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Below are our notes from the business update.  We will follow up with a more detailed note shortly.



  • Agreement to sell Rainbow will allow them to concentrate on their core business – no surprise since this has been rumored in a while
  • Reluctance of customers
  • Low win per day in gaming operations seems to be bouncing back – claim it was weather related
  • Alabama negatively impacting them by 2-3 cents per quarter
  • Italy placements will begin in latter half of 2010.  BYI expects to play a meaningful role on both the games and systems side. Expects to place over 3,000 games and get several systems contracts
  • Releasing Alpha 2 with a 10 times improvement in processing power over Alpha 1. 
  • Digital Towers – great – 900 Powerballs and have commitments for 1300 slot products for their wheel products. 
  • Continue to take share on the systems business.
  • Canada RFP’s represent a big opportunity for them as do other new markets


  • No difference between big operators and small ones on the replacement side
  • G2E meetings were very positive, but the orders just didn’t come – which was surprising based on the feedback from G2E.  Thinks part of this is due to weather and weak performance in Jan & Feb.  Their numbers in game operations bounced back in March and hopes that implies an uptick in operators results
  • Write-offs in Alabama? Not yet, hoping that they will have more clarity in the next few days there.
  • Rainbow – in discontinued operations? 10-11 cents a share from loss of Rainbow. But if they use the proceeds then it’s neutral from an accretion/ dilution standpoint.  Tax basis on Rainbow? Estimate net proceeds of around $60MM (+/- $5MM)
  • Credit Facility Amendment?  Gives them more market pricing and more flexibility to use their balance sheet – old deal was done in the a rough time in the market
  • Still think that their market share is still in their 20% range +/- several percent
  • Think that they can get about 500 cash spins out until the end of June. Alpha 2 platform not out until Sept 2010.  Those 500 are included in the 1,300 wheel number.
  • Fireballs are replacing their products, while Cash Spin is helping them gain incremental floor share (50% or less cannibalization). 
  • Systems business lead time – is that getting shorter or longer?
    • Well shorter since it has shifted more to maintenance products from new openings
    • But its taking customers longer to make decisions
    • Guidance they are giving for the balance of this year is mostly for business in the bag – but there could be some slippage for openings.  However for next year – when they give guidance, a lot of it will be based on upgrade assumptions.

Oil Prices Rule

Over the course of the past week, our quantitative models on commodities have gone from a bearish formation for oil to a bullish formation.  Fundamentally, there are a number of factors that have been driving this change in quantitative set up.


First, geopolitical tensions seem to be picking up on the margin.  In recent weeks, Vladmir Putin has visited with Hugo Chavez and President Karzai of Afghanistan has made a number of anti-Western comments, in addition to reaching out to Iran and China.  This morning, as well, the river card was shown in the way of increased terrorist activities in Pakistan.  A U.S. consulate was attacked in Pakistan and another related bombing killed 25 people in Pakistan.


Second, there is increasing evidence that slack in the global economy will tighten for more than just the short term, which improved the global demand picture for oil.  As we highlighted in our oil Black Book last year, supply globally is tight despite massive investment over the last decade.  Therefore, when projecting for the tightness of supply and demand, the key factor to solve for is a pick up in demand.  In the short term, pundits will point to the most recent relevant data point from the United States - the better than expected jobs report which added 162,000 jobs.  More important though is the sustained growth from Asia, most notably China. 


One of our key themes for Q1 2010 was Chinese Ox in a Box, with which we accurately predicted a correction in Chinese equities.  While we did see a slow-down in various economic data points in Q1 for China, we also see continued demand for commodities, which most directly support sustained demand for oil. Specifically, on March 23rd, we wrote in the Early Look:


“Vale is the second largest mining company in the world, so when Vale speaks, our commodities team listens.  Last night Vale sent a document to its customers saying it was raising iron ore prices to $122.20 per tonne, versus $57 per tonne year last year.  That is a 114% increase.  I don’t need a degree from MIT to know that is inflation.”


In the chart below, we have highlighted the long term oil import trends for the Chinese, suffice it to say, they are up and to the right:


Oil Prices Rule - China Crude Oil Imports


Finally, days supply of oil in the United States continues to trend below year ago levels, as it did for much of February and March. While there are currently 25.2 days’ supply in the United States, it is below last year’s level from the same week by 0.2 days.  Including the Strategic Petroleum Reserve, however (this is above historical levels), the aggregate supply level in the United States continues to be at improved levels versus last year.


Predicting the direction of the price of oil globally is no easy task.  It requires a global supply and demand analysis, and also an incorporation of a varying number of factors, which change with time (as an example the inverse correlation to the U.S. dollar has become slightly less relevant versus last year).  Nonetheless, as with most markets, prices rule, and the prices, combined with the fundamentals on the margin, are suggesting a bullish set up for oil.  Our immediate term price levels are outlined below:


Oil Prices Rule - OIL


Daryl G. Jones

Managing Director

ROST: KM Stepping Up the Short -- Again

ROST: KM Stepping Up the Short -- Again


Keith dipped his toe back in the water again on ROST today, shorting a name that we’ve been on the cautious side on for a while. We remain convinced that the opportunities to meaningfully exceed both guidance and elevated Street expectations are gradually becoming harder and harder to achieve.  When you add in eight quarters in a row of inventory declines (while sales have accelerated) it remains hard to envision anything but a deceleration in momentum is on the horizon.  There is no question that this has been a great run, as it has been for other retailers benefitting from value pricing and the consumer trade-down effect.


Check out this historical perspective below, which takes a detailed but long look at the relationship between the industry’s inventory management (represented by the Sales/Inventory spread) vs. ROST historical same-store sales.  The Sales/Inventory spread for clothing and accessories retailers is currently at its widest margin since before 1996.  Tough to argue with that one…  We then line this up against Ross’ topline results and you will see that ROST’s same-store sales exceed the Sales/Inventory spread far more frequently than not, 139 months out of 169 or 82% of the time.  In fact, of the 30 times the sales/inventory spread outpaced comps over 13 years, 5 have been since September of last year alone.


The cleanliness of the inventory pipeline for retailers and manufacturers alike is about as good as we’ve ever seen and as a result, there are simply less “quality”  goods for ROST to procure.  Additionally, with fewer units floating around in the pipeline, we should begin to see ROST (and others) no longer being able to buy as close to need as we have seen over the past year.  This should have an adverse impact on inventory turns as well as the industry’s ability to flow fresh, unique good as frequently.  All this points to diminishing upside on margins and earnings. This is one of those names where we don’t need to see earnings collapse to be right, but rather simply stop going up.


ROST: KM Stepping Up the Short -- Again - ROST Comps


ROST: KM Stepping Up the Short -- Again - ROST Margins


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Turkey in Perspective

In today’s Early Look (“Inflation is Popular”) Keith noted that Turkish inflation rose +9.6% in March year-over-year (but slowed for the first month in five).  While it’s true that inflation in Turkey is just one of the many inflationary signals we’re seeing across the globe, and rising inflation can be viewed negatively as it is a tax via rising prices on a country’s citizenry, chart 1 (below) shows that this level of inflation has held quite consistently since 2004. Further, this level of inflation is not inconsistent with that of an emerging market economy like Turkey.


Inflation has been one of the outcomes of Turkey’s Central Bank chopping 10.25 pp off its main interest rate since Nov. 2008 to weather the global economic downturn.  With rates held steady at 6.5% since Dec. ’09 and annual GDP growth of +6% in Q4, the Central Bank has issued concern over rising inflation, saying last month that it’s ready to raise rates if “increases in inflation expectations lead to a deterioration in price-setting.”


On 2/25 we put out a note titled “Why We Bought Turkey (TUR) Yesterday” in which we highlighted favorable upcoming GDP comparisons (chart 2).  To refresh, the intermediate term bottom in GDP of -14.7% in Q1 ’09 sets up for a very favorable comparison in Q1 ’10, and beyond. We’ve traded Turkey with the etf (TUR); according to Keith’s models TUR is trading well above its TREND line of support at $54.20 (chart 3) and the Istanbul Stock Exchange National 100 Index is up over 11% YTD.


Matthew Hedrick



Turkey in Perspective - T1


Turkey in Perspective - T2


Turkey in Perspective - T3



Our Financials analyst Josh Steiner has posted some important notes over the past few days.  I am summarizing some of his thoughts and highlighting two charts that warrant close attention.


First, at Hedgeye Risk Management, we think the Fed is behind the curve and that it's now just a matter of time before the Fed begins raising rates.  As Josh pointed out “while on the surface this would seem negative for Financials, in fact it has historically been a positive sector indicator.”


Second, headed into the 1Q10 earning season part of the industry is well positioned.  On Thursday, in a post entitled “XLF SECTOR THOUGHTS AHEAD OF 1Q EARNINGS”, Steiner states, “To summarize, we think the big banks, as a group, should fare better than the small banks in first quarter earnings. That said, going into 4Q earnings, the stocks were coming off a down 3.6% quarter for the XLF. This quarter, the XLF is coming off a +10.8% move to the upside with a more mixed profile. Margins should be better sequentially, but it looks as though reserve builds may be slightly higher than last quarter. Earning assets will be down comparably with last quarter and ASF marks should be slightly better.”


“On the small cap side, margins will be better, but credit should be worse, earning asset growth will accelerate to the downside and ASF marks will not be the tailwind to capital they were in 4Q09. Conclusion: we think much of the good news associated with earnings is already priced into the sector at large, but the big banks should outperform the small banks.”


Third, the XLF is in a BULLISH FORMATION and below are the current Hedgeye Risk Management levels on the XLF.




On the margin front, the environment has clearly improved further for the sector.  As the following chart shows, the 2-10 yield spread - a good proxy for the sector at large - pushed higher to an average 280 bps in the first quarter, up 22 bps from the 259 bps average in 4Q09.






Howard Penney

Managing Director

The Elephant in the Room

March’s ISM Non-Manufacturing Report on Business confirm just what we have been seeing on the inflation front: more acceleration to the upside.


The March ISM Non-Manufacturing survey came in at 55.4, up 4.5% sequentially and above consensus, which was at 54. Going back in time, this is the highest reading since May 2006! Similar to last week’s ISM Manufacturing report, this release screams inflation. Even the service industry, whose costs aren’t necessarily married to the price of commodities like their manufacturing counterparts, is expecting inflation to accelerate meaningfully in the near-to-intermediate future.


Naysayers and tellers of narrative fallacies will point to all the unemployment figures, slack numbers, and core CPI readings in order to keep alive their fledgling Depressionista narratives. That’s fine. They can miss the bus and be late to class all they want. Fortunately for us (and the bond and currency markets), we’ll be at our desks when the bell rings and global cost of capital will start to rise.


Here’s a current snapshot of the global inflation picture:

  • ISM Manufacturing for March just made another higher-high at 59.6 (versus 56.5 in February).
  • Prices Paid continue to ramp, coming in at 75.0 in March (versus 67 in February).
  • After shooting up another +7.8% last week, oil prices are hitting 17 month highs ($85.35/barrel).
  • After melting up another +5.9% last week, copper prices are hitting 20 month highs ($3.61/lb).
  • 2-year US Treasury  yields are up +37% in the last month and hitting new highs again this morning at +1.10%.
  • Russian stocks are up again this morning, inflating their petrodollar stock market to +12.1% YTD.
  • Japanese stocks were up again overnight, inflating their currency debased stock market to +7.5% YTD.
  • Turkish inflation for March was reported at +9.6% year-over-year growth.


While we take some issue with the U.S. government's calculation of inflation (they’ve changed the calculation nine times since 1996), even federal economists have reported inflating prices this year. The January CPI came in at 2.6% and February reported at 2.1%. We expect March figures to accelerate even further. There will come a point in the next 3-6 months when He Who Sees No Inflation will no longer be able to be willfully blind towards inflation picture.


When you keep feeding the four-ton elephant in the room (which Bernanke is doing with his “extended and exceptional” emergency interest rate policy of ZERO percent), there will come a point where you can’t avoid bumping into it. We can only hope that he bumps into it soon and ready to reacts in a manner that takes into account the best interests of the citizens who actually feel in their wallets ALL the components of an accelerating CPI report. Unfortunately for America at large, Helicopter Ben has only raised the Fed Funds Target Rate once since taking over back in early 2006 (June 29th, 2006 to be exact). Let’s just say experience is not on his side.


The next FMOC meeting is scheduled for April 27th - 28th.


Darius Dale



The Elephant in the Room - ISM Non Manufacturing


The Elephant in the Room - Fed Funds Target Rate

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