Smile and Nod

“Well done is better than well said.”
-Benjamin Franklin
On Friday, I used a Thomas Jefferson quote. This morning, I figured I’d keep rolling out the red carpet for America’s men of character. With Washington’s politicians giving nothing but faint lip service to America’s Currency and Credibility Crisis, God knows we need some leadership and guidance.
Relative to the range of possibilities I had in my head going into this weekend’s G-20 meetings in Pittsburgh, nothing really happened. They talked about bankers bonuses. They talked about balancing fiscal deficits. They talked and they talked. They didn’t actually do anything…
At least, somewhere along the lines of his 3-days Smile and Nod meetings with the Chinese, President Obama was slipped one of our Early Looks on Chaos Theory (“Bridging Chaos and Hope”, 9/24) . Check out this prefacing quote from Obama himself: “Because our global economy is now fundamentally interconnected…” Nice!
So, no matter where you go this morning, here we are – right in the same spot that we started ahead of the G-20. While the US Dollar finally had an up week (its first in the last 4), closing up a paltry +0.5% at $76.81, it remains broken across all three of our investment durations (TRADE, TREND and TAIL). The US Treasury Secretary’s impact on global currency markets is basically negative at this point. That’s both embarrassing and sad.
So where do we go from here? Should we fire up the Crash Calling engines again – you know, the ones that seem to find their way into the daily double of CNBC’s manic news-flow every time the SP500 drops a percent? Or should we just take a deep breath, see this market’s current risk management setup for what it is, and deal with it?
Tobias Levkovich, a sell side strategist at a government sponsored bank (Citigroup), is calling for the SP500 to hit 1000 this morning. A perfectly round number… A perfectly useless forecast. There is a reason why most of the real Stock Market Operators in this business say that the sell side shouldn’t make “market calls” – it’s because they can’t!
President Obama is right. Managing risk in this increasingly interconnected global market of colliding behavioral and mathematical factors is the future of fiduciary responsibility. White House strategists, don’t worry – he didn’t say that specifically yet, but you can poach it from me. Other people are fine with doing the same.
After watching Brett Favre stick one in the back of the end zone yesterday with 2 seconds left to get the “W” for the Minnesota Vikings, I am inspired to make a call this morning. Into month end (Wednesday), I’ll take the other side of Levkovich.
Here’s my call:
1.      Two lines matter in the US stock market right now: SP500 support at 1035 and US Dollar Index resistance $77.61.

2.      If those two lines hold, there’s immediate term upside in the SP500 to 1060 and US Dollar Index downside to $75.81.

3.      If they don’t hold, you are going to see follow through selling in everything REFLATION trade, like you saw last week.

Ahead of last week’s -2.2% selloff in the SP500, it paid to proactively manage risk. We did that by doing what we call BETA Shifting DOWN as US and Global Equity Markets were getting overbought into a US Dollar getting oversold. Our Asset Allocation positioning included the following holdings next to a 47% position in US Cash:
1.      US Bonds 19% = TIP (Treasury Inflation Protected Securities)

2.      US Equities 6% = XLV (US Healthcare ETF)

3.      Int’l Currency 10% = CYB (Chinese Yuan)

4.      Int’l Equities 9% = EWG (Germany) and CAF (China)

5.      Commodities 9% = GLD (Gold)

We don’t own oil. We don’t own copper. In terms of Commodity exposure, we simply own gold, and that will not change this morning. We flashed this as last week’s Chart of The Week when it broke, and Dr. Copper remains broken from an immediate term TRADE perspective. That line in the sand is $2.85/lb. Copper was down -1.5% on the week last week, closing down for the 4th consecutive week, reminding us that owning anything China is riskier than it was when we bought China 9 months ago.
Critically, the price of West Texas Crude Oil broke both its immediate term TRADE and intermediate term TREND lines last week. Those lines are $70.83 and $68.94, respectively. While there is long term TAIL support in the $58/barrel range, there is absolutely no reason for me to buy back what I sold (USO) higher anytime soon. This is where you get paid to do nothing.
US Healthcare (XLV) was the best performing sector out of the 9 we follow in Howard Penney’s SP500 Sector Risk Management product on both Thursday and Friday. Meanwhile, Germany (EWG) is flashing what we call a positive divergence versus the rest of Europe this morning, trading up +0.7% after “Angie” (Angela Merkel) successfully won the election this weekend. The German election was one of Matt Hedrick’s major macro catalysts. Great call by our German speaking analyst.
On the International Equity side, I’ll be right on Germany and Japan this morning but wrong on China. Chinese equities got smacked last night, trading down a -2.7% on the Shanghai Exchange. Dr. Copper and China have very high positive correlation to one another in 2009. I should have sold my CAF when I sold Hong Kong (EWH).
“Shoulda, coulda, woulda”, as we ice men from Thunder Bay would say, doesn’t matter. “Better done is better than well said.”
Best of luck out there this week,




EWG – iShares Germany
Chancellor Angela Merkel won reelection with her pro-business coalition partners the Free Democrats over the weekend. We expect to see continued leadership from her team with a focus on economic growth, including tax cuts. We believe that Germany’s powerful manufacturing capacity remains a primary structural advantage; with fundamentals improving in a low CPI/interest rate environment, we expect slow but steady economic improvement from Europe’s largest economy.

CAF – Morgan Stanley China Fund A closed-end fund providing exposure to the Shanghai A share market, we use CAF tactically to ride the more volatile domestic equity market instead of the shares listed in Hong Kong. To date the Chinese have shown leadership and a proactive response to the global recession, and now their number one priority is to offset contracting external demand with domestic growth. Although this process will inevitably come at a steep cost, we still see this as the best catalyst for economic growth globally and are long going into the celebration of the 60th Anniversary of the People’s Republic.

GLD – SPDR Gold We bought back our long standing bullish position on gold on a down day on 9/14 with the threat of US centric stagflation heightening.   

XLV – SPDR Healthcare We’re finally getting the correction we’ve been calling for in Healthcare. We like defensible growth with an M&A tailwind. Our Healthcare sector head Tom Tobin remains bullish on fading the “public plan” at a price.

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.

DIA  – Diamonds Trust We shorted the Dow on 9/3.  In the US, we want to be long the Nasdaq (liquidity) and short the Dow (financial leverage).

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.


Our very own Anna Massion was in Macau and here are some notes from her trip.



MACAU TAKEAWAYS                                                                                                                              


Commission caps:

  • Went into effect on September 22, but the government won’t check until Oct 1, 2009
  • The cap is set at 1.25% or 44% caps for revenue share properties
  • Rooms will be included in cap at a rate at “cost”. which the government estimates as 40% off of advertised room prices
  • F&B will be included in cap at a rate of 30% off advertising pricing
  • Should be easy to enforce since the government gets the numbers daily from the operators and there aren’t many “secrets” in Macau
  • Should be mildly positive margins for the operators that pay above those rates
    • Altira if it ever gets back to where it once rolled
    • Galaxy rumored to be at the high end of the payout scale

Lowering the tax rate:

  • Unless the Macau market is materially negatively impacted by Singapore for more than just a few months there is no reason for the government to seriously consider a tax cut

Visa Restrictions:

  • Restrictions were clearly eased, some say as early as July
  • The reason the restrictions were put there in the first place was to help keep visitation manageable given the current infrastructure constraints
  • There is some fear that if growth becomes unmanageable again that the government will once more restrict visitation

Other random impressions:

  • China stimulus is having a big impact on growth, especially VIP growth
  • There seems to be some confusion about whether quoted revenues of 10bn MOP is an extrapolated number for all of September or a month-to-date number
  • People are feeling more confident about the economy
  • Some don’t believe that Singapore will have a large impact on Macau. The vast majority of the visitors are Chinese coming from Guandong.  The properties with the highest exposure to fly in high rollers from SE Asia & ME will see some impact
    • South & SE  Asia made up almost 7% of the visitation into Macau on a trailing 12 month basis (from July).  Surely some of that visitation will now go to Singapore – at least on a trial basis, or visit Macau less frequently
  • Macau is definitely getting more and more westernized, more and more non-Asian tourists there
  • More people are playing slots ... this was the first time we noticed people playing slot machines
  • Lots of people are coming on package vacations for one day or so and are spending no money – they visit properties but leave without gambling.  Unfortunately, lots of them seem to be going to CoD
  • Macau property market is hot again



  • Macau Junkets don't think they will be in Singapore given the regulatory hurdles
  • It took IGT 9 months to get licensed and IGT is licensed everywhere
  • LVS likely a May/June opening



  • It seems unlikely Wynn will get back to the high teens market share it once enjoyed before the opening Encore, and even that will not guarantee more share; MGM is finally focusing on its operations and CoD has been additive to the market
  • It is unclear exactly why Wynn is doing this IPO but some ideas include:
    • Given his history, he doesn’t like being levered
    • He’s getting old so wants to cash out some while the market it hot
    • Wants to be more “Chinese” than Sheldon
    • Will use the money to eventually build out Cotai
    • Looking at acquisitions (Fontainbleau/ Bellagio)
    • Aqueduct
    • Our view is that since there is no corporate income taxes on Macau gaming profits, it is more efficient to separate as much of Macau operations as possible from the parent (WYNN)



  • Sands should be negatively impacted in 2010 when Oceanus opens.  It is unclear as to how much, but there will certainly be some negative impact
  • Venetian continues to do well, FS should ramp over time.  Good mass business just takes longer to develop
  • Sometimes it's all about perception and press, and the locals are clearly sore about the fact that LVS stopped construction on sites 5 & 6 and fired a lot of people while continuing to construct Singapore
  • We would be surprised if the government doesn’t make them promise to complete 5 & 6 as a pre-condition to the IPO.  So, the hope is that WYNN’s IPO will be white hot, and that LVS can ride on those coattails.  
  • Sites 5 & 6 will likely take at least 18 months to complete so we don’t see anything opening before end of 2011/early 2012.  LVS will have to raise more debt to complete the construction



  • Building a mass business won’t be easy and will take longer than most probably hope.  The jury is still out on whether this property will be able to generate a successful mass business
  • They have 35,000-40,000 visitors daily. Unfortunately that visitation isn’t turning into $$$ yet.  Their mass is still only 30% of Venetian’s despite visitation being 60-65% of Venetian’s run rate.     
  • Commission caps should be incrementally positive for them since they are known to pay the most
  • Says september is definitely slower at CoD- especially mass business. VIP is good though think that october will be better
  • Crown is all VIP. Hardrock all Mass.
  • Crown towers have 92-94% occupancy



  • Will announce scope and completion of their Cotai project by year end, hearing it could be as early as end of 2010 for Phase 1



  • We heard that they held very high for the first three weeks in September
  • Generally doing very well from a share standpoint – they clearly appeal to a specific market
  • L’Arc seemed to open smoothly and Oceanus should do well given the location



  • They are finally focusing on the property
  • MGM is simply too nice of a property not to generate at least $200MM of EBITDA and is on its way of doing just that now that management is focusing on running the property
  • The company has doubled the number of junkets operating there
  • They are planning an IPO for next year. They just want to take some money off the table and have a HK listing, plus they can certainly use the cash



Unemployment in Macau for June to August 2009 rose by 0.1% when compared to the May to July period, to 3.8%.  Underemployment stayed the same at 1.9%.  On a year-over-year basis, the unemployment rate rose by 0.8%.  The employed population decreased by 1,700 from the May to July period to 318,800.  Employment in retail trade and construction saw decrease, while employment in restaurants and similar activities registered an increase. 



Wynn Resorts’ $1.6 billion IPO is more than 10 times covered, according to a source familiar with the deal.  Most of the interest for the unit has come from Asia and the company favors at least 50% of the offering going to Asian investors.  The retail part of the offering was some 50 times covered in the first few hours.



August saw 2.06 million visitors coming to Macau, a 6.4% increase over the same month of last year.  On a sequential basis, the number of arrivals rose by 17.7%.  August’s figure was the highest since March 2008, when 2.13 million people visited Macau.  50.9% of the visitors were mainlanders in August, reaching 1.05 million, up 8.9% year-over-year.

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WEN – A small data point

MHGU is small but represents the current trends at WEN.


Meritage Hospitality Group operates 73 quick service and casual dining restaurants, including 69 Wendy’s restaurants in Michigan and Florida.  The company, which is the only publicly traded Wendy’s restaurant franchisee (MHGU – currently up 12% today), reported 3Q09 earnings for the period ended August 30 and attributed part of its earnings improvement to a successful new Wendy’s product launch. 


Specifically, Meritage’s CEO Robert E. Schermer, Jr. Stated, “We continue to experience improved margins and profit flow-through from our Wendy’s operations…. The new management team at Wendy’s International is delivering on its initial promises to the Wendy’s franchise system beginning with a successful new product launch of boneless chicken wings in June 2009.  Looking ahead, we believe that Wendy’s has a strong new product pipe line and is focused on margin growth at the Wendy’s unit level.” 


When WEN reported its 2Q results, management stated that it had started off the third quarter with great results on both of its wings products, helping to drive comparable sales growth at Wendy’s up 2% in July (from -1.2% in 2Q09).  Although Meritage only represents a small percentage of Wendy’s total U.S. restaurant base, the company’s improved performance could signal that the management changes and new products at Wendy’s are working to grow market share.


WEN – A small data point - wen

DKS: Update from our HQ Visit



We came away from our meeting at HQ incrementally upbeat about DKS' sales/GM trajectory and and levers it has to pull ahead of the Street's number for the quarter and year.  This is not earth shattering, as DKS was one of the few retailers linked to this space that registered a positive inflection this past quarter.  But our sense is that the trends have continued (supported by outperformance of ths sporting goods channel in third party market share data).


Looking out a bit further, it is clear that DKS would like to resume a more normalized mid-teens square footage growth rate but will not do so until the real estate development pipeline begins to build.  In the interim, second-use sites and one-off real estate acquisitions are likely. We were particularly intrigued to learn that less than 10% of its leases come up for renewal over each of the next 4 years (DKS has a 10 yr target duration for its portfolio). We just heard from Finish Line that 40% of its leases are due within 18 months. Yes, the box economics are different between the two as FINL averages about a 5-year duration. But that definitely makes us question if DKS will benefit from the current property cost environment as much as others. In other words, has its aggressive plan to lock up property terms duriing the '-03--'07 bubble coming back to haunt them?


Here are some other notables...


Competitive Environment

- One of the more notable comments of the meeting was in response to a question about the macro environment and its current impact on the industry to which mgmt responded something to the effect of “from our perspective, we would have preferred for the rebound to have come later, it would have resulted in further shakeout within the industry.”


- TSA:

   - status of TSA’s financial health unknown within the industry

   - continue to add stores at same relative pace to prior years

   - not seeing any changes with in-store environment or promotional cadence

   - only competitor with similar box size out west (~50k sq. ft.) – most comparable competitor


- Academy Sports: 110 stores – 73 in TX

   - 80-100k sq. ft. footprint

   - Everyday low price

   - Moving eastward into TN, NC, KY (overlapping more with HIBB)

   - Approaching $2Bn in annual sales


- Hibbetts: much smaller format, not competing much if at all head-to-head


Market /Regional Trends

- All regions performing similarly, no standouts to note. 

- Target market size has/will not change

   - not considering utilizing a smaller format to pursue smaller markets (i.e. HIBB no interest)

   - minimum box size remains ~40k sq. ft.


Store Additions

- Westward growth – have secured 10 of 32 Joes locations

   - (6 to open in Oct, 4 in 2010)

   - Was watching Joes for 2-3 years before sites came on market.

- Chicks acq primarily driven by box size – have built 2 additional DKS stores around these in CA

- Regions of greatest growth opportunity:

   - FL, TX, AZ, CA, Pacific Northwest

- Will build out in 1-5 location groupings, not 10+ chunks

- Priority towards vacant, build out (Greenfield), and second use (in that order)

   - Activity from a developer standpoint still very slow – is capping rate of growth via Greenfield opporty’s

   - Barring further filings, upside to expectations of 24 stores in 2010 is limited

   - Co-tennancy remains key factor in growth plans.  Won’t open sites unless tenants in strips are preferred retailers (i.e  

     BBY, BBBY, TGT, WMT, etc…)

- Mall 20% (~75-80k sq ft), off-mall 80% (~50k sq. ft)

- Unlikely to see any additional specialty concept acquisitions in near-term. 

- Will need to add a West Coast distribution facility in 2 years to support expansion.


Lease/Rent Terms

- Ability to negotiate rents is greater with new build outs with greater upfront capital commitment from DKS

- Don’t have a meaningful % of portfolio coming up for renewal over the next 4yrs, renewals become significant after then

- Typical lease is 10yr term with 4-5 options at 5yrs each. ($0.50 bump in yr 5)

   - Joes slightly different – DKS put up more capital upfront that usual to get them up and running faster

   - Much more favorable rents offset higher capital costs.


Store Economics

- $870k of CapEx / store

- $800-$900k of inventory expenses

- $200-$250k of opening costs

  = ~$2mm cash investment

- Expectation of cash on cash returns of 50%+ by Yr2

- On ~$9-$10mm in sales (~10%+ FCF margin)


Brand/Category Extensions

- Jordan shop-in-shops and yoga concepts are past testing phase and in the process of being rolled out into more stores

  (Jordan in 60+)

- Self service concept test in footwear has been a success (see pictures below), being rolled out in all new stores, retrofit

  will happen overtime.

   - Essentially inventory made available on floor – has enhanced customer satisfaction and conversion

   - Not translating into meaningful labor savings (has been largely reallocated in store)


DKS: Update from our HQ Visit - DKS 2 9 09


Figure 1: New self-service concept in the Footwear department.


- The North Face is now in ~80% of all DKS stores

   - While nearing full penetration, there is room to flex footprint within the store

   - DKS growing Nike ACG private brand within store (competes directly with TNF)

- Product mix (hardline 50%, apparel 30%, footwear 16%) unlikely to change materially

   - Hardline moving away from bigger ticket items (weights, machines, etc.) towards exercise balls & bands

- Private label and private brand continues to grow (last cited as 15% of total sales back in 2006)

   - Both have similar margins ~600-800bps better than product being replaced

   - Private label direct sourced

   - When asked if savings from sourcing will be reflected in pricing, commented that more likely to drop to the bottom line

   - Over the last 12 months, DKS has had more opportunity to purchase branded off-price product

   - Less in the way of exclusive product this year compared to last


Guns & Ammo

- Guns and ammo has buoyed several players in the industry – GMTN was “thrown a lifeline”

- Benefit will be anniversaried 11/15

- Traffic and demand remains strong to date

- Did not specify what % of sales G&A accounted for

- Stressed that was very much in initial stages of growth – “really in startup mode”

- Expected to be neutral to the P&L in 2009, positive in 2010

   - $25mm+ investment in F09


Golf Business

- Trends are improving visibly 

- Has been undoubtedly the most significant drag on GMs 

- Pointed out several times that clearance activity related to merchandise errors in golf will be complete in 3Q and the associated margin drag will end immediately as inventory is cleaned up.

- Considered an attractive growth engine 

- Own ~20% of golf market; ~4x greater than next largest competitor (Golfsmith at ~5%) 

- Vendor pricing advantageous due to size and stability relative to Mom&Pops 

- 3 key issues related to GG integration have been: 

   - Macro environment  

      - beginning to stabilize 

   - Competitive (historically adversarial) cultures 

      - DKS mgmt took control of Golf Galaxy as of 1/09 

   - Product  

      - too much private label; balancing with more private brand

      - reducing overall inventory

Marketing/Advertising Strategy

- Greatest allocation of spend is tabs – will continue to be

- Overall, print continues to shrink – moving towards direct to consumer (e.g. mobile, online, etc.)

- Using more spot network TV advertising, but not material to spend. 


Acquisition Outlook

- DKS: no plan to be acquisitive over next 18-24 months

- When asked about interest in other specialty brands, assured there is no interest – commented to the effect that following

  the recent integration of both Chicks and GG they “could use a breather”


Operating Margins:

- Most significant drag on gross margins (Golf Galaxy & Chicks integration and promotional environment) beginning to ease


- SG&A plans largely fixed for balance of 2009 and 2010 with investments in, new HQ, and merchandising and

  marketing systems


Inventory Control

- Plans to get inventory turns back to 2000-2002 levels over the next 3-years

- Considering a realignment of executive compensation tied to specific inventory turns/mgmt targets

- DKS continuing to push for and get better terms from vendors



DKS: Update from our HQ Visit - DKS Store KSWS 9 09

Figure 2: KSWS prominent end cap display.


There is a substantial high-end business in Las Vegas but it is slots and mid-level table play that comprise the bulk of gaming revenues.  Thus, we can derive a pretty good guess of gaming revenues given the visitation figures and even the airport traffic numbers.  Indeed, the correlation between the number of monthly Las Vegas visitors and gaming volume is 0.66.


Macau is a whole different environment.  Visitation has very little correlation to gaming volumes and revenue.  That may not be a surprise when considering the VIP segment.  However, even the Mass business has shown an immaterial correlation, R Square, and T-stat in the regressions, albeit slightly more correlated to visition than VIP.  The VIP and Mass segments continue to be driven by high end players.  This will probably change over time should slots ever take off and as the market grows.


For now, pay little attention when someone says "the casinos are packed" or "the casinos are empty". 

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