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Over the near term, the prospects for a recovery in replacement demand are likely to drive IGT’s stock. The sustainability of IGT’s still high participation share remains a longer term risk.



Take a look at the charts below.  IGT’s slot ship share has been around the historically low (at least since the 80s) 30% for the last few quarters including 29% in the March quarter.  IGT’s market share of high margin participation units was almost twice its ship share at 51%. 




As we showed in our WMS Black Book (released in April), IGT’s market share of gaming operations revenue has been on a steady decline but can still fall significantly further.  If participation share declines to ship share levels tomorrow, it would mean $350-400 million in lost revenues.  Of course, we are not projecting this in short fashion, but over time, IGT is unlikely to participate in this segment's growth and will likely see declining revenues over the long-term. 


The other overlooked aspect of its gaming operations segment remains the over-reliance on the Wheel of Fortune line of products.  As we wrote about in our 11/27/09 post, “HOW LONG WILL THE WHEEL KEEP TURNING”, the “Wheel” generates almost 50% of the company’s profits.  Last year’s patent invalidation opened the playing field and created one more hurdle for IGT in this segment.


The current outlook on summer job opportunities for teenagers does not bode well for QSR demand.


The 16-19 year old age group is an extremely important demographic for QSR operators and the increasing rate of unemployment among this age group since 2Q08 has taken its toll on QSR demand.  Restaurant management teams across the industry have cited higher unemployment as the primary cause of weaker demand, but QSR operators have been more vocal about how the even higher rate of unemployment among its younger, core users has hurt trends. 


Specifically, JACK management stated on its fiscal 4Q09 (period ending September 27, 2009) earnings call, “In addition, unemployment rates for our core customer demographic which skews towards young males and Hispanics are substantially higher than the overall rates.  According to the Department of Labor, on a seasonally adjusted basis, 16 to 24 year olds had a very rough summer in 2009, with fewer than 50% working.”   Judging by the significant year-over-year decrease in the number of jobs added for 16-19 year olds in May 2010, as reported by the Bureau of Labor Statistics, this summer could prove even more difficult. 


In May, employment among 16 to 19 year olds grew by only 6,000 sequentially from April relative to the 110,000 increase in May 2009 and the 116,000 increase in May 2008.  As the chart below shows, the magnitude of jobs added typically increases in June and July from May levels so it will be important to watch how the rest of the summer plays out to get a better read on the current teen employment picture, but May points to a rough start and could put increased pressure on 2Q and 3Q QSR sales trends.


QSR INDUSTRY – TEEN UNEMPLOYMENT - 16.19 summer employment growth


QSR INDUSTRY – TEEN UNEMPLOYMENT - 16.19 may employment growth


QSR INDUSTRY – TEEN UNEMPLOYMENT - 16.19 unemployment rate


Howard Penney

Managing Director


The Street tends to be way off on its Macau estimates for a variety of reasons. Direct play is an important missing variable in their models.



Direct play is better than junket play.  That is a fact for the Macau operator.  If Wynn Macau/Encore could convert the 85% of its VIP business that is junket-related to direct play, it would result in an incremental $280-325 million in EBITDA.  Obviously, if it was that easy, a smart guy like Steve Wynn would’ve already done that.  The point is there is a lot of margin out there to capture given the 0.4% to 0.5% spread between the junket commission rate and the direct player rebate.


With the opening of the predominately direct play Encore, Wynn is poised to grow its direct play business from 10% to 13%.  That number should grow over time as should Wynn’s margins.  Wynn still falls behind LVS in terms of direct play market share but directionally, Wynn (thanks to Encore) and MPEL are moving higher while LVS’s share is declining.  LVS share should ramp back up when Lots 5 and 6 finally open.  The following chart details direct play market share by company.




To look from a different perspective, we also track the amount of direct play volume as a percentage of total Rolling Chips (VIP volume).  LVS remains the market leader here but MPEL and Wynn look like they have the most to grow.




Direct play is an important factor in determining margins in Macau which is why the Street seems to be consistently off in projecting EBITDA.  Other important details that some on the Street fail to model separately are Mass vs VIP, both volume and hold, and junket commission rates.

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Liquidity in the Eurozone . . . Fugly

Conclusion: Liquidity continues to weaken in European debt and loan markets, and Asia and the U.S. are starting to correlate.


As a leading indicator for equity markets, credit markets globally cotinue to flash warning signs.   Rates are increasing and spreads are widening as markets proactively adjust to the new reality of credit worthiness in the interconnected global market place.


In the chart below, we’ve highlighted Eurozone liquidity which is measured by recourse to the ECB over night deposit facility.  In effect, banks are basically warehousing every Euro bill they can find, rather than lending in Euros. And this is occuring at pace not seen late 2008.  


Coincident with this is Euro Libor continuing to widen, currently at a 2010 high of 0.65%.  This means one thing: liquidity is getting worse, not better.  Despite what the Fiat Fools (politicians) might be saying.


Also related to Eurozone liquidity is this excerpt form the newswires in reference to Spanish Banks:


“Elsewhere in the Spanish financial sector, newspaper Cinco Dias is reporting that second tier Spanish banks are being frozen out of the European interbank market and that only the largest institutions are managing to finance their operations smoothly, adding that the situation has worsened since the start of the week.”


While liquidity issues are clearly most prevalent in the Eurozone, they have natural derivative effects.  The most obvious is a decline of purchasing power, and thus slowing import demand. (Note: 1/3 of U.S. exports go the Eurozone.)  This will obviously lead to slower growth in the U.S. on the margin, but also slower growth in Asia.  Since loans and investments in Asia, specifically China, are predicated on high projected growth rates, a European credit crunch potentially has very negative impacts on Asian banks, and their growth based economies.


In fact, we are already starting to see Asian Sovereign Debt spreads widen dramatically, even if not at Eurozone levels.  Chinese CDS spreads have almost doubled in the last 30 days. 


In the U.S., one of the best proxies for short term liquidity is the commercial paper market.  The current 7 day commercial paper market in the U.S. hit levels of 0.61%, which are the highest levels since the equity market sell off in March 2009.  There is an estimated $670 billion of commercial paper maturing over the next couple of months, which will be reset at these higher rates.  The chart of 7 day commercial paper is outlined below.


The world is interconnected, and to believe that the issues in Europe are isolated would be naïve at best – which is exactly what the credit markets are telling us.


Daryl G. Jones

Managing Director


Liquidity in the Eurozone  . . . Fugly - ECB Liquidity


Liquidity in the Eurozone  . . . Fugly - 7 day

R3: 6/9 -- UK, check. Canada, check. US, check.


June 9, 2010


Positive sales reports out of JD Sports in the UK, Forzani in Canada, and another week of acceleration of sales in the US are all notable – especially given that World Cup is still an inventory event for retail rather than a sales event. In other words, World Cup sell-through is yet to occur. Good for our calls on FL, UA and NKE. Other boats will rise. 





Positive sales reports out of JD Sports in the UK, Forzani in Canada, and another week of acceleration of sales in the US are all notable – especially given that World Cup is still an inventory event for retail rather than a sales event. In other words, World Cup sell-through is yet to occur. Good for our calls on FL, UA and NKE. Other boats will rise.


US sales accelerated for the 3rd straight week, with particular strength in the athletic specialty channel. We don’t particularly trust the absolute results from this sample (Sportscan), but we view it as a consistently flawed sample. In other words, things continue to get better directionally.


R3: 6/9 --  UK, check. Canada, check. US, check.  - 1


R3: 6/9 --  UK, check. Canada, check. US, check.  - 2





- When asked about whether ROST has cut inventories too far (they’re down about 33% since ’07 per store), management suggested quite the opposite. The company intends to continue cutting inventory until it begins to impact sales, which it is currently not doing. Unfortunately, this strategy suggests that sales at some point will be negatively impacted before any changes are made to stabilize overall inventory levels. We can’t imagine how that top-line impact, and subsequent leverage to EBIT, will be a positive event for the stock. Overall, it smells like rather lackluster risk management.


- One of DG’s key initiatives is to roll out back-office computers which will facilitate the transfer advertising information to the stores, transmit shelf labels, download training programs and perform pre-employment screening. Prior to this rollout, these tasks were manual and paper based. Welcome to 2010.


- Neiman Marcus noted that the rebound in New York City was particularly noteworthy over the past few months. Bergdorf Goodman reported a 25% increase in sales for the quarter. In fact management noted, “it’s amazing how much it bounced back”. It still remains to be seen how sustainable this NYC revival will last, especially with Euro impacted tourism on the decline and increased financial market volatility.





Brown Shoe Continues International Expansion with Parternships in Russia and Ukraine - Brown Shoe Co. announced Tuesday a partnership with MTB Group Ltd. to offer the Naturalizer brand in Russia and the Ukraine. The deal allows MTB’s affiliate, Monarch Group, to wholesale the label and sell it in its 80 Monarch retail stores by late August. Additional standalone Naturalizer shops are planned for 2011. Brown Shoe also recently disclosed expansion plans for Naturalizer in the U.K., Germany, Korea and Morocco. <wwd.com/footwear-news>

Hedgeye Retail’s Take: Newsflash: DO NOT confuse MTB Group for MBT, which is the originator of the toning shoe back in the late 1990s (no, Skechers did not create the product, it just knocked it off!).  As far as this move by Brown Shoe, it’s a push to broaden exposure to Eastern Europe. Probably not a bad idea because 1) it’s not a great brand here – maybe it actually works there (I say that tongue-in-cheek), and 2) this is actually not a bad time for US companies to be investing capital in Europe.


Forzani Crushing it in Canada: The Forzani Group Ltd. reported sales rose 6.8% due to comp increase of 9.8% offset by a 5% decline in wholesale. Strategic initiatives, strong market share and seasonal weather all contributed to improved same store sales, margin and operating cost in the Q1. Strategic initiatives: FGL's plan to increase its golf, fitness and cycling businesses within Sport Chek delivered a combined 27% same-store sales increase in the quarter in those categories. Seasonal weather: seasonable weather through much of the quarter positively impacted sales of all spring categories, most notably outerwear, athletic clothing, footwear and hockey equipment. The 2010 Vancouver Olympics spurred sales of licensed apparel, in particular Team Canada hockey jerseys. Gross margin grew 240 bps due to gains in the corporate retail business which has higher margins and improvements in age and mix of inventory to avoid significant discounting. Results in the four weeks of the fiscal 2011 second quarter continued to show improvement over the prior year, despite somewhat unseasonable weather in Western Canada. On a same-store category basis, the increase was led by athletic clothing, footwear and fitness equipment. <sportsonesource.com/news>

Hedgeye Retail’s Take: Long live the Olympics! (Let’s hope so, because Canadians generally could care less about World Cup).


New Balance Pushes Apparel with Signing of Pitcher Johan Santana - New Balance announced the signing of All-Star and award-winning pitcher, Johan Santana, to a multi-year endorsement contract. New Balance will be Santana s official on-field footwear and on and off-field athletic apparel provider . <sportsonesource.com>

Hedgeye Retail’s Take: This is actually more meaningful than it might seem. I could care less about whether this is Johan Santana or Johan Sebastian. One person does not matter. But a new initiative in a new category for a company that has been pigeonholed as a stodgy old running company makes sense. Also, it suggests to me that New Balance will not need to solely defend its running presence as Under Armour pushes harder into the category. On the margin I think this takes a little pressure off of KSWS as New Balance’s R&D/marketing budget shifts elsewhere on the margin.


UK Sport Retailer JD Sports Fashion Reports Improving Sales - JD Sports Fashion has reported improved trading in the UK and Republic of Ireland with like-for-like retail sales up 4.1% for the eighteen weeks to June 5. <drapersonline.com>

Hedgeye Retail’s Take: Yet another sign that the athletic space tends to have a mind of its own relative to the rest of retail. We could have the best economy in the world, and this space could be in the tank – and vice versa. Note that World Cup has been more of an inventory event for retail so far – not a sales event. Yes, this is bullish.


Juicy Couture and Social Media - Kate Foster, VP of global marketing and communications at Juicy Couture, explained the brand’s devotees tend toward the fanatic, a trait the company has leveraged in its social media program. “Social media perpetuates Juicy mania,” Foster said. “Our customer wants to participate in our brands. She wants to interact with the brand, and she’ll go that extra mile to share her experiences with others. She loves us, and we love that she loves us.” In 18 months on Facebook, Juicy Couture has garnered about 360,000 “likes” and is on track to clear 500,000 by the end of the year. Juicy's customer profile is smack in the middle of the social media demographic. Juicy treats Facebook like an editorial outlet with a proper editorial calendar. The company uses social media to drive consumers to its own online store and to retail. <wwd.com/business-news>

Hedgeye Retail’s Take: We won’t dispute any of this. But EVERY brand manager will say this about their respective brands. Have you ever heard a brand manager or marketing exec say “the person that uses our product really has very little interest in doing so.”  The real question here for Juicy, and all brands for that matter, is whether they can use social media tools to actually grow the top line.




Although PFCB’s Co-CEO Bert Vivian opened up his presentation today by saying (I am paraphrasing), “I have been asking people if the world is coming to an end.  If so, what I am about to say probably does not matter much,” his comments regarding current sales trends were more optimistic.  Specifically, he said that management continues to believe that the second half of the year will be better than 1H10, and in line with management expectations, they are continuing to see a gradual improvement in trends across the country.  They are seeing signs of life in Arizona and California and although retail activity slowed in May in California, the Bistro continued to show steady progress. 


The company implemented a 1% to 2% price increase at the Bistro in May in an attempt to support average check, which has been a drag on comp growth as traffic has improved.  And, Mr. Vivian stated that comp growth is “getting dangerously close to getting positive.”  Weekday sales growth is improving ahead of weekend growth, which he attributes to stronger business travel spending (accounts for about 30% of Bistro’s tickets).  He also commented that sales and traffic trends at Pei Wei continue to improve in 2Q10. 


During the first quarter, PFCB’s margins suffered as the company invested behind its newly rolled out Happy Hour program.   The inefficiency around executing this new program, along with some other incremental discounting activities at the Bistro, cost the company about 80 bps on the COGS line and 100 bps on the labor line, or about $0.13 per share.  For reference, in the Happy Hour test markets (Arizona and Pacific Northwest), it took about 3-5 months for margins to normalize.  PFCB had said on its 1Q10 earnings call (and reiterated today) that this program would continue to be a slight drag on margins in the second quarter.  However, he said that with a little wind behind the Bistro from a sales perspective, combined with the price increase taken in May, operating margin should get better in the second quarter.


Mr. Vivian also outlined some potential issues, which he referred to as “black clouds”:


Europe…the company is not yet seeing any pressure that he could link directly to the recent issues in Europe.


The Gulf…Longer term, he is more concerned with the potential impact of a slowdown in drilling, particularly in Texas, which is an important state for the company from a sales perspective.



Howard Penney

Managing Director

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