  • Draghi will be on hold to issue outright QE – in the Fall Draghi may begin issuing QE-lite (ABS buying) to follow on his June announcement of the TLTROs (a new lending program intended to reach the “real” economy). We don’t expect these programs in and of themselves to reverse what’s been slowing economic data and expect the inflation rate will be the big tell – if CPI doesn’t bounce off its current 0.4% Y/Y level, we think market expectations of QE will be put into motion.
  • EUR/USD weakness – a more dovish ECB and beginning signs of a quantitative breakout in the US Dollar may continue to drive the cross lower.
  • Geopolitical risks clear and present – regionally we expect tensions with Russia over Ukraine and threats of contagion flair-ups (like the financial issues at Banco Espirito Santo) to persist.  Further we expect risk premium to remain elevated as conflicts, like the war between Israel and Palestine and US involvement in Iraq, to play into downside risks in equities, globally.

For a more nuanced view of EU regional data and policy dynamics see our note titled Draghi Dangles QE Carrot; On Hold for Now

 

Matthew Hedrick
Associate

 


LEISURE LETTER (08/12/2014)

Tickers: 8198.HK

EVENTS

  •  Aug 12:
    • Stations Casino 430pm:  
    • HMIN 2Q 9pm: , pw HOME INNS
  • Aug 14:
    • GENTING SINGAPORE 2Q earnings
    • Revel Auction Proceedings

COMPANY NEWS

8198:HK – MelcoLot Ltd awarded Lawrence Ho and seven directors share options in the firm.  Ho was awarded 4,384,000 MelcoLot shares at the exercise price of HKD1.14 per share, which was also the closing price of the shares on Monday.  Seven directors shared options on a further 67,744,000 shares. MelcoLot closed at HKD1.14 per share today.  MelcoLot Ltd is a 50/50 investor in a joint venture (BCN Integrated Resorts 2 SA) with Veremonte Espana SL to operate a casino at BCN World.

Takeaway: Laurence Ho's new growth vehicle emerges.  

INDUSTRY NEWS

Japan Gaming Expansion(Bloomberg) USJ Co, the operators of Osaka's Universal Studios Japan is holding partnership discussions with MGM Resorts International, Caesars Entertainment and Genting Bhd for a possible joing bid to operate a casino resort. 

Takeaway: As a Gaijin, if you can't beat 'em, join 'em. 

 

South Korea Gaming Expansion – South Korea's Ministry of Culture, Sports and Tourism South Korea will reduce regulatory barriers for the development of integrated resorts that contain gambling facilities. The country is hoping to defend against potential competition from Japan, which may open to casino gambling by 2020, coinciding with the Summer Olympics in Tokyo.  South Korea may has processes in place by the first half of 2015, including a bidding system for awarding casino licenses. 

Takeaway:  South Korea is trying to capture its fair share of foreigners gaming revenue.

 

Revel Auction Likely – According to Philadelphia's NBC 10, no "qualified bids" were received ahead of Revel's scheduled auction.  As a result, Revel's Board of Directors will meet to determine the next steps and whether or not the property will close.  CZR CEO Gary Loveman also indicated Revel has not received any qualified bidders - even at the minimum price.

Takeaway: Once hailed as the savior and turnaround for Atlantic City, Revel is quickly becoming a white elephant.

 

New Jersey Casino Closures – The New Jersey Casino Control Commission said it cannot force owners (Showboat, Trump Plaza and potentially Revel) to require the casinos to remain open past their expected closing dates. 

Takeaway: Capitalism and Laissez-faire economics at their best.

 

Upstate New York Casinos (NY Times) Criticism is mounting over Governor Cuomo's plan to award up to four additional casino licenses in upstate New York. Despite hopes to increase employment and taxes, critics argue the Governor's plan is 15 years too late as the Northeastern States are already suffering the effects of fierce competition as well as potentially saturation.

Takeaway: Built it and the gamblers may not come.

MACRO

Singapore Economy - during Q2 2014, Singapore GDP unexpectedly increased at a meager 0.1% annualized rate versus -0.8% forecast and +1.8% for Q1 2014. Manufacturing contracted 15.2% in Q2 2014 versus the prior quarter. Services rose 4.5% while construction increased 0.3% also during Q2 2014. 

Takeaway:  Flat growth in 2Q

 

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.


MACAU FLAT AS EXPECTED

Full month GGR projected to be flat to slightly up.

 

 

Flattish growth in average daily table revenues (ADTR) is in line with our expectations. We would note that the ADTR of the first 11 days summed to HK$10,075 million, EXACTLY the total of the first 11 days of last year.  Table revenues averaged HK$916 million per day through the first 11 days of August – flat with the comparable period last year but up seasonally from July’s weak ADTR.

 

 MACAU FLAT AS EXPECTED - 1

 

Sources indicate that Mass revenues are trending in the low-mid 20s mtd and our full month projection stands at 22% mass growth.  The VIP picture remains cloudy with volumes down significantly on normal hold.  For the full month of August, we are projecting gross gaming revenue (GGR) growth of flat to slightly positive.

 

Our sources confirm the competitive pressures on the premium mass market remains a risk going forward, particularly with the Mass slowdown.  While our Mass Decelerating theme, first espoused in June, remains intact, August's likely Mass bounce back should be judged more on the weakness in July rather than a reversal of trend.  We expect high mid to high teens YoY Mass growth beyond August.

 

For the concessionaires, LVS leads the way with high VIP hold driving market share well above recent trend, completely at the expense of SJM.  All other operators are at slightly above trend shares. LVS has consistently been lucky this year while MPEL has been much less fortunate in the past 6 months.  CoD is holding poorly again in August on lower volumes we think. 

 

MACAU FLAT AS EXPECTED - 2


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BRIGHT SPOT IN INDIA

Client Talking Points

INDIA

BSE Sensex up another +0.8% overnight to +23.3% year-to-date, leading what was a low volatility session for Eastern Equities. We did a full day in Boston yesterday and the bull case for Indian stocks remains under-owned (India passing public REIT legislation this morning too).

DAX

The DAX fails at its first line of resistance (@Hedgeye TRADE resistance of 9232) and has no support to 8848 – this morning’s ZEW reading was one of the worst sequential #GrowthSlowing data points (in the world) of the year – Putin will enjoy that.

OIL

What Vlad (Putin) won’t enjoy is that both Brent and WTI continue to breakdown (both are undergoing bullish-to-bearish TREND reversals @Hedgeye). WTI is down -0.7% this morning vs Gold and Copper in the green (metals continue to diverge bullishly vs Energy commodities).

Asset Allocation

CASH 46% US EQUITIES 0%
INTL EQUITIES 14% COMMODITIES 6%
FIXED INCOME 26% INTL CURRENCIES 8%

Top Long Ideas

Company Ticker Sector Duration
HOLX

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.

OC

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.

LM

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

TWEET OF THE DAY

EUROPE: every major European Equity market just failed @Hedgeye TRADE lines of resistance (again)

@KeithMcCullough

QUOTE OF THE DAY

Nobody's a natural. You work hard to get good and then work to get better. It's hard to stay on top.

-Paul Coffey

STAT OF THE DAY

Consumption trends in the natural channel remain very strong, growing at approximately 9% in the quarter. Organic wheat prices remain at historically high levels, up around 40%.


CHART OF THE DAY: The Comp Table $KMI Didn't Publish

CHART OF THE DAY: The Comp Table $KMI Didn't Publish - COD KMI Comp Table

 

Far be it from us to question someone who yesterday made more money then we will perhaps ever make, but we do think it is important to consider KMI’s risk profile in the context of some basic financial metrics.


The Portals of Discovery

"Mistakes are the portals of discovery."

- James Joyce

 

There is nothing like a mistake to enhance our learning.  At times, defining a mistake can be a nuanced exercise.  For stock market operators, though, a mistake is very easy to define.  Simply: if a stock price goes against you meaningfully and over a sustainable period, you are wrong.

 

The most successful investors are often those investors that are effective at both learning from and minimizing their mistakes.  Many successful portfolio managers implement a stop loss so as to ensure that their mistakes are minimized. Others buy value plays with little perceived downside to minimize mistakes.

 

About a year ago, we introduced Hedgeye’s Best Idea list.  The idea of the list was to focus our research team on developing deep dive investment ideas with asymmetric reward characteristics. Overall, the list has had some really strong performers.  Not surprisingly we’ve also had some stocks that have not performed very well.  Due to a light global macro calendar this morning, we are going to do a deep dive on one of our very public “mistakes”.

 

Back to the Global Macro Grind . . .

 

Yesterday, one of our Best Ideas, Short Kinder Morgan Energy Partners (KMP), went against us and decidedly so.   Rich Kinder, the CEO and Company’s namesake, decided to consolidate the group of companies that existed under the Kinder Morgan umbrella.  In the announced deal, KMI, the C-Corp GP, will acquired its two MLPs, KMP/KMR and EPB in a ~$71B transaction comprised of 56% KMI equity, 38% assumed debt, and 6% cash.  

 

On one hand, it is worth applauding Kinder for this move.  After a long and successful run, we thought he was out of tricks, but he wasn’t. On the other hand, in implementing this dramatic corporate restructuring, Kinder readily acknowledged our thesis, which was that transparency was limited, cost of capital was very high, and growth options were limited for the Kinder Morgan complex.  And by bidding for our favored short of the group, KMP, at premium, he also marked the idea against us by about 15%.

 

It doesn’t matter that we’ve had some great calls on other MLPS, such as Linn Energy (LNCO) and Boardwalk Partners (BWP), on KMP we are now seriously in the red.  As always though, the question is what to do with the stock from here (even if you have been long and taking the other side of our trade it is worth considering).  As my colleague Kevin Kaiser writes:

 

“On 2014 Pro Forma (“PF”) metrics, we have PF KMI valued at 17x EV/EBITDA, 24x EV/EBIT, 27x market cap/pre-tax earnings. If we strip out the E&P segment at a $5.5B valuation ($1.0B of EBITDA x 5.5x multiple), PF KMI Midstream is valued at 19x EV/EBITDA. On an absolute basis, the valuation multiples are very high, in our opinion (19x EBITDA for a capital intensive, fully-taxable, highly-leveraged business), but even relative to peers, PF KMI seems mispriced here. EPD – which is not subject to federal income taxes – is valued at 17x EV/EBITDA, two EBITDA turns below PF KMI Midstream”

 

Combined with this egregious valuation is the more interesting point of KMI’s ability (or inability) to pay out its massive distribution going forward.  As Kevin also writes:

 

“On a cash flow basis, assuming a full tax shield, PF KMI will generate ~$5.3B/year in operating cash flow. Run-rate total CapEx is ~$4.1B/year (excluding Trans Mountain), putting run-rate, pre-tax Free Cash Flow at $1.2B, or $0.56 per PF KMI share. PF KMI is trading at a 1.4% pre-tax FCF yield. Its annual distribution burden will be $4.3B starting in 2015, putting its annual funding gap around $3.1B. These are rough metrics, but a good guide for how much capital PF KMI will need to raise on a go-forward basis.”

 

In the Early Look today, we’ve included two charts.  The first chart is a comp table that Kinder Morgan showed in their presentation yesterday comparing KMI against blue chip companies with growing dividends.  Included in the table are companies like McDonald’s, Cisco, Altria and so on.  The title of the table is quite explicit, “KMI Compares Favorable to its Mid-Stream Energy Peers and S&P 500 High Dividend Companies.”  Since the Company is guiding us to 10% dividend growth and a yield of 4.5%, on these basic metrics, KMI does look great!  But beauty, as always, is in the eye of the beholder. 

The Portals of Discovery - KMI Table

 

In the second chart in today’s note, we’ve included, “The Comp Table KMI Didn’t Publish.”  In this table we look at payout ratios, valuation metrics, and leverage ratios.  Far be it from us to question someone who yesterday made more money then we will perhaps every make, but we do think it is important to consider KMI’s risk profile in the context of some basic financial metrics.

 

The Portals of Discovery - COD KMI Comp Table

 

Now perhaps we’ve lost all credibility because we didn’t see this corporate restructuring coming (we thought Kinder Morgan was in a proverbial box), but if you are contemplating owning KMI here, you do need to take the Company’s advice and look at your options, like S&P 500 high dividend companies. 

 

On a basic level, would you rather own a company like Cisco that grows its dividend at ~7.9%, trades at ~6.0x EBITDA, and has $30 billion in net cash, or a company with the financial profile of KMI that trades ~19.0x EV/EBITDA, has debt/EBITDA at 5.5x, and has a dividend payout ratio of 130 – 200%.  Perhaps we are just simpletons, but to us the answer is obvious.

 

Keep your head up and stick on the ice,

 

Daryl G. Jones

Director of Research


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