Big Water

“When supper time came the old cook came on deck
Saying fellows it's too rough to feed ya”

–Gordon Lightfoot, The Wreck of the Edmund Fitzgerald


This week I have been writing my morning missives from our family house on the Big Lake that the Ojibways call “Gitchigumi”, meaning "Big Water".


Thunder Bay is at the head of Lake Superior. Canadians call it The Lakehead. It’s a much safer place than CNBC. It’s quiet and you’d really have to look long and hard to find any finance oriented groupthink. That said, there are plenty of other things to worry about up here – lots of bears and Big Water.


Gordon Lightfoot wrote that the Big Lake “never gives up her dead.” We locals are always mindful of that and we’re always managing risk appropriately.


As most of you know, in addition to hockey, I’m big on metaphors. In the past week we’ve somehow successfully traversed the Big Water of a US stagflation unwind with the following Early Look titles:


“Part of Hell” = 8/26

“Ball Underwater” = 8/27

“Numb is The New Deep” = 8/28

“Duration Mismatch” = 8/31

“Circumstances Rule” = 9/1

“Danger Ball” = 9/2


This, of course, all started with one of our favorite behavioral strategists, the late George Carlin, reminding us that, “I'm not concerned about all hell breaking loose, but that a PART of hell will break loose... it'll be much harder to detect.”


We then moved toward marking our own bottom in what we’ve labeled the Burning Buck (covering our short position in the US Dollar and selling mostly everything, other than Gold, that was priced in those Dollars). Then the Ball Underwater (the US Dollar) shot to the upside, and everything else is history. The SP500 has been down for 4-straight days, correcting -3.5% from her YTD high of 1030.


Whether you agree with us or not that that the ISM Prices Paid report was a Danger Ball (stagflation preview), or that the US Dollar remains THE driving factor in global macro right now, is up to you. This morning, US Dollar down (pre-US market open) has US Equity futures indicated up, and no matter where you go this morning, there’s that Big Water again.


The Buck started to Burn again intraday yesterday (see our midday note titled “US Dollar Update: Pandering Politicians”) for 2 reasons: Tim Geithner spoke and the Fed’s FOMC Minutes were released. As predictable as the sun rising on the East of our Big Lake this morning, Geithner will trot his squirrel hunting gear out to the G-20 meetings in London and tell the world of revisionist financiers that it’s “too early” to raise rates or remove free money stimulus. Get this guy some Sapporo.


The Fed’s Minutes were just an analytical shame. There is no credibility in a currency which is dominated by a US Federal Reserve that is as politicized as this one. If you changed the script to Japanese, you wouldn’t be able to discern which bureaucratic nation penned the outlook. Bernanke’s group-thinkers said that there was “uncertainty” about nearly everything other than the Great Depression Part 2 being a certainty. Gee, thanks guys.


Yesterday, I spent most of the day covering shorts and buying equities. To be clear, I was already playing with a lead here in September and consciously opted to play that move aggressively. I was doing so with tight stops. With the US Dollar down this morning, I suspect that I might get some good prices to sell into, and I will. The $30/oz monkey chase in Gold was a little much for me yesterday, so I sold into that strength too.


When there is Big Water like this coming on deck, there are no established rules. The first Nobel Prize in Economics wasn’t handed out until 1969. This game of managing global market risk is far from an established science.


The Big Water I see this morning has nothing to do with anything other than what’s there. I’m not one of those Wall Street “strategists” who is being rained on that will say with a straight face that he isn’t getting wet.


If I end up selling everything I am long in the US this morning, I’ll probably smile and go on with my day. The Thunder Bay Firefighters Golf Classic is tomorrow, and my Dad is retiring. I’m sure I can learn a thing or two about managing risk from the boys who fight the real stuff with Big Water every night.


My risk management model hears that ole cook coming on deck saying “fellas it’s too rough to feed ya.” So I have shifted our Asset Allocation to a very defensive posture. We are long low-beta sectors and low-risk income generating macro positions (Healthcare, Utilities, TIPs, and Chinese Yuan). I think selling strength today, taking a step back from the Big Water, and watching it settle for a few days is the best way forward.


My immediate term TRADE resistance line for the SP500 is 1004. For the Nasdaq, I’m up at 1991.


Best of luck out there today,






XLU – SPDR UtilitiesWe bought some low beta dividend yield on its lows on 9/2. Utilities traded down 1% and they should act ok during stagflation fears. 


XLV – SPDR Healthcare We’re finally getting the correction we’ve been calling for in Healthcare. It’s a good one to buy into. Our Healthcare sector head Tom Tobin remains bullish on fading the “public plan” at a price.


EWH – iShares Hong KongThe current lower volatility in the Hang Seng (versus the Shanghai composite) creates a more tolerable trading range in the intermediate term and a greater degree of tactical confidence.


QQQQ – PowerShares NASDAQ 100We bought Qs on 8/10 and 8/17 to be long the US market. The index includes companies with better balance sheets that don’t need as much financial leverage.


CYB – WisdomTree Dreyfus Chinese Yuan The Yuan is a managed floating currency that trades inside a 0.5% band around the official PBOC mark versus a FX basket. Not quite pegged, not truly floating; the speculative interest in the Yuan/USD forward market has increased dramatically in recent years. We trade the ETN CYB to take exposure to this managed currency in a managed economy hoping to manage our risk as the stimulus led recovery in China dominates global trade.


TIP– iShares TIPS The iShares etf, TIP, which is 90% invested in the inflation protected sector of the US Treasury Market currently offers a compelling yield. We believe that future inflation expectations are currently mispriced and that TIPS are a efficient way to own yield on an inflation protected basis, especially in the context of our re-flation thesis.





LQD – iShares Corporate Bonds Corporate bonds have had a huge move off their 2008 lows and we expect with the eventual rising of interest rates that bonds will give some of that move back. Shorting ahead of Q4 cost of capital heightening as access to capital tightens.


EWJ – iShares Japan While a sweeping victory for the Democratic Party of Japan has ended over 50 years of rule by the LDP bringing some hope to voters; the new leadership  appears, if anything, to have a less developed recovery plan than their predecessors. We view Japan as something of a Ponzi Economy -with a population maintaining very high savings rate whose nest eggs allow the government to borrow at ultra low interest levels in order to execute stimulus programs designed to encourage people to save less. This cycle of internal public debt accumulation (now hovering at close to 200% of GDP) is anchored to a vicious demographic curve that leaves the Japanese economy in the long-term position of a man treading water with a bowling ball in his hands.


SHY – iShares 1-3 Year Treasury Bonds  If you pull up a three year chart of 2-Year Treasuries you'll see the massive macro Trend of interest rates starting to move in the opposite direction. We call this chart the "Queen Mary" and its new-found positive slope means that America's cost of capital will start to go up, implying that access to capital will tighten. Yields are going to continue to make higher-highs and higher lows until consensus gets realistic.



Las Vegas Sands Corp announced yesterday that it had secured commitments to raise up to US$600 million through the sale of exchangeable bonds.  The bonds will be mandatorily exchangeable into shares when it spins off its Macau operations in an initial public offering in Hong Kong early in 2010, an exercise the company hopes will raise a further US$2.5 billion.

The convertible bonds were offered at interest rates of up to 16%, according to “people who had seen the documents prepared by Goldman Sachs, LVS’ appointed investment bank.  Sheldon Adelson was quoted as saying, “the completion of this financing, which we expect to occur in a matter of days, will enhance our current liquidity position and further our efforts towards reaching long-term financial stability.”

The company owes US$10.8 billion to its banks, including US$3.3 billion of Macau debt largely originating from the construction of the Venetian and Four Seasons resorts in Macau.  Following a recent credit agreement amendment, and this bond sale, the company has bought time to either repay debt or restart lots 5&6. 

MACAU: 18% ON TOP OF 40%

Total table revenue in July grew 18% y-o-y, driven by 21% growth in the Mass and a 17% increase in the VIP market. The growth was even more impressive given the 40% comparison.



Macau is rolling, and not just the Rolling Chip segment.  An 18% table game increase - the best in a year - driven by VIP and Mass, is impressive enough.  Considering the difficulty of the comparison - +40% last year, the August 2009 performance is stunning.  Going forward, the catalysts remain positive:  11 straight easy comparisons beginning in September, high probability of a gaming tax reduction by the summer of 2010, excess demand, and more junket credit availability.  We remain concerned about the significant increase in Mass supply in 2010, but for these stocks that issue is light years away.


Crown, LVS, SJM, and MGM were the clear winners this month, all experiencing table growth in excess of market growth.  Crown gained more share as City of Dreams (CoD) continued its ramp.  SJM and MGM had strong growth despite weaker year-over-year hold comparisons.  LVS benefitted from high hold and growth at FS (although still too tiny to move the needle).  WYNN was the only operator which experienced a decline in table hold this month.




Y-o-Y Property Observations:


LVS table revenues up 19%

  • Sands was up 12%; with the entire increase driven by 24% growth in VIP win
    • VIP RC decreased at Sands (~25%),  however hold comparisons were very favorable
  • Venetian was down 4%; Mass down 6% and VIP down 3.5%
    • VIP RC (Rolling Chip) was down 18%, but hold was favorable
  • Four Seasons had a strong ramp in revenues with estimated table revenues of $50MM compared to an anemic July
    • RC more than doubled compared to July, hold was also very high

Wynn table revenues were down 10%

  • In a reversal from July, Mass was up 6%, offset by a 14% decline in VIP
    • Lower VIP revenues were due to a combination of lower RC volume and lighter hold

Crown table revenue up 33%

  • Altira was down 33%, RC volumes were down 35%
  • While not as strong as July, CoD had another good month, generating an estimated 110MM of revenues
    • Mass ramped to $20MM from $17MM in July
    • VIP RC grew 18% sequentially (so much for sell side reports claiming that Macau properties don't ramp)
    • Hold was above MPEL's "normal" 2.85% at both properties, but not as high as the huge hold % we saw at CoD in July

SJM was up 28%

  • Mass was up 30% and VIP was up 25% despite very weak hold
    • RC increase a whopping 58%

Galaxy table revenue was up 15%, entirely driven by a 19% increase in VIP win

  • Starworld continued to perform well with table revenue up 11%, driven by a 13% increase in VIP revenues despite weaker hold (on a easy comp)

MGM table revenue was up 23%

  • Mass revenues were down 2%, but VIP revenue was up 32%



Market Share:


-LVS share increased to 24% from 21% in July

  • Sands' share declined to 7%
  • Venetian & FS' share increased to 17.1%  from 12.3% in July
    • Most of the increase was driven by VIP up 6.7% to 16.5% from 9.9% in July

-WYNN had its weakest share month since we've been tracking this data (March '08) with share of only 12.6% vs 14.5% last month

-Crown market share wasn't as good as July at 17.8%, but still up materially at 16%

-SJM share was back up this month at 26.4% from 23.8% in July

-Galaxy lost a little share, ending at 10.1% vs 10.6% in July

-MGM's share decreased to 10.5% from 12.4% in July, but the company had one of its best share months since opening


                                                               MACAU: 18% ON TOP OF 40% - Macau Total Bac Marketshare


                                                               MACAU: 18% ON TOP OF 40% - Macau MM Rev Share Aug


                                                               MACAU: 18% ON TOP OF 40% - Macau RC Turnover Marketshare



Early Look

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The per key valuation of recent hotel transactions are starting to look interesting (for buyers).



We've got a pretty extensive database of hotel transactions over the past several years.  We can make that available to interested clients.  The chart below provides a look at the price per key trends.  We've presented it on a rolling basis and have excluded trophy assets to smooth it out.  Included are transactions ranging from economy to upper upscale where prices were disclosed. 


The declining values are instructive.  While clearly not a positive for the sellers, the industry as a whole may benefit from a more liquid transaction market.  Transfers of ownership to buyers with lower costs of capital and better balance sheets is a natural and efficient outcome of a severe demand downturn.



LODGING DEALS - Hotel transactions

PSS: Numbers Need To Go Higher

Black Book thesis solidly intact. No changes to our estimates on PSS or the view we articulated in our Black Book (let us know if you are interested in a copy) about how and why PSS has $2.00+ in EPS power over 2-years – about 65% ahead of the Street’s expectation.


The quarter in itself was kind of a yawn. Probably more puts than takes – which is one thing we outlined in our Black Book, but it was definitely not anywhere near as bad as it could have been given the circumstances and the sentiment. Comp was right in line (but still weak at -7.3%), GM a 100bps worse than we had in our model.  SG&A in line.  Tax rate helped, but will be a benefit on an ongoing basis. Working capital and cash flow was really solid – the CF trajectory was better than I modeled, and inventories are in check.


As for the outlook, the only thing that was new to me was that mgmt quantified a 20%+ decline in rent on leases being renegotiated during the course of business. This is above the mid-teens rate I had in my model (you do the math – rent is 15% of COGS, and 20% of stores up for renewal per year at 20% price cut).


Rubell probably kept earnings in check for 3Q by noting that product costs (68% of COGS by my math) will be down only low-single-digits in 3Q and then will accelerate to 10%+ in 4Q.  I think the 3Q is a low-ball number. Even with better meat on the bone from PSS on financials, my sense is that numbers won’t go up anywhere near as much as they should.


As for other items that lead to my 6% margin and $2.00 in EPS power number… nothing really changed. Own out of the print, not into it.  This continues to be a BIG idea.


 PSS: Numbers Need To Go Higher - PSS S 9 09

Europe: When Boring is Good

There are a number of European Data points out this week worthy of mention. While most of the figures below are decidedly rear-view, they underscore the sequential improvements in the region’s fundamentals. We’re currently not invested in Europe.


Eurozone Data-


Q2 GDP down 0.1% quarter-on-quarter   (after -2.5% in Q1)

Q2 Household expenditure up 0.2% Q/Q   (after -0.5% in previous quarter)

Q2 Exports decreased by 1.1% Q/Q   (from -8.8% in Q1)

Q2 Imports down 2.8% Q/Q   (after -7.8% in the previous quarter)


  • Bullish data, especially with a positive external balance (surplus) of 19 Billion EUR for the Eurozone in Q2.

(source: first estimates from Eurostat)


CPI down 0.2% in August Y/Y (-0.7% in July Y/Y)


  • The new data is in line with our thesis that the strong economies of the Eurozone are importing deflation. This deflationary level is stable in the near term with interest rates low and growth slowly returning; we expect to see annual inflation compares shift towards the positive in Q4 due in part to energy prices a year earlier.  Eurostat issued just its initial CPI estimates for August so we don’t have component stats yet but, as an example, Germany, the Eurozone’s largest economy, saw food prices fall between 0.9%-1.7% in August M/M, a clear benefit for the consumer.

Industrial Producer Prices down by 0.8% in July M/M (or -8.5% Y/Y)


  • Producers are also benefitting from deflationary energy costs sequentially. On an annual basis, prices in industry fell 4%; in the energy sector alone prices fell 20.2%. 

Unemployment rose 10bps to 9.5% in August


  • We expect this number will rise (esp. as cash for clunkers winds down (Germany, today) and stimulus packages fade). As unemployment pushes up look for confidence numbers to erode, ending months of sequential improvement.  Retail sales continue to be a poor gauge of economic health, however as unemployment rises look for the consumer to pull back in spending. 

PMI Manufacturing rose to 48.2 from 46.3. Final PMI Services comes out tomorrow, but initial estimates showed improvement and composite PMI reached the 50.0 mark in August, the line dividing contraction from growth.


Business and consumer confidence improved for the fifth straight month in August


Industrial Orders jumped +3.1% in June M/M


As we prepare to reinvest in Europe if attractive entry points arrive we’ll have our Eye on both country and regional performance. For now, the data above, though rear-view, clearly shows improvement across a number of metrics. As noted, a rising unemployment rate and dwindling stimulus packages may create a stumbling block in market performance on the TREND duration.  Sometimes the best thing an investor can do is do nothing. That’s where we are at, for now. Stay tuned.



Matthew Hedrick


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