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3D Risk

“People are nervous about the long term outlook, and they should be.” 

-Paul Volcker


I had a great day of meetings in New York City yesterday. It’s always additive to get the City’s pulse on risk management matters. The biggest risk that I found myself talking about was one that I haven’t spent enough time writing about – the risk associated with the world’s largest current bubble imploding – short term US Treasuries.


This morning, on the heels of a very disappointing earnings report out of one of America’s largest growth engines (Google), yields on 2-year US Treasuries are trading down to 0.58%. The inverse of this yield equates to the highest prices for short term US Treasury Debt EVER.


Ever, as we like to say at Hedgeye, is a very long time. Particularly when considering bubbles and the tail risks they incubate, it’s critical to never accept ever as forever.


I could go off this morning on the credit quality of US Treasuries, but Jim Grant has done a much better job than anyone else on this topic and I’ll point you to his most recent “prospectus” for US Treasury bonds as required reading. His conclusions weren’t bullish.


Back to the tail risks embedded in the lowest Fed Funds and Treasury yields ever, I’ve started to frame this up using 3 D’s – The Disguise, The Dare, and The Delay.


What risks are implied when the US government is setting unsustainable and unreasonable expectations that rates will stay at ZERO percent forever?

  1. The Disguise – considering an ever forever disguises financial risk and unintended consequences.
  2. The Dare – both the Fed and Treasury are effectively daring you to get out there and lever yourself up with either “cheap” liabilities or chase “higher yielding” asset classes than the “risk free” rate of zero percent.
  3. The Delay – bad actors who are bad stewards of capital get their bad capital allocation decisions (losses) socialized and this delays much needed restructuring of their balance sheets.

When US interest rates push higher – and they will when you least expect them to – you are going to see a 3D version of massive global asset management blowups. This time, no one can say “no one saw this coming.”


Getting the timing right on this is what it is – difficult. That’s why we call this a tail risk. There is a less than a 3% probability of US Treasuries imploding today, or next week. But… every day that 2-year yields hit their lowest level ever, creates a higher probability over the intermediate to long term that Treasury rates go up.


In terms of immediate term leading indicators for interest rate risk, I think the best one for a country’s fiscal and balance sheet health is its currency. Watching the US Dollar hit lower-immediate-term lows yesterday hopefully got President Obama’s attention.


The US Dollar Index is down for the 6th consecutive week and has lost -6.7% of its value since the beginning of June. For the world’s alleged “reserve” fiat currency, that’s a lot and we, as your Risk Manager, think you should be paying acute attention to this.


As a reminder, our Q3 Macro Theme of American Austerity submits a very straightforward thesis – the US Dollar is going to become what the Euro has been for the last 3-6 months as both the US and the world come to grips with the reality that both the US deficit and debt to GDP ratios are going to look a lot like Spain’s in 2011.


Put another way, assuming that the US Dollar is going to be an American entitlement that we can use and abuse as the world’s reserve currency forever, and that short term US Treasury Bonds will trade at their highest prices ever and forever, is no longer reasonable.


My immediate term support and resistance levels for the SP500 are now 1077 and 1121, respectively. We shorted the US Dollar on June 7th via the UUP etf and remain bearish on both the US’s fiscal position and its balance sheet health.


We’ll be doing a full slide presentation and conference call on American Sovereign Debt and the implications of the aforementioned tail risk that’s mounting on the short end of the Treasury curve in a few weeks.


Have a great weekend and best of luck out there today,



Keith R. McCullough
Chief Executive Officer


3D Risk - 2Y


The only surprise will be if HOT doesn’t surprise on the upside and raise full year guidance when it reports next Thursday. 



We’re not sure that there are a lot of mysteries to HOT’s Q2 earnings and outlook, although margins are more uncertain than for MAR.  Like Marriott, we expect HOT to beat the quarter and raise guidance for 2010.  Consistent with history, the company will likely provide pretty conservative guidance for next quarter, in this case Q3.  Our Q2 projection is $217MM of EBITDA and $0.27 in EPS versus the Street at $209MM and $0.25, respectively.  For the full year, we anticipate the company will raise guidance from $810MM and $0.88 closer to our estimate of $847MM and $0.99 in EBITDA and EPS, respectively.


Now more than ever, the macro environment will drive revenues and lodging profits, and investors’ views of the future macro environment will drive stock prices.  Current RevPAR trends are strong but the reported quarterly results and weekly RevPAR numbers just give investors a glimpse into the rear view of the mirror.  We find it amusing listening to the sell-side repeatedly asking questions on 2011 trends and beyond.  Face it, there is very limited visibility in this space and hotels only have pricing power when occupancies exceed 70%.  Lodging trends have historically been lagging indicators, since what’s on the books today was booked at some point in the past.  If sentiment changes or things begin to deteriorate, future bookings are impacted, and by the time the numbers show a slowing trend, it would be already too late.  No matter what these companies report, how they trade depends on people’s outlook. The issue today is that investors’ collective view of the future is dimming and comps get much tougher in 2H 2010.    


Here are the details of our projections:


2Q2010 Detail


Owned, leased & other revenue of $416MM and gross margin of 17.9%

  • We expect room revenue to grow 7%.  Starwood owned room based has shrunken roughly 5% since 2Q09.
  • Non-room revenue growth of 4%, less lost NOI from the sale of the retail space at the NY St. Regis.
  • CostPAR growth of 2.9%.

Management, franchise, and other income of $175MM; $136MM (14% YoY growth) of which comes from real fees with the balance coming from “other stuff”.

  • Base management fees of $68MM, up 13% YoY.
  • Incentive fees of $29MM, up 13% YoY.
  • $39MM of franchise fees, growing 15.5% YoY.
  • $30MM of amortization of deferred gains, termination fees and other one time items.
  • $8MM of miscellaneous other revenues.

$132MM of VOI revenues and $30MM of gross margin

  • Originated sales revenues up 3% YoY with gross margins of 35%.
  • $61MM of other sales and services revenues, which includes $21MM of interest income on securitized and unsecuritized loans with $45MM of associated expenses (27% margin).
  • $8MM of deferred revenues and $6MM of deferred expenses.

Other stuff:

  • $80MM of SG&A.
  • $77MM of D&A.
  • $61MM of net interest expense.
  • 22% tax rate.


While estimates have been rising, LVS should beat consensus EBITDA projections.  Whisper expectations are high though.  For the stock to react, Singapore will be the pivot.



LVS should beat the Street pretty handily and even top the recent high estimates.  At $1.65BN of revenues and $440MM of EBITDA, we’re 5% and 17% ahead of consensus, respectively.  We’re pretty comfortable with our Macau projection but Singapore will be the driver of upside/downside from our estimate.  Singapore represents the pivot for the stock, in our opinion.  If Singapore beats the Street and management provides comfort that Street estimates are too low for Singapore (in other words, our numbers are right), this stock will go higher.  We’re not sure management can provide much incremental insight to Macau and Las Vegas.


Our estimates for FS and MBS are almost double consensus estimates.  We’ve got proprietary property data so we know Four Seasons held very well during Q2.  For MBS, our estimates are partly driven by our analysis of Resorts World Sentosa – namely $78MM of reported EBITDA but closer to $114MM when you add back the pre-opening charges.  We don’t think that MBS numbers will be as strong coming out of the box given that Resort’s World had some distinct advantages including:  1) knowing the market better, for example in electronic games, since it has operating experience next door in Malaysia, i.e. Genting Highlands,  2) opening first and thus having no competition during its first quarter, and 3) a busing program.




  • Net revenues of $280MM and $69MM of EBITDAR, in line with the Street.
  • We estimate a 2% increase in slot handle and slightly higher hold.
  • Table revenues down 6% due to market share losses to MGM.
  • While Venetian had very low table hold in 2Q09, Palazzo had high table hold; net net table hold was about average in 2Q09 at 19.3%.
  • Cost cuts should be lapped by now.




Sands Macau: 

  • Projection of $301MM of net revenues and $74.5MM of EBITDA, in-line with the Street.
  • Slot win of $23MM and Mass table win of $128MM, in-line with the Street.
  • $7.1BN of RC volume and $217MM of VIP win  (3.07% hold).
  • Fixed costs flat sequentially.

Venetian Macau:

  • We expect a huge quarter on the back of high hold and a very easy Y-o-Y comparison. 
  • We’re at $572MM of net revenues and $185MM of EBITDA, $6MM above the Street.
  • Slot win of $50MM and Mass table win of $228MM.
  • We expect RC volume to be down 5.5% YoY to $9.35BN but high hold of 3.4% will produce record VIP revenues of $322MM.  The comp is easy as well since Venetian suffered from low hold of only 2.3% last year.
  • Y-o-Y cost cuts should be lapped by this quarter.

Four Seasons:

  • Results should blow away expectations given its nice ramp up and massive hold percentage.  We expect FS to report $153MM of net revenues and $50MM of EBITDA versus the Street at $28MM.
  • Slot win of $5MM and Mass table win of $26MM.
  • We believe that FS’s junket RC volumes were $2.4BN.  In 1Q2010, Four Seasons direct volume was $1.6BN, 43% of total RC volume or roughly $534MM/month.  If we assume roughly 41% of total RC volume in 2Q2010 is direct, then total RC volume for FS would be roughly $4.1BN.  Assuming our RC estimate is correct, FS appears to have held over 3.7%.
  • Given the high percentage of direct play at this property, commissions have been quite low, so flow through should be good.

Total Macau: 

  • Excluding the cost of ferry operations and some other costs, LVS’s 3 properties could produce $310MM of EBITDA in 2Q on $1.025BN of revenues.
  • Street is projecting $280MM.




Our projection for MBS is $261MM of revenues and $100MM of EBITDA (excluding any pre-opening charges) versus the Street at $73MM.  Our assumptions are as follows:

  • Slot: 1,450 slots at $500/win per day.
  • Mass: 442 Mass tables, $500MM drop, 22% hold.
  • VIP:  75 tables doing $25k/table/day, offering rebates of 90bps in 2Q2010, which we project will steadily rise in subsequent quarters.
  • Hotels: an average of 950 rooms open, ADR’s of $250 and occupancy of 60%.
  • Mall: only 20% of the square footage opened this quarter; we assume straight-line rents of $150/ per square ft.
  • Fixed expenses of $105MM this quarter.

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Shorting Mexico . . . Aye Carumba!

Oh, down in Mexico
I never really been so I don't really know
Oh, Mexico
I guess I'll have to go

 - James Taylor


Conclusion:  We are short Mexico via the etf EWW due to its exposure to sequentially slowing growth in the U.S., drug wars that are accelerating, and declining oil revenue.

On July 6th we initiated our short position in Mexican equities.  Currently, we are down -1.8% on the position.  As Risk Managers, we aren’t happy being down on any position, even if just a couple of percent.  Call us lucky, or call us Risk Managers , but we have fortuitously only used one allocation for this position, so we still have the opportunity to average down up to three total allocations.


The short thesis for Mexico is threefold: oil, drug wars, and U.S. exposure.



  • The oil industry in Mexico is nationalized via PEMEX, the Mexican oil conglomerate.  In 2004, Mexico was producing 3.5 million barrels per day and that number is expected to be 2.5 million barrels in 2010, or a 29% decline over six years.  The bulk of this decline has come from the Cantarell field, which has declined ~70% from its peak production in 2004 (2.1MM barrels per day).  In the most recently reported quarter ending March 2010, oil production by Pemex was flat y-o-y, but the long term trend of declining volumes remains intact. 
  • PEMEX funds an estimated ~35% of the federal budget of Mexico, so as the production of oil declines over time, the federal government will be required to find other sources to fund its budget, or will be required to cut government spending.  In terms of general economic growth, the declining aspect of this national funding mechanism will be a sustained headwind well into the future. The chart below of Mexican oil production on a daily basis shows this clear trend of declining production. 

Shorting Mexico . . . Aye Carumba! - Mexico Oil Production


Drug Wars:

  • In 2009, there were more than 6,500 fatalities attributed to Mexican drug wars.  To put this in perspective, in the totality of the Iraq War, over an almost six year period, less than 4,500 U.S. troops were killed.  Based on year to date results in the Mexican drug war, the number of fatalities is expected to exceed 10,000 in 2010.  Currently, the Mexican government has over 45,000 troops directly focused on the drug war.  As the drug war continues to accelerate, alongside the headlines of murders, it will have a direct and significant impact on one Mexican industry: tourism. 
  • Tourism is one of the most important industries to the Mexican economy.  Globally, Mexico ranks tenth in tourism with more than 23 million tourist visitors every year.  In 2008, U.S. dollar spending by tourists was north of $13 billion.  In aggregate, tourism contributes roughly 13% of Mexico’s GDP.  Clearly as drug war violence accelerates, as it is, it will have a negative future impact on the tourism industry, a key driver of the Mexican economy. 

Trade with the United States:

  • Given the massive shared border and the nature of the North American Free Trade Act, Mexico is inextricably tied the economic fortunes of its largest trading partner, the United States.  Mexico is the United States’ third largest supplier of goods at ~$177 billion in 2009, which is more than 15% of Mexican GDP.  The United States is Mexico’s single largest export market.  Therefore, as the United States slows, so too will Mexico. 

  • In an attached chart we’ve outlined GDP growth in Mexico versus the United States.  The data for the past few years show us, not surprisingly, that there is a high correlation of growth rates between the two countries.  Additionally, the last down turn indicated that the Mexican economy has a tendency to overreact to the downside versus the United States.  Specifically, in 2009 Mexico experienced negative growth of -7.9% and -10% in Q1 and Q2 of 2009, which lagged the troughs in U.S. GDP growth of -5.4% in Q4 2008 and -6.4% in Q1 2009 by one quarter.

Given these systemic risks to Mexican GDP growth, we continue to like Mexico on the short side and will average in as prices permit.


Daryl G. Jones

Managing Director


Shorting Mexico . . . Aye Carumba! - Mexico GDP





“This is an exciting time for Marriott. Business and leisure stays at our hotels are trending up. Revenue per available room increased more than expected in the second quarter and room rates at company-operated hotels in North America rose for the first time in nearly two years. We anticipate even more favorable pricing in the second half of 2010 and into 2011. Combined with productivity improvements achieved over the last year, strong unit growth and increasing demand, we look forward to growing cash flow and strong earnings in 2010 and beyond.”

- J.W. Marriott, Jr., chairman and chief executive officer of Marriott International



  • Business is showing strong results which are continuing in the second quarter.
  • In period 5 (May) room rates rose for the first time (1%) and in June, they rose 3% (period 6). Primarily due to mix shift.
  • 75% of their company operated hotels increased rates in period 6. Corporate and premium rates rose 10%.
  • Roughly 15% of their rooms are under price guarantees negotiated previously. When negotiations start this year for group rate, they expect rates to be up.
  • Corporate group nights were up 10% YoY, with 20% booked within 3 months of arrival.
  • Group business for the quarter paid rates that were up 5% YoY.  Revenue is up 10-15% for group business booked 12 months out. Expect Group revenue to be up 2-4% in 2010.
  • Business in Europe and UK remained strong, benefiting from increased American tourism despite weak economies.
  • Asia is very strong, and China is benefiting from the Expo in Shanghai.
  • 3 cents of the upside was due to higher fee revenue and 1 penny was due to better timeshare results
  • Have 22 hotels under construction in China, and will shortly be MAR's largest market outside the US.
  • Have another 5 hotels awaiting conversion to the Autograph brand.
  • Have seen a modest uptick in interest to develop their limited service brands.
  • Timeshare was driven by cost efficiencies, lower marketing, and an 11% increase in rental revenues.
  • Have only 17 hotels on or near the Gulf coast.  Announced a beach guarantee for those hotels that allows guests to cancel if beaches close.
  • Guidance assumes that strong RevPAR growth they are seeing continues through the 2H of the year.
  • Introduced point program to give guests more flexibility to take longer or shorter trips. Also, now that they are selling a system vs. a specific location, they can now build less locations and better leverage sales centers regardless of availability.  This will also lower the % of revenues that are deferred since they will only need to sell developed units.
  • Don't expect to develop any new timeshare product in the foreseeable future.
  • Will reach leverage targets by year end and are turning focus towards value enhancing investments.
  • Acquired Seville hotel in Miami which will be converted into an Edition hotel post renovation.


  • Expense reduction program and how they can keep costs in check in the future
    • Think that they can have fewer managers at their hotels.  Obviously hourly staff will grow with occupancy. Can keep the procurement efficiencies.  Zero bonus compensation and frozen base pay are not sustainable.
  • Timeshare margins? 
    • More about not chasing that marginal customer.
    • Think that the will see higher closing percentages with the new points program which means margins can continue to improve.
  • 2H RevPAR system-wide outlook - mix of ADR/Occupancy
    • Expect to continue to see good performance around rate.
    • Rate growth is by and large driven by corporate travel and group; the next few months are leisure driven, so 3rd quarter will be more challenged but expect that to reverse in the 4Q.
    • Occupancy comps will become tougher.
  • Is their increase in room openings this year pull forward some demand from 2011?
    • Feel pretty good about 25-30k gross room openings in 2011 since 50% of their pipeline is under construction.
  • It will take several years to get back to the same levels of hotels paying incentive fees (60-65% in last peak). Their all-time high was 72% of hotels paying fees.
  • Timeshare - former pricing was 25-30k per week.  Average pricing on weeks was up about 5% in the quarter. They dropped their pricing aggressively last year (15-20%) so they expect to do meaningfully less going forward.  Expect pricing to increase.
  • Worldwide house profit margins were up 90bps for both domestic and international
  • Termination fees were also included in their guidance so they claim, at least vs. their guidance, that that didn't drive the upside.
  • Have seen very little cancellation because of the Gulf spill, but expect less bookings.
  • If operating profits in NA move up 20%, then it just moves a small number of hotels into the black.
  • Where did the growth this quarter in incentive fees come from? New additions (especially in Asia) and increases in results from hotels that were already paying and also had $1-2MM of fees accrued in prior quarters paid this quarter. There is some seasonality though in the incentive fees - and 3Q is seasonally a weak quarter since that quarter is driven by leisure. NY is already paying incentive fees. Courtyard that they manage - none are paying incentives today.
  • The incentive fees:
    • In the US, they don't get any fees until an owner priority fee is hit and then can get about 25% of profits.
    • International: no owner's priority but more like a high single digit fee from day one.
  • Giving existing owners the ability to participate in the point program and using the point program for new buyers. Fee to opt into the point program (conversion fees) won't move the needle for them because there are costs associated with switching to this new system.
  • Supply growth that they are seeing this year is primarily limited service and that's impacting the growth in those brands.
  • They aren't seeing any change in corporate demand in Europe, despite the sovereign debt crisis.
  • Color on corporate negotiated rate process
    • It's about 12-15% of their room mix.
    • In a quarter, they will be into those conversions but few will be completed. More of a year-end event.
    • Expect that rates will be up meaningfully over what was negotiated last year.
  • What sectors are driving strength?
    • Generally, it's across the board since everyone was hit last year or at least frightened.
  • Some special corporate rates are down 20% from peak rates. Expect those to be up high single digits on rate for 2011.
  • Share buyback?
    • First, they want to remain investment grade/ below 3x leverage.
    • Second, they want to make good investments.
    • Unlikely to see a buyback in 2010 though, but they do look to return cash to shareholders.
  • Seeing a very modest increase in the booking window.
  • Property level revenue forecast have started to come up closer to their guidance.
  • Had $6MM of termination fees booked in 3Q2009, which will not repeat in 2010.


As I stated in the today’s Early Look, until the consensus begins to catch up with the weakening reality, reporting risk continues to be to the downside of expectations. 


Consistent with that theme, the Empire Manufacturing Index fell from 19.6 to 5.1 in July.  Consensus expectations looked for a level of 18.  The index has fallen a cumulative 27 points from the 2010 peak of 31.9 reached in April.

  1. New Orders Index dropped 7 points to 10.1.
  2. Shipments Index fell 13 points to 6.3.
  3. Unfilled Orders Index declined 15 points to -15.9 (its lowest level since December).
  4. Delivery Time Index turned negative (a sign that delivery times had shortened)
  5. Inventories Index rose from a level near zero to 6.4 (inventories are building after holding steady in May and June).


Along those same lines, the Federal Reserve Bank of Philadelphia’s factory survey index fell to 5.1 in July from 8 last month, again missing consensus estimates.  A Bloomberg survey forecast the measure would rise to 10. 


Lastly, the Fed showed industrial production rose 0.1% June, boosted by utility output (hot weather), while manufacturing declined 0.4%.  On this factor, the consensus was bearish enough at -0.1%.


No matter where you turn there it is - growth is slowing!  Taken together, NY, NJ and PA make up 15% of the nation’s economy and the market is trading down over 1% on the news. 


Tomorrow, we get the preliminary look at the July University of Michigan Consumer Sentiment Index.  The consensus is looking for 74 vs. 76 last month.  Given the plunge in the most recent Conference Board confidence reading, reporting risk continues to be to the downside of expectations. 


Howard Penney

Managing Director



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