Since early 2008 we’ve singled out housing as the #1 macro driver of gaming revenues. An updated analysis shows housing and unemployment are even more critical now.



Sorry to bore you with statistics but I’m a bit of a nerd and it’s a big part of our process.  Way back in early 2008, we regressed all important macro variables on gaming volumes and found that over the period from 1993 to 2007, housing was the most important driver, followed by GDP.  It was an easy call then for us to be negative on gaming for most of 2008.  Statistics do matter.


When we updated the regressions for Las Vegas Strip gaming volumes, we saw that correlations and R Squares have increased.  Over the last 15 years, national housing prices, interest rates, and unemployment are the only three macro variables that mattered, and mattered in that order.  T-stats are all close to or above 2.  Surprisingly, GDP was an insignificant driver of Las Vegas Strip gaming volumes.  Combined, these macro variables drove an R Square of 0.48.




The housing (wealth effect) and unemployment impacts are fairly obvious.  The positive relationship between interest rates and gaming volumes may not be as intuitive to the casual observer.  The average age of a LV visitor is 50 years old, and weighting age with gambling dollars would surely result in an even older demographic.  Many of these gamblers live on fixed incomes so discretionary spending goes higher as interest rates move up.  This phenomenon has been consistently borne out in our statistical analysis.


We also broke down the analysis into shorter periods.  The impact of housing and unemployment escalated over the last five years while GDP remained insignificant.  Interest rates were also insignificant during that period.  The housing coefficient doubled from the 15 year regression while the unemployment coefficient went up slightly.  Most importantly, the R Square actually increased to 0.69 despite fewer observations (months).  Now more than ever, investors need to have a view on housing and unemployment to make real money in this sector in our opinion. 




So where do we stand?  We defer to the Hedgeye Macro group and our financials guru Josh Steiner.  Hedgeye Macro is negative on unemployment relative to consensus and Josh has written extensively on the significant hurdles the housing market face.  If we are right, Las Vegas won’t be recovering anytime soon and MGM MIRAGE will struggle to maintain its 12x EBITDA multiple and/or the consensus EBITDA projection.


Reported a solid quarter and issued smart guidance; smart, as in very conservative Q3 but reasonable full year.



Not surprisingly, MAR reported solid Q2 results and bumped up 2010 guidance.  MAR remains attractively valued, particularly on a relative basis, and is certainly the most defensive of the lodging names. 


They beat our EPS estimate by a penny and beat the Street by $0.02.  Adjusted EBITDA of $278MM was $3MM above our estimate and 7% ahead of the consensus.  On the surface it may look like the beat was driven by stronger RevPAR and room openings.  Not to take anything away from Marriott, but looking under the hood that’s not exactly correct.  


By our math, the beat came from higher termination fees on the owned, leased, corporate housing and other, higher incentive fees, lower timeshare costs, and lower SG&A.  At least the first three items are lower multiple drivers of value.  Even so, 3Q guidance of $0.18-0.22 seems awfully low given the revised RevPAR guidance and upwardly revised room growth.  Even if we use MAR’s seemingly high $155MM SG&A guidance, it seems that they should easily beat the top end of their range.  Consensus heading into the release was $0.22.



The Details:


Owned, leased, corporate housing and other revenue of $255MM was $6MM below our estimate but gross margin was only $1MM below our estimate.

  • Termination fees net of property closing costs were $6MM this quarter; that’s pure margin but low to no multiple revenue.  We typically estimate $2MM of termination fees per Q.
  • Assuming that branding fees were stable in the $19MM range implies that F&B and other revenue only increased 1% YoY, which is somewhat disappointing given the pickup in occupancy and improved corporate travel.

Fee income of $287MM was $1MM ahead of our estimate.  However, Management and Franchise fees were lower than our estimate with Incentive fees making up the difference.  We believe Incentive fees are less valuable.

  • Management fees grew 7.9% YoY, which is below the aggregate of the room managed, room base growth and RevPAR growth.
  • Incentive fees came in $6MM above our estimate.
  • Franchise fees were $2MM below our estimate.

Timeshare results managed to beat our estimates and management guidance despite weak contract sales given the difficult YoY comparisons, which included 25 year anniversary promotions.  Timeshare before SG&A was $8MM better than our estimate.

  • Some of the lower contract sales were offset by the fact that MAR was able to recognize a higher percentage of sales.  Last year MAR had to defer recognition of 14% of contract sales, while this quarter they were able to recognize 92% of contract sales.
  • Finance income was a little lower then our estimate due to a lower loan balance ($987 down from $1046MM last Q).
  • Timeshare sales and services, net margins, were 21.6%, in line with 1Q2010 margins and a nice improvement over 2009 margins.
  • SG&A declined another 6% on top of a 36% decline last year.

SG&A came in $8MM below management guidance.  Oddly, the guidance for Q3 is $13MM higher than the actual Q2 quarter.  As a reminder, 3Q2009 included $15MM of unfavorable impact associated with deferred comp compared with 2008 and $5MM of certain litigation expenses.  At the time, MAR claimed that $130MM was a normalized number.  MAR’s $155MM guidance implies 19% YoY growth which, again, seems way too high.


Looking for changes on the margin that impact operational performance


Nirvana - At the restaurant level, the company is operating smoothly.  Sales and margins are headed in the right direction.  On the surface this gives management the benefit of the doubt that they are not aggressively using pricing to manage the business.  There is sometimes the potential, however, that a company is operating in Nirvana as a result of positive comps that are driven entirely by pricing.  In that case, if customers are not coming in the door, positive same-store sales growth will not be sustainable.


Who’s got it right as of their last reported quarter?  CMG, MCD, YUM U.S., YUM China, DPZ, PNRA, SBUX, CAKE, MRT and TXRH


As shown in the sigma chart below, it should be of no surprise that the companies operating in Nirvana, on average, also trade at the highest NTM EV/EBITDA multiples. 


Moonlighting in Nirvana?  Most of the names located in the upper right quadrant did not come as a surprise; that is, except for TXRH and MRT.  In 1Q10, TXRH and MRT both reported positive comparable sales growth for the first time in about 2 years (slightly longer for TXRH).


TXRH’s full-year same-store sales guidance of flat to +1% implies that same-store sales remain relatively positive for the balance of the year (toughest comparison in 4Q10) even if trends slow somewhat on a two-year average basis, as has been the case for the casual dining industry on average in 2Q10, as measured by Malcolm Knapp.  That being said, TXRH’s YOY restaurant level margin compares get more difficult in 2Q10 and even more so in the second half of the year.  Lower food costs in 1Q10 were the primary driver of the significant margin growth in the quarter and management stated that food deflation will be less for the balance of the year and lowest in 2Q10.  Remaining in Nirvana will be challenging; though same-store sales improved substantially in 1Q10 on a 1-year and 2-year basis and the trend in top-line may be more important to investors now.


As for MRT, the company started out 2Q10 strong with same-store sales up 6% in April and guided to +4% to +6% same-store sales for the quarter.  Maintaining positive comps in 2H10, particularly in 4Q10, as comparisons get more difficult, is unlikely.


Other Nirvana Standouts: 


CMG – The Company will likely put up positive comps for the balance of the year, even if top-line trends slow somewhat on a 2-year basis from the first quarter.  CMG’s full-year same-store sales guidance of up mid single-digits implies steady-to-slightly better two-year trends for the remainder of the year.  On a YOY basis, the company most likely posted its strongest restaurant margin growth, however, in the first quarter.  Restaurant level margin will face increased pressure in the second quarter and could potentially turn negative in 2H10, pushing CMG into the “Trouble brewing” quadrant.  After benefiting from favorable food and labor costs as a percentage of sales in 1Q10, management guided to modest commodity inflation in 2H10 and higher labor costs as of 2Q10 due to wage rate inflation and the lapping of labor efficiency initiatives implemented in 2Q09.  Also hurting margins for the balance of the year is the expected increase in other operating costs as the company ups its marketing spend to 1.8% of sales for the full year from 1.1% in the first quarter.  Specifically, management said, “we expect to de-lever this line during the rest of the year as we invest in our new marketing campaign.”  Given the increased cost headwinds, remaining in Nirvana will be difficult in the second half of the year, but investors may be more focused, in this environment, on the company’s ability to maintain positive comparable sales growth.


CAKE – Like CMG, CAKE most likely posted its strongest FY10 quarter in 1Q10 from a YOY margin growth perspective as restaurant level margins get increasingly more difficult going forward, largely in 2H10.  Also, like CMG, the company expects to face increased pressure from higher commodity and marketing costs in 2Q10. These increased cost pressures will likely push CAKE out of Nirvana as we trend through the year even if the company is able to maintain its positive same-store sales growth (management guided to flat to +1% growth in 2Q10 and for the full year).  And, even if the company achieves its full-year guidance, it will be challenging for the company to maintain its positive comp growth in 4Q10 given the sequentially more difficult comparison.


YUM U.S. – YUM’s stronger-than-expected 2Q10 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.


YUM China – YUM 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 higher food and labor costs materialize.



Deep hole - The concept is experiencing negative same-store sales and declining restaurant level margins. 


They are feeling the pain: DIN, SONC, BKC, KONA, EAT, PZZA, PFCB, RRGB, CPKI, JACK, JACK, BOBE and TAST


Deep hole Standouts:


EAT – Sales will remain choppy in the near-term as consumers adjust to the significant menu changes at Chili’s and the company could remain in the Deep Hole for another reported quarter.  Beginning in FY11, EAT should begin to move up and to the right on the sigma chart as margin initiatives materialize and same-store sales recover.


PFCB – PFCB has the potential to report the biggest sequential quarterly swing in same-store sales growth at the Bistro in 2Q10 as the company implemented a +1% to +2% price increase during the quarter in late May.  At the same time, PFCB hopes to support average check, which declined 3.5% during 1Q10, by reducing its reliance on discounting.  Although traffic was positive in 1Q10, it will be important to see if the company can sustain its recent traffic momentum at the Bistro while also increasing prices.  Prior to the price increase, management stated that for most of April both the Bistro and Pei Wei experienced a roughly 200 bp improvement from 1Q10 comp trends. 


Margins should improve as the company refines the Happy Hour initiative at the Bistro and improves execution.  It is important to remember that 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 in 1Q10.  I would expect restaurant level margin to decline again in 2Q10 (though to a lesser magnitude) and gradually improve during the balance of the year, pushing PFCB up and to the right in the sigma chart.



Trouble brewing - positive same-store sales and YOY decline in restaurant level margin.  We recognize the trends associated with operating in both the Life-line and Trouble brewing territories as unsustainable.  Typically, if a company is posting positive same-store sales and declining margins, the company is unable to leverage its positive top-line and is therefore spending too much on either growth related costs or increased discounting.  Either way something has to give and it usually ends ugly.   


The red flags are being raised for:  BJRI and BWLD 


Trouble brewing Standout:


BWLD – With same-store sales only up 0.1%, BWLD was extremely close to falling into the Deep hole in 1Q10.  Same-store sales slowed 30 bps in 1Q10 on a two-year average basis and deteriorated 420 bps sequentially in April from the 1Q10 level.  Given that same-store sales were down 3.7% in April, I do not expect BWLD’s sigma position to improve in 2Q10, but rather the company could fall into the Deep hole if top-line trends did not improve materially during the balance of the quarter.  I would expect continued pressure on restaurant level margin in 2Q10 despite the fact that the company will benefit from lower YOY chicken wing prices after facing inflation of 17% in 1Q10 (traditional wings account for about 20% of restaurant sales).


It all comes back to sustainability, and BWLD lost it….BWLD grew too fast.  New unit volumes are declining.  Growth related costs will become more evident as same-store sales remain under pressure.  BWLD needs to slow growth and cut costs and that does not yet appear to be in the plans. 



Life-line - Negative same-store sales and YOY increase in restaurant level margins.  At Hedgeye we have another term for this and it’s called “pulling the goalie.”  When you are down and out (customers are not coming back), you need to do anything to make the numbers and preserve margins.  The reduction in costs is not sustainable and can lead to further issues down the road.  It will certainly not do much to bring the customers back in the door.   


Looking for answers: DRI, RT and WEN


Life-line Standout:


RT – RT’s same-store sales trends have gotten better on a one-year and two-year basis for the last five quarters.  Maintaining this trend on a one-year basis will be more difficult in fiscal 4Q10.  Management’s full-year comparable sales growth guidance of -1% to -2% implies a pretty wide range of results during the fourth quarter of -2.5% to +1.5%.  Whether or not same-store sales turn positive (I am modeling a slightly negative comp, roughly in line with 3Q10), restaurant level margin is expected to be down in the fourth quarter, shifting RT into either the Trouble brewing quadrant or the Deep hole.  Management guided to a 25 bp to 50 bp decline in full-year restaurant profit margin as a result of the company’s focus on offering compelling value and the associated negative impact of food costs.  This full-year guidance implies a 25 bp to 125 bp decline in the fourth quarter. 





Howard Penney

Managing Director

Early Look

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The Singapore Sling: Why We Are Long of Singapore

Position: Long Singapore via the etf (EWS); Bullish on SGD-USD.


Conclusion: As part of our call that growth will slow globally in 2H10, we want to be long currency and equity markets that are poised to accelerate domestic consumption. Singapore is one of those economies and, as a result, is one of Hedgeye’s top Macro investment ideas.


Based on recent strength in manufacturing and exports Singapore posted a 2Q10 GDP growth number of 19.3% Y/Y. The record gain was fueled by strong industrial production growth, which accelerated in May to +58% Y/Y. Manufacturing in Singapore has grown by an average of 45% in the first five months of 2010, led by strong output in the pharmaceutical and electronic sectors – two of Singapore’s largest export bases.


Despite the EU’s sovereign debt issues, the large growth in exports during the 2nd quarter, the net of which compromised 25% of GDP in 2009, is an incrementally bullish read-through in conjunction with the 2Q GDP release. Singapore’s non-oil, domestic exports accelerated on the margin in June to +29% Y/Y vs. +24% Y/Y in May. Upon further scrutiny, however, we find that European austerity and economic stagnation in the U.S. paints a more sober picture of the intermediate term trade outlook for the $182 billion economy. Today, the Trade Ministry of Singapore stated:


“In the European Union, domestic demand remains depressed as concerns over the sovereign-debt crisis persist… The implementation of fiscal austerity measures in some of the economies may further weaken their domestic demand. The weakening of the euro against key trading partners will also dampen import demand in the European Union. Signs of a slowdown in the labor market in the U.S. have affected consumer confidence, and sluggish final demand from the world’s largest economy as well as Europe has led to a moderation in manufacturing in Asia.”


The consensus belief that European Austerity may negatively negative impact Singapore’s exports has upside risk.  Nominal exports to the EU are less than 8% of the total with the economically healthy Germany compromising 20% of that share. That said, just last week, the EU Delegation to Singapore plainly stated that trade between the two entities would remain vigorous in 2H10, despite austerity measures.


Breaking down the most recent trade numbers in more granularity, we find that growth of non-oil, domestic exports (NODX) to the EU accelerated in June (+75% Y/Y vs. +5.7% Y/Y in May) due to a favorable inventory cycle for pharmaceuticals, electrical machinery, and computer parts. This is likely to moderate going forward, as Singapore PMI slowed in June (though still showing expansion in all major categories: total, new export orders, new orders, and order backlog). The takeaway from this is that, while cause for concern, European austerity fears  should not be overstated in an analysis of Singapore’s trade outlook.


The Singapore Sling: Why We Are Long of Singapore - 1


Trade Outlook: Moderate


In fact, the majority of Singapore’s exports go to Asian economies, with the largest recipients being: Hong Hong (11.6%), Malaysia (11.5%), China (9.7%), Indonesia (9.7%), and Japan (4.6%) (CIA Factbook, 2009). The U.S. is a destination for roughly 11% of Singapore’s nominal exports, so continued weakness (Y/Y growth flat sequentially from May to June) from that market – which we expect – may continue to weigh on Singapore’s export growth throughout the remainder of this year. Conversely, bullish demand from China – supported by government stimulus and recent wage growth – may help offset any potential declines in exports caused by the U.S., which we’re already seeing evidence of. While growth of NODX to both China and Hong Kong slowed marginally in June, the Singapore Trade Ministry has credited one or both of these markets as the largest contributors to overall export growth in every month this year except February. Even then, Taiwan and Indonesia picked up the slack in February as two of the largest contributors to growth. Asian markets will likely be the key drivers to Singapore’s export growth going forward and the recently launched China-ASEAN Free Trade Area agreement holds the potential to greatly accelerate intra-regional trade.


All said, Singapore’s export growth is still likely to moderate from here and, like many world economies, will slow in 2H10. Despite this, we contend that the economy is in a bullish setup supported by internal demand, as supported by the Ministry of Trade’s third upwardly-revised 2010 GDP estimate today (+13-15% Y/Y vs. previous forecast of +7-9%).


Domestic Consumption Outlook: Bullish


At a mere 2.2% in 1Q10, Singapore’s latest unemployment rate is at its lowest level in 18 months, thanks to private and public efforts to bolster the services sector the Southeast Asian economy. The opening of two casino resorts by Genting Singapore Plc and Las Vegas Sands contributed to a net addition of 36,500 jobs in the quarter and record tourism for the sixth consecutive month (+30% Y/Y in May and driven by intra-Asian visitation). Singapore has a resident population of roughly only 5 million, so 36,500 job adds and high tourism rates will have an measured impact on the economy. Further, Singapore also has an open policy of importing highly-skilled labor to meet its growing demands (1.5 million immigrants from China, India, and Malaysia).


The demand for highly-skilled labor is particularly prevalent in the financial services, construction and energy sectors. For the third consecutive year, the World Bank has ranked Singapore as the easiest place in the world to do business and the fundamentals behind that calculation make Singapore a likely destination for relocated financial services as a result of global industry regulation. Singapore is already Asia’s leading OTC commodity derivatives hub with more than 50% of the region’s volume. According to Singapore’s Ministry of Trade and Industry, increased intra-regional trade will likely result in the need for upwards of $8 trillion of infrastructure and insurance investment over the next decade, so the government has been busy making concessions to accommodate this growth. In the construction sector, the government has set aside 25% ($250 mil.) of the National Productivity Fund for manpower development and technology adoption. In the energy sector, Singapore is developing a facility to store liquefied natural gas to reduce dependence on imports from neighboring countries where the pricing outlook is uncertain. All in all, Singapore is making moves in line with our TAIL thesis that Asian markets will continue to take share from the U.S. and the EU in the global economy.


The Singapore Sling: Why We Are Long of Singapore - 2


Risks: Moderate in the Absolute; Negligible Relative to the Downside Risks of Other Advanced Economies (U.S., Spain, France, Greece, Mexico)


So what are the downside risks to the bullish case on Singapore’s economy? With the equity market up only 1.9% YTD and far from the top of the performance leaderboard, this leading indicator suggests there are risks associated with this thesis. Those risks include: an expedited move in the Singapore Dollar vs. the U.S. Dollar, which would further dampen export prospects to that market; and a potential for a hiccup in pharmaceutical manufacturing, which itself is a very volatile industry subject to large production swings by big companies such as Sanofi-Aventis SA.


With 19% Y/Y GDP growth and CPI currently running at the highest level since Dec. ’08 (+3.24% Y/Y), the Singapore Dollar is in a hawkish setup ahead of the next Monetary Authority of Singapore policy review in October (the Monetary Authority uses the Singapore Dollar instead of interest rates to manage inflation). The currency rose as much as 1.2% on the day of the last MAS meeting back in April when the board allowed a revaluation of the Singapore Dollar and shifted to a stance of gradual appreciation. If the currency continues to strengthen against the U.S. Dollar from here, export competitiveness to the U.S. market may come under pressure. SGD-USD has gained 1.5% against the last two weeks alone and our Short the US Dollar thesis makes this trend likely to continue. If the euro appreciates further from here, however, relative strength in that currency may offset a portion of this pressure. Fifty-eight percent of the U.S. Dollar Index is Euros, further U.S. Dollar debasement from here will provide reasonable support for the EUR-USD, which is teetering on a TREND line breakout above $1.28. SGD-EUR supports this view, down (-0.3%) in the last two weeks.


The Singapore Sling: Why We Are Long of Singapore - 3


The Singapore Sling: Why We Are Long of Singapore - 4


A second risk to Singapore’s go-forward outlook is the prospect of an eventual overheating in the housing sector. An alarming report by CIMB suggests that overall housing affordability in Singapore is now inching closer to the banks’ mortgage-to-income threshold ratio, after a 10% YTD increase in private home prices which has elevated those levels above the 1996 peak. While appropriate cause for alarm, further analysis suggests that housing prices are far from a China-like bubble. First, housing CPI (the largest component of the consumer price index) has lagged overall inflation for the past 12 months. From the November 2008 peak-of-peaks, housing CPI has experienced a (-4.2%) decline. Furthermore, a marginal deceleration of Y/Y growth in the latest housing CPI reading suggest that concerns are likely overdone for now. In the event that they aren’t, however, expedited appreciation in Singapore’s housing market will likely put more pressure on the MAS to raise the value of the currency – which would further augment our bullish consumption thesis. Moreover, immigration policies designed to expand Singapore’s population by over 50% in 10 years suggest there won’t be any “ghost towns” on the island anytime soon.


The Singapore Sling: Why We Are Long of Singapore - 5


Conclusion: Long EWS; Long SGD-USD


In summary, we like economies in the back half of 2H10 and 2011 that are setup to accelerate domestic consumption to offset a decline in global trade and industrial production (China, Brazil, Singapore). Keep in mind, however, that every market and currency has its price and with growth poised to slow globally, relative economic performance will matter even more in 2H10. We are no longer in a “rising boat lifts all tides” investment environment, so we’re waiting for price confirmation in markets like China and Brazil on the long equity side. From a quantitative standpoint, Singapore’s price is right. We expect Singapore’s FTSE Straits Times Index to outperform many global equity markets throughout the remainder of the year. From a currency perspective, Singapore’s hawkish economic setup and low deficit-to-GDP ratio (2.6% in 2010) makes the Singapore Dollar a strong FX play - particularly relative to the $USD.


The Singapore Sling: Why We Are Long of Singapore - 6


Darius Dale


Bear Market Macro: SP500 Levels, Refreshed...

What a difference 6 hours of trading makes… 

  1. Intel (INTC) posts a blockbuster quarter, trades up +7% in the pre-market and is now only up +2.5% with TREND line resistance = $21.98
  2. SP500 (SPY) falls hard from pre-open futures indications, breaking down back below our critical long term TAIL line = 1096
  3. Volatility (VIX) continues to push higher (closed up on the day yesterday as well), trading convincingly above our long term TAIL = 23.69. 

All that said, unless 1076 is violated to the downside on a closing basis, what was immediate term TRADE line resistance last week (1076) is now immediate term TRADE support. This is the most immediate term duration in our model, but it definitely matters.


Altogether, I say respect the math from here. A break of 1076 is now flashing no downside support to 991. In other words, I’d consider the SP500 trading in an intermediate term range of 991 to 1144 probable scenario that you should manage risk towards.


Short high, cover low.



Keith R. McCullough
Chief Executive Officer


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

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