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While there is precedent for a lower multiple, we think the Street is too low on margins. The next year should validate the Board’s decision to replace Dan Lee.



Why is PNK getting demolished?  Potential exposure to the Gulf oil spill, an economic wall of worry, high leverage, Baton Rouge concerns, a lousy May in the regional markets;  the list goes on and on.  The stock is down almost 40% in two months with no real announcements from the company.  That brings the valuation multiple down to 6x our 2011 EV/EBITDA.  One could take it a few steps further and point out that multiple includes $50 million in capex related to the construction of Baton Rouge (almost $1 per share) and doesn’t include non-EBITDA producing assets such as BR, Reno, and AC land that we value at $200 million or over $3 per share of equity value.


So the stock is cheap.  Blah, blah, blah.  After the market nose dive, a lot of stocks are cheap.  Besides, we’ve seen these regionals trade into the 5xs.  There has to be catalysts to buy a cheap stock these days.  We think better margins will be the main catalyst this year and next, although a completely revamped marketing program could boost top line as well.


Earlier this year, the PNK Board replaced the developer/empire builder Dan Lee with the operator Anthony Sanfilippo as CEO.  Mr. Sanfilippo, who has been buying stock recently, cut his teeth in the Harrah’s organization so he knows a little about database marketing.  He also seems to know a little about cost cutting.  We detailed the cost cutting plan first back in April in our Q4 earnings preview note so we don’t want to rehash the components here.  We did see evidence of the plan in Q1 where PNK surprised on the upside due to margins.


In looking at the following charts the potential for margin improvement is obvious.  We’ve compared PNK to the other pure regional gaming operators in terms of overall EBITDA margin and a more apples to apples comparison of EBITDA margin less gaming taxes.  PNK under Dan Lee clearly trailed the industry in this very important metric.  The other companies began to cut costs in 2008 when the industry turned, so their margin comparisons are much more difficult than PNK.  ISLE probably has more room to cut, although there are structural issues with some of their properties.  We believe PNK will still be comping against a higher cost structure through 2011.




As we mentioned, cost cutting shouldn’t be the only area of significant improvement.  Marketing is Mr. Sanfilippo’s specialty.  The chart below shows that PNK has trailed the industry on the operating side as well.  It compares PNK’s revenue per position in each of its major markets to the competition.  With the exception of PNK’s L’Auberge, PNK trails the market badly in win per position per day, presenting significant room for improvement for a good operating team.  L’Auberge, of course, is a much newer and better product than the weak Lake Charles competition.




We understand the market’s concern surrounding consumer spending in general and very discretionary gaming spend in particular.  Meaningful leverage only adds to the risk.  At least PNK has a few major levers left to pull vis-à-vis the rest of the industry.  Of course, if the economy double dips, no casino operator will emerge unscathed.


This morning's data makes it 8 of the last nine weeks that the MBA Mortgage Purchase Applications index fell sequentially. The index dropped another 2% this morning falling to its lowest level since 1996 in spite of record low mortgage rates. The Purchase Applications Index is a good proxy for overall demand as it captures at least 50% of all mortgage purchase application volume.


Home prices are a simple function of supply and demand, but housing assets are sticky assets and reprice with a lag. We've found the lag to be one year. As such, record low demand today will manifest in materially lower home prices a year from now. We are now two months removed from the stimulus expiration and are still hitting new lows in demand. We'll keep a close eye on the remaining summer months to see whether demand rebounds as we get further removed from the stimulus expiration.




As a reminder, housing demand is positively correlated with affordability, meaning that demand wanes as prices go down. Similar to retail investors chasing performance, the math suggests that as home prices increase either as a result of high mortgage rates or appreciation of home values, more buyers come to the table. This is in stark contrast to the consensus belief that high affordability will stimulate housing demand and help clear burgeoning inventory.




Joshua Steiner, CFA


Allison Kaptur




To Be or Not To Be Tax Free

As fiscal losses mount at the local level and the back to school season begins,  the discussion surrounding tax free holidays is building.   Some states view these holidays a stimulus to help local businesses and consumers while others are clearly seeing incremental sales tax as a source of revenue.  As we head into the critical back-to-school selling season, it’s important to understand what’s different this year vs. last from both a timing and magnitude perspective.   And, with June sales reported tomorrow,  we expect to hear the first indications of how tax free holidays may be expected to impact July and August results. In an effort to capture the various shifts in timing and program parameters versus last year, we present the following graphics below. Here are a few noteworthy observations:

  • There are typically 3 different types of sales tax holidays: hurricane preparedness, clothing and school supplies, and energy efficient appliances.  For the purposes of this post we are focused on the clothing and school supplies.
  • The top 5 states most exposed to teens in the 15-19 year-old demographic are CA, TX, NY, FL, IL, representing 37% of the entire domestic teen market.  However, only three offer a tax free holiday (TX, NY, & FL).
  • The two biggest teen states (CA & IL) that don’t offer the tax free holiday have some of the highest state sales taxes in the country.  CA and IL are also #1 and #4 respectively on a list for highest projected budget gaps as a percent of the state’s general fund budget.
  • So far, FL and MD are the only two states adding events vs. this time last year.  They are adding 3 and 7 day tax-free events respectively.
  • GA, Washington DC, and South Carolina have either repealed or suspended their respective tax free holidays.
  • NY just repealed it’s tax-free status on shoes and apparel under $110, however this will not take effect until October 1st.  The suspension will last until April 1st, 2011, at which point a $55 tax-free threshold will be established for a year.  Then, in 2012, the original exemption will be reinstated.

With municipalities struggling to meet budgets, we should expect continued contraction in this list of tax free events as well as growth in efforts to add or boost sales tax overall.  


To Be or Not To Be Tax Free - TeenStateExp 7 10


To Be or Not To Be Tax Free - taxfree

Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.51%
  • SHORT SIGNALS 78.32%


Continuing a trend from last week the MACRO calendar continues to provide us with disappointing news.  Yesterday, the ISM non-manufacturing index fell to a four-month low of 53.8 in June from 55.4 in May, as new orders fell for a third straight month, declining to 54.4 from 57.1 in May.  The biggest concern was the demand outlook as order backlogs slipped to 55.5 from 56 and the employment index edged back below 49.7 from 50.4 in May.


Despite this, the S&P 500 experienced a Bear Market Macro bounce, as the S&P 500 finished higher by 0.54%.  The upside was driven by the strength in global markets, especially China.  The euphoria faded as the Consumer Discretionary (XLY) names underperformed heading into same-store sales Thursday.  The XLY was the only sector to be flat on the day.


The biggest divergence yesterday was the decline in the Russell 2000 which declined 1.5%.  Within the small cap space the S&P 600 Restaurant Index declined 3.6% on the day.  Yesterday, the S&P Retail Index declined 0.5% on a flurry of June same-store sales previews which focused on the favorable impact from the calendar shift, but raised concerns over 2H10 expectations.


The RISK AVERSION trade was evident yesterday as Treasuries were stronger with some help from the weaker-than-expected non-manufacturing ISM data.  The dollar index closed lower, closing at $84.03 down 0.62%.  The Hedgeye Risk Management models have the following levels for the USD – Buy Trade (83.80) and Sell Trade (85.18).  The VIX moved lower by 1.5% - the Hedgeye Risk Management models have the following levels for the VIX – Buy Trade (25.65) and Sell Trade (30.61).


With a sharp decline in the Dollar index, it’s worth noting a big spike in the euro - the euro traded up 10.87%, closing at 1.26.  The Hedgeye Risk Management models have the following levels for the EURO – Buy Trade (1.22) and Sell Trade (1.28).


The three best performing sectors yesterday were Utilities (XLU up 1.2%), Energy (XLE up 1.0%) and Technology (XLK up 1.0%).  The oil services group finished higher for a fourth straight session with the OSX +0.5%.  Despite a reversal in natural gas, coal stocks still finished mostly higher with some help from M&A activity.


The XLK outperformed as the S&P Software index rose 1.8% on the day, with CTXS +2.5%, MSFT +2.4%, ORCL +2.2% and RHT +1.8%.   


The Materials (XLB) was a laggard, weighed down by the paper and forest products group, where falling pulp prices have gained some attention.   The S&P Steel Index also declined by 0.8% on the day. 


In early trading copper is trading down for the first time in four days as the dollar is rallying.  The Hedgeye Risk Management Quant models have the following levels for COPPER – Buy Trade (2.83) and Sell Trade (2.98).


In early trading gold is trading at a six-week low.  The Hedgeye Risk Management models have the following levels for GOLD – Buy Trade (1,187) and Sell Trade (1,229). 


The Hedgeye Risk Management models have the following levels for OIL – Buy Trade (70.79) and Sell Trade (75.29). A slowing global growth outlook and a cyclical build-up in U.S. stocks are exerting downward pressure on the price of oil. 


As we look at today’s set up for the S&P 500, the range is 50 points or 2.6% (1,001) downside and 2.2% (1,051) upside.   Equity futures are trading below fair value continuing the weakness from yesterday afternoon.  On the Macro Calendar today, we have MBA Mortgage Purchase Applications.


Howard Penney













The Crossroads

“We have arrived at that point in time in which we are forced to see our own humiliation, as a nation, and that a progression in this line cannot be productive of happiness, private or public.”

-Henry Knox


I just finished reading 1776, by David McCullough.  He’s of no relation to Keith, but he, too, is a fine Yale man; even if not a hockey player. 


So why am I wasting my time reading early American history? Well, very simply, because the United States is at the crossroad of political and economic policy leadership.  The future will look remarkably different than the most recent past, and that future will be shaped by the decisions made by those who take leadership roles in the years ahead.


This is a year that is not unlike the year of 1776.  While the battle for independence was fought for many long years, the Founding Fathers changed the trajectory and future of America by declaring independence in 1776.  Many well known names played critical roles that year and in the continued battle for independence, but the name Henry Knox was one that jumped out at me from my readings.


Knox was a book seller from Boston, who quickly earned the trust and confidence of General George Washington.  Like much of the American Army in those days, he had very little real military experience.  But what he liked in experience, he made up for in courage and leadership.


The crucial recommendation that Knox made to General Washington, as a 26-year old, was that the Guns of Ticonderoga should be retrieved as they could have a crucial impact on ending the Siege of Boston. Washington appreciated the importance of increasing his artillery surrounding Boston, so he sent the young colonel on the mission to retrieve the Guns of Ticonderoga.


From early December of 1775 to late January of 1776, Colonel Knox and his men transported 59 cannons and mortars weighing more than 60 tons over 300-miles through the dead of winter.  Knox and his team averaged over five miles a day, and despite death and hardship, eventually arrived in Boston.  The British quickly realized they were outgunned, and shortly thereafter withdrew from Boston, which ended the Siege of Boston.


The key current strategic question facing the nation also relates to resolving a siege, the Siege of Deficit and Debt.  The United States currently has more debt on its balance sheet than any year since World War II.  You don’t have to be a student of history like David McCullough to realize that is not ok.


The Keynesians will have you believe that the way to reignite the American economy, and ultimately narrow deficits, is to Pile Debt Upon Debt. The flag bearer for this school of thought is none other than Nobel Laureate Paul Krugman. In a New York Time column on July 1st Krugman wrote:


“What’s the evidence for the belief that fiscal contraction is actually expansionary, because it improves confidence? ( By the way, this is precisely the doctrine expounded by Herbert Hoover in 1932.)”


While this is a synopsis, Krugman has consistently argued that the recent stimulus was not substantial enough and that austerity will lead to slow growth and, by the aforementioned association to Herbert Hoover, a Depression.


While using history as a guide is important, fear mongering as a way of substantiating economic policy, like using erroneous comparisons to Herbert Hoover, is not.  The stimulus undertaken globally over the past couple of years is about as good of a Keynesian experiment as we can analyze.  While the massive stimulus may have served to halt the economic slowdown in the short term, the massive amount of debt that was used has leveraged the economic future of the free world.


So, what’s the solution? Well, for starters, it begins with admitting what doesn’t work.  Massive government borrowing and associated debt that doesn’t create long run economic activity or build new industries, such as after World War II, doesn’t work.  Increasingly, it is also becoming clear that expanding the government doesn’t work either.


To this point, Krugman’s counterpart at the New York Times, David Brooks, offered some quantified support against increasing government spending.  As Brooks recently wrote:


“Moreover, public spending seems to have odd knock-off effects. Professors Lauren Cohen, Joshua Coval and Christopher Malloy of Harvard surveyed 42 years of government spending increases in certain Congressional districts. They found that federal spending increases dampened corporate hiring and investment in those districts.”


Brooks went on to highlight the need for confidence in our economy above all else.  The type of confidence that does not come with burgeoning deficits and fiat currencies.  According to Brooks, Lord Keynes wrote that the state of confidence is “a matter to which practical men pay the closest and most anxious attention.”


One thing I don’t currently have is confidence in the economic leadership of America.  I do have confidence that new leadership will emerge, just as it did with the 26-year old Henry Knox in 1776.


The real work at our firm gets done by the Young Hedgeye Knights who sit on our trading floor every day.  They open the office up at 430 a.m., and they are the guys and gals that shut the office down at night when most of us are already in bed.


Yes, indeed. The future economic leadership of this fine nation is not going to come from the Hallowed Halls of the Fiat Fools in Washington, but will come from the youthful entrepreneurs of our economic future. 


We are lucky to count many on our staff: Darius Dale, Matt Hedrick, Zach Brown, Allison Kaptur, Rory Green, Felix Wang, and Christian Drake.  All of these folks are in their mid to early 20s and collectively show more economic leadership daily than most of the Fiat Fools in Washington have shown in their careers.


The history of this nation has simply taught us this:  when this fine republic is at a crossroads, new leadership will emerge. 


I’m lucky enough to see this every morning.


Keep your head up and stick on the ice,


Daryl G. Jones

Managing Director


The Crossroads - DJ

China: The Great Shift Forward

Conclusion: After a series of shrewd moves by the government which have centered on raising domestic consumption, China is positioning itself as a defensive play in late 2010 and heading into 2011.


Here’s what we know – growth in China is going to slow. After posting +11.9% Y/Y 1Q GDP, calling for a sequential erosion from here in the midst of a sovereign debt scare in Europe which has eroded the purchasing power of China’s largest export market isn’t exactly a tough call to make. The government even said on Friday that their full year growth estimate is 9.1%, explicitly implying a deceleration from 1Q. With the Shanghai Composite down 27.3% YTD as of today, prices confirm this. Using marked-to-market prices as leading indicators, however, Chinese equity prices have been telling us to expect slowing growth all year long.


At a price, China’s growth will become attractive on the long side irrespective of slowing growth in the U.S. and in Europe because their government is proactively preparing them to weather the storm by fueling domestic consumption. Over the past several weeks, China has taken a number of steps to increase their citizenry’s purchasing power – none arriving with more fanfare than the de-pegging of the yuan.


Since relaxing the fixed exchange rate on June 19th, the yuan has gain roughly 0.7% vs. the dollar and today’s 12-month non-deliverable forwards suggest an appreciation bet of roughly 1.5% in a year’s time. Despite the prospects of a stronger currency, the People’s Bank of China has ruled out any sudden large appreciations and still mandates that the currency only fluctuates 0.5% from the daily official rate. As a result, we caution that the yuan’s appreciation may not likely be the silver bullet China is looking for to stimulate domestic consumption, which has fallen from 46.4% of GDP in 2000 to 35.6% of GDP in 2009. As a percentage of GDP, personal income has had an even more dramatic decline: 53% in 1999 down to just 39.7% in 2009.


There have, however, been a number of positive developments regarding wage growth and government stimulus that will help move China forward towards a more consumption-oriented economy, rather than one that has been fueled by manufacturing and exports in recent years. Those developments are listed below and are by no means limited to this summary: 

  • In April, Shanghai raised minimum wages 17% to 1,120 yuan per month. Guangdong (China’s largest export base) took up minimum wages in five locales within the province by an average of 21%.
  • On June 3rd, China extended its home appliance trade-in program until 2011. Sales of such appliances have reached 54B yuan and 5B yuan of subsidies were handed out since the start of the program.
  • On June 8th, a survey of Chinese employer’s hiring  plans reached a six-year high.
  • On June 11th, the IMF reported that the surplus of rural workers for labor-intensive work has fallen to about 25 million from roughly 120 million in 2007, which is bullish for wages in that sector (less supply). Conversely, research from China International Capital Corp. that suggests that 31 million Chinese will return to the labor market in 2011 after the completion of projects resulting from the government’s 4T yuan stimulus package. Net-net: supply of labor-intensive workers is still shrinking but perhaps at a slower rate, which is net bullish for wages.
  • On July 1st, Bejing increased monthly minimum wages by 20% to 960 yuan. In a similar fashion, Henan (China’s most populous province) raised its minimum wage by 33% to 600 yuan per month. 

All told, more than 20 provinces and municipalities plan to increase minimum wages this year, according to the Ministry of Human Resources and Social Security. As a result, we should begin to see evidence of accelerating domestic consumption in the coming months. Furthermore, companies that are positioned to service the Chinese local economy (i.e. domestic retailers and savings deposit institutions) will see an added kick from this wave of wage inflation.


Currently, both the Shanghai Composite and Hang Seng are broken from a TREND perspective and last Tuesday’s 4.3% and 2.3% respective declines in both indices on the heels of a downwardly revised Conference Board Leading Index suggest that consensus still has some ground to cover on the slowing Chinese growth story. When consensus finally catches up, our Hedgeyes will be looking to buy their capitulation on sale.


Darius Dale



China: The Great Shift Forward - Yuan Consumption

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