The more work we do on PENN’s Ohio opportunity, the higher our estimates go. Net return – even after Cincinnati’s impact on Lawrenceburg – will be very strong, at a minimum.
Even if Columbus’s 1.5 million adults spend less than the lowest comparable existing gaming market per capita, PENN’s casino will blow our $191 million EBITDA estimate out of the water over time. Although it won’t be out of the water since Columbus will be land-based and not a riverboat casino like most of the rest of the Midwestern casinos. Our estimate for Toledo EBITDA of $60 million may also prove low, again given the performance of comparable markets.
We analyzed the most comparable markets of Columbus and Toledo: Cincinnati, Kansas City, St. Louis, and Omaha (Council Bluffs). Those are all Midwestern markets with fairly similar income demographics. Chicago was excluded since there is a gaming position cap which distorts the data. The following chart shows annual gaming revenue per capita (adult) for each of the markets.
Omaha/Council Bluffs generates the highest spend per capita and Cincinnati the least. It is somewhat encouraging for PENN's Lawrenceburg property that Cincinnati seems to be under-penetrated. Lawrenceburg will be competing with a new Cincinnati casino across the river in Ohio in late 2012. In terms of median household income, Columbus falls right in the middle of the pack – a little above Kansas City – while Toledo would be the lowest. The following chart projects gaming revenue for Columbus and Toledo based on the high, low, and average per capita gaming spend of the other markets.
What’s pretty clear is that our gaming revenue estimate for Columbus could potentially be very low over time, while Toledo looks reasonable. More importantly, EBITDA could be off the charts for Columbus relative to our estimate of $191 million using the gaming revenue figures from the previous chart as shown below. We’ve also added in estimated lost profits from the opening of a competing Cincinnati casino across the river from Lawrenceburg.
According to the math, Columbus has the capability to generate nearly $500 million in EBITDA. However, we don’t want to mislead anyone into thinking that is within the realm of near-term possibility. If Columbus ended up generating that level of revenue per adult (unlikely), it would take years to fully penetrate the market. But significant potential remains. Despite opening up with 3,000 slots and 100 tables, PENN can legally expand to 5,000 slots and an unlimited number of tables. We think this market will support a 60%+ increase in both. $400-500 million is certainly a stretch but our current EBITDA estimate falls almost 20% below even the lowest estimate derived from per adult capita spend of $439 (Cincinnati).
In our opinion, the returns on Ohio promise to be excellent and are not reflected in the stock price. If PENN’s Ohio casinos can attain only a Cincinnati type market penetration, ROI on the combined $700 million investment would be a whopping 37%. That ROI is a net number that reflects the Lawrenceburg EBITDA decline following the opening of a competing casino in Cincinnati - a 26% drop per our model. If Columbus can reach the average Midwestern market penetration or higher, the returns will be through the ceiling: 50-83% by our math at maturity.
So what would limit the Columbus returns and why is our estimate below the low projection for market penetration? For one, it will take some time for PENN to fully penetrate the market. Our Columbus estimate is probably a reasonable start but years of same store EBITDA gains should ensue. The property would need to expand its slot and table base from the initial 3,000 and 100, respectively. However, there is another reason to believe our estimates will prove very low. Our operating expense levels are much higher than PENN’s other properties. For instance, Lawrenceburg has more slots and tables, yet our projected Columbus expenses are 33% higher.
We generally see only upside to our current Ohio estimates for PENN. Even with conservative estimates in place, our current 2013 EPS projection contemplates 26% CAGR growth.
The bullish news here is time – with time, consensus changes…
I still don’t think consensus is Bearish Enough yet… but with lower-lows, that will come…
At 1062 in the SP500, we’re testing the lowest-lows we’ve seen since the cycle top that was registered on April 23rd. It’s been an expedited correction of -12.7% from the cycle’s peak, and now risk managers around the world are asking themselves the right question – can we crash? Using a peak-to-trough decline of 20% as a definition for crash, Greece, Spain, Slovakia, China, and Italy have already crashed so far in 2010.
Our April Flowers/May Showers call wasn’t for a cycle peak-to-trough crash of 20% in US Equities, but the probability of such a move obviously mounts as prices go lower. As they say in probability-speak, a 20% crash in US Equities should no longer be considered improbable within the distribution of probable outcomes.
Since I have now used the word “crash” 5 times (actually now that makes 6), this means we are at least testing the bounds of my being Too Bearish here. That said, provided that the SP500 closes below the long term TAIL line of support (1078), this market is in what our Hedgeyes call a Bearish Formation (bearish across all 3 core investment durations - TRADE, TREND, and TAIL) with our immediate and intermediate term TRADE and TREND lines of resistance at 1082 an d 1144, respectively.
As of 2PM EST, my immediate term downside support is now 1050. Importantly, that should be considered not only probable but a line that is below the prior closing YTD low established on February 8th of 1057.
If we see lower-lows, we’ll acknowledge that this market is becoming Bearish Enough.
Keith R. McCullough
Chief Executive Officer
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Which companies are toughening up in this macro environment?
The most bearish data point for the restaurant industry came with Friday’s jobs report. Private payrolls added for the month of May was reported at an anemic 41,000 – the first marginal deceleration since December of 2009. There are a number of factors that drive incremental trends in eating out but, in the current environment, jobs take center stage. The biggest benefit to current top-line trends will be having more consumers collecting a paycheck.
As you can see for the chart below, the casual dining industry is right to be focused on the employment trends. The Knapp figures correlate strongly with employment growth – more strongly, in fact, than retail sales figures do.
Right now it appears there are two key consensus calls in the restaurant sector. The first is that MCD will continue to dominate the QSR space. Second, Bar & Grill is an uncompetitive concept and will not be able to take share.
MCD is a power house and the absolute trends are very impressive. But it looks like expectations are ahead of current trends. The beverage initiative is an important initiative for the company and driving some improvement is current trends. Longer term it complicates operations and will not be a long-term driver of traffic. In May, two-year trends have slowed for MCD around the world. Lastly, GMCR is trading on rumors that MCD is going to buy them. I will say categorically, MCD will never purchase GMCR.
As for the Bar & Grille space, the negative sentiments can be summed up in two thoughts. (1) High-end brands will take significant market share from mass-market brands and (2) Convenience-based brands are more likely to see sales lag in a recovery than destination-oriented brands.
It’s a very difficult and often a losing proposition to pigeon-hole a certain company/brand/stock in a certain classification. In the early stages of the improving top line trends, the consumers with money went to places where they feel comfortable with the food and the service. Over the next 12-month the MACRO environment will be very challenging.
I continue to believe that it’s important to focus on those companies that are being proactive and changing the variable cost structure. Those that can create leaner, meaner cost structures will be better positioned to mitigate any margin erosion.
EAT is one name that is pursuing a proactive strategy and remains a core focus name.
Conclusion: A theme we will be discussing more and more is the sovereign debt issues in the U.S., which could lead to a bounce of the Euro versus the U.S. dollar.
If there has been one global macro trend that has remained consistently intact in the year-to-date, it is the decline of the Euro. Since its short term peak in December of 2009 at ~$1.50, the trajectory has been basically straight down.
The decline in the Euro seems to be accelerated by new headlines every day, which continue to support the longer term structural impediments facing the Eurozone. Specifically, as we recently wrote:
- Interconnectedness - It should come as no surprise that the eurozone has willfully ignored its own rule-making. European economies are too interconnected to permit anything else. Most nations within Europe borrow from, and lend to, each other: Spain holds one-third of Portugal's debt; Spain owes Germany $238 billion; Italy owes France more than twice that. So while the Maastricht Treaty requires the eurozone to direct Greece to restructure its debt, most major banks within the eurozone are holders of Greek debt and would distinctly feel the pain of any Greek debt restructuring.
- Lack of Political Consensus - The sovereign debt crisis has exposed the ineffectiveness of a one-size-fits-all monetary policy for a continent with significantly disparate economies. Spain shapes its monetary policy to combat its 20% unemployment; Germany's works to keep its economy from overheating. The absence of a stronger political union to manage the divergent economic goals of the member nations destines the Maastricht Treaty to regular flouting by its members.
So, while the Euro remains in a bearish formation, we are starting to consider trading off the immediate term oversold readings on the long side, then sell high/buy low on the short side on rallies to $1.22-$1.25 from $1.19-$1.20.
The key catalyst for a rally in the Euro versus the U.S. dollar, will be the US facing a European-like sovereign debt crisis in 6 months. While arguably the U.S. doesn’t have the structural issues outlined above, the U.S. does indeed have major fiscal issues with its defict-as-a-percentage-of-GDP in the danger zone of north of 10% and gross-public-debt-as-a-percentage-of-GDP north of 90%. With debt maturities accelerating in the U.S. over the next couple of quarters, the number one reason to buy Euro is being bearish on USD, not being bullish on the Euro in absolute, due to these coming maturity catalysts.
Chief Executive Officer
Daryl G. Jones
With German Factory Orders getting a fair share of mention this morning I thought it worth noting what most aren’t pointing out: the latest +29.6% annual number is versus last April’s abysmal -37.1% reading! Also, month-over-month orders slowed to +2.8% versus +5.1% in March.
While positive, taken in context, the orders were less fabulous. As the chart below points out, Factory Orders have “easier” comps for the next four months off depressed (negative) levels before bumping up against tougher compares in September (+12.8%).
We continue to believe that Germany has some of the best fundamentals in Europe, yet remain wary of contagion threats in the region. Below is a review of recent German data points.
- An improvement in the unemployment rate, ticking down to 7.7% (Eurozone Ave. = 10.1%)
- Managed fiscal balance sheet: German Deficit-to-GDP = 5.0% (versus double digits for Spain, Greece, and Ireland) and bullish comments today from Chancellor Merkel on additional government spending cuts.
- Manufacturing PMI was flat and Services PMI improved only marginally in the latest reading; the coming months look to roll over.
- Consumer Confidence (GfK) turned down. 3.5 in June versus 3.7 in May.
- ZEW economic sentiment index plunged to 45.8 in May from 53.0 in April.
- Retail Sales fell -3.1% in April Y/Y versus +3.7% in March.
Our risk/reward profile for Germany weighs to the downside. While a weaker Euro will favor the export-heavy economy, sovereign debt concerns across the region continue to enhance market volatility in the capital markets across Europe, and we think that the DAX is setting up to give back some of its YTD outperformance.
We currently do not have an investment position in Europe, but are looking to trade countries like Spain, France, or Italy on the short side on a bounce.
Beware of scheduled strikes in Spain tomorrow!
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