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AC has seen 33% of its slots exit the market over the last 5 yrs including 2k or 7% since the end of 2009; yet, overall slots in the Northeast have grown.



The number of slot machines in Atlantic City has fallen from 42k to 28k in only 5 years.  That’s a 33% decline including a 7% decline just since December.  Atlantic City is a market long under pressure from slots in Delaware, New York, and Pennsylvania, and expansion in CT.  While this is probably a smart strategy to improve productivity in a declining market and save on taxes since New Jersey levies an annual $500 per slot license fee, fewer slots is not a positive trend for the equipment suppliers. 


While everyone tries to figure out whether the “new” replacement cycle is 7, 10, or 12 years, what if the slot base starts declining?  We guess that’s the potential partial offset to the new market thesis.  However, as the following analysis of the Northeastern market shows, new markets are the more powerful theme.  Despite the huge drop off in AC slots, non-AC slots in the northeast outnumbered AC beginning in Q4 2006.  Since then, AC lost 8k more slots through Q2 2010 while the other states gained 25k.




Our point is that the US slot market is a growth market, as it is internationally.  To be sure, mature markets tend to lose slots over time due to rationalization and more importantly, the opening of new and competing markets.  However, the US is not slot saturated.  New markets have always brought incremental slots.  Replacements ebb and flow but they remain.  Despite the Great Atlantic City Depression, per our conversations with the operators, casinos there are still replacing roughly 8% of their floors annually.


With the state budgets in serious decline, more and more states will legalize or expand gaming.  This may not be good for existing operators, but as the Northeastern market shows, it should be a big net positive for the slot suppliers.

The Week Ahead

The Economic Data calendar for the week of the 26th of July through the 30th is full of critical releases and events.  Attached below is a snapshot of some (though far from all) of the headline numbers that we will be focused on.


The Week Ahead - c1

The Week Ahead - c2

Bear Market Macro: SP500 Levels, Refreshed...

It’s kind of getting fun to watch this market trade between its TRADE (1085) and TREND lines (1144). Fun enough to be sitting here at 3PM on a Friday afternoon in July. Provided that 1144 remains overhead, I’ll call the US stock market a bear with refreshed immediate term TRADE resistance at 1109.


It was also fun watching American and European professional politicians make things up all week. I wrote two Early Look notes this week with one name in common, Fiat – the Fiat Guns and the Fiat Republic – but it’s really all one and the same. There is a very serious group of conflicted and compromised politicians in the Western world who genuinely believe that government is the answer to economic problems.


Next week’s big catalyst on the American Austerity front will be the National Commission on Fiscal Responsibility and Reform meeting in DC on Wednesday. Don’t forget that Clinton’s ex-Chief of Staff, Erskin Bowles, has already served up the opening volley on the deficit spending front by calling America’s debt and deficit balances “a cancer that can destroy the country from within.”


It’s the weekend – at least our long positions are safe until Monday.


Have a great weekend with your families,



Keith R. McCullough
Chief Executive Officer


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

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R3: RL… Another Move People Will Underestimate


July 23, 2010


Korea gives yet another leg of growth to one of the most consistent growth stories in retail. Will RL sandbag integration costs, etc…1Q print? Yeah…probably. But there’s enough gas in the tank in this model that it shouldn’t matter. Consensus numbers are too low. 





RL’s announcement to repo its South Korea license from Doosan Corp is a slam dunk.  The price seems fair, and the integration costs are likely to be relatively small in light of RL’s ability to leverage recent structural investments in China.  Consider the following…

1)      This is spot on with the company’s strategy to control all of its brands, at all price points, in all channels of distribution, in all regions of the world. Have you ever visited a RL store in Korea? Not pretty…

2)      Korea is one of the more attractive ‘accessible luxury’ markets in the world. For comparison, Korea’s per capita spending is #30 in the world at $27,978, China is #95 at $6,567.

3)      Doosan has 5 freestanding locations and 175 shop in shops through S. Korea. By way of comparison, the Chinese license got RL 40 stores and 100 shop in shops.

4)      Interestingly enough, the risk profile in Korea is meaningfully less than in China – largely due to a more established and sophisticated consumer.

5)      Not only is the Korean consumer base more stable, but as of January 1 2010 RL has a major DC open in China. This allows them the luxury of materially ramping utilization of a new expensive asset.

6)      If you’re living in Europe or Asia, try going online and buying RL product. Good luck… Dot.com is not yet ‘turned on’ there. They’ve only got the US humming. International in dot.com begins later this year. As it relates to Asia, try selling a 60% margin business when there is an unconsolidated partner who has full control over retailing similar product in a given region. 

7)      The price tag here seems reasonable. Keep in mind that most of these license acquisitions seem very expensive at the time as RL is buying an underloved asset who’s real growth potential has not been realized due to lack of integration with the rest of the company. The license cost $47mm (including $22mm of variable inventory and assets) compared to $18mm for China, and $26mm (10 years ago) for Japan.

8)      Two geographical licenses remain. One controlling Oceania, and the other controlling the Virgin Islands and parts of Latin America. The LatAm license makes sense next (tourist shopping markets), but Oceania is likely a rounding error.


The punchline here is that this gives yet another leg of growth to one of the most consistent growth stories in retail. Will the company start sandbagging integration costs, etc…when they print their upcoming quarter? Yeah…probably. But there’s enough gas in the tank in this model that it shouldn’t matter. Consensus numbers are too low. 





Adidas Preannounces Postive Earnings From World Cup - World Cup success isn't limited to Spain. Releasing preliminary results on Thursday, Adidas AG, the world's second-largest sporting goods company, said second-quarter profit jumped to 126 mm euros , from 9 mm euros during the same period a year ago, boosted by sales of soccer gear. Sales increased 19% and first half of 2010, profit reached 295 mm euros. Adidas outfitted 12 of the national teams competing in the FIFA World Cup in South Africa, including Spain.  <wwd.com/business-news>

Hedgeye Retail’s Take: Lets not forget the impact of Easy Tones boosting Reebok sales, either.  World Cup goes away next year. Let’s hope for Adidas’ sake that the ‘toning’ category accelerates.


Fashion World To Experience Inflation - Life is getting more expensive in the fashion world, and consumers could get stuck with some of the bill. “The era of apparel deflation is now over,” said Richard Noll, chairman and chief executive officer of Hanesbrands Inc. Cotton prices are up more than 50% from a year ago, labor and transportation expenses are rising and factories that closed during the recession remain dark, keeping a cap on supply as demand perks up. To top it off, Chinese officials have become more willing to allow the yuan to appreciate against the dollar, which could make goods made in the country even more expensive. “You’re starting to see price increases come through the entire supply chain, not just from commodity costs, but also from a supply and demand imbalance,” Noll said. “There is no question that costs are working their way through the supply chain and you will see a broad-based increase, I think, in retail prices for apparel in 2011.”


Hedgeye Retail’s Take: If ‘The era of apparel deflation is now over’ is not the quote of the year, then I don’t know what is. Now someone answer me this… If cost deflation is history, then it means that to purchase the same number of units, consumers to stomach a price increase for apparel. Anyone want to check the record books and see when the last time was that consumers took an apparel price increase?


New Balance Concept Store Opens in Dedham - New Balance opened its new concept store in Dedham, MA. The Dedham store will showcase a new design concept that highlights New BalanceÂ’s strong performance and technology brand story. <sportsonesource.com>

Hedgeye Retail’s Take: Too bad New Balance still can’t make money.


Supply-Side Limitations in Asia Hit the Top and Bottom Lines at LaCrosse Footwear - BOOT reported a second-quarter net profit of $0.1 million, or 2 cents a share, which is down 94% from $1.7 million, or 26 cents, in the same period a year ago. Net sales were down 11% with both the work and outdoor categories suffering declines in the quarter. Sales in the work market were down 15% due primarily to the timing of U.S. government orders. Sales in the outdoor market declined 2% from constraints on the supply of finished goods caused by capacity limitations at the firm’s manufacturing partners in China. <wwd.com/footwear-news>

Hedgeye Retail’s Take: Capacity limitations = harbinger of higher prices.


Skechers Hires The Licensing Company To Oversee European Expansion - The Licensing Company has been appointed to oversee a European-focused merchandise program for Skechers. As agent, TLC will seek partners for the brand in apparel, fashion accessories, hosiery, bags, outerwear, sporting goods and luggage for men, women and kids. Skechers joins TLC's other clients, including Airwick, Bic, Jim Beam, Umbro, Cosmopolitan, Lysol, Jelly Belly, Perrier, Jeep, Michelin and Welch's. In the U.S., Skechers licensees include children's apparel, bags, eyewear, legwear, medical scrubs and leather accessories.  <licensemag.com>

Hedgeye Retail’s Take: SKX smells really bad to me here. A) They’re riding a massive unsustainable wave, b) They’ve underinvested in the base (ie they’re overearning), and c) are now outsourcing the job of finding ways to license out content in foreign markets.


Gilt Groupe Continues App Success With a Droid App - The limited-time sale retailer is building on its iPhone app’s success with a new Droid app. “We are starting to see downloads of the Android app and sales through it already this morning,” Shan Lyn Ma, senior director of product development at New York-based Gilt Groupe Inc., said earlier today. “The main insight we’re seeing so far is that the orders have been primarily from men.” That wasn’t surprising because men are known to be strong users of smartphones that run the Android operating system. And they’ve been an important part of the early growth in mobile activity on Gilt’s iPhone and iPad apps, which the retailer launched in August 2009 and April 2010, respectively.  <internetretailer.com>

Hedgeye Retail’s Take: These retailers continue to fascinate me. They’re definitely doing the right things to navigate the fact that their models are not scalable.


Sluggish top line is well known but margin upside is likely going forward.



As we pointed out in our “PNK: MOVING INTO OVERSOLD TERRITORY” post on 7/7/10, the Street is likely underestimating PNK’s margin potential and the magnitude of the properties’ marketing underperformance.  PNK’s properties have generally underperformed the important metrics of revenue per slot and profit margins.  We believe the new management is a vast improvement to the empire builders of the past.  While progress will be gradual – only some margin improvement will be evident in the Q – PNK is an intermediate term secular margin story.  In other words, PNK has margin expansion potential that its competitors do not.


For the quarter, we are at $49.6 million in adjusted EBITDA, slightly below the Street.  Given the regional top line trends, we believe whisper expectations are low.  The driver for the stock will be margin expectations for the future which we believe will be ratcheted northward.  Cost cutting should be a two year story, consistent with other gaming operators.  The difference is that the other operators began cutting in 2008.  We expect cost cutting to fuel margin improvement through the end of 2011, even if top line trends remain sluggish.  We cannot say that for the other gaming operators.


We do harbor some longer term concerns:  the consumer, particularly as it relates to domestic gaming spend, and the long-term impact of political pressure on Gulf drilling as the oil industry drives 16% of Louisiana’s economy.  However, the influx of relief workers related to the oil spill should have a net positive impact on near-term business.  


For all of 2010, we are projecting $207 million in adjusted EBITDA, $10m above the Street.  The differential grows in 2011, $245m versus the Street at $228m.  That puts the valuation at only 6.1x 2011 EV/EBITDA.  Excluding construction in progress associated with Baton Rouge, which won’t contribute any EBITDA in 2011, the valuation falls below 6x.


U.S. market saw weak volume on yesterday’s rally. 




As we look at today’s set up for the S&P 500, the range is 20 points or 1.0% (1,083) downside and 0.9% (1,103) upside.  Equity futures are trading mixed ahead of the European banking stress tests results due at noon.  Analysts expect between 5-10 banks to have failed and will need to raise additional capital.




Moody's Investors Service said it placed Hungary's credit rating on review for a possible downgrade after the government was unable to reach agreement with international donors on fiscal targets.


The U.K. economy grew almost twice as much as economists forecasted in 2Q10.  Gross domestic product rose 1.1% after increasing 0.3% last quarter.  Economists forecasted 0.6% growth, according to Bloomberg. 


German business confidence unexpectedly surged to a three-year high in July after exports boomed and economic growth accelerated. The IFO institute said its business climate index, based on a survey of 7,000 executives, jumped to 106.2, the highest since July 2007, from 101.8 in June.




Overnight the MSCI Asia Pacific Index end the week higher for the third straight week.  China closed up another 0.4% last night, bringing the weeklong rally to 6.1%; China was the best performing market in the world last week.  The improving sentiment in China is due in part to speculation about some relaxation of property tightening measures.  China is still broken on TREND.


Copper was up 2.3% yesterday to close at 3.18, 0.01 below the TRADE line of resistance.  Oil is trading near its intermediate TRADE line of resistance of 79.12.  Yesterday, we shorted copper (JJC).  


Treasuries were weaker yesterday with the strength in global equities.


Europe was another bright spot on the back of the upside surprises in the flash Euro zone manufacturing, services and composite PMIs for July.


Yesterday, the S&P rallied on decelerating volume, while the down days are on accelerating volume; a bearish sign.




The Industrials (XLI) sector provided a nice chunk of upside leadership in the S&P 500.  Strength was fairly broad-based, though Transports +3.9% were the standout after UPS +5.2% beat consensus EPS expectations for Q2 on margin upside, while the company also raised 2010 guidance above the Street.

The rail companies were another bright spot following a meaningful EPS beat from UNP +4.8% on a lower-than-expected operating ratio.


Housing-leveraged stocks were among the best performers today with the XHB +3.7%. Recall that the group rallied nearly 4% on Tuesday despite the weaker-than-expected June housing starts data.


The third best performing sector yesterday was the Financials (XLF).  Along with the asset managers, which rallied on the back of an unexpected improvement in Q2 flows at JNS +11.8%, the financials were underpinned by the strength in the banking group, with the BKX +3.9%. Regional’s provided the upside leadership. 


Howard Penney

Managing Director


US STRATEGY – UP MARKET, DOWN VOLUME - levels and trends 723













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