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Gas prices are due to become a headwind for gaming markets all over the country, having been a massive tailwind for much of the past year. Some markets will be hit much harder than others.




We’ve proven that gasoline prices are a statistically significant variable in driving gaming revenues.  While the coming surge in year-over-year gas prices will negatively impact gaming markets around the United States, some markets are worse off than others.  The chart below illustrates the spread between the respective areas and the national average price of gas.  The most notable outlier is California and it’s big.







If current gas prices stay constant, California will be hit far harder by the year-over-year growth in prices than other areas of the country.  As the second chart (below) demonstrates, December would bring a 70% y-o-y hike in gas prices in that state.  Gas prices are highly significant in influencing consumer behavior.  California has its own tribal casinos which will no doubt be impacted.  California also provided 28% of the visitation to Las Vegas in 2008, with Southern California being the origin of 24% of visitors in the same period.  Despite the economy, car traffic from California has been positive every month since March due in part to huge YoY declines in gas prices.






It is clear that all gaming markets in the United States will be hit by the effects of the gas price inflation in the back end of this year and the beginning of next year.  The East Coast and Gulf Coast markets will have more moderate increases in the price of gasoline, but the increases of 47% and 44% respectively are certainly not to be dismissed. 


On a relative basis, Las Vegas’ auto-traffic should suffer more than other gaming markets.  Even given the steep sequential drop off in the monthly year-over-year increases in gas prices, the increase in California’s February gasoline prices will still be almost an average of 10% higher than the other markets depicted in the chart above.

The Eurozone, On the Margin

Research Edge Position: Long Germany (EWG)


We’ve been writing about improving fundamentals in Western Europe for months now, and have recently cautioned that we expect this improvement to slow sequential due to the rate of the ramp itself, a strong Euro, and the headwind of rising unemployment. Below are the salient data points from the Eurozone this week:


Reuters PMI data for the Eurozone, Germany, and France in October show sequential improvement, excluding a second straight month of contraction in German Services. Importantly the numbers are all above the 50 level that signals expansion, yet as noted we expect the rate of improvement to slow in the coming months as the aforementioned macro factors weaken confidence and future expectations. 


For the region’s largest economy, German business and investor confidence are showing signs of slowing.  Last week the German ZEW survey of investor and analyst expectations fell to 56 in October from 57.7 in the previous month. And today, in a survey from the Ifo institute, German business confidence rose to 91.9 in October from 91.3, while Current Expectations gained a meager 20 bps to 87.3 in October. If tops and bottoms are processes, not points (Keith McCullough), we’re noticing a sequential deceleration in improvement, and we’ll be looking for confirmation over the next two months.


Across much of the data the tail from stimulus packages—especially the auto rebate programs—is noticeable. French consumer spending rose 2.3% in September M/M, with spending on automobiles up 10%.  And Germany reported today that construction orders rose 3% in August Y/Y, from -8.4% in July, indicative of a boost in road construction. Manufacturing numbers as well as confidence have been receiving a sizable boost from stimulus incentives.



Eurozone inflation fell to -0.3% in September year-over-year, from -0.2% in August Y/Y. As stated in previous work, we expect inflation to increase at a relatively stable rate. As we come off of last summer’s manic energy prices on an annual compare in back half of Q4, energy prices should yield inflationary numbers.  We still contend that the uneven rate of inflation/deflation across the region will remain a political football for the ECB when it considers raising rates as certain countries are experience lower levels, like Ireland at -3% or Portugal -1.8%. We continue to like Germany’s mild deflationary environment right now, at -0.5% in September Y/Y, as a catalyst to stoke consumer spending as the economy melts up.



Unemployment tipped higher to 9.6% in August.  In our post “Jobless Recovery in Europe” on 10/8 we argued that a jobless recovery in the Eurozone may be more bullish than in the United States because of the significantly stronger foundation of social services than those available to US citizens and due to the historically higher levels of unemployment throughout Europe.  That said, we expect rising unemployment to dampen sentiment and spending in aggregate.



A “weighty” Euro remains on our radar screens for as a macro catalyst it makes Eurozone exports less competitive. Although rear-view, Eurozone exports were down 5.8% in August sequentially, which dropped the trade balance to 1 Billion EUR from 6 Billion EUR in the previous month when exports rose 4.7% month-over-month. Rhetoric is heating up from the likes of Trichet that the Euro is too strong versus the USD, however if we’re right on our call on the USD (we’re currently short UUP in our model portfolio) the Euro should continue to melt high as the Buck burns.  Currently the Euro is trading at $1.5032.



Matthew Hedrick

CAKE – Lacking conviction right now

Sales trends look better that most in 3Q09, but 4Q09 guidance is troubling.


There is no reason for me to patronize Doug Benn, but since landing at CAKE the company seems to be in much better shape.  It’s clear he brings a financial discipline to this company that it has lacked in the past.  Understanding that the significantly slower unit growth helps too!


Knowing that historical valuations are meaningless, it’s really hard to determine what the right multiple for any given name is.  As a group, the Full Service restaurants are trading at 6.1x NTM EV/EBITDA, with CAKE trading at 7.6x.  So it looks expensive on a relative basis.  The FCF yield is 10%, but it looks like capital spending is going higher in 2010.


Sales trends are under control and the proper financial disciplines are in place to assure some stability to the earnings trends.  The Cheesecake Factory is a strong concept, but the Grand Lux is an orphan. 


I don’t see a great short story, nor do I see a reason to be super long.  If CAKE can do $1.05 next year, it’s trading at 19x EPS.  Given some of the risks that are still facing the company and the industry, any multiple expansion from here is unlikely. The strong balance sheet and free cash flow is net positive. 


3Q Same-store sales trends – CAKE posted sequential improvement in same-store sales; sales decreased 2.4% and 6.0% at The Cheesecake Factory and Grand Lux Café, respectively.  This represents no improvement on the 2-year trends at The Cheesecake Factory and a deceleration of 0.6% at Grand Lux.


At The Cheesecake Factory, the trends were slightly more negative in the west, particularly in California and the northwest.  In the southwest, including Arizona and Nevada, CAKE is seeing stabilization on a sequential basis.  Surprisingly, Florida and the southeast were actually both slightly positive for the quarter. 


The sequential decline in sales trends at Grand Lux is troubling.  Management is working to address the issues.  I’m not confident there is much momentum behind that brand and would expect management to close some stores in the coming quarters.


Operating Expenses – In 3Q09 Cost of Sales decreased to 23.9% vs. 25.7% last year.  The 180bps improvement was driven primarily by lower restaurant costs of sale.  About 50% of the decline was due to the cost of sales initiative and 50% from lower commodity prices.  Labor costs were 32.9% vs. 33.2% last year.  Other operating costs and expenses were 25.5% vs. 25.6% last year.  Utilities costs decline by 50bps offsetting higher marketing expenses.  G&A expenses for 3Q09 were 6%, up 70bps from last year.  The majority of this increase came from performance bonus accruals. 


Development - CAKE is looking at 2010 and may open as many as three new Cheesecake Factory restaurants.


Strong Financial Position – At the end of the 3Q09, CAKE had a cash balance of $82 million and used $50 million to pay down debt during the quarter.  CAKE’s credit balance now stands at $125 million, as they have repaid $150 million so far this year.  The stated goal was to reduce debt by $125 million this year.  CFFO for the nine months was $146 million ($24 million capital expenditures); generating $122 million in free cash flow.


Outlook – EPS guidance is for 4Q09 EPS of between $0.18 and $0.20, based on same-store sales of between negative 2% to 3%. Impacting the sales trends in 4Q09 by 1% are (1) Halloween falling on a Saturday and Christmas will fall on a Friday, both of which will hurt year-over-year comparisons. (2) A new focus on gift card sales this holiday season.  The impact is expected to slow 4Q09 sales, but will build future traffic trends.


As you can see from the chart below, management’s current guidance for 4Q09 SSS would signify a significant slowdown in sales trends from where we ended 3Q09.


If these numbers are right, CAKE will have issues, but right now I don’t want to bet against Doug Benn being conservative.



CAKE – Lacking conviction right now - CAKEsss

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COLM: Guidance Makes No Sense

This is a weird one. Street estimates for FY10 are shaking out to be pretty realistic at $1.95, but they’re way too low for the upcoming quarter. Check out our preview note from yesterday for color, but backlog trends have inflected on the positive side, inventories are close to being cleared, FX starts to help COLM in 4Q after a year and a half of hurting, SG&A cuts implemented in late 4Q08 still carry through this quarter, cold-weather gear has been a stand-out in early fall selling, and footwear growth for COLM was the best we’ve seen in over 4-years. Yes, I still have issues with the parts of the company as it relates to brand management, but let’s face it…more is going right than wrong. That’s the first I can say that for COLM in a while. High-single-digit 4Q revenue decline? No way… We’re shaking out at $0.60 vs. the Street at $0.40.


It's all about WAPs.


WMS guided to $160 - $168MM of revenues for 1Q2010, on August 3, 2009, and we don't think they are going to miss.  While the for sale market remains sluggish in NA given an anemic number of new openings and suppressed replacement orders, WMS already knew this when they gave guidance.   They should make up this weakness with another strong showing in participation. 


We estimate that WMS will report EPS of $0.37 and revenues of $167MM. Below are some of our assumptions and thoughts on the quarter.

  • Product sales will likely come in light, we estimate $90.5MM
    • Total unit sales just shy of 5,000 with pricing up 10% y-o-y
  • Participation should be good, we estimate $76.4MM


WMS's unit shipments are particularly difficult to gauge this quarter given the anemic number of North American new and expansion unit shipments - we estimate around 3,650 units.  So it's really all about replacement orders for WMS.  In addition, many of the new and expansion units are going to tribal gaming jurisdictions and may be Class II. Therefore, we would not be surprised if WMS's shipshare of new and expansion units this quarter comes in low, as it did last quarter. 


Last quarter we estimated that only 10.3k replacement units shipped to North American casinos.  This quarter's shipments will likely be even lower, since 2Q09 is a seasonally better quarter. How much lower is the million dollar question; our best guess is 7.5k units. For last quarter, we estimate that WMS got 36% share of replacement units, assuming a similar share in 3Q09 would put total WMS total NA unit sales around 3,000.  


We have less "edge" on the international shipments, as the majority of those units are replacement orders.  While WMS is entering Mexico and Australia, which should help them grow FY2010 international shipments, we estimate that y-o-y shipments to international markets in 1Q2010 will be down 5%.  International replacements have also been negatively impacted by this economic slump.



FY2010 thoughts:

  • FY2010 EPS of $1.89 and revenues of $770MM.  We believe that WMS may miss its new unit sales forecast but more than make up for it with strength on the participation side.
  • Product sales:
    • We think that FY2010 unit sale guidance is aggressive, unless international and Class II has materially more upside than we are modeling
    • Pricing guidance seems conservative and implies that WMS is pricing in some success in lower price Helios platform markets, as well as in international jurisdictions like Mexico
  • Participation:
    • WMS ended FY09 with an install base of 10,350.  Their guidance implies no growth in their install base, which we believe is very conservative given the positive qualitative feedback we continue to hear about WMS's participation products


4Q09 "Youtube"

  • In fiscal 2010, a heavier mix of lower margin product sales revenues and in fiscal 2009, coupled with lower initial startup margins on certain of our new revenue sources such as Class II in Australia, is expected to partially offset some of the anticipated improvement in our judicial businesses, resulting in product sales gross margin ranging from 52% to 54% for the full year.
    • Pricing on the Helios platform is roughly $8-10k per box, therefore should WMS have a lot of success here and meet their unit shipment guidance, pricing should indeed be lower than one would expect given the higher mix of BB2 platforms vs last year
  • We expect to sustain our gaming operation margin in the low 80's, in a range that will average between 80% and 82%, which includes a dampening effect of achieving our higher percentage of WAP units in our installed base.
    • WAP's do have lower margins than standalone participation games due to the associated jackpot expenses
  • We expect that depreciation expense will increase modestly in fiscal 2010, while declining as a percentage of total revenues
    • Typically participation games are depreciated over 2 years. The longer the average life of the participation box, the lower D&A expense on box on average.  We've seen WMS's "D&A per box" steadily decline as their games last longer over the last several years
  • We can still see participation business grow. But the rate of growth won't be like it’s been for the last couple of years.
  • On the international sales, I believe that they were 35% or 37% of units this year. That's likely to remain relatively constant next year.
  • We see the first six months of this year continuing on the trends of fiscal 2009 with the second half of the year picking up slightly in the calendar '10.


Research Edge Portfolio Position: Long EWT


Export Orders data for September released by the Ministry of Economic Affairs this morning showed that order flow last month picked up sequentially to a year-over-year decline of -3% as Production levels rose to positive year-over-year growth for the first time in 12 months (see chart below).


PANDA HUG - tai1


On an absolute USD basis, orders exceeded every month since October of last year, a sign that the warming relations with the mainland are firing a strong recovery, with critical Electronics sectors feeling the largest impact of Beijing’s stimulus (see chart below).


PANDA HUG - tai2


Not everyone views this apparent mainland largess as purely positive however; in a legislative committee meeting on Wednesday, Minister of Economic Affairs Shih Yen-shiang again voiced his firm stance that the proposed economic cooperation framework agreement will exclude cheap mainland industrial and agricultural goods and, critically, cheap mainland labor in response to continued criticism.  DPP Legislator Su Chen-ching responded that the proposed agreement is heavily skewed in favor of the mainland and would be “unfair and humiliating” for Taiwan to sign.  The overlapping political issues facing lawmakers are daunting: beyond the understandable mistrust of Beijing, which still refuses to acknowledge Taiwan’s status as an independent nation, concerns about job and intellectual property security are significant. At 6.09% the unemployment rate is at the highest level in over 30 years, making the prospect of a flood of cheap migrant labor from the mainland untenable for elected officials. Meanwhile, other voices in government have taken issue with the prospect of PROC based companies acquiring Taiwanese strategic technology through acquisition.


We are long Taiwanese equities via EWT, and continue to believe that orders from “the client”, particularly the voracious appetite for consumer electronics of the rising mainland consumer class, will drive a strong recovery in the coming quarters. On measure, we do not envy the leader there however, as they calculate the risks and rewards of accepting Beijing’s “panda hug” embrace.


Andrew Barber



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