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REGIONAL ROLL

Sorry to knock the regionals again but are there any catalysts to get these stocks to reverse fortune?  The numbers look bad and that’s with a gas tailwind.

 

 

Illinois, Indiana, and Michigan are all out for August and they look like crap.  Same store revenue fell 10%, 12%, and 5%, respectively, and the moving average line is negative and trending downward for each state.  If this is recovery, I’d hate to see a depressed environment.

                                                                     REGIONAL ROLL - Illinois August Revenue

                                                                     REGIONAL ROLL - Indiana Delta Chart

 

Here are the catalysts.  Try and find a positive one among them.

  • ISLE did not provide any comfort on their 8/26/09 conference call:
    • “Cost reductions may be over”
    • “Discounting accelerating”
    • July no better than May and June
    • No improvement in August other than an easier comparison

 

  • Gas price tailwind reversal – this is a biggie
    • Despite 50% lower gas prices year-over-year, gaming revenues look terrible.  We’ve shown that every 10% change in gas prices has a 1.5% inverse impact on regional gaming revenue.  What happens when gas prices are up 50% in December and into 2010?  See our recent note “GAMING REGIONALS: NOT YET IN THE RECOVERY ROOM” (08/23/09)

 

  • The Consumer – Housing, the “wealth effect”, need vs want
    • We and our macro team have written extensively on the long-term structural issues facing the American consumer

 

  • Regression to the mean
    • Casino revenue as a percentage of PCE keeps falling from its mid-2008 peak.  We’ll have more on this in a later post

 

So why do the analysts show 2H09 growth in revenues for most of the regional gaming companies (see below)?  Growth in 2010 might even be a stretch, especially considering the gas headwind in the first half of 2010.  A recovery thesis looks very premature.  Look for estimates to come down for most of the regionals.

 

 

                                                                     REGIONAL ROLL - REGIONALS 2010 2H09

 

 


SHFL: 3Q09 CONF CALL HIGHLIGHTS

SHFL reported 3Q09 results, handily beating Street EBITDA and EPS expectations.

 

 

Shuffle Master reported $45.1MM of revenues and $15.6MM of EBITDA, slightly ahead of Street revenue expectations of $44.3MM and handily beating EBITDA estimates of $14.2MM.

 

"We are continuing to see the real impact on our bottom line of specific cost containment measures initiated earlier this year and are confident that regional expansions, new openings in Asia, increased momentum in the shuffler replacement cycle and the i-Table roll-out this fall are all milestones on the path toward future top line improvements as well."

 

3Q09 Highlights

  • 967 installed iDeal shufflers replaced old Ace shufflers which are being phased out; 133 of which were installed in the 3Q09, 3000 (of the total 4500 in the field) Aces are expected to be converted to iDeal by the end of 2010
  • Proprietary table game revenue increased primarily due to Texas Hold Em
  • New Rapid concept - Rapid 37 for Indian Gaming markets where roulette isn't legal
  • Customers expressing interest in paying for shufflers based on usage; however, determining/tracking usage is a challenge
  • Continue to acquire and develop properietary table games - newest game incorporates iDeal into the game, still in preliminary testing stages
  • Stronger USD has caused their top-line results to look weaker, however, bottom line impact is very small
    • 3Q09 gross margins where impacted by FX though - Australia and EGM, ex FX GM would have been 59% (unchanged y-o-y)
  • Leasing products (iDeal) negatively impacted gross margins since they were initially rolled out under "introductory" discount pricing
    • Will continue to focus on emphasizing this business
  • Utility sales declined (shifting to lease); however pricing increased
  • Proprietary table games revenue increase was driven by sales activity
    • Margins were down as a result of higher depreciation
  • Electronic Table Systems - majority of tables sold in the quarter were in Australia
    • Higher lease prices were offset by higher amortization
  • Electronic Gaming Machines margin increase driven by higher conversions
  • Cost containment has generated 8.7MM of non-FX related savings
  • SG&A reduced by 2.6MM (ex FX)
  • Leverage was 1.8x
  • Expected full year tax rate is 28-33%
  • Working capital - inventory is the largest tangible asset on the balance sheet. Increase related to ramp of utility projects going to openings in Asia and products close to completion to be shipped in the 4Q09
  • $55MM available on RC
  • Openings of Genting and LVS Marina Bay - nice opportunity for them. City Center will also have some of their products.  Delaware & PA table game introductions will present an opportunity to ship shufflers

Q&A

  • 3Q09 level of stock comp is a good run rate to use going forward
  • Internal goal for operating margin as they move their mix more towards lease?
    • Taking advantage of cost efficiencies to not always need to raise rates, but want to get to remain in the high 50's maybe eventually low 60's
  • Use of free cash
    • Nothing obvious on the M&A front - just add on products and game titles
    • Look to paydown debt as their primary use of cash
    • As they continue to increase leases they will need to spend money on inventory
  • Expecting to replace over 3,000 of the 4,500 old Ace shufflers over of the next 14 months or so
  • Trying to become more "build to order" and improve supply chain management
  • Shipping to Singapore in F1Q2010 (their FY), both lease and sales

Coyote Ugly: The Performance of Natural Gas

For those global macro investors that have been long of natural gas this year, it has been an ugly relative ride.  Some might even say, coyote ugly.  In fact, natural gas at the Henry Hub fell to $2.25 per MMBtu last week, which is its lowest price since February 15, 2002 when natural gas traded at $2.18 per MMBtu.  This isn’t surprising given that natural gas inventories continue to pile up and are currently 18 percent above their five year range and on pace to exceed the all time high level of 3,565 billion cubic feet, which was recorded in October of 2007.

 

The commodity investment race is not even close this year.  Crude oil is up ~+59.4% and natural gas is down ~-50.4%.  Obviously a primary fact that has worked in oil’s favor is that it is a global commodity that is priced in USD, so USD down will naturally equal oil up.  Any commodity trader that has abided by our “Burning the Buck” call this year is sitting pretty on his energy book at the moment.  Conversely, the natural gas longs, who have been focused on the Dennis Gartman-esque investment thesis that was based on the extremes of the oil / natural gas ratio (outlined in the chart below) have been on the wrong side of the pain trade.

 

The benefit to low natural gas prices will of course be seen this winter for consumers.  As the Beccy Tanner from the Wichita Eagle reported yesterday:

 

“ The price of heating a home with natural gas is expected to be half what you paid last year — that is, if the hurricanes don't disrupt fuel supplies to Kansas or snow and ice storms don't blanket the state later this year.  The market price can change, it all depends on the weather," said Dave Springe, consumer counsel for the Citizens' Utility Ratepayer Board in Topeka, a state agency charged with representing consumers in utility cases. "But generally, the news is good. What we are seeing right now is that natural gas prices are at all-time lows.  Average household savings of $200 to $300 for the winter are possible.  In this economy, this is good news for consumers, said Al Walker, a spokesman for Kansas Gas Service, a utility company that provides service to 642,000 customers in 343 Kansas communities. The utility, which adjusts its cost of gas charge monthly, now charges $5.19 for 1,000 cubic feet of gas, compared with $10.47 a year ago.”

 

For the average consumer who pays a $400 - $500 dollar heating bill in the winter, the decline in natural gas prices will provide some real relief versus last winter.

 

Also, as natural gas stays at low relative prices, it’s possible that it may take some share from coal and oil, which is longer tail and prices relative to transportation demand.  In fact, we saw increased focus on this issue in congress this week.  Specifically, Senator Schumer, Democrat of New York, stated that “the Senate is more open to natural gas as a transition fuel than the House was, but the Senators from the coal states who are crucial votes are going to want first consideration for coal.”  Oil is currently trading at roughly $11.70 per MMBtu, so on an energy equivalency basis almost 4x the price of natural gas, which is a real and tangible factor in the long term.

 

According to most estimates, coal provides roughly half of the electrical power in the United States, while natural gas provides roughly 20%.  As is widely known, natural gas is also much more environmentally friendly. In fact, on every pollutant level natural gas scores more favorably versus oil and coal.  We’ve outlined this in the table below:

 

Coyote Ugly: The Performance of Natural Gas - DJ2

 

The reality is this: with lower pollutant levels, a cheap relative energy price, and ample domestic supply, natural gas will have its day, but investors, as they have learned in the year to date, can only focus on these long term trends, in lieu of short term fundamentals, quantitative levels and global macro factors, at their peril.

 

Daryl G. Jones

Managing Director

 

Coyote Ugly: The Performance of Natural Gas - a1

 


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Burning The Buck: Update...

It put a smile on my face to hear of my least favorite manic media network talking about a “burning buck” today. I wonder where they read about that investment theme…

 

This is a funny business. If you can’t wake-up to something to laugh at, you probably aren’t awake. The 2009 Global Macro inverse correlation that continues to dominate is that which is anchored on a US Government sponsored Burning Buck. It can make you smile and cry all at once.

 

Today, despite a Burning Buck becoming consensus, the US Dollar continues to get sold. The chart below outlines the severity of this US Currency Crisis. At down -0.36% today, the US Dollar Index is threatening to crash through the $77.00 line. Crash? Yes. When the world’s said “reserve currency” drops -13.5% in 6 months, by Research Edge’s definition - that’s a crash.

 

There are actually two charts below – the intermediate term one showing that the US Dollar Index is broken across all 3 of our investment durations (TRADE, TREND and TAIL), and the long term chart showing the US Dollar Index price dating back to the date that matters, 1971, when Nixon abandoned the Gold standard.

 

The long term chart provides the critical context of our Burning Buck call. On only one occasion in the last 38 years has the US Dollar Index sustainably weakened below the $78 level other than right here and now – that occasion, of course, was one of the leading indicators to our calling the 2008 US stock market crash.

 

At what point does Burning The Buck hurt US stocks rather than help them? In 2009, after watching the US Dollar crash on the downside and the US hedge fund community seeing their shorts crash to the upside, anything can happen here. At 1041 in the SP500, I have the generational short squeeze in US stocks running out of momentum.

 

Remember, like calling bottoms, calling tops are processes, not points.

KM

 

Keith R. McCullough
Chief Executive Officer

 

Burning The Buck: Update...  - a1

 


RESTAURANT INDUSTRY – DEMAND ISSUES

Given the news from MCD today, the following thoughts on unemployment help to explain why MCD is seeing sluggish trends in the USA!

 

This chart tells the story about a key demographic for the QSR segment - the core 16-24 year olds - which are heavy users of fast food. 

 

The following is taken from Andrew Barber’s post “Stagflation: Where the Pain is...”:

 

IDLE YOUTH

Looking at total employment ratio’s estimated by the Department of Labor shows that, on a seasonally adjusted basis 16-24 year olds had a very rough summer in 2009 with the figure hitting the lowest level since inception in 1948 and fewer than 50% working for the first sustained period since the draft ended (without seasonal adjustment that ration would be over 51%).

 

DOL methodology excludes military personnel from the labor force estimates but, with up a huge percentage of all men 18-21 drafted (or motivated to enlist by the draft) at periods between the end of WW2 & early 70’s, and furthermore with 72% of all Vietnam period veterans accessing GI bill benefits (significantly higher than WW2 & Korea vets, presumably because Vietnam vets were significantly younger as a group) it must have skewed this data immensely. Note that the prior Assistance Readjustment act of 1972 raised GI bill benefits for returning servicemen to payout levels exceeding many entry level salaries –essentially creating a huge incentive for veterans not to work during the subsequent recessionary periods. This all suggests that, on the whole, the employment picture for young Americans is significantly worse than at any point in the living memory of the majority of the population.

 

RESTAURANT INDUSTRY – DEMAND ISSUES - 16 24

 

 


PSS: SELL MORTIMER, SELL!

CEO Matt Rubel sold 100,000 shares just days after commenting on the 2Q earnings call that Q2 marked the bottom. Yes, that came as an initial shocker to us on many levels. But the picture becomes far less suspect after a deeper dive.

 

First off, when Matt Rubel joined PSS in July 2005, his employment contract included an option on 720,000 shares of common stock at $20.93/sh and 214,250 shares of restricted stock. Under the vesting schedule, 120,000 shares were to vest on the 1st and 4th anniversary of the grant, with 240,000 shares on the 2nd and 3rd anniversary.  We just passed the four year lockup. 

 

Secondly, and perhaps most importantly, check out the chart below. We’re not looking at the most stellar track record of market timing here. Rubel’s last three sales left money on the table as the stock kept grinding higher. In fact, he had a $630k sale immediately before a 100% run in the stock in July 2008.  His best trade was calling the top and selling 25% of his stock in the late summer of 2007 – just as the credit environment melted down, the economy went sour, and the SRR deal turned out to be horribly timed.

 

THE question here is whether he is again ‘calling the top.’  That answer is No. Say what you want, but the guy has a Macro process. We sat down with him for a couple hrs last month, and walked through the macro call, and how he is aligning the company’s resources to leverage the upside. I’m genuinely not concerned about this sale. Check out our PSS Black Book for more details on our thesis.

 

 

PSS: SELL MORTIMER, SELL! - PSS RubelTrans 9 09


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