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US STRATEGY – JOBS, JOBS, JOBS

The S&P 500 finished at the low of the day on Friday, after opening sharply lower on the pre-market release of May nonfarm employment data.  The Industrials (XLI), Financials (XLF) and Materials (XLB) were among the worst performers, as the lower beta sectors outperformed. 

 

On Friday, the May nonfarm payrolls reported 431,000 vs. consensus 536,000 – a huge disappointment.  In a post on 6/2 (“Friday’s Jobs Report - Great Expectations”), we noted the spread between what the economists were saying and what reality turned out to be since 2008 and 2009, when nobody saw the recession coming.  Temporary census workers reflected 411,000 of the gain, perhaps the key concern in the figure; April payrolls were unrevised from 290k. The unemployment rate dropped to 9.7% vs. consensus 9.8%, and prior month 9.9%.

 

The DXY rallied 1.3% on Friday and the Risk Management models have the following levels for the USD – Buy Trade (86.90) and Sell Trade (88.29).  The VIX rose 20% on Friday and 10% last week.  The Hedgeye Risk Management models have the following levels for the VIX – Buy Trade (30.77) and Sell Trade (39.29).

 

Comments made by a spokesman for Hungarian PM Orban served to increase fears of contagion in the Eurozone on Friday and only added to Thursday’s talk of a Greek-style scenario unfolding in Hungary. The CDS spread on government debt widened significantly, and the forint traded lower on Friday. The Euro also fell sharply, and broke thru a key quantitative level of $1.21, as European markets closed lower on the day.  The Hedgeye Risk Management models have the following levels for the EURO – Buy Trade (1.19) and Sell Trade (1.22).

 

The Industrial sector (XLI) was the worst performing sector on Friday, declining 4.7%.  Concerns over the jobs release and the pace of the economic recovery put pressure on the RECOVERY trade.  The transports index declined 4.84%; the S&P Railroads index declined 5.54%; the Airlines index declined 4.68%.

 

Energy (XLE) and Materials (XLB) rounded out the bottom three performing sectors.  The XLB was led by the S&P Steel index declined 5.95%.  The sector came under pressure following price cuts at Chinese steelmaker Baosteel.   The XLE declined with the market amid continuing uncertainty around the ongoing situation in the Gulf of Mexico and the pace of economic recovery.

 

On Friday, the CRB declined 2.5% and finished down 2.4% for the week.  The Hedgeye Risk Management models have the following levels for OIL – Buy Trade (68.55) and Sell Trade (72.39).

 

On a relative basis, Consumer Staples (XLP) and Healthcare (XLV) were the two best performing sectors on Friday.  Last Friday, UNH and WLP outperformed following a NYT article summarizing the evolving relationship between insurers and the Obama administration. 

 

The Hedgeye Risk Management Quant models have the following levels for COPPER – Buy Trade (2.76) and Sell Trade (3.03). 

 

The Hedgeye Risk Management models have the following levels for GOLD – Buy Trade (1,203) and Sell Trade (1,232).   

 

As we look at today’s set up for the S&P 500, the range is 29 points or 1.1% (1,053) downside and 1.6% (1,082) upside.  Equity futures are trading mixed to fair value in the wake of Friday's more than 3% drop.  Weekend news flow was light and there are no major economic or corporate releases due out today. 

 

Howard Penney

 

US STRATEGY – JOBS, JOBS, JOBS - S P

 

US STRATEGY – JOBS, JOBS, JOBS - DOLLAR

 

US STRATEGY – JOBS, JOBS, JOBS - VIX

 

US STRATEGY – JOBS, JOBS, JOBS - OIL

 

US STRATEGY – JOBS, JOBS, JOBS - GOLD

 

US STRATEGY – JOBS, JOBS, JOBS - COPPER


PENN: WHY SO CHEAP?

PENN isn’t the cheapest stock we’ve ever seen but on a relative basis, the valuation doesn’t seem to make much sense. So what’s the explanation?

 

 

In an era when debt is considered a liability (no pun intended), one would think that PENN’s low leverage would be rewarded.  Looking at its EV/EBITDA multiple, it is clearly not.  PENN trades at under 7x 2011 EBITDA, slightly below the peer group average.  We’ve seen regional gaming stocks trade down to 6x EBITDA, so there is precedent for downside.  However, EBITDA is depressed and PENN’s story is much more compelling than the stocks we’ve seen trade at 6x.  Moreover, compared with other regional gaming operators, PENN maintains much more positive investment attributes:

  • Best management among the regionals and maybe all of gaming – history and commitment to ROI
  • Best balance sheet among all operators
  • More growth – more development opportunities
  • Self-funded growth – leverage stays around 2x during the construction phase of Columbus, Toledo, and Cecil County
  • Growth mostly in new markets – much higher ROI than building in an existing market

So what gives?  I guess PENN is not the most exciting story over the near term but neither are any of the other regionals.  Unless you are expecting a sharp recovery in regional gaming revenue which would benefit the earnings of highly leveraged companies disproportionately.  In this uncertain environment, investors seem afraid of capital driven growth and the perception is that PENN will be levering up to drive investments in risky projects.  Other than PNK and its Baton Rouge project, PENN is the only company investing in new casinos.  There is also acquisition risk.  PENN maintains a ton of liquidity to buy assets or companies and, again, investors may not want to see capital put at risk. 

  • Growth fueled by investment spend - people may want to play recovery growth
  • Exposure to additional supply – Lawrenceburg will be hit hard by a new casino in Cincinnati but the net Columbus/Toledo/Lawrenceburg should still be high ROI
  • Acquisition risk

We recognize PENN isn’t the most non-consensus call on the sell side.  Most analysts have buy ratings.  However, even a broken clock is right twice a day.  Downside appears limited – numbers look better than they did when the stock fell through $23 – and we think the sell side may have this one right.


The Week Ahead

The Economic Data calendar for the week of the 7th of May through the 11th is full of critical releases and events.  Attached below is a snapshot of some (though far from all) of the headline numbers that we will be focused on.

 

The Week Ahead - c1

The Week Ahead - c2


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PSS: CompBusters

PSS: CompBusters

 

You ever see ‘MythBusters’ on Discovery Channel? We dug into the facts surrounding PSS comps, and think that the myth of management overstating its comp exposure to weak parts of the country is Busted.

 

We’ve had several requests since PSS conference call about clarity on comp store sales, and whether management overstated a) PSS’ exposure to California and the Southwest, and b) the relative weakness in those particular states. Several companies noted yesterday with same-store-sales results that the Northeast, Midwest, and Southeast were the strongest regions. Furthermore, we plugged the lats and longs of all of the Payless US stores into our mapping software, and it spit out the results below. You ever see that show ‘MythBusters’ on Discovery? It’s the one where they test myths, movie stunts and legends to see if they are plausible according to the laws of physics. Well…we can pretty safely say that the myth of management overstating its exposure in states that were particularly weak in the quarter is officially ‘Busted.’

 

PSS: CompBusters - PSS Store Dist 6 10

 


MCD MAY SALES PREVIEW

Topline trend will be difficult to sustain.

 

McDonald’s is expected to report its May sales numbers before the market open on Tuesday.  On a year-over-year basis, May 2010 has one less Friday, and one additional Monday, than May 2009.  

 

Today McDonald’s announced that it is recalling the “Shrek Forever After 3D” collectable drinking glasses due to potential cadmium risk; the impact will be felt in the June 2010 sales data. 

 

Getting past top line trends and looking at cost trends in 2Q10, the focus will be on commodity prices.  On the margin, the biggest benefit the company has seen from lower commodity prices is behind them.  In 1Q10, MCD’s basket of goods in the U.S. decreased 5% (this compares to the 6.7% increase in first quarter 2009). For the full year 2010, the outlook in is for costs to be down 2-3%.

 

Below, I am providing my view on comparable sales ranges for each of MCD’s geographic segments as indicators of what I would rate as GOOD, NEUTRAL, or BAD results based largely on 2-year average trends.

 

 

U.S. (facing a 2.8% compare, including a calendar shift which impacted results by -0.4% to 1.4%, varying by area of the world):

 

GOOD:  Any result greater than approximately 5.5% would be perceived as a good result because it would imply that the company was able maintain U.S. 2-year average same-store sales only slightly below those of March and April but considerably above the lower levels of the preceding months.  While usually I look for 2-year average trends to be maintained or surpassed for a “GOOD” result that would demand a print of 7% for May.  In light of the current unemployment picture, and given that a 7%+ print has not been attained since February ’08, I am looking for levels clearly above the 2%-3% region that MCD’s U.S. same-store sales languished in – on a 2-year average basis – from August ’09 through February ’10. Last month’s number resulted in a 2-year average trend of 5%, which equaled that of March, the best 2-year number since February 2009.  In order for May’s number to imply a 2-year average trend that sustains the divergence from August-February’s slump, a 5.5% print will be needed. 

 

NEUTRAL:  Roughly 4.5% to 5.5% implies 2-year average trends that are not reverting to the pre-March slump, but are still below those seen in March/April.

 

BAD:  Any comparable store sales number below 4.5% would imply a significant sequential slowing from the 2-year average numbers of March and April and would also indicate business trends declining towards the level seen during the difficult months at the end of 2009 and beginning of 2010. This would be a meaningful disappointment and would likely be received negatively by investors.

 

 

Europe (facing a 7.6% compare, including a calendar shift which impacted results by -0.4% to 1.4%, varying by area of the world):

 

GOOD:  Above +6% would signal a 2-year average trend equal to that seen in April; this would solidify the significant sequential jump in 2-year average sales numbers seen from March to April.  For Europe I am maintaining the usual standard because 6% comparable store sales results have occurred as recently as March 2010.

 

NEUTRAL: +5% to +6% would signal that 2-year trends are slightly below April levels but still above the +6%.  

 

BAD:  Below +5% would indicate that trends have sequentially deteriorated from April levels. 

 

 

APMEA (facing a 6.4% compare, including a calendar shift which impacted results by -0.4% to 1.4%, varying by area of the world):

 

GOOD: Better than 5.0% would signal that 2-year average trends have improved sequentially from last month’s rebound from the dip seen in March (adjusting for the calendar impact).  This would instill further confidence that March was an anomaly and that the strong performance seen at the start of the year is sustainable.

 

NEUTRAL:  Roughly 3% to 5% would indicate that 2 year-trends were level on a sequential basis from April.

 

BAD: Below 3% would imply 2-year average trends that have slowed further from the level seen in April.  Below 1% would point to trends in line with the trough 2-year average trends indicated in December.

 

 

Howard Penney

Managing Director

 

 

 


An Employment Gong Show

Conclusion: Employment “growth” is anemic and looks weak going forward, which will be a negative catalyst for equities.

 

Today’s underwhelming Employment report was no doubt made worse by Goldman Sachs Chief Economist Jan Hatzius’ lofty forecast of +600,000 payrolls for the month of May (a +100,000 increase from his previous estimate). While being “a little low on the census contribution” was his chief reason for upping his forecast far above the median consensus estimate of a 536,000 gain, our Hedgeye estimate was that he (and consensus) was “a little too high” on the private contribution. Jan’s estimate was for an incremental 150,000 private payrolls to be added in May vs. 180,000 consensus.

 

Private payrolls added for the month of May was reported at an anemic 41,000 – first marginal deceleration since December of 2009. After a 9% drop in the S&P throughout the month, and a near 11% drop from the highs of April to the end of May, it was proactively predictable that the rate of job growth would slow on the margin. For clarification, the S&P 500 and Net Private Payrolls have a 0.72 positive correlation over the last three years. That’s an r-squared of 0.53, which suggests some level of statistical significance.

 

Interestingly, if we normalize for the birth-death adjustment, which we admit is the fodder of conspiracy theorists, and exclude the 215,000 birth-death adjustment, the economy actually lost 226,000 jobs.  Even if you aren’t willing to accept that dire of a claim, those unemployed longer than 27 weeks hit a new record coincident with this report at 46%.  The likelihood that people just give up hope and drop out of the workforce increases every week with that statistic.

 

We shorted the QQQs into the close yesterday based on the view that this payroll number was going to be worse than expected.  While Hatzuis’ took the shot, and we admire him for that at least, by inflating the whisper consensus number, he actually increased the probability that we would be right on our short call and that payroll additions would be worse than expected by implicitly increasing consensus expectations.

 

While consensus hiring is boosting over all payroll additions and, temporarily, decreasing the unemployment rate, this payroll report should be framed for exactly what it is . . . a disaster.  As we’ve highlighted in the chart below, this is a sequential decline in the addition of private sector jobs and highlights two critical points: a) this is a jobless recovery at best and b) the stimulus package has failed to stimulate any real sustainable jobs additions. 

 

With the stimulus behind us and census hiring also primarily in the rear view mirror, it is likely that the payroll additions will continue to be anemic, and that the actual unemployment rate ticks back up.  And that, as they say, is not good.

 

Daryl G. Jones

Managing Director

 

Darius Dale

Analyst

 

An Employment Gong Show - US Net Payroll Addtions


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