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US STRATEGY – DELEVERAGING

The S&P 500 finished lower on Monday after a late afternoon collapse, which coincided with the release of the consumer credit data.  After showing a glimmer of hope last month, the most recent data continued to show a sharp contraction in credit.   Revolving consumer credit (card debt) declined in April at a rate consistent with the fastest rates we've seen since the start of the crisis. On balance, this is a negative for the Financials (XLF), though a net positive for the balance sheet of the American consumer.  The flight to safety continues as the only sector that ended the in positive territory was the Utilities (XLU - up 0.6%).  

 

There was more evidence of the safety trade with Treasuries stronger yesterday and the Dollar Index closed up 0.19%.   The Hedgeye Risk Management models have the following levels for the USD – Buy Trade (87.14) and Sell Trade (88.51).  The VIX rose another 3% yesterday on back of a 20% up move last Friday.  The Hedgeye Risk Management models have the following levels for the VIX – Buy Trade (33.18) and Sell Trade (38.52).

 

The EURO has now declined for the past six days, trading down 0.12% yesterday.  The Hedgeye Risk Management models have the following levels for the EURO – Buy Trade (1.19) and Sell Trade (1.22).  The European MACRO data points focused on the Hungarian government, as it tried to play down previous comparisons to Greece and committing to meeting deficit targets.  The most recent comments were more about politics than a different assessment of the countries financials.  Hungarian CDS have come off recent highs, but remain elevated. 

 

There was some positive news out of Europe as a better than expected April Factory Orders was reported in Germany up 2.8% month-to-month vs. consensus (0.4%).  Greece continues to struggle as the market declined 5.45% to a 12-yr low (in early trading today the market is up 1%).  The UK market is currently trading down 1.2% as Fitch Ratings said that “the scale of the U.K.'s fiscal challenge is formidable and warrants a strong medium term consolidation strategy.”

 

The second best performing sector yesterday was Healthcare (XLV).   Bristol-Myers Squibb (BMY) rose 6.3% (the most of any company in the S&P 500 yesterday) after positive drug data showed two of its cancer drugs (ipilimumab and sprycell) could change the standard of care for patients with deadly skin and blood malignancies. 

 

The Industrials (XLI) has now been the worst performing sector for the past two days.  Yesterday, machinery names were weaker – DE down 3.7%, CAT down 3.3% and CNH down 4.2%.  Airlines, rails and shipping were also weaker - FDX and UPS declined 3.6% and 3.5%, respectively. 

 

Rounding out the bottom three performing sectors were Financials (XLF) and Consumer Discretionary (XLY) - the XLY is now the only sector positive for the year-to-date.  Both groups were negatively impacted by the continued decline in consumer credit trends.  Homebuilders and related equities were under considerable pressure, down 4.3% and 13.6% over the past week.  The much anticipated introduction of the new iPhone was not enough to lift AAPL and GOOG is facing an investigation by CT AG Blumenthal regarding data collection and privacy concerns.

 

In early trading, crude reversed a gain of as much as 1% as European stock markets are declining.  According to a Bloomberg, U.S. oil supplies probably dropped by 1 million barrels last week.  The Hedgeye Risk Management models have the following levels for OIL – Buy Trade (69.03) and Sell Trade (75.31).

 

In early trading, copper is trading down for the seventh day in a row.  The Hedgeye Risk Management Quant models have the following levels for COPPER – Buy Trade (2.75) and Sell Trade (3.03). 

 

The Hedgeye Risk Management models have the following levels for GOLD – Buy Trade (1,217) and Sell Trade (1,248).   

 

As we look at today’s set up for the S&P 500, the range is 36 points or 0.6% (1,044) downside and 2.8% (1,080) upside.  Equity futures are trading mixed to fair value in the wake of yesterdays late day slide.  The MACO calendar is light again today.    

 

Howard Penney

 

US STRATEGY – DELEVERAGING - S P

 

US STRATEGY – DELEVERAGING - DOLLAR

 

US STRATEGY – DELEVERAGING - VIX

 

US STRATEGY – DELEVERAGING - OIL

 

US STRATEGY – DELEVERAGING - GOLD

 

US STRATEGY – DELEVERAGING - COPPER



COLUMBUS WILL DISCOVER THE AMERICAN CASINO

The more work we do on PENN’s Ohio opportunity, the higher our estimates go. Net return – even after Cincinnati’s impact on Lawrenceburg – will be very strong, at a minimum.

 

 

Even if Columbus’s 1.5 million adults spend less than the lowest comparable existing gaming market per capita, PENN’s casino will blow our $191 million EBITDA estimate out of the water over time.  Although it won’t be out of the water since Columbus will be land-based and not a riverboat casino like most of the rest of the Midwestern casinos.  Our estimate for Toledo EBITDA of $60 million may also prove low, again given the performance of comparable markets.

 

We analyzed the most comparable markets of Columbus and Toledo: Cincinnati, Kansas City, St. Louis, and Omaha (Council Bluffs). Those are all Midwestern markets with fairly similar income demographics.  Chicago was excluded since there is a gaming position cap which distorts the data.  The following chart shows annual gaming revenue per capita (adult) for each of the markets.

 

COLUMBUS WILL DISCOVER THE AMERICAN CASINO - metro1

 

Omaha/Council Bluffs generates the highest spend per capita and Cincinnati the least.  It is somewhat encouraging for PENN's Lawrenceburg property that Cincinnati seems to be under-penetrated.  Lawrenceburg will be competing with a new Cincinnati casino across the river in Ohio in late 2012.  In terms of median household income, Columbus falls right in the middle of the pack – a little above Kansas City – while Toledo would be the lowest.  The following chart projects gaming revenue for Columbus and Toledo based on the high, low, and average per capita gaming spend of the other markets. 

 

COLUMBUS WILL DISCOVER THE AMERICAN CASINO - metro2

 

What’s pretty clear is that our gaming revenue estimate for Columbus could potentially be very low over time, while Toledo looks reasonable.  More importantly, EBITDA could be off the charts for Columbus relative to our estimate of $191 million using the gaming revenue figures from the previous chart as shown below.  We’ve also added in estimated lost profits from the opening of a competing Cincinnati casino across the river from Lawrenceburg.

 

COLUMBUS WILL DISCOVER THE AMERICAN CASINO - metro3

 

According to the math, Columbus has the capability to generate nearly $500 million in EBITDA.  However, we don’t want to mislead anyone into thinking that is within the realm of near-term possibility.  If Columbus ended up generating that level of revenue per adult (unlikely), it would take years to fully penetrate the market.  But significant potential remains.  Despite opening up with 3,000 slots and 100 tables, PENN can legally expand to 5,000 slots and an unlimited number of tables.  We think this market will support a 60%+ increase in both.  $400-500 million is certainly a stretch but our current EBITDA estimate falls almost 20% below even the lowest estimate derived from per adult capita spend of $439 (Cincinnati).

 

In our opinion, the returns on Ohio promise to be excellent and are not reflected in the stock price.  If PENN’s Ohio casinos can attain only a Cincinnati type market penetration, ROI on the combined $700 million investment would be a whopping 37%.  That ROI is a net number that reflects the Lawrenceburg EBITDA decline following the opening of a competing casino in Cincinnati - a 26% drop per our model.  If Columbus can reach the average Midwestern market penetration or higher, the returns will be through the ceiling:  50-83% by our math at maturity.

 

So what would limit the Columbus returns and why is our estimate below the low projection for market penetration?  For one, it will take some time for PENN to fully penetrate the market.  Our Columbus estimate is probably a reasonable start but years of same store EBITDA gains should ensue.  The property would need to expand its slot and table base from the initial 3,000 and 100, respectively.  However, there is another reason to believe our estimates will prove very low.  Our operating expense levels are much higher than PENN’s other properties.  For instance, Lawrenceburg has more slots and tables, yet our projected Columbus expenses are 33% higher.

 

We generally see only upside to our current Ohio estimates for PENN.  Even with conservative estimates in place, our current 2013 EPS projection contemplates 26% CAGR growth.


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Bearish Enough? SP500 Risk Management Levels, Refreshed...

The bullish news here is time – with time, consensus changes…

 

I still don’t think consensus is Bearish Enough yet… but with lower-lows, that will come…

 

At 1062 in the SP500, we’re testing the lowest-lows we’ve seen since the cycle top that was registered on April 23rd. It’s been an expedited correction of -12.7% from the cycle’s peak, and now risk managers around the world are asking themselves the right question – can we crash? Using a peak-to-trough decline of 20% as a definition for crash, Greece, Spain, Slovakia, China, and Italy have already crashed so far in 2010.

 

Our April Flowers/May Showers call wasn’t for a cycle peak-to-trough crash of 20% in US Equities, but the probability of such a move obviously mounts as prices go lower. As they say in probability-speak, a 20% crash in US Equities should no longer be considered improbable within the distribution of probable outcomes.

 

Since I have now used the word “crash” 5 times (actually now that makes 6), this means we are at least testing the bounds of my being Too Bearish here. That said, provided that the SP500 closes below the long term TAIL line of support (1078), this market is in what our Hedgeyes call a Bearish Formation (bearish across all 3 core investment durations - TRADE, TREND, and TAIL) with our immediate and intermediate term TRADE and TREND lines of resistance at 1082 an d 1144, respectively.

 

As of 2PM EST, my immediate term downside support is now 1050. Importantly, that should be considered not only probable but a line that is below the prior closing YTD low established on February 8th of 1057.

 

If we see lower-lows, we’ll acknowledge that this market is becoming Bearish Enough.

KM

 

Keith R. McCullough
Chief Executive Officer

 

Bearish Enough? SP500 Risk Management Levels, Refreshed...  - S P


EAT - WHEN THE GOING GETS TOUGH

Which companies are toughening up in this macro environment?

 

The most bearish data point for the restaurant industry came with Friday’s jobs report.  Private payrolls added for the month of May was reported at an anemic 41,000 – the first marginal deceleration since December of 2009.  There are a number of factors that drive incremental trends in eating out but, in the current environment, jobs take center stage.  The biggest benefit to current top-line trends will be having more consumers collecting a paycheck.

 

As you can see for the chart below, the casual dining industry is right to be focused on the employment trends.  The Knapp figures correlate strongly with employment growth – more strongly, in fact, than retail sales figures do.

 

EAT - WHEN THE GOING GETS TOUGH - sales

 

Right now it appears there are two key consensus calls in the restaurant sector.  The first is that MCD will continue to dominate the QSR space.  Second, Bar & Grill is an uncompetitive concept and will not be able to take share.

 

MCD is a power house and the absolute trends are very impressive.  But it looks like expectations are ahead of current trends.  The beverage initiative is an important initiative for the company and driving some improvement is current trends.  Longer term it complicates operations and will not be a long-term driver of traffic.  In May, two-year trends have slowed for MCD around the world.  Lastly, GMCR is trading on rumors that MCD is going to buy them.  I will say categorically, MCD will never purchase GMCR. 

 

As for the Bar & Grille space, the negative sentiments can be summed up in two thoughts.  (1) High-end brands will take significant market share from mass-market brands and (2) Convenience-based brands are more likely to see sales lag in a recovery than destination-oriented brands. 

 

It’s a very difficult and often a losing proposition to pigeon-hole a certain company/brand/stock in a certain classification.  In the early stages of the improving top line trends, the consumers with money went to places where they feel comfortable with the food and the service.  Over the next 12-month the MACRO environment will be very challenging. 

 

I continue to believe that it’s important to focus on those companies that are being proactive and changing the variable cost structure.  Those that can create leaner, meaner cost structures will be better positioned to mitigate any margin erosion. 

 

EAT is one name that is pursuing a proactive strategy and remains a core focus name.

 

Howard Penney

Managing Director


Charting the Euro . . . Time For A Bounce?

Conclusion: A theme we will be discussing more and more is the sovereign debt issues in the U.S., which could lead to a bounce of the Euro versus the U.S. dollar.

 

If there has been one global macro trend that has remained consistently intact in the year-to-date, it is the decline of the Euro.  Since its short term peak in December of 2009 at ~$1.50, the trajectory has been basically straight down.

 

The decline in the Euro seems to be accelerated by new headlines every day, which continue to support the longer term structural impediments facing the Eurozone.  Specifically, as we recently wrote: 

  1. Interconnectedness - It should come as no surprise that the eurozone has willfully ignored its own rule-making. European economies are too interconnected to permit anything else. Most nations within Europe borrow from, and lend to, each other: Spain holds one-third of Portugal's debt; Spain owes Germany $238 billion; Italy owes France more than twice that. So while the Maastricht Treaty requires the eurozone to direct Greece to restructure its debt, most major banks within the eurozone are holders of Greek debt and would distinctly feel the pain of any Greek debt restructuring. 
  2. Lack of Political Consensus - The sovereign debt crisis has exposed the ineffectiveness of a one-size-fits-all monetary policy for a continent with significantly disparate economies. Spain shapes its monetary policy to combat its 20% unemployment; Germany's works to keep its economy from overheating. The absence of a stronger political union to manage the divergent economic goals of the member nations destines the Maastricht Treaty to regular flouting by its members. 

So, while the Euro remains in a bearish formation, we are starting to consider trading off the immediate term oversold readings on the long side, then sell high/buy low on the short side on rallies to $1.22-$1.25 from $1.19-$1.20.

The key catalyst for a rally in the Euro versus the U.S. dollar, will be the US facing a European-like sovereign debt crisis in 6 months.  While arguably the U.S. doesn’t have the structural issues outlined above, the U.S. does indeed have major fiscal issues with its defict-as-a-percentage-of-GDP in the danger zone of north of 10% and gross-public-debt-as-a-percentage-of-GDP north of 90%. With debt maturities accelerating in the U.S. over the next couple of quarters, the number one reason to buy Euro is being bearish on USD, not being bullish on the Euro in absolute, due to these coming maturity catalysts.

 

Keith McCullough

Chief Executive Officer

 

Daryl G. Jones

Managing Director

 

Charting the Euro . . . Time For A Bounce? - Euro


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