Catching the Contagion

“Prediction is very difficult, especially when it is about the future.”

-Niels Bohr


Keith has taken his young lad, wife, and daughter up to his ancestral home of Thunder Bay, Ontario, so I’ve been handed the baton on the Early Look.  In a similar spirit, I thought I’d quote someone from the land of my ancestors, Denmark.


One would think that Niels Bohr was a Danish version of Yogi Berra given the quote above.  In fact, Niels Bohr was a physicist.  Well, much more than a physicist really, Bohr was the Nobel Prize winner in Physics in 1922 for developing the Bohr model of the atom.  


The man basically discovered how the most discrete parts of life work, and for such fine work his home country put him on a postage stamp, put him on the 500 kroner bill, had two elements named after him, and, get this, he even has an asteroid named after him.  (As an aside, I’m starting  to think my good friend and 12-time Olympic medalist in swimming, Jenny Thompson, got the raw end of the deal when she only got a swimming pool in her hometown named after her.)


Bohr also developed the principle of complementary, which states that “items could be separately analyzed as having several contradictory properties.”  As we stare at our screens this morning trying to predict the future, this might have been his most valuable contribution.


While Europe is up small this morning, Asian got pounded over night.  China is down more than 4% to a 8-month low and the Nikkei in Japan is down almost 3.5% (after a holiday earlier this week), its largest single day decline in over a year. 


Yes, friends, the world is starting to have a freak out moment about sovereign debt.  Global markets are getting pounded, Spain is seeing its cost of debt rise to levels not seen since the global financial crises of 2008, and Moody’s has piled on this morning saying contagion could threaten banks in “Portugal, Spain, Italy, Ireland and the U.K.”.  While I woke up with a cold, the world, it seems, has Caught the Contagion.


When the world is freaking out though, it’s best to go back to science and facts when trying to predict the future.  As it relates to the immediate term future, I’m going to focus on Bohr’s principle of complementary.  These freak outs usually create the best buying opportunities, and within the European Union our favorite set up of long Germany and short Spain is one to focus on as they have “very contradictory properties”.


I’ve asked our European Analyst Matt Hedrick to provide a brief overview of some key economic metrics for these two countries, which are outlined below.


On Spain:

  1. Spain’s unemployment rate is north of 20%, which is almost 2x the EU average.  The unemployed consists largely of recent immigrants (unemployment rate closer to 35%) and construction workers, which will be difficult to re-employ, and thus will keep unemployment high for some time.
  2. Spain’s budget deficit-to-GDP was 11.2% at the end of last year and has expanded this year.  This is well beyond the danger zone of 10%, which typically highlights the increased potential for a debt default and increased borrowing costs.
  3. Spain’s economy at its peak was more than 20% driven by construction and real estate, which will not rebound any time soon.  As a result, growth in the “recovery” has been anemic and GDP is expected to decline -0.4% in 2010.

On Germany:

  1. German unemployment has held steady in the low 8% level over the past 12 months, with recent improvement coming in last two months, falling to 8.0% in March and 7.8% in April. This outperformance over the Eurozone average (currently at 10%) is due to the success of the government’s short-time work program (Kurzarbeit), which buffered the impact of the economic downturn on unemployment.
  2. Germany’s budget deficit stands at 3.5% of GDP.  We see this low figure as an extreme advantage, especially as the cost of capital rises for European states over the medium term. 
  3. The decline of the Euro versus the USD stands to boost Germany’s large export base. Year-to-date the Euro is down 10.8% versus the USD. While GDP is forecast to grow under 2% this year, we expect Europe’s largest economy to outperform, especially as many of its peers are mired in sovereign debt.  

While the points above are somewhat of a science in and of themselves, we’ve also represented this Sovereign Dichotomy in our Chart of the Day attached below.  This chart outlines the divergences of unemployment in the two countries.  Spain’s unemployment parallels that of economic leaders like Sudan and the West Bank, while German unemployment is amongst the lowest in the industrialized world and improving.


When the world Catches the Contagion, volatility will spike (as it has) and investors sell stocks, assets classes and countries indiscriminately.  A quick application of Bohr’s principle of complementary tells the science-fearing team at Hedgeye one thing, not all members of the European Union are created equal.


“Prediction is very difficult” . . . especially when we make it so.


Keep your head up and stick on the ice,


Daryl G. Jones

Managing Director


Catching the Contagion - Spain v Germany Unemployment



The Macau Metro Monitor, May 6th, 2010




Sundart International Holdings Ltd., a major fitting-out contractor, said that a curb on foreign labor could lead to higher costs for casino operators building in Macau.  Sundart is in talks to negotiate with Galaxy Entertainment Group Ltd. to raise the value of its contract to fit out the company's HK$14.1 billion casino project by an estimated 10% or more as a result of the labor shortage, Chairman William Chan said Wednesday.  Sundart will need to increase pre-fabrication work in factories in mainland China to fulfill its obligations, said Chan, but this will require more planning and precise engineering, commanding a higher contract price.  The target size of Sundart's contract with Galaxy is HK$500 million-HK$600 million versus the estimated HK$1 billion in total it will cost to fit-out the company's Cotai project.


The proposal to limit nonresident labor causes "more headache," said Chan, "but this is not the first time we have faced this."  Macau is the most challenging operating environment for the contractor, which also does work in mainland China, Hong Kong and Qatar, said Chan.  Sundart is also bidding for work on Sands China's expansion project on Cotai, but the process of fitting-out the project is still in the "planning stage," said Chan.


Citing a number of analysts, the bulk of the gamblers at the two casinos are Singaporean citizens and permanent residents, who have to pay a S$100 ($72) daily or S$2,000 ($1,435) annual levy to play the tables.  A recent report by Bank of America-Merrill Lynch noted that they make up 50% to 60% of RWS' casino patrons.  Of this lot, nine in 10 pay the $100 levy for a 24-hour turn at the tables, with one in 10 forking out the $2,000 annual fee.  This could be a concern since local players are mostly gambling relatively small amounts, a contrast from the high-rolling Chinese officials and businessmen who flock to Macau, even if strict Singapore regulations have made it difficult for them to bring in these high rollers.


In the meantime, the Marina Bay Sands ran into an embarrassing series of glitches on its opening --delays, management shake-ups, staff woes, construction problems and now the latest salt to be rubbed into the wound – threats of legal action by organizers of the Inter-Pacific Bar Association (IPBA) Conference, the first event it hosted after opening on April 27.


For the past two days, the pattern of the move to the downside is clearly more aggressive than that of the recent push higher. On Wednesday, US stocks were weaker for the second straight day; the S&P declined 0.66%.European sovereign credit contagion concerns remained the big headwind for stocks today, as the RISK AVERSION trade is continues to press on. The VIX was up 4.4% yesterday and now up 14% for the week.


The Dollar index was up 0.94% yesterday and is up 2.69% this week.


On the MACRO front, the labor market is providing some positive economic momentum in the US and the focus will shift to the April payrolls data due out on Friday. Yesterday, ADP private employment was up 32,000 last month, slightly above the 30K consensus. In addition, February and March were revised up a cumulative 69,000. Services sector payrolls rose 50,000 in April following a 54,000 gain in March, while manufacturing payrolls were also a bright spot, up 29,000 on the back of a revised 19,000 increase in March.


Also on the MACRO calendar, ISM non-manufacturing was unchanged at 55.4 in April vs. a Bloomberg survey of 56.0. The bulk of the core components were also little changed on the month, but the takeaways from the report are still consistent with the recovery momentum theme. The pace of improvement is slowing, however.


While the labor market is providing some positive momentum to the RECOVERY trade, the China tightening concerns are rattling the Chinese market and providing a headwind to the RECOVERY trade. Last night, the Shanghai Composite Index finished down 4.1% and is now down 16.4% for the year-to-date.


The Hedgeye Risk Management Models have all nine S&P sectors broken on TRADE.


For the second day in a row, the low beta sectors (Healthcare (XLV), Utilities (XLU) and Consumer Staples (XLP) were the best performing sectors. Both the XLP and the XLU were up on the day.


Two of the three worst performing sectors were the Industrials (XLI) and Materials (XLB). Declining commodities and a strong dollar are providing a significant headwind for the group. A big laggard in the XLI was GE trading down 2.6% yesterday. Yesterday, crude dropped 3% and is now down 7.3% over the past three days.


Another notable laggard was Consumer Discretionary (XLY). Within the XLY, Media names were notable laggards on the back of disappointing fiscal Q4 guidance out of NWSA, and TWX missed on the top-line. Gaming, lodging and Restaurant stocks also came under pressure. Also, the bulk of the stocks leveraged to the housing sector underperformed again today with the S&P 500 Homebuilding index down 3.6%.


In early trading, equity futures are trading above fair value as European markets look to have stabilized, while Asia was much weaker. Today sees a further raft of corporate earnings with weekly jobless numbers. As we look at today’s setup, the range for the S&P 500 is 32 points or 0.5% (1,160) downside and 2.2% (1,192) upside.


Today’s MACRO events: 

  • MBA Mortgage Applications
  • April Challenger Job Cuts
  • April ADP Employment
  • April ISM Non-Manufacturing Composite 

Howard Penney

Managing Director

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Death of FL Greatly Exaggerated

In advance of today’s Nike analyst day, it’s first meeting in three years, there was much speculation about an unveiling of a major company-owned retail rollout.  Taking this a bit further, there was also a belief that this announcement would be detrimental to Footlocker and its efforts to ultimately compete with Nike, it’s largest vendor.  Now that the presentation is complete, we remain confident that this speculative threat in the domestic market was greatly exaggerated.


The bottom line here is that Nike plans to add 280 stores, of varying formats, sizes, and product offerings on a GLOBAL basis over the next five years.  Management went on to further clarify that the North American market will likely see less owned-retail growth as Nike is mindful of an already advanced wholesale/retail partnership network here.  Overall, we heard nothing that would impair Foot Locker’s ability to achieve and potentially surpass its EBIT margin goals of 7.5+% over the next few years. 


Importantly, there were subtleties that stood out that may benefit FL and its relationship with Nike.  First, we heard a thorough discussion about the company’s sophisticated tools which allow Nike to analyze specific markets and potential sales opportunities across all points of distribution (not just Nike owned stores).  Secondly, we also heard the mention of House of Hoops as an example of how they can work with a partner to specifically target a local market with a very specific product offering and merchandising message.  While these are just little anecdotes, we continue to believe this is indicative of the positive transformation in the relationship and collaboration between the two companies.


Overall, our view on Foot Locker remains unchanged and favorable following what we heard today.  Nike’s product driven initiatives and investments in infrastructure will benefit the 3,500 unit chain well beyond the potential challenges Foot Locker may face from an uptick in Nike owned retail.  Importantly, the speculative threat centered on massive retail growth was overdone.


Eric Levine



Expecting an in line quarter, it's going to be all about outlook and cost control



"Table drop, slot coin-in and visitation [at River Rock] witnessed double-digit improvements when compared to February 2009.  Unfortunately though, the benefit of these increases was offset by a table hold percentage of 14.9%, well below River Rock’s historical average.  While this is always very effective marketing, it did in combination with the Olympics related closure of Hastings Racecourse contribute to February 2010 revenues in BC declining by 7.6%, when compared to last year.  In January 2010 for comparison, BC revenues were essentially flat, when compared to January 2009."

- Milton Woensdregt, Chief Financial Officer


Milt kind of said it all with the comment above.  The local government numbers showing the gov't share of provincial casino revenue numbers also tells us that revenues in 1Q2010 should be modestly down y-o-y.  Everyone already knows this, so in this quarter all eyes will be on March and April trends and cost controls.  We estimate that GC will report an in-line quarter with revenue of $94MM, slightly below the Street's $95MM estimate.  However, despite lower revenues, GC should be able to slightly exceed the consensus EBITDA estimate of $31MM.


Aside from the poor hold at River Rock in February and closure for part of the quarter at Hastings, the y-o-y comparisons are pretty clean - that is, no weather or major hold issues in either quarter.  Local share of provincial casino revenues data implies that Great Canadian's BC casinos had a 5% y-o-y decline in gaming revenues.  We're estimating a 4% y-o-y decline in BC gaming revenues.  On the call we will be focused on:

  • March and April trends.  We think March was pretty uninspiring - the data implies 3-4% degradation from last year
  • Early signs of feedback on the new player tracking rewards program
  • Feedback on additions at Georgian Downs and View Royal and the slot refresh at Nova Scotia
  • Evidence of control and ROI on their marketing expenditures


1Q2010 Detail


We estimate that River Rock will report $29MM of revenues and $11.4MM of EBITDA.

  • We estimate 4% decline or $22.3MM of gaming revenues, assuming:
    • 7% increase in drop, 18% hold; 10% increase in slot coin in and 7% win rate
    • In 1Q09 table hold was 21.9% and slot win % was 7.1%
  • 15% increase in other revenues driven by a 10% increase in F&B and a 29% increase in hotel revenues
  • $17.3MM of operating expenses, which compares to $17.4MM last quarter and equates to a 3% increase from 1Q09, driven by an increase in marketing costs.



We estimate Boulevard will report $16.9MM of revenues and $7.8MM of EBITDA.

  • We estimate a 4% decline in gaming revenues to $14.4MM, assuming:
    • 5% decrease in drop and 19.15% hold; 6% decrease in slot coin in and a 7% win rate
    • 1Q09 has an easy hold comparison of 18.3% on tables and slot win % of 6.9%
  • We estimate that other revenues are flat relative to 4Q09 results at $2.5MM or up 5% y-o-y
  • $9.1MM in operating expenses, down 3% y-o-y

GC 1Q2010 PREVIEW - boulevard


We estimate that Vancouver Island properties will report a $10MM of revenues and $5.9MM of EBITDA.

  • We estimate a 2% decline in gaming revenues to $9.1MM, assuming:
    • 3% decrease in drop and 23.5% hold; 2% decrease in slot coin in and a 7.2% win rate
    • 1Q09 table hold was 24.2% on tables and slot win % of 7.2%
  • We estimate that other revenues will increase to 860k.
  • Operating expenses flat to 4Q09

GC 1Q2010 PREVIEW - vancouver


Other properties:

  • We expect Nova Scotia revenue of $10.8MM and $2.6MM of EBITDA.  We actually expect gaming revenues to be up almost 4% at the Nova Scotia properties this quarter and costs to be in-line with last quarter.
  • We expect Georgian Downs to be flat with last quarter revenue wise and EBITDA wise.
  • Great American properties should be up handsomely due to the FX benefits of a strong Canadian dollar.
  • Racetrack revenues should be down about 10% y-o-y given the closure at Hastings.


In preparation for OEH's Q1 earnings on Thursday, we've highlighted management's forward looking commentary from its Q4 conference call. 




  • "To drive revenue and EBITDA, we have minimal opportunities now to cut cost further.  It’s now about the revenue line."
  • "The key focus in 2010 will now be on the sale of developed real estate.  In January, we completed the first phase of Porto Cupecoy, our 184 condominium development on the Dutch side of St. Martin in the Caribbean. To-date, 99 apartments have been sold and closings have now commenced."
    • "Gross sales to-date are over $68 million, of which $34 million has been received and invested in the project.  This leaves the further $34 million of closing proceeds, which will be received over the next few months as units are handed over to the buyer.  This will be sufficient to repay the outstanding debt and the residual construction costs, which means that we will then have further 85 units left to sell, three of that which should generate free cash flows of approximately $60 million.  This cash flow does not include additional projected sales of our mega-yacht marina slips, all commercial component, which we anticipate to produce the further $15 million of net cash...We will definitely sell the units within the two-year period. "
  • "So, the weather, has hit us on three fronts in 2010.  Firstly in Peru, major flooding, we have to close the Cuzco-Machu Picchu railroad, which will be reopened in early April.  This will have an impact on our hotels business, and whilst it is, we hope a non-recurring item... Net of insurance, we expect to lose between $2 to $4 million of EBITDA for the year."
  • "We completed two great acquisitions in January, the Grand Hotel Timeo and the Villa Sant’Andrea in Sicily, backed by successful equity raise from our shareholders.  Both properties are currently closed and will reopen in late May as Orient-Express property.  These along with the new Peru Hotel, Rio Sagrado, Hotel das Cataratas in Brazil, the villas at Jimbaran Puri Bali and the expanded Cambodian property will add to our portfolio in 2010."
  • "Our January revenues were up just over 10% ....  This growth was dominated by our rest-of-the-world properties, particularly the southern hemisphere ones, which are currently in high season."
    • "Copacabana Palace was up almost 40%, Russia up a healthy 6%, and both Africa and Asia in positive territories."
  •  "Quarter one bookings are currently tracking 6% ahead of the same time in 2009.  However, we expect ADR to be slightly lower in the first quarter, due in part to aggressive pricing decisions for shoulder season months. Quarter two bookings are currently tracking 10% below 2009 levels, but this gap is closing each month. One month ago, the gap was 60%. The equivalent numbers for quarter three, 8% down at the moment and this was 14% one month ago; obviously the third quarter is our high season quarter."
  • "Bookings for our Trains and Cruises businesses, 23% ahead of this time last year, and this is on a revenue basis. And VSOE, 25% ahead, encouraging news."
  • "The bulk of the Sicilian debt falls into the after-2012 category. The $60 million repayable in 2010 includes $27 million drawn on the Cupecoy project, which will be repaid over the next six months as the sold units are delivered and the final installments are collected from buyers."
  • "At this early stage, we’re expecting cash tax in 2010 to be in the range of 12 to $14 million."
  • "The largest maturing loan in 2011 is the European facility... it remains our intention to have this debt refinanced by no later than early in the fourth quarter of this year."
  • Properties update:
    • "Reid's and Madeira, La Residencia, Ritz Madrid, even Grand Hotel have big occupancy drops, but only small drops in rate.  I think actually the Grand has a slight increase in rate because the rooms mix change so much. So, I think having experienced a 15% drop in occupancy and only 5% drop in rate, one would like to think that the occupancy numbers would come back quicker and rate tends to follow."
  • "Booking windows in Brazil have been very short.  Copacabana Palace is sitting 16% up on rooms booked at the moment, but that is a small proportion of the overall number of rooms that they would book for the year.  On the other hand, the Peruvian hotels tend to be booked sort of eight, nine months on average in advance and they are sitting mainly because of the closure of the train line at the moment; they are sitting between 10 and 15% down.
  • Lender refinancing to credit facility: " The tone is very good.  Clearly, the pricing is going to be difference to the current pricing which is I think 70 – 90 basis points on that facility.  A year ago, it was going to be, if we’d done it a year ago, [inaudible] we would have been easily over 300 basis points, but I still feel today we can achieve something in mid-200s."
  • Portfolio customer breakout: "It’s about 40% North America, 40% Europe, and 20% Rest of the World, and it’s quite interesting when you look at the spend per capita. I was in Russia recently and at the top of the league table were the Russians, lined number two were the Americans, UK was number three. We came to see that in the domestic market, the domestic customer is the higher spender followed by Americans."

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