prev

UA: Sweeping Apparel Under The Carpet?

Yes, footwear is performing well. But my analysis begs the question as to whether UA is sweeping ad spend associated with cleaning apparel inventories under the performance footwear rug.

You've seen me throw out some incrementally positive comments recently on UA - particularly given what appears to be very solid execution on its footwear launch (which is still tracking extremely well, by the way). Footwear is extremely important to future growth UA, but let's not forget that apparel accounts for 90% of its current cash flow. For every positive datapoint I see on footwear, I get more guarded on apparel.

Our analysis shows the heavy step-up in brand-promotion media spend in the first half. Yes, we all know that UA lowered the earnings boom early this year for this very reason, but that was due to the footwear launch. We're seeing this come through, but what I'm surprised to see, however, is the massive year/year increase in print ad spending on performance apparel. While I am not yet certain as to why, let's stay intellectually honest and at least ask the question as to whether the company is sweeping ad spend associated with cleaning apparel inventories under the performance footwear rug.

My long standing take on UA is that the brand is tremendous, and that I don't question for a minute that it can grow 30% top line for another 3-5 years. But simply think that the gross margin needs to come down another 2-3 points to reach UA's potential. Last I checked, growth stocks at 30x+ earnings don't like when margins come down. I like the brand, but I still don't like the stock.


Exhibit 1: The increase in instances of promotional activity synch almost perfectly with change in the Sales/Inventory spread. Interpreting the chart shows that promotions are high, but so are inventories. Margins have yet to take the big hit.

ADMIRALING PNK'S PRESIDENT OPPORTUNITY

Was that Dan Lee I saw trying to cut the stern line of the President? Cutting the boat loose during the Mississippi River flooding could have generated some nice insurance proceeds. In all seriousness though, it looks like we've gotten past the worst of the flooding and that is good news. The President suffered no major damage and while collecting insurance proceeds is not an option, PNK maintains some nice optionality on this facility.

The zero cash flowing Admiral President (AP) casino is worth not much more than a bag of rocks as far as Wall Street is concerned. A Chain of Rocks President Casino, however, is a whole different matter. PNK management is contemplating moving the AP 8 miles north, but still within city limits, near the Chain of Rocks Bridge spanning the Mississippi River. I can hear it now, "Why is this guy talking about the smallest property in PNK's portfolio?" I've got 25 million reasons why. That's $25m in potential incremental EBITDA which equates to over $2 in equity value after assuming a $50m investment. Not bad for an option that falls way below Wall Street's radar screen.

Since opening Lumiere Place (LP), PNK has operated the AP at a loss in downtown St. Louis. The company maintains 3 options on this:

Status quo
Close it down - $6-14m accretive to EBITDA
Convert to the Chain of Rocks - $6-25m accretive to EBITDA

The biggest delta here is the impact on Lumiere Place. AP run rates around $35m in annual gaming revenues and is a stone's throw from LP. Will LP get 1/3, 1/2, 2/3 of that business? Your guess is as good as mine but each scenario moves the needle. There is little question in our minds that with a $50m investment for renovations and a pavilion, Chain of Rocks should pull in at least $4m in monthly revenues, up from the current $3m at the downtown location.

What's the hold up? Come on folks, this is the gaming industry. Doing anything in the world of gaming is like issuing a sell side (non-Research Edge) research report. One needs multiple levels of regulatory approvals. In this case, PNK is seeking evaluation and approval from the Missouri Gaming Commission and the City of St. Louis. We don't anticipate material issues with obtaining these approvals although timing is never certain.

MACAU JUNKET COMMISSIONS APPROACHING JUNK BOND YIELDS?

  • This is a gross exaggeration I know, but I am increasingly alarmed by the junket price war. My source indicates that LVS may have boosted its commission again, from an implied 1.25% of roll to 1.3%. I believe MGM may have moved even higher than LVS. No indication on Crown but if I had to guess I'd say MPEL will or already has followed suit. This chart examines the relationship between escalating junket commission rates and declining theoretical EBITDA margins on VIP revenues. I estimate the casinos break even on VIP business around a commission rate of 1.5%.
  • No word yet on WYNN but I am skeptical they can hold out any longer. WYNN has proven to be the best operator in Macau and their performance resilient despite an uncompetitive junket rate. At some junket rate, price will win over product, at least with some junkets and players. I am not sure we are there yet but any market share loss or softening of its junket position could be a major dent to this Bugatti. WYNN's stock has been a massive outperformer relative to the group and deservedly so. Could WYNN's stock become a victim of its own success? Follow the junket rates and market share.

real-time alerts

real edge in real-time

This indispensable trading tool is based on a risk management signaling process Hedgeye CEO Keith McCullough developed during his years as a hedge fund manager and continues to refine. Nearly every trading day, you’ll receive Keith’s latest signals - buy, sell, short or cover.

MORE MARGIN CONTEXT FROM A SLIGHTLY OLDER ANALYST

Margin mean reversion is a scary thought. Revenues get all the attention since they are released monthly. However, I do not believe enough focus has been placed on the margin side of the equation. Hotel margins in Las Vegas have expanded almost 10% in 15 years while F&B margins increased 15%. We all know hotels and restaurants are two of the most cyclical industries out there in consumer land. In fact, other than in 1998, the only other year that hotel margins contracted were during the 9/11 induced travel slowdown in 2002. While casino revenues are certainly not recession proof, they have proven to be somewhat recession resistant. Hotel and F&B margins were significantly above their 15 year mean in 2007 while casino margins were less than 1% above.
  • Some on the sell side have defended the recent only modest drop in Las Vegas' monthly casino revenues. The fact that casino revenues are down just slightly is not terribly surprising considering the historical resiliency of the casino to economic cycles. However, the revenue and margin contribution of Hotel and F&B has never been higher than now. That is terrific in an expanding economy, but last we checked the US consumer was facing stronger headwinds than they have in the past 15 years. I am obviously concerned about falling airline capacity, the rising airfares to Las Vegas, housing, inflation, etc but I'll leave that analysis for a later posting. Here I've looked at what happens if margins revert to the average of the last 15 years. F&B contribution falls by 67%, hotel contribution by 10%, and total EBITDA by $869 million or 17%. Take it a step further and assume 2002 margins, EBITDA for the industry in Las Vegas would fall by a whopping $1.9 billion or 37%.
  • Gaming companies have done a phenomenal job transforming the product and developing other profitable revenue sources. The downside is that they have tied the industry much more to the economy. I'm really showing my age here but I still remember when Las Vegas was the city of great deals: $3.99 buffets, $75 hotel rooms, and $0.25 craps. Those days are long gone and good riddance. There hasn't been a time over the last 5 years that I've gone to Las Vegas and haven't been astonished at how expensive everything is. Indeed, hotel and F&B margins expanded 590 and 400bps in the last 5 years alone, all due to pricing. How will pricing and margins hold up with the US consumer under siege? We haven't had a consumer recession in 15 years but I have a feeling we are going to find out.

MEAN MARGIN MEAN REVERSION: A LITTLE LV CONTEXT FROM AN OLD ANALYST

First the good news: Las Vegas property level EBITDA margins have expanded 10 out of the last 15 years and were 4% higher in 2007 than the average over that period. The bad news: Mean Reversion is probably rearing its inevitable head. Why am I concerned about mean reversion? The impressive margin expansion was driven primarily by the hotel and the food and beverage product lines (casino margin has been stable) which should contract first and most dramatically as consumer spending slows and probably recedes. The following chart clearly shows the relevant trends.

In 2007, rooms and F&B contributed 40% of revenues and 38% of total departmental profits in Las Vegas, big contributors for sure. Room rates are already under pressure and casinos won't drop occupancy to hold rate. ADR's are the highest margin revenue source in Vegas. Do you see where I'm going? I'm not sure F&B traffic and pricing can hold up in this environment either. Restaurant traffic certainly hasn't across the country.
My partner Keith McCullough constantly reminds me that context is not just the last few years. Context in this case is at least 15 years. Unfortunately, when it comes to margin mean reversion, this context is not very comforting.

WHALES AND MINNOWS

(previously posted under Keith McCullough: 06/08/08 10:12 AM EST)


Main Street vs. Wall Street: Whales vs. Minnows

I ate a $38 steak (the cheapest on the menu) at Sleek Restaurant at Lumiere Place in the city of St. Louis, of all places. As I looked at the suits and fashionable dress shirts in the restaurant and the t-shirts, baseball caps, and blue hair in the casino, I was struck by the contrast.

The obvious disconnect between the quality of this new US Gaming facility and the quality of the customers got me thinking about the Main Street vs. Wall Street dynamic in our current economy.

More important to the US Gaming investor than St. Louis is the gaming Mecca of Las Vegas. It's been at least 10 years since Las Vegas has been considered anything approaching cheap . Prior to the cheap money leverage boom of capacity builds, Vegas was always resilient because you could spend $3.99 for the buffet, $80 for a nice room, and drink for free.

Sure you lost a bunch in the casino, but that never factored into the decision to go to Vegas because it's so cheap . Even as the operators jacked up hotel rates, food & beverage pricing, and table minimums, the consumers were perfectly willing to lever up their balance sheets to spend, spend, spend. Why not? The value of their houses were probably going up 20% a year forever right?

The new new Vegas was built for Whales, Dolphins posing as Whales, and Minnows posing as Dolphins.

Something's gotta give here. Vegas runs on a model of high hotel room occupancy. My bet is we'll see a resurgence of the food court and the buffet you don't need a credit card to pay for.

Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.33%
  • SHORT SIGNALS 78.49%
next