Drill Baby Drill

Long Oil via the etf USO


Surely and silently domestic drilling rates have been picking up in the United States this year.  In fact, as outlined in the chart below, oil and gas rig activity is approaching the almost all time highs of 2008.  Of the two, oil drilling has been even more robust and has in fact surpassed all time highs.


Oil rigs in the domestic United States’ last peaked in activity on November 2008.  On February 1, 2010, a new post-1993 peak was established, and as of March 12th the oil rig count is now 5% above that level.


According to the Energy Information Administration:


“Half of the overall increase in rig counts since June 2009 has been in the Permian Basin of West Texas, where rigs drill primarily conventional vertical wells. Just under one-fifth of the increase has occurred in the Williston Basin, straddling Montana and North Dakota, where horizontal drilling programs have rapidly increased production from the Bakken Shale. (These two areas also accounted for about two-thirds of the drilling during the previous peak in 2008.)”


In effect, it is back to normality for the major drilling companies.  They are executing on their historical drilling plans, and investing real capital.


From a broader supply and demand perspective, there is not a whole lot read into this activity since it is in the U.S. is a small portion of global oil production (less than 10%), and the United States exports very little of its oil (less than 5% of total production).  It does, though, speak to the confidence of oil companies that we are at a price that may be sustainable.


Consistent with drilling increasing for oil domestically, days of supply has been consistently below year ago levels for the past two months.  While oil supply domestically is at or above its five year range, it is noteworthy to see supply normalize versus year ago levels – and a bullish indicator for the price of oil.


Interestingly, also as it relates to oil is the ongoing relationship with the US dollar.  Last year, the key driver for the price of oil was the weakness in the U.S. dollar.  With a negative correlation of close to 0.85, as the U.S. dollar went, so opposite went the price of oil.  In the second chart below, we chart oil versus the U.S. dollar for the last three months.  The inverse relationship has clearly broken down.  So despite oil getting more expensive in U.S. dollar terms, it keeps going up in price, which is also a bullish indicator.


We are long of oil in here, and continue to like it.


Drill Baby Drill - 1


Drill Baby Drill - NA Rotary Rig Count


Daryl G. Jones

Managing Director


We’ve got some takeaways from Singapore. The good:  busy and decent table win, the less good: expensive busing may be playing a role.



Resorts World Sentosa (RWS) has been open for more than a month.  The initial read we got from our consultant this weekend was positive with a caveat.  Mass revenue per table per day looks good at between US$3,600 and US$5,300, which compares favorably to the Mass average in Macau at US$3,600.  While this should not be too surprising since RWS is operating a monopoly, a busy casino cannot be considered a bad thing.  The only thing tempering that enthusiasm is that we are hearing that the property is operating an aggressive busing from Malaysia – no doubt impacting its Highlands property - which is expensive and highly promotional.


Here are some observations: 


RWS Details:

  • Opened 2/14/10
  • 380 Mass tables, 120 VIP tables, 1,100 slots (only 850 appear operational)
  • Budget of US$5bn, up from US$3.4bn
  • Locals have to pay entry fee of S$100 per day or S$2,000 per annum
  • Foreigners pay no fee


Customer Base:

  • Visitor traffic predominately Malaysian
  • Tapping into current Highlands customer base in Malaysia
  • Aggressive and expensive busing from Malaysia
  • Local play builds beginning late afternoon



  • Roulette (20% of Mass floor) much bigger than Las Vegas or Macau
  • Baccarat only 23% of Mass floor
  • Slots more popular than Macau
  • Peak time for Mass floor is late afternoon
  • Only 250 of the 380 Mass tables are open at peak – lack of staff may be the problem
  • Due to inexperience, game speeds are very slow
  • Minimum bets are averaging around S$50
  • Win per Mass table estimated to be S$5,000-7,500 per day


As Keith alluded to in today’s Early Look, the sad part about playing this game every day is the shameless use of inside information by people trying to make money. 


We don’t have inside information but we think Mr. Macro Market is whispering in our ear.  The CRB Index and gold are breaking down from an intermediate term perspective for one reason: interest rates are heading higher. 


Last week there was a compression in our “Piggy Banker Spread”, especially with gains in the 2-year yield. The 2-year yield remains in a bullish formation* and typically when the Hedgeye model flashes a bullish formation we assume a high level of conviction on our call. 


Interest rates are going up globally!  Domestically, they are going up because we are a debtor nation and inflation is going to accelerate on a reported basis in March from February’s data.  Lastly, the dollar is in a bullish formation and last week hit at 3-week high, confirming the bullish formation on interest rates. 


From a MACRO perspective, that RHYMES because somebody knows something you don’t know.  Another thing that RHYMES today is that rumors create fear and bubbles that people are terrified of being short into!  Today’s speculation:


(1)    Pactiv (PTV) is trading higher in reaction to a rumor that it is an LBO candidate

(2)    Martin Marietta (MLM) is moving higher in reaction to rumor that private equity is interested in the company

(3)    SK Broadband rises most in eight months on merger speculation

(4)    Papandreou Says Talk of Greece Leaving Euro Zone a ‘Joke’


Shorting is difficult enough to do, never mind in a market so affected by ridiculous rumors.  Shorting due to valuation or a small earnings miss might not be worth the price of admission.  Stick with flawed business models. 


Have a great day,


Howard Penney

Managing Director


* Official definition (glossary on  A bullish formation occurs when the TRADE, TREND, and TAIL lines of support for a security's price sit below the current price, with the TRADE line closest to the current price and the TAIL line farthest below, with the TREND line in between. A Bullish Formation predicts a behavioral response by the market in which investors of different durations are driven by the price to conspire to drive the price higher through their mutually reinforcing investment activity.




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This indispensable trading tool is based on a risk management signaling process Hedgeye CEO Keith McCullough developed during his years as a hedge fund manager and continues to refine. Nearly every trading day, you’ll receive Keith’s latest signals - buy, sell, short or cover.


Tidbits from our guy on the ground in Macau




  • Expectations are high for Wynn Encore both inside and outside the company
  • Wynn Macau is under roomed so Encore will be hugely additive
  • Details and timing on Wynn Cotai are scarce.  If there is any announcement it would be at the opening of Wynn Encore


  • Mass ramp continues at City of Dreams (CoD)
  • VIP is struggling at CoD - turnover less than Altira
  • Whispers are surfacing that CoD is pushing up commissions despite agreement with Venetian to hold rate


  • Sale of Four Seasons residences seem likely
  • Politics could complicate matters as Macau Chief Executive is under pressure to build more affordable housing
  • Real estate developers will not be happy if LVS is allowed to sell apartments on Cotai


This week we will be getting some incremental data points on the health of the casual dining space from DRI earnings on Tuesday and Brinker’s annual analyst meeting on Friday.  In both cases I expect the news flow to be positive. 


Over the past 90 days, casual dining stocks are up an average of 34.9% while quick service stocks are up 21.8% on average.  The outperformance is attributable to the data; consumer confidence trends are showing that consumers in higher income brackets have higher levels of confidence.  Additionally, a relative improvement in higher-end retail sales (Tiffany’s today and Nordstrom in February), as highlighted by our Retail team, has been observed recently.  Household income is also picking up disproportionately at the “high end of the income spectrum”, according to J.P. Morgan’s investor day (highlighted by financials sector head, Josh Steiner, on 2/25).  Management commentary from chains like PFCB also suggests that business expense expenditures may be picking up.


Coming into the summer months, the trends in top line sales will take on increased importance for overall stock price performance.  Casual dining, like quick-service, is facing some notable operating cost increases, on a year-over-year basis, particularly in the third quarter.  As seen in the chart below, declining food costs have been a significant tailwind for the industry in 2009.  The benefit from lower food costs began in earnest in 1Q10, but the favorability accelerated throughout the year peaking in 3Q09.  It’s impossible to make a blanket statement about every restaurant company and the impact of foods costs on the P&L, but it is helpful to look at a broader measure of food cost trends. 


Given that most companies contract out a year or more (in some cases) for 75% or more food costs, the timing of higher foods costs impact on the P&L is delayed by six months or more.  The broadest measure of overall food inflation, The CRB Foodstuffs Index, is trending upwards and is likely to remain at elevated levels for the next few quarters (currently at +15.7% YoY) given that 2Q09 saw a decline of -30% YoY for the Index.


Given the current trends, 3Q09 will be a very difficult quarter for the industry from a cost stand point, putting incremental pressure on the sales trends to continue to improve. 




Additionally, it’s not likely that labor costs will provide any tailwind for Casual Dining operators.  Unionization is not currently in the media’s crosshairs but it is probably going to be a focus of the current administration at some point in the next three years.  It is also worth considering the chart below; labor costs are growing at a steady rate on a two-year average basis.


CD – LOOKING AT THE TRENDS FOR 2010 - cd labor costs


EBIT margin trends, shown in the chart below, vividly illustrate the benefit of cost cutting and lower food costs that occurred through 2009.  As it stands now, it’s is not very clear where any margin tailwind will come from unless there is positive traffic trends and incremental pricing.  Labor cost trends are not promising and food costs look set to increase as a percentage of sales in the middle and second-half of next year.  As a point of reference, EBIT margins rose 110 bps in 3Q09 and 120bps in 4Q09; it will be difficult for the casual dining chains to match these levels of margin expansion. 


CD – LOOKING AT THE TRENDS FOR 2010 - cd ebit margin


Sales trends in casual dining are showing considerably more stabilization that in quick service restaurants.  We are hearing that February and March same-store sales results continue to improve on a sequential basis.  On a two-year average basis, sales trends in January improved by 380bps from December, to -3.2%.  The improvement is impressive despite the fact that unemployment, the increase in the savings rate, and inflationary consumer prices are all a potential drag on spending patterns.


It seems that, as PFCB management alluded to, an improvement in “expense account” spending could be helping trends at casual diners.   While consumer confidence among higher income brackets is currently providing a boost to casual dining, a reversal in the overall stock market could quickly change this.  Darden restaurants is reporting after the close Tuesday and I will be eager to hear what commentary, if any, they offer on current trends in early fiscal 4Q10.





Howard Penney

Managing Director

Being Japanese

We had our Sovereign Debt Conference call last week (email us if you want the slides), and highlighted that on a number of metrics, specifically debt-to-GDP and deficit-to-GDP, the United States has comparable ratios to the PIIGS.  In effect, the United States is a PIIG.


We have highlighted our concerns over growing debt issuance in the United State many times, and we are not alone in this regard.  According to our estimates debt issuance by the U.S. government grew by 24% in 2008 and 22% in 2009.  Currently, the United States has $12.6 trillion in debt on its balance sheet, with a debt-to-GDP ratio of 88% (this according to estimates at  Our view is that too much debt is bad, and based on long term historical studies, we are nearing that “too much” level.


Those who support increasing levels sovereign debt levels in the United States, point to Japan.  The Japanese currently have a debt-to-GDP ratio of almost 200%, and, as the narrative fallacy goes, they are fine.  This higher debt ratio is cool because most of it is owned domestically by the government (about half) and 95% of the remainder is owned by Japanese citizens, so foreign investors have very little sway.  In addition, Japan has very low interest rates, and its overall cost of servicing debt is 1.3%. All good, right? Being Japanese is cool?


Now certainly, these are facts, and facts are good, but the question remains: Do we want to become like the Japanese?  This is certainly not a bigoted point, and I for one absolutely love Sushi, but one look at a long term chart of the Nikkei 225 over the past thirty years, and we get our answer.  This major Japanese stock index has done nothing but go straight down for the last 20+ years.  So, while the country hasn’t defaulted and her interest rates are low, Being Japanese, is not all it is cut out to be.


Obviously the primary issue in Japan is long term deflation, and our view is that the opposite will likely occur in the U.S., at least in the short term, which is inflation.  The point is, though, as the counter argument goes, if we are wrong on inflation, then maybe all this debt isn’t so bad.  It probably isn’t bad if you don’t mind two decades of lower highs in your stock market. 


Daryl G. Jones

Managing Director


Being Japanese - nikkei


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