A potential short-term cross breeze (earnings reductions) but the long-term wind remains at the tail of the slot sector.



They’re cute (at least WMS is), safe (well, they should be), fun to own (when they go up), and the long-term story is as attractive as any in consumer land.  Unfortunately, they’re not cheap and analysts keep overestimating slot demand.  Ideally, we’d like to see estimates come down, particularly for the 1H CY2010, and the stocks come in.  This is a space that needs to be on the radar screen.



I feel like a broken record but unit sales to new casinos and expansions will be down considerably in 2010.  We estimate almost a 50% decline.  See our 11/25/09 post “ONE IN THE HAND IS WORTH TWO IN THE BUSH”.  Replacement demand should accelerate, but will it grow more than the 50% necessary to make the Street’s slot projection?  That’s a tall order.  The first half of calendar 2010 is at risk with March being the most difficult comp of the year.  We project new/expansion units to fall 80% in the March quarter.  Yet, analysts are projecting significant revenue, EBITDA, and EPS growth in the first quarter as shown below.




Needless to say, we are below the Street for IGT and WMS, but in-line for BYI.



They’re not cheap on a forward earnings basis.  IGT and WMS both trade at 21x consensus 2010 earnings while BYI clocks in around 17x.  Again, we think the IGT/WMS estimates are too high so the valuations may be even more inflated.  However, we think there is approximately 50% upside to the numbers from normalized replacement demand alone.  Combine “regression to the mean” replacements with a significant new market pipeline – domestically and internationally – and the gaming supply segment could generate 20%+ EPS growth over a 5+ year period.  From that perspective, 20x EPS doesn’t seem so expensive although I’d prefer mid-teens.  Maybe they’ll get there.


The Mexico Catalyst      

This is one market that could surprise on the upside in 2H 2010.  From what we are hearing, the transition from Class II games to Class III is showing promise.  Operators like the performance.  Class III games are also faster – 11 games per minute versus 8 for Class II.  The Class II market is anywhere from 35k machines to 50k machines so there is a lot of potential for Class III replacements.  Look for some color on the Mexico potential during the earnings conference calls.  Stay tuned for more on Mexico from us as well.


The Perfect Storm

We could be at the trough of a huge 5-7 year cycle for slot demand.  In a few years, we may look back on the 2008-2010 period as the perfect storm:  slot customers on the verge of bankruptcy; a dearth of new markets, new casinos, and casino expansions; and the dud that is (was) server based gaming.


Please join us as we launch our Black Book:

Top 10 Retail Predictable Unpredictables in 2010


Conference call FRIDAY January 8, 2010 -- 11 AM EST 



Simply put, these are 10 ideas that we assess at better than 60% chance of happening, but today's Wizards of Wall Street either:  

A) do not acknowledge that such ideas exist, OR

B) see them as so unlikely, they do not bake them into their investment process.  

Some of our deeper conclusions will come from the following topics...


1.       M&A Targets
2.       Looming Business Failures
3.       Unionization
4.       The Retail Private Equity Pipeline
6.       Asia's Role in Sourcing
7.       Inventory Cycles and Capacity Utilization

8.       Asia Free Trade Agreement Impact

9.       Consumer Retrenchment

10.     Commercial Real Estate’s Next Leg

Research Edge institutional strategy calls are available to current and prospective institutional subscribers. Please contact or reply to this email to request call information.

Research Edge Retail Black Books are available to Premium subscribers to our Retail vertical and on an a la carte basis to other qualified institutional investors.

to request access to the conference call.




FL: Close ‘Em or Suffer

FL: Close ‘Em or Suffer

Our team has roughly 30-years of cumulative experience analyzing this beast. Throughout our tenure, what we have not seen is a respectable analysis showing cannibalization factors by FL concept. Well… here you go. We still like the low-hanging fruit here.



Here’s an update on Foot Locker – one of our top bench ideas for 2010. Our team has roughly 30-years of cumulative experience analyzing the beast that has become Foot Locker. Throughout our tenure, what we have not seen is a respectable overlap analysis showing likely cannibalization factors by FL concept. Well… here you go.


The bottom line is that the overlap stats are quite sad, actually.


Here’s the analysis:


There are 111 stores or 5.4% of the domestic FL portfolio that suggest self cannibalization.  In other words, 111 units are located within a ½ mile or less of another unit with the exact same nameplate.  Think Foot Locker in a mall and another at the other end of the mall or just down the street.


FL: Close ‘Em or Suffer - 1

Source: ESRI; InfoUSA; Research Edge. Note: InfoUSA database represents 90% of the total U.S. store base.  Data not available for Champs.


The overlapping stores listed above represent the most obvious candidacy for closure.  Provided the upfront lease termination fees are justifiable, it seems reasonable to assume a productivity boost would result from closing stores that are in close proximity to other locations carrying the same brand name.  As a sidenote, FL’s implied portfolio lease duration is among the lowest in retail. It has not done a whole lot right in its history, but keeping landlords on a short leash has been an area of strength. High lease flexibility is definitely a big positive.  


After eliminating some of the more obvious locations, store closures become more strategic.  Our analysis suggests that FL’s domestic store portfolio is 81% self-cannibalizing.  In other words, 81% of all Foot Locker sub-brands have another sub-brand within a ½ mile.  However, we caution not to get overly fixated on this high number.  The majority of the concentration comes from Lady Foot Locker and Kids Foot Locker, both of which were clearly positioned with co-location in mind.  This brings us to our next step in store closures: Lady Foot Lockers.


FL: Close ‘Em or Suffer - 2

Source: ESRI; InfoUSA; Research Edge


FL: Close ‘Em or Suffer - 3

Source: ESRI; InfoUSA; Research Edge


Over time, management established Foot Locker stores as a central hub and then added additional locations in the same mall  with the opening of Lady Foot Lockers and Kids Foot Lockers.  It seemed logical to place Lady Foot Lockers next to or near Kid’s Foot Lockers because they do not compete, but instead complement each other.  That makes sense to us at some level, but with 1.7 Lady Foot Lockers for every Kids Foot Locker, the opportunity to right-size the Lady portfolio appears compelling.  In fact, we wonder why Lady and Kids need to separately exist? A one stop shop for women and children, while leveraging overhead.  After all, ‘kids’ is not a gender.  Kids also could care less where their Mom buys their kicks. Stores should cater to the person holding the cash – not the 4-year old that cannot dress himself in the morning. 


We’re still awaiting signs of management’s actual intentions, but for now we’ll continue to explore all options and ideas.  We continue to believe there is ample low hanging fruit here, and real estate may just be the easiest to pick given a 20 point+ margin delta in profitability between the best and worst performing stores.


Zachary Brown

Eric Levine

Early Look

daily macro intelligence

Relied upon by big institutional and individual investors across the world, this granular morning newsletter distills the latest and most vital market developments and insures that you are always in the know.


Obviously this is not a bright spot for me to start the year.  Right now $9.43 represents the 2 standard deviation oversold line…..


From a fundamental perspective, SONC is getting killed by weather, a high concentration of partner drive-in stores in Texas and intense industry discounting.  Not all of this is new, but the magnitude of the impact was far greater than expected.  Today’s shellacking is probably over done on the downside, but it will take time for the stock to regain investor confidence. 


With two sell-side downgrades this morning on top of the already 5 sell recommendations (a lot relative to most other QSR names), I don’t think now is the right time to get incrementally more bearish on the name.  Add to that the fact that short interest on the name is high at 7.6% relative to the QSR group’s average of 6.5%.  I was obviously early on this name, but EBIT margin comparisons remain easy for the next two quarters.  This may not matter much to investors if we don’t see any abatement in same-store sales declines.  We know that fiscal 2Q10 is going to be another tough quarter from a top-line perspective, but management made that very clear yesterday on the company earnings call so that should be baked into expectations as of today. 

Bernanke's Letter V

He Who Sees No Data (Bernanke) can look at the following chart, and pretend no one else is looking.  He claims to be “data dependent”, but that must be a joke.


This morning’s ISM Non-Manufacturing reading for the month of December came in above the all so important 50 line (economic expansion line), at 50.1. This was another sequential improvement versus the November reading of 48.7.


Now, both the ISM Manufacturing (released earlier this week) and Non-Manufacturing surveys are holding at/or above the levels we saw in early 2008. These, to the plain eye, look a lot like the Letter ‘V’. Unfortunately, the willfully blind of Washington groupthink aren’t allowed to see these charts, and the rate of return we are issued by the US Government on our savings accounts remains ZERO as a result.


I am by no means suggesting that this V-bottom is sustainable. But I am definitely not refuting that a V-bottom has occurred. It’s now a fact. To have witnessed the incompetence of the US Federal Reserve’s forecasting ability in missing this chart on the way down in late 2008 was one thing. Now we are seeing them miss the entire bounce on the way up, and it is both professionally embarrassing and sad altogether.


I remain bullish on US Treasury Yields (short SHY) and bullish on the US Dollar (long UUP) for the intermediate term (3 months or more). Either the Fed’s mea culpa is coming, or something far darker than I can imagine for America’s place of leadership in setting global monetary policy.


America’s Creditors are watching.



Keith R. McCullough
Chief Executive Officer


Bernanke's Letter V - ISM6


Bingo!: U.S. Debt Watch

“If you establish a democracy, you must in due time reap the fruits of a democracy. You will in due season have great impatience of the public burdens, combined in due season with great increase of the public expenditure. You will in due season have wars entered into from passion and not from reason; and you will in due season submit to peace ignominiously sought and ignominiously obtained, which will diminish your authority and perhaps endanger your independence. You will in due season find your property is less valuable, and your freedom less complete.” –Benjamin Disraeli


As we roll our broader coverage and expand our focus on the macro research side of our business in 2010, one area of focus will be sovereign indebtedness, which changes daily.  Internally, we have ceded the critical role of following the national debt of the United States to Darius Dale, and you will likely be seeing some notes from him on this topic in the near future.  As a precursor to what will become an ongoing discussion for us, I wanted to outline some key facts relating to the burgeoning U.S. national debt:

  • Total current U.S. National Debt - ~$12.17 trillion;
  • Total current U.S. National Debt per taxpayer - ~$111,622; and
  • Debt to GDP ratio – 83.5%.

These numbers are subject to some debate and we have sourced them from  Setting aside specific debate on the precise number, the point remains the U.S. National Debt is large and expanding.  The key components of this debt are as follows:

  • Medicare and Medicaid 21.9%;
  • Social Security 19.2%; and
  • Defense and Wars 19.1%.

U.S. National debt as a percentage of GDP has been climbing steadily since 2000, and has seen exponential growth in the last two years.  At the current ratio of ~83.5% debt to GDP, we are at level not seen since the 1950s. We have outlined this metric in the chart below going back 90 years. By the end of 2010, this number is projected to be near 100% of GDP absent a dramatic shift in domestic budgetary policy.  As with any borrowing, the more a person or entity borrows, even the United States of America, the cost of borrowing will go up, all else being equal.  This will have an increasing impact on the pricing of U.S. government securities in time.


Interestingly, the national debt of ~$12.17 trillion, actually excludes Fannie Mae and Freddie Mac debt.  The U.S. government became the effective conservator of both of these entities with the Housing and Economic Recovery Act of 2008.  The estimated combined on and off balance sheet debt of Fannie and Freddie is purported to be just over ~$5 trillion. Including this additional $5 trillion in debt, U.S. Government debt as a percentage of GDP is actually more than ~120%.  On that basis, U.S. government debt as a percentage of GDP is the highest ratio it has ever been, or at least since the numbers have been recorded, which is since 1792.  Needless to say, both ever, and since 1792, are a long time.


Globally, this data hasn’t been updated since 2008, but based on 2008 data, the U.S. has the fifth highest indebtedness as a percentage of GDP, just barely above Singapore and just below Jamaica, man.  The only other countries more indebted than the U.S., on this basis, are the economic stalwarts of Zimbabwe, Japan, and Lebanon. 


Keep your eyes  on U.S. government debt . . . this Queen Mary is not turning any time soon and will hold investment implications related to many asset classes for years to come.  Not to mention, as former British Prime Minister Benjamin Disraeli states above, implications for our very freedom and prosperity.


Daryl G. Jones
Managing Director


Bingo!: U.S. Debt Watch                - feddebt



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