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Growth and Progress

“Without continual growth and progress, such words as improvement, achievement, and success have no meaning.”

-Benjamin Franklin


Given the amount of time I spend ripping on American professional politicians, I’m happily surprised to say that the most enjoyable read I’ve had this summer was Walter Isaacson’s “Benjamin Franklin – An American Life.”


I actually picked the book up off of my wife Laura’s side of the bookshelf on a Saturday morning (my side is long Canadian hockey year in reviews - hers, American history), and she’d already flagged a page with the following passage:


“But the image he created was rooted in reality. Born and bred a member of the leather-aproned class, Franklin was, at least for most of his life, more comfortable with artisans and thinkers than with the established elite, and he was allergic to the pomp and perks of a hereditary aristocracy. From these attitudes sprang what may be Franklin’s most important vision: an American national identity based on the values and virtues of its middle class.”


Franklin’s story is All-American. It’s accessible. And it’s believable. Every one of us wants to live a successful life that has meaning. “Improvement, achievement, and success” are certainly goals that both my family and Hedgeye teams have. “Without continual growth and progress” however, we will pass up the precious opportunity of life by telling ourselves stories that we are making a difference.


That’s my problem with American government right now. That’s why I go off on it so often. Our economic growth is based on a false premise that ‘government is good’ and it has the ability to bail us out of all our problems. As a result, there is no progress in financial markets right now. Instead we get what our Compliance Czar, Moshe Silver, calls Dodd-Frankenstein “financial reform.”


Barney Frank and Chris Dodd are not men of Ben Franklin’s definition of virtue. They lie. You Tube is one of America’s greatest modern day innovations partly because it has offered us this plain and ugly truth.


Whatever this “government stimulated” growth is that gets reported in this morning’s Q2 GDP number, I can proactively forecast this about it – the GDP number will reveal nothing in terms of the standard of progress that this country should hold itself accountable to.


Never mind the stock market being Wall Street and the manic media’s bogey for progress anymore – for we hard working Americans (I have my green card!) who have actually been creating American jobs for the last 3 years as opposed to bitching about them, here’s what we are looking for as a multi-factor scorecard for American Growth and Progress:

  1. Strong Employment
  2. Strong Currency
  3. Strong Rates of Return

This isn’t political commentary. This is a pragmatic plan. If you’re a professional politician who has been forwarded this email and you don’t like being called names or being called out – too bad. Quit whining, pointing fingers, and fear mongering and fix these 3 things. You actually have a job with wage growth, so start earning your keep.


America has no Growth and Progress right now because we have none, never mind one, of the above:

  1. Employment – Given yesterday’s weekly jobless claims number of 457,000 we can be assured that the unemployment rate for July will remain above 9%. On a net basis, there have been ZERO net jobs added in this Fiat Republic in the last decade.
  2. Currency – the US Dollar has been down for 8 consecutive weeks, losing -9% of its value since early June, solidifying the long term TAIL of wealth oriented risk that remains in this country of debauching the currency of our citizenry.
  3. Rates of Return – sorry middle class Americans with a hard earned savings account. Short term Treasury rates just hit another all-time low this morning and if you want to get yourself levered long another 301k, the SP500 has a negative return for 2010 of -1.3% YTD too.

We get that professional modern day politicians are more focused on their job security than they are showing “continual growth and progress” on these 3 critical scores. As the Benjamin Franklin reminds us, “anyone who trades liberty for security deserves neither liberty nor security” and when it comes to jobs or rates of return in this country today, ain’t that the sad truth.


My immediate term support and resistance levels for the SP500 are now 1076 and 1119, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Growth and Progress - frank


Wynn Macau may have indeed missed whisper expectations but those expectations were probably too high due to bad modeling. We don’t see any signs of accelerating commissions or promotional activity.



We thought Wynn Macau’s $216MM EBITDA was a solid number above our estimate of $211MM. Unfortunately for WYNN, whisper expectations were probably too high.  At least one analyst had recently gone to $235MM and some on the buy side were talking $250MM. 


So what went wrong?  Nothing actually.  The problem was in the expectations where bad modeling likely drove unreasonable estimates.  Our guess is that these bullish analysts/investors simply projected the Q1 margin of 30.7% and assumed it would go higher based on the addition of Encore and its concentration of higher margin direct play.  Holding everything else constant, a higher mix of direct play should drive margins higher.  However, the mix change was only slight sequentially and mix change doesn’t occur in a vacuum.  The key here is that commissions, rebate rates, and promotional activity – all metrics that analysts will blame for the whisper miss – did not accelerate in Q2.  Wynn Macau actually beat our margin estimate driven by lower casino expenses. 


Here are some details to back up our contention that you can’t just stick in EBITDA margin on net revenues:

  • Based on our calculations, direct play only increased 100bps as a % of total RC over last quarter as junket growth was also strong.  For those analysts that actually take the time to model direct play they may have assumed it would be higher.  According to our database, direct RC did increase 15% sequentially compared to a 6.5% sequential increase in Junket RC at the property. 
  • We calculate the VIP rebate rate on was only 0.93%, thus Wynn does not appear to be buying this business.  As a result, the net VIP win was $1MM above our estimate.
  • While we won’t know the exact commission rate until Wynn Macau files, we estimate that the commission rate was about 40%.  Many analysts/investors will blame whisper miss on higher commissions but this does not appear to be the case.  Higher hold rates typically come with higher rebates and commissions – so despite having a slightly higher mix of direct play this quarter- those modeling high hold should have modeled a higher commission rate.  Last quarter’s commission rate was 39.1% - lower than normal for Wynn given the low hold in the quarter.  Wynn’s commission rate for 2009 was 42% as a point of reference.
  • Slot handle growth of 43% YoY was a nice reversal of sluggish growth over the last year for Wynn but hold % was low – 4.5% (which is not unusual given the high limit additions which typically have higher payouts) – this also negatively affected the sequential margin


Other Details:

  • Wynn Macau’s $714.4MM of revenues was actually $5MM below our number but lower casino expenses more than made up the difference
  • Most of the revenue difference was due to lower room occupancy, which was offset by lower promotional spending
  • VIP gross win of $709MM was $10MM below our estimate, RC was $800MM below our estimate, while hold percentage was 7 bps above our 3.15% estimate
  • High hold on VIP play, which we knew about and analysts should’ve known about, boosted revenues by $80MM and EBITDA by $15MM
  • High hold on Mass boosted revenues by $5MM and EBITDA by $3MM.  Mass drop only grew by 14% which was a little disappointing
  • Implied fixed costs increased from $79.0MM to $84.5MM


The Macau Metro Monitor, July 30th, 2010



Sands China acting CEO Leven says in the coming months, Sands will "study the economics" of using junkets versus direct marketing to VIP players.  This echoed Adelson's comments in the conference call on pulling back on the direct VIP business.  According to CLSA, there are currently 75 active junkets in Macau, the top five of which control about 80% of Macau's VIP market.


According to a person familiar with the situation, Wynn Macau also pursues its own high-end customers, but not in large volumes.


According to Irwin Abe Siegel, a board member of Sands China, the salaries of all members who have completed at least one full year of service as of July 1, 2010 and are still in employment as of August 31, 2010 will rise by 3.5%, effective as of July 1.

According to sources contacted by Macau Business, around two thirds of Sands China’s 18,000 workers will benefit from this wage increase.

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Here are our notes from the WYNN conference call.  We will have analysis in an upcoming post.




  • Business is slightly better in Las Vegas given the shift in business mix
  • The beach club which just opened is doing great, as is the rest of their night club business which can do north of $150MM of revenues for them at 40+% margins
  • Encore Macau's opening was accretive to their quarter
  • Have 10% of the position in Macau and 17% of the revenue there. Their fair share ratio is 1.62x.
  • Cotai project design is complete, will start foundation drawings in a few weeks, so they are a little ahead of schedule with their development process.
  • Impact of the financial reform bill that President just signed - has the potential to have a catastrophic impact on business


  • Vegas: They are starting to improve their rates as they become less dependent on the leisure business and trading it for the convention and group business which is trending at 17-18% of their rooms
    • They are taking 15-16% of the inventory out of commission as well though - so that really helps them increase the rate since they have less rooms to fill
    • Remove 400 rooms per quarter through January and then they will start their suite remodels
  • Asian business in Vegas has decreased but sustained better market share through their cross marketing efforts
  • Wynn Las Vegas will be all spruced up by Spring 2011
  • Hoping that they will have a lot more to show the investor community about their Cotai project either next quarter or 1Q2011
  • Any improvement in spend per occupied room rate in Las Vegas?
    • No - they aren't seeing any improvement
    • Only the nightclub business is doing great
  • When they finished design development in Cotai they noticed that they still had 12 acres left over, so they may do 2 phases. They are right across the street from MGM's site
  • Cash base business is up year over year and continue to see improving trends in July in Vegas
  • Wynn Cotai will be positioned consistent with their existing property- and do what they do best. It will have 1,500-1,600 rooms which will be bigger and more beautiful than anything they have ever built. They will have 500 tables and 1300 slot machines.
    • The extra 12 acres they haven't made any decision on what to do with it.  Their design only use 40 acres not 52.
  • In the convention segment, they are seeing some strengthening going into next year
  • Seeing some lift in food and beverage as a result of the club business, which is why they are adding 2 outlets - L'Cab (Nov 2010) and Lakeside Grill
  • Any impact from recent strength in the Euro?
    • Nothing. They got a small lift when the Euro was around $1.50
  • Ramp up of Encore Macau through out the quarter?
    • Accounted for all the expenses going into the opening.  They had everyone on payroll in 1Q2010
  • Wynn Macau generates 25% of the EBITDA in the market and 40% of the net income
  • Cost of the Wynn Las Vegas room remodel: $99MM + baccarat remodel cost
  • Doesn't think that anyone will open before them on Cotai aside from Sites 5 & 6 and Galaxy
  • Hold % of slots going up in Vegas?
    • They are changing the composition of their floor.  They've been removing some of the 99% payout poker games.
  • The reason the table drop per table is soft in Vegas is because there are so many tables. Customer acquisition costs are up because when their customers can't maintain their buildings and get desperate for customers they become very promotional. Promotional environment in Vegas is continuing into the 3Q.


Here is a look at RUTH’s guidance going into earnings tomorrow.


Earnings and Same-store Sales

  • RUTH needs to post company-owned same-store sales of +4.4% to maintain two year trends
  • Per reuters estimates, company-owned same-store sales are expected to come in at +4.7% and franchise same-store sales are expected to be +4.7% 
  • The street’s estimates imply an acceleration in same-store two-year trends
  • Over the past three and six months earnings revisions have trended higher, but little changes in the past month


  • Opening one franchise Ruth’s Chris Steak House in May
  • Opening one Mitchell’s Fish Market late in the second quarter
  • Food and beverage costs are projected to be between 29% and 30% of restaurant sales
  • Marketing spend is expected to be between 3% and 3.5% of total revenues
  • G&A expenses are expected to be in the 25% to 30% range
  • CapEx spending is projected at 7 to $8 million
  • Free Cash Flow is expected to be in the 18 to $20 million range
  • 50% of prime beef is locked for 2010, slightly below average 2009 cost
  • 10% of tenderloins are locked for 2010
  • In the market trying to lock down price given the elevated beef prices…too early to speculate for 2011
  • Locked in on shrimp for 2010


  • In March and April, sales growth was in the mid-single digit range
  • “Movement away from the Ruth’s Classis with 39.95, 49.95 price fix promotion has not led to a fall-off in mix which continues to be in the 30% range” – it will be interesting to see how mix has continued to hold up
  • Half of beef is tender, half is prime, and beef represents 35% to 40% of their total cost of goods sold




Howard Penney

Managing Director


SKX: Overearning

Note to SKX management: C’mon guys…don’t get lost patting yourself on a job well done with Shape-ups (and it was, in fact, a job well done). But switch gears and deploy capital in a way that will prevent another blow up. The Street’s over $4.00 in ’11. I can get closer to $2.50.


Yes, it was a love fest on the SKX conference call. Shape-ups, product mo, blow-out quarter, etc… I get it, and so does the consensus. But there are some bigger questions to be asking here – and the answers don’t give me one iota of confidence in the sustainability of this business model or growth trajectory. Consider the following…


1) Shape-ups now account for ~25% of total sales according to our estimates, and accounted for 75%+ of growth vs. last year. Excluding Shape-ups, sales were likely up +10-15%. I will never take anything away from a company that is printing revenue based on hitting – and even creating – a trend. But we also cannot straight line this performance in perpetuity.

2) Industry-wide, ‘toning’ went from ~2.5mm pairs, at an average price point of ~$95 in 2009 to a current annual run rate closer to $1.2-$1.5Bn, 15-18mm pair at $80-$85, respectively.  SKX’ share is roughy 60% and has trended down recently as Reebok sales ramped up. Let’s face it folks, with fashion, nothing attracts a crowd like a crowd. Now Payless is selling them for $29.99 with a BOGO (buy one get one half off) and it is 1% of sales today moving towards 6% by year end. That alone would represent ~8% of the industry’s unit share in this category.

3) Why does all this matter? SKX cannot afford either a slowdown in unit demand or ASP compression in this category. Period.

4) Why? Because SKX deploys capital throughout its organization when it can, not when it should. Even today the company is deferring new DC and related equipment spend into next year.  Since launching Shape-Ups in early 2009, better than 55% of incremental revenue has landed on the bottom line as outlined in the chart below. After COGS and incremental store build costs alone, this should result in flow through less than 50%. Then add on capacity expansion (DC and equipment, but more importantly, people to crank on R&D and Sales/Marketing to play offense against potential pressure in toning). No one knows the exact flow through needed, but my math suggests that it's closer to 30%. 

5) The bottom line with margins is that this company should realize about a 600bp boost in margins this year. If we’re going to give the model any shot at sustainability, then they should be investing more, and printing margin improvement that is half what we see today.

6) In addition, despite higher product costs due to labor, commodities, transportation, yuan, etc… SKX is guiding to higher Gross Margins – which is anomalous and raises a red flag with me as to the sustainability.

7) Longer term, lets not forget that SKX is massively net short Yuan. With 90% of its product sourced in China and less than 5% of its revenue generated in China, this is a pretty steep delta against a freight train of a long-term Macro backdrop for the Yuan.  Nike, on the flip side (and even Adidas) only makes 26% of product in China. So it has $10bn in COGS, and $2.6bn in rmb exposure. But it has a growing and profitable China revenue engine, that stands at about $1.8bn today. I could make a strong case that Nike is net long the Yuan within a 2-year time period. That puts it near the top of any other consumer-related multinational that has such favorable exposure.  Skechers? Not quite.

8) The punchline? We’re going to see the sales delta slow within 2-quarters, which is the same time that prices in the toning category will be more competitive. Then higher product costs will matter, as will deferred infrastructure investment. Add that all together and it’s not unrealistic to get to 2011 being a down year. The point is that estimates are likely to come in over $4 in 2011 after this quarter. But $2.50 is perfectly within reach – and more likely. When SKX misses, it will get a 10x pe at best. That’s a $25 stock, or 33% down from here.

9) Timing: Will this deck of cards come crashing down next week? I dunno. I doubt it, actually. But I don’t think we have to wait a year, either. Looking at the quarters ahead, and synching with product flow, and competitive climate, I place a 60% chance it happens before Dec 31, and 80% before the end of 1Q11.  I’ll work closely with Keith and let him make the call as to what to do in the interim from a TRADE and TREND perspective. But if I owned this name today, I’d be punting it.



SKX: Overearning - SKX Incr EBIT Flowthr 3 7 10



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