Back To The Future

The superior man, when resting in safety, does not forget that danger may come. When in a state of security he does not forget the possibility of ruin. When all is orderly, he does not forget that disorder may come. Thus his person is not endangered, and his States and all their clans are preserved."
While our Confucius (Keith) is on T.V. this morning, I’ve been handed the pen on the Early Look. The real Confucius is, of course, the ancient Chinese philosopher whose writings have influenced China in varying degrees for the last 2,000 plus years.  They espouse a practicality and logic that can be transferred readily to many types of societies.  The quote above suggests that the superior man, or government, will proactively plan for the future.  In money management, we call that a Risk Manager.  These are typically the guys or gals with long careers.
The United States continues to be the global leader in GDP market share, but its share has consistently eroded over the past ~35+ years.  Based on current and projected GDP growth rates, and GDP growth capacity of nations, it will not be long before China surpasses the United States.  While this may be shocking to some, the reality is that this is really Back to the Economic Future in terms of economic market share as China had a larger economy than the United States for most of the 1800s.
Many astute short sellers are incredibly bearish on the prospects for China.  Jim Chanos, an investor who we hold in regard for more than the fact the he roomed with current Yale Hockey Coach Keith Allain in college, is at the top of that list.  Having never spoken to Jim about China specifically, what I can surmise from reports is that his thesis is primarily based on the inaccuracy of government data (“they make it up”) and that there is serious risk to the banking system in China due to writing a lot of bad loans.
Even if Jim is correct, we would be remiss to believe that China’s GDP market share gains will slow for the longer term.  As Kenneth Rogoff and Carmen Reinhart write in their must read book, This Time Is Different:
“China’s four large state owned banks, with 68% of banking system assets, were deemed insolvent.  Banking system nonperforming loans were estimated at 50%.”  
They were referring to the epic bank failures in China in the late 1990s.  When 68% of your banking system is insolvent, it can’t get much worse.  But guess what happened over the ensuing decade? China recovered and continued to take massive GDP market share. This centralized communist government led the nation back from the financial abyss.
While our financial crisis is largely behind us, the reality remains in the United States: healthcare needs reforming, the longer term impact of entitlements needs to be addressed, mounting national debt issue needs to be resolved, and our financial system needs better regulation.  Absent a permanent super majority in congress, which seems unlikely to happen, the only way anything will be accomplished is if the parties work together in the spirit of a true constitutional democracy.
For that to occur, it will require a willingness of whomever the President is at the time to reach across party lines and work with his or her political opponents.  The four issues outlined above need solutions and if they aren’t addressed the longer term outlook for investment in the United States and in United States government debt (especially at current prices) is a lot less compelling than other nations.
With the startling victory by Scott Brown in Massachusetts, one would hope that that both the President and the Democrats realize that while they have the power, they need to respect the middle and independents it they have any hope to effectively govern and solve any of the major problems facing the nation.  
We have been writing to our subscriber base that we expect to see a shift in politics in the coming years.  A shift to more independents and independent candidates, as the electorate continues to lose faith in the partisan political system.  A recently poll from Rasmussen suggested that Americans unaffiliated with either party is now at 32.3%.  
The immediate term market reaction to this shift in the character of political and government leadership is a continued Buck Breakout. This morning the U.S. dollar is breaking to 5-month highs based on recent political events and the anticipation of continued change.  This change will come in the form of politicians whose core qualification for being elected is not already having been a Washington Weasel (an elected politician).
Our current political system is beholden to the attempts of both parties to implement a tyranny of the majority.  In the Federalist Papers, Publius defined the tyranny of the majority aptly:
“. . . a number of citizens who are united and actuated by some common impulse of passion, or of interest, adverse to the rights of other citizens, or to the permanent and aggregate interests of the community."
This quote embodies our current age of politics.  Yesterday, President Obama was out pumping that this remains, “the second largest Democrat majority in a generation.”  While this is factually correct, that emphasis is not exactly what the Founders had in mind.  The reality of continued attempts at tyranny of the majority in the United States is political deadlock and Back to the Economic Future for global GDP market share. China gains, we lose.
Keep your head up and your stick on the ice,
Daryl G. Jones
Managing Director

XLK – SPDR Technology
— We bought back Tech after a healthy 2-day pullback on 1/7/10.
UUP – PowerShares US Dollar Index Fund — We bought the USD Fund on 1/4/10 as an explicit way to represent our Q1 2010 Macro Theme that we have labeled Buck Breakout (we were bearish on the USD in ’09).
EWG - iShares Germany —Buying back the bullish intermediate term TREND thesis Matt Hedrick maintains on Germany. We are short Russia and, from a European exposure perspective, like being long the lower beta DAX against the higher beta RTSI as well.  

EWZ - iShares Brazil — As Greece and Dubai were blowing up, we took our Asset Allocation on International Equities to zero.  On 12/8/09 we started buying back exposure via our favorite country, Brazil, with the etf trading down on the day. We remain bullish on Brazil's commodity complex and believe the country's management of its interest rate policy has promoted stimulus.

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 mispriced and that TIPS are a efficient way to own yield on an inflation protected basis.


EWW – iShares Mexico
We do not want to be net long Latin America (Brazil) anymore. Mexico short is a solid compliment to our short position on oil and our concerns about sovereign debt risks.

USO – United States Oil
Fund We have been waiting, patiently, to short the US Oil Fund on an up day, which we got on 2/2/10. We are bullish on the Buck and bearish on China right now. These factors contribute to our multi-factor (bearish) intermediate term stance on the oil price.

EWJ – iShares Japan
We shorted Japan on 2/2/10 after the Nikkei’s up move of +1.6%. Japan's sovereign debt problems make Greece's look benign.

UNG – United States Natural Gas
Fund Macro DJ (Daryl Jones) and I remain bearish on Commodities. Natural Gas had a healthy price pop on 2/1/10, prompting us to short it.  

XLE – SPDR Energy
The Energy ETF was up +1.7% on 1/29/10 and we remain bearish on both oil and commodity prices for the intermediate term. Shorting green.

SPY – SPDR S&P 500
The SP500 broke our intermediate term TREND line earlier this week and remains broken. The 4Q09 GDP report confirms that Bernanke has to raise interest rates. ZERO is not a perpetual policy unless the USA wants to become Japan. We shorted SPY on 1/29/10.

GLD – SPDR Gold Shares
We re-shorted Gold on a bounce on 1/25/10. We remain bullish on the US Dollar and bearish on the intermediate term TREND for the gold price as a result.

IEF – iShares 7-10 Year Treasury
One of our Macro Themes for Q1 of 2010 is "Rate Run-up". Our bearish view on US Treasuries is implied.

RSX – Market Vectors Russia
We shorted Russia on 12/18/09 after a terrible unemployment report and an intermediate term TREND view of oil’s price that’s bearish. Russia’s GDP fell 7.9% in 2009.
EWJ - iShares JapanWhile 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.


The S&P 500 declined 0.55% yesterday on decelerating volume.  Yesterday’s theme seemed to focus on the fact that sovereign debt issues will not go away.  While the European Commission backing of Greece's deficit reduction plan may have put that country concerns on the back burner, sovereign credit concerns shifted to Spain and Portugal.  As a result there was a pick up in the RISK AVERSION trade.  The dollar Index was up 0.45% yesterday and VIX was marginally higher too. 


The Hedgeye Risk Management models have the following levels for VIX – buy Trade (20.70) and Sell Trade (22.23). 


Given the sovereign debt issues, we do not want to be net long Latin America (Brazil), and as a result we shorted Mexico.  Mexico short is a solid compliment to our short position on oil and our concerns about sovereign debt risks.  The Hedgeye Risk Management models have the following levels for DXY – buy Trade (78.01) and sell Trade (79.73). 


On the MACRO front the ISM non-manufacturing index rose to 50.5 in January from 49.8 in December. However, the headline reading came in below the 51 consensus.  The data highlighted the extent to which the services sector continues to lag the recovery in manufacturing.  This was made clear in the employment component, which increased to 44.6 from 43.6, a slowing rate of improvement. 


Also on the MACRO front the ADP employment fell 22K in January vs. consensus expectations for a drop of 30K, marking the smallest decline since January 2008.


Yesterday, the worst performing sector was Healthcare (XLV); the XLV also broke TRADE.  The earnings miss from Pfizer (PFE) and scaled back financial targets for 2012 was not received well.  The managed care group also came under pressure with the HMO’s down 1.6% following reports that House Democrats plan to revive a small piece of their healthcare reform agenda that would repeal the HMO antitrust exemption.


The Financials (XLF) was one of the worst performing sectors yesterday.  While the insurance space was in focus following a number of earnings reports, the banking group provided a meaningful headwind with the BKX index down 2.4%.  The regional’s remained on the defensive amid concerns about the extent of their run-up on the back of the largely favorable takeaways from Q4 results.  Money center names held up better on the day, as the group has been a beneficiary of recent thoughts that regulatory concerns may be overdone.


Consumer Discretionary (XLY) was one of two sectors that finished up on the day.  Media names were a big driver of the strength following better-than-expected December quarter earnings.  MCD also outperformed after the stock was added to the Conviction Buy List at Goldman, while YUM was down 1.3% before it reported mixed results after the close. 


As we look at today’s set up the range for the S&P 500 is 33 points or 2.0% (1,075) downside and 1.0% (1,108) upside.  Equity futures are trading below fair value following yesterday's decline.  Earnings remain in focus and markets may try to draw some benefit from Cisco System's (CSCO) Q2 earnings reported after the close.


In early trading Copper looks to be headed lower for the 2nd day in a row.  The Hedgeye Risk Management Quant models have the following levels for COPPER – Buy Trade (2.89) and Sell Trade (3.14).


In early trading Gold also looks to be lower on the strength in the dollar index.  The Hedgeye Risk Management models have the following levels for GOLD – Buy Trade (1,076) and Sell Trade (1,113).


Crude oil is headed lower on inventory gains and a stronger dollar.  The Hedgeye Risk Management models have the following levels for OIL – Buy Trade (72.04) and Sell Trade (78.32).  We remain short the US Oil Fund (USO).


Howard Penney

Managing Director
















While Q4 consensus has come down, it may not be enough. The stock has fared poorly (down almost 30% since late November) so a miss is probably discounted to some extent.



PNK reports Q4 EPS tomorrow morning.  In projecting an Adjusted EPS loss of $0.13, we are below the Street consensus at ($0.08). Our Adjusted EBITDA estimate of $37.1 million compares to the Street at $40.3 million.  Louisiana, which has held up so well during most of this downturn, has been in a tailspin.  Total EBITDA from the state could fall over 30% from last year.  Recovery here is likely to take longer than the rest of the regional markets and will depress PNK’s profits for much of 2010.  Remember that 60-70% of PNK’s property EBITDA is generated in Louisiana.


The following “Youtube” highlights management’s forward looking commentary from the Q3 earnings release and conference call.





Property specific

  • “Residents from New Orleans have seen a significant increase in marketing from casinos along the Mississippi Gulf Coast, and that has in turn affected our business at Boomtown. The good news is that with October now largely complete, it appears that revenues have stabilized at Boomtown New Orleans. With revenues now stable, we'll use the remainder of the year to focus on bringing margins back up at the property.”
    • I assume he meant stabile relative to 3Q trends because in the 4th quarter state reported gross gaming revenues for the property declined 13.4% vs. an 11.6% decline in Q3
  • “In Reno, according to the monthly revenue statistics put out by the state, the entire Reno market continued to see declines in gaming revenues during the 2009 third quarter, caused by both additional Native American casinos in Northern California and general economic conditions. We were not immune to that trend. Based on recent trends, however, it does appear that gaming revenues are starting to stabilize for Boomtown Reno.  We hope to get profitable over the next, let's say 12 months going forward and hopefully improve from there.”
  • “I think the major single factor other than the economy that affected New Orleans was competition from the Mississippi Gulf Coast, which is not very far away. As they try to figure out how to keep their hotels built, since they weren't getting people from Florida or Atlanta anymore, they just reached out for people that are in our way.”
  • “What did happen in Lake Charles was Delta Downs got very aggressive with their promotions earlier this year. They took some market share from us. We got more aggressive in the recent quarter and I think we've got our market share back,that hurt our margins a little bit. So we've had a little bit of a promotions battle going on between us Delta Downs, we're twice their size, more than twice their size. And I think we'll continue to show good results at L'Auberge as we have.”
  • “If we never open River City, I think you continue to see strong growth with Lumière Place but obviously, River City will take a bite out of that. And we think between the two, we'll do at maturity, $120 million, $130 million a year EBITDA and maturity might be a couple of years away because of some disruption when we first opened.”
  • L’Auberge margins:  “I think it may take a couple of quarters for us to get the margins back up. We'll eventually get up there, I don't know if it will be the fourth quarter or not.”
  • L’Auberge: “so October was at a pace of third quarter, but we're more optimistic on November and December.”
    • Unfortunately, Nov & Dec gross gaming numbers were down 22% and 24% y-o-y, respectively
  • “I think we're on a positive trend in New Orleans. I think we're just starting a positive trend now at L'Auberge.”


Development update

  • “River City continues to move along on time and the same basis of budget that we previously outlined, the cash portion of that budget continues to be $357 million, of which we spent to date, $228 million approximately. And the timing of the project is expected to open in the spring of 2010 and we feel very good about the prospects of that property upon opening next year.”
    • On December 14th, PNK announced that the opening would be accelerated to March 2010
  • “Sugarcane Bay, we started driving piles earlier this month to put in the foundation for the project. The project that actually started last year when we started doing the road that expanded. The visibility of our property and access at L'Auberge and that would also be the road to Sugarcane Bay. With the project budget is the cash basis at $391 million, we expect to be on that pace and progress on that project as we move on through the fourth quarter and into next year.”
    • On Nov 24th the project's budget was updated to “approximately $305 million, excluding capitalized interest, and includes approximately $54 million spent to date” and noted that  completion is expected “ in late 2010 and open the hotel and related amenities in the first half of 2011”
  • Baton Rouge: “We will start construction of that project promptly after the approval of the contracts, which we would expect will happen in May of next year.”
    • On Nov 24th PNK announced that it “is proceeding with plans for its casino project in Baton Rouge, Louisiana, which represents an investment of approximately $260 million, excluding capitalized interest. As announced previously, the Baton Rouge project will include a new, single-level riverboat with an expansive casino; a 100-room hotel; an exciting mix of restaurants and lounges; and an entertainment venue.”
  • “Regards to CapEx, we expect Sugarcane Bay next year to grow somewhere around $225 million in a cash basis, excluding cap interest. And go through the rest, Baton Rouge, that number is somewhere near $60 million and you have 40 or so maintenance CapEx across the portfolio.”  I assume this will change with the revised budgets
  • “We hope both Sugarcane Bay and Baton Rouge do about a 15% cash-on-cash return.  That's 15% on the $400 million investment. And so that'd be an incremental $60 million of EBITDA above the 80 or 90 is doing now. The run rate I think is about 85, so...”


CKR reported period 13 and fiscal 4Q10 blended same-store sales today of -6.4% and -6.0%, respectively.  The biggest challenge continues to be at Carl’s Jr., which reported a 9.0% comparable store sales decline for period 13.  Although this -9% number is a 65 bp improvement from period 12 on a 2-year average basis, the full fourth quarter result of -8.7% implies 230 bps of deterioration from 3Q10.  Hardee’s same-store sales decreased 2.8% during period 13, which marked a significant fall off from the prior period with 2-year average trends declining more than 100 bps on a sequential basis. 


The company attributed weakness at both concepts to continued high levels of unemployment, “deep-discount burger wars” and weather.  Specifically, CKR’s CEO Andrew Puzder said, “Both brands' sales results were also significantly impacted by worse weather this year than in the prior year. Carl's Jr., experienced severe rain in its core West Coast markets for most of the final week of the period and Hardee's experienced severe winter weather in several of its core mid-west and southeast markets.”


Despite the impact of weather, CKR’s full year 2010 3.9% blended same-store sales decline came in at the lower end of management's guidance of -3.5% to -4.0%.  Management also reiterated its prior full-year outlook for a 20 to 40 bp decline in restaurant level margin, but provided 4Q10 guidance of 16% to 16.3%, which implies full year numbers will come in toward the lower end of the range.  Relative to fiscal 4Q09’s 18% restaurant margin, this guidance assumes that margins will decline 170 to 200 bps YOY, reversing the prior three quarters of margin growth despite the decline in top-line trends.  We have been saying that it was only a matter of time before gravity would set in. 


During the fourth quarter, management expects about 40 to 50 bps of YOY food and packaging cost favorability to be offset by sales deleveraging on both the labor and occupancy expense lines.  Food cost favorability has helped to stave off margin declines earlier in the year despite the significant demand headwinds with food and packaging costs as a percentage of sales declining 60 bps YOY in Q1, 140 bps in Q2 and 180 bps in Q3.  CKR will begin to lap this benefit in the first quarter of fiscal 2011, making it increasingly more difficult to hold the line on margins.  And as 4Q10 guidance makes clear, even with food costs providing a tailwind in the quarter, margins cannot continue to move higher with blended same-store sales  down 6%.



Howard Penney

Managing Director







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