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Outside Reversals: SP500 Levels, Refreshed...

This market continues to have issues traversing our updated Range Rover line of topside resistance (we changed that line to 1041 on our last monthly strategy call – it’s the dotted red one in the chart below).


All together, while it’s paid to ride the rocket of the Pain Trade higher (buying dips) for the last few weeks, this week a new strategy is emerging as potentially profitable – selling the rips!


I don’t have to be bullish or bearish. At this stage of the game we are seeing outside reversals – breaking out to new highs versus the prior closing high, then reversing intraday to a lower closing high – and, on the margin, outside reversals are more bearish than bullish.


I have immediate term TRADE support at the 1009 line (dotted green). If that line breaks, watch-out below (TREND line support = 940). If 1009 holds, and the US Dollar puts in another lower-high, buy the dip.


This isn’t trading. This is risk management.



Keith R. McCullough
Chief Executive Officer


Outside Reversals: SP500 Levels, Refreshed...  - a1



CORN SUPPLY - The USDA recently updated its crop forecast and is now calling for a near-record U.S. corn harvest this fall.  This is happening at a time when the global economy and other factors have reduced the need for corn, creating a potential supply imbalance.  The USDA forecasts the corn crop will be 12.8 billion bushels, just slightly lower than the 2007 record crop of 13 billion bushels.  The large crop is projected in a year when the number of acres planted is down: 6.5 million fewer acres in the U.S. than in 2007. This year's crop continues to benefit from improved seeds and an ideal growing season for much of the Corn Belt.

CORN DEMAND - In 2009, corn exports for this year's first six months were down 40%.  While the BURNING BUCK could help to boost the export picture, uncertainty prevails.  Gas prices have started to move higher, and thus one could expect the ethanol producers to see increased need for corn, but I’m not convinced.  The economics of ethanol never made sense, and there is less capital chasing the business; as a result, we are unlikely to see a repeat of the past issues.  Approximately half of the corn produced in the U.S. is used for animal feed.  Due to last year’s spike in corn prices and the slowing economy, there are fewer animals out there to feed, so the need for corn is less.



ADM and BG grow corn and as such are hurt from lower corn prices as their crops command lower prices on the market.

MTC and D produce corn seed and they stand to feel the pinch if farmers buy less corn seed.  Additionally, improved seeds allow farmers to get bigger yields per acre, suggesting the need to buy fewer seeds.

POT and MOS may see less business from farmers if they use less fertilizer on their crops.

Consumer staple companies will benefit.  Food, Beverage and the meat processing industry will benefit from lower ingredient costs.  The Restaurant industry will continue to be the beneficiary of benign food cost trends.






A Crain’s article reported yesterday that MCD’s Chicago-area restaurants are bringing the Dollar Menu to breakfast “as the fast food chain turns to discounts to revive slowing morning sales.”  According to the article, the local deal, which will include six items priced at $1: sausage biscuit, sausage McMuffin, medium coffee, two hot cakes, two hash browns, and fruit-and-yogurt parfait, is similar to the breakfast value offerings that MCD has sold in other markets, such as Seattle.  For reference, the sausage sandwiches previously sold for around $2.


MCD said on its last earnings call that outside of the benefit the company has gotten during the breakfast timeframe from advertising coffee, the rest of breakfast has slowed down some.  This slowdown is not unique to MCD as the article states that morning meals at fast food restaurants fell 2% YOY during the spring, according to the NPD Group.  It does signal, however, that MCD’s coffee and specialty beverage sales are not creating the much anticipated lift in sales during breakfast.  MCD just launched its national advertising campaign behind the espresso-based beverages in May.  Although MCD stated that it experienced some benefit during the breakfast daypart from the advertising, if there was a substantial pick up in coffee purchases (MCD has said that more than 50% of McCafe sales happen at breakfast), I would have expected that to translate into increased breakfast food purchases, which was not the case. 


The article references a memo that Steve Plotkin, the head of McDonald’s Western Division, wrote to franchisees last month, in which he states, “Breakfast sales are declining, and the only growth that we have had in the last two years has been based on price and not demand.”


This slowdown in breakfast demand just increases my conviction that MCD’s specialty beverage launch will not prove to be the success that investors have anticipated for some time.  U.S. same-store sales growth has come under pressure in recent months.  If the company cannot drive incrementally more specialty beverage sales during the initial months of this national campaign (while offering giveaways) and in the summer months, it will become significantly more difficult going forward.


From a margin standpoint, this move to launch more value items at breakfast could prove to be detrimental.  Historically, breakfast has generated a lower average check for MCD than the other dayparts but yielded a higher margin transaction.  Increased dollar menu sales at breakfast will remove some of this margin favorability. 

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ISLE missed and contrary to popular belief, July was not any better than the difficult months of May and June. Trends haven't improved in August either. Not good for the regional gamers.





Highlights from the release:

"Our results during the quarter make it clear to us that the economy appears to be engaged in a slow, long-term recovery process, and consumers are being more discriminating about their leisure spending"


"First quarter results were generally in line with our expectations at most of our properties, with the decrease in company EBITDA primarily attributable to decreases in gaming revenue and EBITDA at the Company's properties in Biloxi and Lula MS, Lake Charles, LA and Bettendorf, IA. The Mississippi properties were impacted by continuing softness in their respective markets and an increase in unemployment rates, Bettendorf was negatively impacted by access issues caused by bridge repairs and the opening of a new gaming facility by one of our competitors in the Quad Cities, and Lake Charles was negatively impacted by changes in the promotional spend in the market."


" It is, however evident that our year-over-year revenue and margin comparisons are difficult because government stimulus checks during the same period of the last fiscal year clearly had a positive impact on consumer spending."


"We are holding firm in our resolve to defer the great majority of our planned renovation and project capital expenditures until we achieve more visibility into an economic turnaround. However, we are continuing to evaluate the competitive landscape in Colorado to capitalize on the opportunity presented by recent regulatory changes in that market, and we are also looking forward to the substantial completion of our Lady Luck conversion projects by the end of this month at our properties in Caruthersville and Marquette."


General management observations:

  • Biggest operating challenge is consumer spending
  • Industry is going through significant changes. Over the next few years supply increases will likely outpace demand



  • Color on August in Colorado
    • Not seeing trends in August quite as strong as what they saw in July, but will add some tables to accommodate demand. Up in line with the market in July (19%)
  • Betterdorf - we're encouraged by the opening of the 2 way bridge - which was one of biggest issues they had.
    • Last year in 1Q09, Betterdorf benefited from Davenport being closed.  Lots of noise in the market to just back out bridge opening impact
  • Florida:
    • Just waiting to see what happens.  Governor has until end of August to sign the compact with the Seminoles
      • Unclear what happens if the deadline passes.  Seminoles are still trying to change the compact. However, if those changes are substantive than the legislature may want to reopen the session to get comfortable.
    • Still hoping for the tax cut
      • Minimum will be an aggregate number from parimutuel - must pay at least what they paid last year but there will be 2 new facilities to split among more facilities (ongoing)
      • Tax will be split equally by casino, not "pro-rata" by revenue
  • International - Zero in 2011
  • Cost structure is just about as lean as they can get it, so future opportunities hinge on better flow through whenever a recovery occurs
  • They are seeing slightly better to constant volumes in most locations.  However, there is a decrease in what people are spending per patron when they show up.  Seeing an increase in unemployment across all locations.  Increase in gas prices isnt going to help.  They have seen an increase in promotions across most markets, but they are trying very hard not to buy revenues
  • Why not look at new states like Maryland/ Kansas for a managment opportunity?
    • That's what Eric Hausler has joined the company to focus on
    • A lot of these situations will take a long time to play out, whether bankruptcy situations or new markets
    • Don't have the capacity for a new greenfield project
    • Why not look at new states like Maryland/ Kansas for a management opportunity
  • Decrease promotional spending at Lake Charles
  • Still buying and replacing slot machines, maybe not to same extent as in the past
  • Growth capital spending?
    • Very little committed right now: Colorado, renovations at Lake Charles
    • Won't commit until they see some economic recovery
  • Corporate expense?
    • $40MM for 2010, including $7MM of stock comp
  • Rated vs non-rated play trends?
    • 3% decrease in rated play vs 8% in retail play
  • Lake Charles and Mississippi unemployment rates are going up
  • New licenses in Iowa, impact on ISLE? Probability?
    • Only accepting applications from counties where referendum has passed
    • Very conscious of impact on other casinos
    • Appears that the upper NW corner of the state that shows some growth potential without significantly cannibalising another property
  • $93MM R/C balance
  • May and June were pretty rough for ISLE and the industry, and July looked to be a little better, how about August?
    • ISLE didn't see a big difference / improvement in July
    • Middle of their 2009 was when they saw their business fall off the map (Sept), so comps will start to get easier
    • However, fundamentally, August is no better
  • Bank line EBITDA calculation: EBITDA + losses from UK operations (unrestricted sub) (+/-) non cash charges/ gains ; Net Debt: get to net cash over $65MM


If you have been reading the headlines attached to Japanese export data releases in recent months you will be excused for being somewhat confused, as the pundits vacillate between optimism and despair with each new data point. Below are the headlines reported by Bloomberg news for each release since the April data was published in late May:


5/27: “Japan Exports Fall at Slower Pace as Recession Eases”

6/24: “Japan Export Slump Deepens, Casting Doubt on Recovery”

7/23: “Japanese Exports Fall at Slower Pace as Slump Eases”

8/26: “Export Slump Deepens, Signaling Japan Economic Recovery Could Be Weakening”


This manic depressive cycle of hope and fear underscores the great dilemma for anyone following the Japanese economy: the almost complete dependence on external demand for expensive durable goods and external supply of basic materials. Until recovery in the EU and North America achieves critical mass, Japan is essentially dead in the water. All government attempts to stimulate internal demand will ultimately function as a band aid since the economy is structured with such a profound dependence on external trade (fun fact: according to some estimates Japan is calorically 60% dependent on food imports).   To make matters worse, the new programs being cooked up by the presumptive Democratic Party victors will not only fail to address these structural weaknesses or the looming demographic disaster, they will actually increase the national debt to well beyond 200% of GDP and keep the zero rate train rolling.


Exports for July reported last night declined by 36.46% year-over-year. We have begun to see signs of recovery in the major European economies, and some of the important developing economy markets for Japanese exports are starting to show modestly increasing consumer spending levels, but there is clearly no chance that auto or big ticket consumer electronics sales in any these markets will be able to rebound to pre recession levels in the intermediate term.


As Japan readies for this weekend’s national election it finds itself in the familiar role of global waterboy, sitting on the bench next to the US while the real recovery game is happening on the field. We will continue to trade Japanese equities tactically on Yen relative strength, but remain bearish on the long term on fundamentals there.


Andrew Barber



STICKING TO OUR STORY - Japan Exports0826



Despite recent management assertions to the contrary, we believe the big slot expansion at Sands Bethlehem will be delayed past year end.



Everyone knows that the retail and hotel portion of Sands Bethlehem is being mothballed until both economic and liquidity conditions improve. However, we have now confirmed that LVS will only "modestly" increase its slots at Bethlehem by 250 units instead of the 2,000 units commonly expected (by the sell side).  We've also seen incorrect sell side projections of almost 3,000 units shipping into PA in 2010, despite the fact that only one of the two Philadelphia projects has even broken ground and the other still hasn't nailed down a site.  But we're used to the sell side being wrong.


Back to Sands Bethlehem, the property appears to be promoting very aggressively to increase visitation to the property, especially midweek.  Our EBITDA estimate for Bethlehem is $22MM in 2009 and $38MM in 2010 (vs the Street close to $70MM).  Unless there is a miraculous economic recovery, it could take at least three years for the property to reach mature margins approaching 20%.  The Street consensus numbers suggest Sands hitting 19% margins after just 2 full quarters of operations.  Pipe dream.  As a reminder, when you include the fees payable to PA, the real tax rate is close to 60%.  According to another PA operator, there is no way that labor will be less than 10% of revenues, and then one has marketing and all the other costs to consider.  That same competitor allocates 4-5% of gaming dollars to marketing, but given that Sands' property is brand new, its spending on marketing is materially above that percentage.


LVS is still all Macau, all the time, and that is certainly our focus.  The Bethlehem situation is only marginally negative for LVS and the slot manufacturers.




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