The market’s retracement following the GS selloff is centered on the upbeat sentiment surrounding Q1 earnings season, which continues to beat analysts' expectations. 


According to Bloomberg, 82% of the S&P 500 companies that have reported first-quarter results beat the average analyst earnings estimate, up from 79.5% in the fourth quarter of 2009.  So far in 1Q, operating profit for the S&P 500 is up 35% year-over-year.  Volume declined 10% day-over-day and the VIX declined 9.2%, bringing its two day slide to 14.8%.  The Hedgeye Risk Management models have levels for the VIX at: buy TRADE (14.62) and sell TRADE (16.95). 


On the MACRO front Greek sovereign issues, China’s measures to curb real estate speculation and hawkish comments from India and the Bank of Canada are having little lasting impact on the risk/recovery trade.  Earlier today, Bundesbank President Weber's comments that Greece may need up to €80B of bail-out money is putting pressure on Greek sovereign spreads again today, rising to all time highs.


Yesterday, Energy (XLE) was the best performing sector.  The oil services group fared particularly well, with the OSX posting its biggest one-day gain since August 3rd, +4%.  The drillers and the E&P group outperformed the broader market with the EPX rising 2.1%.  In early trading, Crude is trading higher on speculation that supplies are shrinking.  The Hedgeye Risk Management model’s levels for the OIL are: buy TRADE (83.54) and sell TRADE (84.99). 


On the back of a busy day for bank earnings, the banking group provided some upside leadership for the Financials (XLF), with the BKX up 2.7% and up 11% over the past month.  The upside was largely driven by better-than-expected credit quality.  There was some disappointment surrounding results in investment banking and asset management, though the pullback was attributed to the fact that a beat was widely expected, while regulatory concerns also remained on the front-burner.


While Technology (XLK) was higher yesterday, the sector lagged the S&P 500. The big headwind came from IBM (1.9%), even though the company beat on both the top- and bottom-line and raised full-year guidance above the consensus.  On the positive side, the Semis snapped a two-day losing streak today with the SOX +1.6%.


Parts of the SAFETY trade continue to lag the market.  Healthcare and Consumer Staples were the two worst performing sectors yesterday.  The packaged food and soft-drink names were among the worst performers in the staples sector yesterday following the top-line miss from KO.  In addition, SVU was another big decliner  after becoming the latest grocer to offer disappointing guidance.


Additionally, a stronger dollar is putting some pressure on the REFLATION trade and the commodity related sectors.  The Hedgeye Risk Management models have levels for the Dollar Index (DXY) at:  buy TRADE (80.86) and sell TRADE (81.52). 


In early trading, gold is trading higher for the second day in a row on the back of its safe haven status.  The Hedgeye Risk Management models have the following levels for GOLD – Buy TRADE (1,126) and Sell TRADE (1,168).


In early trading, copper is trading slightly lower despite bullish news from China.  Copper imports by China for the month of March rose 53% over February and 14% year-over-year.  The Hedgeye Risk Management Quant models have the following levels for COPPER – Buy TRADE (3.50) and Sell TRADE (3.64).


In early trading, equity futures are trading above fair value and look continue the earnings season upside momentum.  On the MACRO front it’s a light day, but a heavy day for earnings with 35 S&P 500 companies reporting, including Morgan Stanley and Wells Fargo before the bell.  As we look at today’s set up, the range for the S&P 500 is 15 points or 0.7% (1,199) downside and 0.6% (1,214) upside. 


On the MACRO calendar today, Mortgage applications in the U.S. rose by the most in seven weeks.  The Mortgage Bankers Association’s index increased 13.6% in the week ended April 16th. Last night after the close, the ABC consumer confidence index declined to -50 from -47 the week before. 


Howard Penney

Managing Director














If it quacks like a duck...


In the breaking news department MGM MIRAGE announced they've changed their name again, this time to MGM Resorts International.  I'm not sure if this is going to help the multiple but hey it's worth a shot.  We remember other MGM incarnations:  


  • THE Las Vegas company - nobody wants to be this now
  • A Brand company - yes they have some management opportunities but fee revenue will never be close to owned EBITDA
  • A P/E stock (until the accounting for acquired intangibles leveled the playing field.  Negative earnings aren't great for P/E either)
  • Back to EV/EBITDA now that WYNN and LVS trade at a premium and the huge tax advantages of deriving most of your profits in Macau isn't captured in EBITDA
  • And most recently, a Convention company - with only 11% of room nights from conventions last year, this doesn't pass muster, but hey, Goldman signed on and the stock has moved higher


Their perception goal is pretty transparent here.  However, it doesn't really change the reality that MGM is highly leveraged to the domestic hotel casino market but with a small convention business and an even smaller international presence.


I'm guessing that 'MGM Resorts International' won out over 'MGM Conventions And Brands Worldwide' and 'Anything But Domestic Gaming Incorporated'.


Please see our 4/16 earnings preview for commentary on PENN’s upcoming quarter.  Below we highlight the important forward looking commentary from PENN’s FQ1 earnings release and conference call.




  • “Looking forward, as you can see from our guidance, we don’t see a whole lot of reason for enthusiasm in 2010.” 
  • “What we’ve done is done a lot of internal trend analysis for lack of a better description of it, which is indicating to us that the rate of decline is slowing. But rate of decline is slowing is not good news.  What that just means is it’s getting bad, it’s just getting bad slower, and we’re not on the breakneck pace to zero that we were before.” 
  • “If you take out both Penn National and Joliet, which we’re doing for internal purposes…January’s numbers – revenue numbers were down 5.3%. Now the good – if there is good… we were behind our own internal forecast up until the last weekend of the month, and then we came roaring back”
  • “Joliet, as you know, we’re operating with just the casino right now, and we don’t have much to sell there. And the competitive environment has increased in the fourth quarter. Now, labor is being managed well. We still have opportunities to be more efficient with our marketing spend there. We did open in the beginning of this week our new parking garage there. So I fully expect we’re going to see margin improvement in Joliet from what you saw in the fourth quarter”
  • “We continue to see more softness than anywhere in Southern Mississippi and Southern Louisiana.  And specifically, in Bay St. Louis, the promotional spending in that market, driven by our chief competitor in Gulfport, is deteriorating all of our margins and we’re trying to continue to find ways to protect our share, but not overspend to protect that share.”
  • “Tunica, it was a little bit different. We’ve been improving margins there. We had some unusual adjustments that negatively affected the fourth quarter in excess of $1 million of adjustments for inventory, bonus and severance, some repairs we made to the building and some increased healthcare costs. I do think those were one-time occurrences in Tunica and I don’t expect that to be a recurring theme. The promotional environment in Tunica is not like it is in Southern Mississippi.”  
  • “Charles Town, that’s one where we’re seeing some softness. We did have some weather effect in December, but even through the entire quarter, we still saw softness there in the market. And it’s an opportunity we continue to look at to improve our efficiency of our marketing spend. Again, labor is being managed well. We did see in line performance in the month of January in Charles Town, but again, we’re trying to get the right mix given the introduction of tax free promotional credits in that market to make sure that it’s as efficient use of those marketing dollars as it possibly can be and that’s the theme for Charles Town as we get into 2010 as well”
  • Answer to the impact of table games on property margins in Charles Town:  “That table tax rate is going to be 35%. So I don’t think it’s going to be enhancing our margins in Charles Town given the labor component there. I think, net-net we’re probably in the 27, 28%  area”
  • “Typically what we see across our properties are roughly 15%, table games are roughly 15% a slot, in mature markets where they both been existing sort of similar period of time. Obviously at Charles Town, what we’re expecting is that it will take some time to ramp to that level.”
  • “With the good weather and not much on TV to occupy people’s time on weekends, we continue to see reasonably good growth from our capital investment at Lawrenceburg, 8 to 9% in the fourth quarter and we had record attendance levels on Saturday.”
  • “I think the reality is this, you’ve extracted the easy stuff. The low hanging fruit has been pulled out of our cost structure. And I think as we go forward, we’re going to struggle to keep or to  basically reduce cost commensurate with revenue declines that we’re starting to get to the point where this is not as effective as we’ve been – of being able to match the revenue declines with operating cost declines.”
  • “They’re just gambling at lower threshold and you see it too and how they are playing the slot products. You see a continued trend to play the low denomination slots.”
  •  “What we’ve got for a corporate overhead number next year is around 69 million. Obviously, we continue to expect it doesn’t really have any significant amounts for lobbying. I mean there are certain amounts that we recognize we’d be spending. But it’s certainly much reduced than the current levels. The other items I mean obviously – we don’t have table games in here, because quite candidly, we don’t really have a good date for when we think it will be up and running. And the state regulatory process in Pennsylvania historically has proven to be incredibly lengthy.”
    • “So and those 69 million could be ratably throughout, let’s say, 70 million split fairly evenly throughout the year? That’s our expectation”
    • From 4/15/2010 Telsey  Conference: “I would point out that in the corporate overhead number, there’s probably – there’s almost $24 million worth of Ohio referendum costs associated with our efforts last year in Ohio.”

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ROST: KM Shorting, Thesis Unchanged

Keith remains opportunistic with a Ross Stores’ position on the short-side, with shares nearing an immediate term overbought level at 56.87 and a bullish line of support down at 54.63. Our thesis remains unchanged and is outlined below as highlighted in our April 5th post below:


“…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 Shorting, Thesis Unchanged - ROST SalesInv Spread 4 10 1


ROST: KM Shorting, Thesis Unchanged - ROST SalesInv Spread 4 10 2




Please see our 4/16 earnings preview for commentary on IGT’s upcoming quarter.  Below we highlight the important forward looking commentary from IGT’s FQ1 earnings release and conference call.




  •  “While we continue to have limited visibility around replacement demand, we believe future demand will exceed trough levels experienced in the early part of 2009.”
    • Not exactly encouraging as Pat’s referring to the measly 1,800 replacement units that IGT shipped in the March 09 quarter and the 2,300 replacement units shipped in the June 2009 quarter. 
  • “Going forward, we expect product sales gross margins to remain in the low 50% range, also [benefitting] by our cost savings initiatives and impact of product sales mix.”
  • “We continue to move towards our goal of the previously announced $200 million of cost cuts when compared to the fourth quarter of 2008. We feel that we are on track to achieve our cost reduction goals as we move throughout fiscal 2010."
  • “We expect the quarterly SG&A run rate in the range of $95 million to $100 million.”
  • “We expect a quarterly R&D run rate in the low $50 million area”
  • “As it relates to R&D, Q1 is naturally lower just due to the fact that the team is largely preoccupied with G2E. And we do have some initiatives underway that we know will require us to uptick that a little bit going forward...R&D probably over time is going to run somewhere around the couple of hundred million. I don't think we can get it much lower than that, given that the sheer number of things we do”
  • “The decline in total depreciation and amortization was primarily due to lower depreciation in our domestic MegaJackpots and Mexico lease operations. Please note that some of this will come back as we refresh our installed base of assets over time.”
  • “Going forward, we expect our quarterly tax rate to trend at approximately 37% to 39% before discrete items.”
  • “CapEx is expected to trend in the range of $50 million to $75 million, although we do continue to come in nearer the lower end of the range as we more proactively manage our CapEx as part of our efficiency and cost reduction efforts.”
  • “Our guidance for 2010 remains a range of $0.77 to $0.87 per diluted share. As always, our guidance excludes the one-time items like the first quarter tax benefit of $0.01, which resulted primarily from our recent stock option exchange program. Our guidance also assumes no dilution impact from our convertible notes.”
  • “We see an improvement in Europe. Last year was a horrible year in Europe. Latin America will be a big contributor as it was in Q1 for the year. And then I think we see stability in places like South Africa and Australia where they've been consistent providers. And I think the same for the U.K., the consistent contribution. But again, we're not forecasting huge year-on-year improvement internationally, just given that many of the international markets are suffering the same economic and credit woes that the U.S. has felt.”
    • I guess ex- Japan there would be a decrease – since Japan contributed over 3,700 units to FY 2009 shipments 


  • “Lower year-over-year blended yield saw the combined result of the decline in play levels and the continued shift in the installed base mix to include more lower yield machines in leased.”
  • “In product sales, the first quarter has historically been our lowest due to the holidays and the tendencies for customers to carefully consider their options after G2E and ahead of the release of their annual budget.”
  •  “We know that new or expansion units will be off year-on-year pretty heavily just because there isn't as many new properties opening or expanding during the fiscal year. And so everything else constant would say you have to make that up in replacement. And so you can already assume that we do assume in our guidance a decent uplift in replacements, but visibility to that is pretty limited I'd have to say at this point.”
  • “SG&A, we did have a couple of items during the quarter that's favorably impacted that won't be recurring… a couple of our accruals in the compensation area.. to the tune of about $3 million that obviously was kind of a one-time thing as we adjusted to our new comp plan.”
  • “We're just listening to what our customers are telling us about how they intend to spend capital and how much of it. And neither of those two comments would suggest that you should have a real hockey stick kind of uptick in replacement activity. And then just to stay flat with prior year, we've got to have a pretty significant uptick in replacement units just to offset the loss that would definitely be there from newer expansion.”



  • Question:  “I guess what I'm struggling with is this, revenues are seasonally at a low -- revenues are probably out of trough for the cycle; replacement sales seem to be going up; your expense have been reduced dramatically; you've committed to continue to reduce expenses on a go-forward basis; and if you print a $0.25 quarter in the first quarter, how can you not get to over almost $1 easily in the next year? I mean, I understand you guys want to be conservative and beat the number, but gosh, there must be something that we're missing because it sounds like things are going much better and this quarter was a good example of you controlling the things you can control and keeping things tight in front of what looks to be like a pretty good year on the revenue side as we move forward.” – Steve Kent, Goldman Sachs Analyst
    • IGT Response: I think we look at this more as a $0.22/$0.23 quarter with an adjustment for some of the one-time events…We feel very good that the replacement cycle will make its way back from the trough loads. It is timing that is less obvious to us… We have a bit of risk adjustment for the worst case scenario in Alabama. If you look at Game Ops, the Game Ops business, we're still experiencing a fair amount of mixed shift.”
  • “Our internal estimates should base on tracking of one order to the next, would suggest we're somewhere around 40% on the replacement side, which is consistent with where we were for Q4”
    • Actually it was closer to 30% in the December quarter and 35% in the September quarter
  • Market share for new/ expansions in NA:  “Some north of 50% and kind of varies widely”
    • Well that’s not really possible because between IGT, BYI and WMS there were over 4,600 units shipped this quarter… we think the number is closer to 1/3

Government’s Marking to Model . . .

Despite the catastrophic collapse of the real estate bubble and housing prices, property tax revenue collected by states and localities is still on the rise - up 2.7% in 2009. This is a disconnect from the reality of the current state of the U.S. housing market, which is a direct result of most State and local governments marking their property tax collection schemes to model.


In the most recent economic downturn, receipts to State and local governments have largely gone south, declining (-10.9%), (-16.4%), and (-11.6%) in the last three quarters alone, according to the National Association of State Budget Officers.  As to be expected with a 9.7% unemployment rate, data from the Bureau of Economic Analysis shows that in 2009, income and sales tax receipts have posted the largest annual declines on record (-19% and -4.8%, respectively). In fact, of all the major State and local government tax categories, only receipts from corporate income and property taxes grew in 2009.


Government’s Marking to Model . . . - 1


Furthermore, BEA statistics show that property taxes have been a great source of income for struggling local governments, which collect over 96% of all property taxes. With property included, receipts to State and local governments declined  5.5% in 2009. Without property taxes, however, receipts declined 9.1% in 2009.


So with everything we know about depressed home prices, how can it be that property tax receipts are actually still on the rise?


The answer is easy - most State and local governments notoriously mark their property tax collection processes to model. That is, property taxes are often based on rather outdated appraisal values that consistently lag fair market values throughout most States. On average, as determined by Federal Reserve economist Byron Lutz, it takes three years for changes in the market value of homes to get reflected in an owner's property tax bill. So most State and local governments are raking in property tax receipts based on home values appraised in 2006 - the peak of the housing bubble.


So one would think that the consumer finally gets thrown a bone in the form a property taxes finally starting to roll over and catch up to the sunken home values across the country.


Not so fast, my friend.


In classic marked-to-model form, some State and local governments have raised property tax rates to offset declining home prices. Others have adjusted tax rates to keep property tax revenue stable, regardless of what happens to prices on the real estate market. Even more appalling, some State and local governments have actually raised property taxes to deal with budget shortfalls.  All told, the budget shortfall facing State and local governments in the next three fiscal years is $136.1 billion, according to NASBO.


In a twisted way, with property tax appeals well above historic means in most municipalities, it sounds insignificant to suggest that many State and local governments across the country have each planned to spend well over a hundred million dollars on property tax appeals in the next fiscal year. That's right - millions of Americans across the country are appealing their property taxes, citing home values well below the last State-appraised values the taxes are being based upon. Twenty to forty percent of appeals are granted. If the average holds, the lifeline that property taxes have been to flailing State and local government budgets will be eroded on the margin.


Perhaps that is why 41 states are behind their fiscal 2010 revenue projections (NASBO). Six were on target as of February 20th; a paltry three were ahead of schedule (NASBO). Moreover, NASBO studies suggest States are projecting a further decline of over 1.4% in tax collections for fiscal 2010. Thinned-out receipts have left States’ Rainy Day funds at 4.8% of expenditures - the lowest ratio since 2004 (NASBO). Back out the ultra-conservative Texas and Alaska, and that ratio is only 2.7% - the lowest since 1992 (NASBO)!


It neither sustainable for State and local governments to raise taxes based on marked-to-model housing prices, nor is it sustainable for homeowners to continue to a growing percentage of the tax burned.  Yet another reason to be concerned about the Domestic PIIGS, and the outlook for municipal bonds.


Darius Dale


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