In preparation for PENN's Q2 earnings release on July 22, we've put together some forward looking commentary from the company's Q1 and subsequent conferences.



Commentary From Q1:

  • “The one area in the country that we're seeing the most softness is in Southern Mississippi-Southern Louisiana. And in the first quarter in '09, it was one of the stronger markets we had. So we think it's got a bit of a lag effect and we have not seen any material signs of recovery from what's being reported by the state so far. In addition, the level of promotional activity especially in Southern Mississippi remains -- is probably the one market in the United States or markets in the United States that continues to show the most softness.”
  • “There's clearly a little bit of little better margins reflected in the rest of the year but also reflecting that as we get a little more cost conscious on our marketing programs; we're going to have some negative impact on our revenue as we pull out from possible customers... So I think what you're seeing is slightly improved margins for the rest of the year, but I wouldn't say that we meaningfully moved our EBITDA guidance at the end of the day.”
  • “We're seeing…customers coming but their spend per visit has been down and that's been a trend now for about three or four quarters. So we've gone back in our businesses and looked on a customer-by-customer basis the profitability we have against these customers given our past marketing practices and in certain segments of our business--we found certain groups of customers were spending less. We're redefining the terms of what they're going to get in terms of their rewards and incentives, and pulling back to make them more profitable for us to continue the relationship going forward, and it's really just as simple as that. Going in program by program down to the customer level and determining what margins we want to operate these programs against, and then making tough decisions on customers, where they got an offer before they're going to get either a lower offer or no offer going forward. And that's what you saw in the first quarter and that's what we're working on as we continue into the second quarter and the balance of the year.”
  • “Second quarter we're projecting about $1.8 million in cap interest and then $7.1 million for the year.”
  • Q: “And then corporate overhead, it's ran, what $16 million or so in the quarter? Is that a decent run rate?”
    • A:  We're projecting a little higher than that. We're on a normalized run rate looking at probably about $58 million for the year.”
  • “We're going to certainly have some increased marketing spends in advertising and creating awareness for these two properties now that table games is being offered.  For West Virginia, we're expecting sometime in July to get up and running. So probably in June, July and maybe partially in August and then it will start to burn off after that. At Penn National, it's probably going to be later in the third quarter, we're anticipating. So it would probably be a third quarter kind of effort to create the awareness that table games is there as well.  Once the awareness is created and we start driving the trial, then you'll see the pullback of those advertising efforts.”
  • “Second quarter, we're projecting project CapEx of roughly $85.7 million and maintenance CapEx of $23.6 million. For the year, these numbers are highly dependent on -- or expect the inclusion of--paying $100 million in license fees for Columbus and Toledo.  We're looking at project CapEx for the year of roughly $439.8 million; maintenance CapEx is now looking closer to $94 million for a total of $533.8 million.”


Post Earnings Conference Commentary:

  • “In terms of visitation, we’re flat across most of our properties, and it’s been flat for a long time, actually in the gaming industry in general and at our properties specifically. Where we’ve seen the decline obviously is in the spend per visit; that was down pretty significantly in ‘09….I think that is sort of portfolio-wide; it’s steady as she goes and I think April and May have been sort of the same as what we’ve seen in the first quarter as well.”
  • “I think on the Gulf Coast, we’ve seen a little bit of weakness there primarily because of the lagged effect of the hurricanes in 2005; there was obviously a big boom period there in that part of  the country and that’s starting to obviously recede now and so that’s sort of what we’re seeing there.  On the other hand, there are some markets that are doing pretty well, primarily due to capital that we put into those properties, primarily Lawrenceburg and Penn National.”


U.S. and China in Nirvana.


YUM reported 2Q10 numbers that were much better than I was modeling from a profit standpoint, with the biggest upside to my estimates coming in the U.S.  Relative to my estimates, U.S. same-store sales were basically in line, a little better at Pizza Hut and KFC but a little light at Taco Bell.  In the U.S., there was more leverage than I was expecting across most of the P&L (particularly on the labor line).   In total, restaurant level margin increased 140 bps YOY.  The improved margin performance at KFC stands out as an anomaly given the 7% decline in same-store sales, although KFC’s two-year average same-store sales trends improved 350 bps sequentially from 1Q10.  Also, management commentary about “lower insurance expense” in the U.S. speaks to managing the P&L around a difficult sales environment.   


YUM’s stronger-than-expected results in the U.S. enabled the company to move out of what we call the “Deep Hole” (negative same-store sales and YOY decline in restaurant operating profit margin) earlier than I had anticipated.  I had expected this segment to begin to recover in the second half of the year as the company lapped easier comparisons, but as of 2Q10, the company is now straddling the line between “Life-line” (negative same-store sales and positive restaurant operating profit margin growth) and “Nirvana” (positive same-store sales and positive restaurant operating profit margin growth).


Going into the quarter, I also said that I would not be surprised if YUM fell short of its 5% operating profit goal in the U.S. but this 2Q10 upside makes this guidance more achievable, particularly as the company laps 4Q09’s 23% decline in operating profit.




Same-store sales in China were in line with expectations, implying a 300 bp deceleration in two-year average trends, but again, the bottom line came in slightly better than expected.  Restaurant level margin improved 170 bps as food costs as a percentage of sales were down 240 bps YOY, more than I had anticipated.  That being said, the company continues to expect to face labor and commodity inflation in the second half of the year.  Overall, as expected, China continued to operate in “Nirvana” during the second quarter, but will likely move into the “Trouble Brewing” quadrant (positive same-store sales and YOY decline in restaurant operating profit margin), and potentially, into the “Deep Hole”, during the back half of the year as the higher food and labor costs materialize.




YUM increased its FY10 EPS guidance to $2.43, from $2.39, but this guidance still falls short of the street’s $2.47 estimate.  YUM has a record of beating expectations but management will likely get a lot of questions tomorrow on its earnings call about whether this new guidance is conservative.


Howard Penney

Managing Director



The Deficit Still Looks Ugly, Normalize For Tarp And It Looks Uglier

Conclusion: While June was an improvement for the deficit due to timing related to Memorial Day, the year-to-date numbers remain concerning.  On the other hand, the appointment of Jack Lew to OMB Director is a marginal positive.


The U.S. government reported a smaller monthly budget in June versus June 2009 with a deficit of $68.4 billion versus $94.3 billion last June.  In the year-to-date, the budget deficit is $1 trillion versus $1.1 trillion over the same period in 2009.  On a year-to-date basis, the budget deficit as a percent of GDP is 9.2% versus 10.2% in the same period in 2010.  While this high level summary suggests marginal improvement, the underlying facts still suggest dire fiscal issues in the United States on a number of fronts.


First, the June improvement in deficit can be attributed primarily to timing of revenues.  Due to the Memorial Day, a large amount of tax revenue was pushed into June.  In aggregate for the year-to-date, overall revenues are only up 0.5%, with corporate income tax contributing all of this increase growing 33% y-o-y.  Personal income tax, on the other hand, is down -4.4% in the year-to-date.  So despite the “economic recovery”, tax receipts from individuals are still lagging on a year-over-year basis (jobless recovery sound familiar?).


Second, while reported outlays were $73 billion, or 3%, lower for the first three quarters of the fiscal year, this decline included a reduction in nearly $350 billion from a combination of TARP, Treasury payments to Fannie Mae and Freddie Mac, and net outlays for FDIC insurance.  If normalized for TARP, so removing the $350 billion from last year’s numbers, then spending ex-Tarp is up 10.6% on a year-over-year basis!  Not a good trend.


While a large proportion of this was driven by unemployment insurance, every major line item showed a meaningful increase year-over-year.  Specifically,

  • Defense spending was up 5.8%;
  • Social security was up 6.0%;
  • Medicare was up 4.3%;
  • Medicaid was up 8.9%; and
  • And Other was up 9.1%.

Line item spending dramatically outpaced the economy vis-à-vis GDP growth and tax revenue growth.


In conjunction with this release, President Obama also named Jack Lew the new budget director.  While Orzag has a following amongst the paparazzis in Washington, Lew is actually an experienced hand in the budget area and has spent seven years in the OMB. He was lastly OMB director under President Clinton until 2001, and produced a budget, with the help of a healthy economy, that resulted in a surplus of $236 billion. 


Given his prior experience, prior success, and proven ability to work across bi-partisan lines, President Obama seems to have made a solid choice in Lew.  Even though he spent some time as Chief Operating Officer at Citi Alternative Investments, we will still give him a free pass on that job choice for now.  He certainly has the wherewithal to take a tough stance on the budget, but the next few months will actually show how serious the Obama administration is about narrowing the deficit.


Daryl G. Jones

Managing Director


The Deficit Still Looks Ugly, Normalize For Tarp And It Looks Uglier - US Federal Budget


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Bear Market Macro: SP500 Levels, Refreshed...

We are in the 6th day here of a bear market bounce. At 1096 in the SP500 this easily makes me feel as uneasy as I have felt… well… in 6 days.


From an intermediate term TREND perspective, unless the SP500 closes above 1131, this will remain a bear market by Hedgeye’s definition. That doesn’t mean that the bulls can’t annoy me and/or test the validity of either of our American Austerity of Housing Headwind Q3 Macro Themes in the meantime.


Quantified, a close above 1096 puts the probability of a move to 1131 in play. That’s why I have been doing a lot of waiting and watching today. The long term TAIL line of resistance for the SP500 is 1096 and the long term TAIL line of support for the Volatility Index (VIX) is 23.69. As of 3PM EST, we are trading right at these lines.


What was TRADE line resistance is now immediate term TRADE support at 1074. While the 1004 level of downside support is still what we would consider probable on a 3-day probability model basis, its also what we would call less probable than what we called it yesterday.


As the markets change we will continue to, but we need these SP500 and VIX levels to confirm for at least 3 days on a closing basis to change our positioning.



Keith R. McCullough
Chief Executive Officer


Bear Market Macro: SP500 Levels, Refreshed...  - S P


With the exception of a couple of properties, top line trends have been less than inspiring. PENN needs to pull the cost cutting lever to make the quarter.



Same store sales (SSS) be damned.  2010 was supposed to be a year of recovery for US gaming markets following an awful 2009.  Easy comparisons have become not so easy.  PENN’s Q2 SSS fell 10% in 2008 and another 3% in 2009.  Still, we project Q2 SSS will decline 7% further in 2010. 


For Q2, we expect that EBITDA and EPS will fall slightly short of management’s guidance of $0.26 and $141.5 million, respectively.  For the year, our EPS and EBITDA projections of $1.12 and $575 million, respectively, are close to management’s guidance of $1.13 and $578 million.  At the time of management’s last update, we thought they were padding guidance.  However, casino revenues have remained sluggish and their previous guidance looks reasonable.


Lawrenceburg and the Hollywood Casino in PA are the only two properties showing year over year growth.  However, Lawrenceburg will have lapped the Q2 2009 expansion by the start of Q3 2010, thus impeding further growth.  PA should continue to grow with the advent of table games later this year. 


We remain positive on the long-term prospects for PENN.  Management is strong and the company does maintain a growth pipeline consisting of projects in NEW markets.  Thus, investment returns will be significantly higher and exceed PENN’s cost of capital.  The Ohio projects should contribute up to 25-30% CAGR in EPS from 2010 to 2013.  Our hang up remains domestic gaming trends and the macro environment.  Gaming revenues are tied to housing and GDP and the Hedgeye macro call is fairly negative on these important metrics.  Still, the valuation of 7x 2011 EV/EBITDA is reasonable for the growth and certainly attractive on a relative basis for patient investors.

American Austerity: Leading Indicator or Buy-And-Hope?

Conclusion: Short the US Dollar (UUP)


Our call 6 months ago was the same for the Euro as it is for the US Dollar now. The currencies of countries with burgeoning deficit and debt to GDP ratios are leading indicators for their domestic stock markets.


The US Dollar is getting smoked to lower-intermediate-term-lows today and the US equity market is cheering it on as “reflation” because that’s exactly what Dollar Down equated to during the 2009 phase of what we called Burning The Buck.


Unfortunately, inverse correlations and r-squares aren’t perpetual. There are always multi-factor and multi-durations to consider. As chaos theorists, it is our job to recognize these risks and intermediate term TRENDs as they emerge from immediate term TRADEs.


If the week were to end today, the US Dollar will be down for a 6th consecutive week. Not only is the immediate term TRADE line for the US Dollar broken, but the long term TAIL and intermediate term TREND lines are broken as well (see chart).


This time we don’t think the “reflation” TREND will recur because global equity and commodity prices don’t have the tailwind of accelerating global and domestic growth. Our outlook on US growth in particular for the next 3-6 months is actually for quite the opposite. The US stock market is sucking some people into the long side today, much like early 2010 rallies in European equities suckered people in as the Euro started to break down.


Keith R. McCullough
Chief Executive Officer


American Austerity: Leading Indicator or Buy-And-Hope? - DXY

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