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Don't Do Dogma

“And remember, no matter where you go, there you are.”

-Confucius

 

I’ve learned, un-learned, a re-learned this lesson in trading markets many times in the last decade  - Don’t Do Dogma. The larger your risk management and research team becomes, the harder it gets to adhere to that discipline. The more research edge you have, the more confident you tend to become. This breeds confirmation bias and risk.

 

A disciplined risk management approach to allocating capital is a process best learned by doing. I don’t learn much when my team is right on the research - I work with winners who wakeup expecting to be right. I learn the most when our positioning to express that research is wrong.

 

This gets to the heart of a structural problem with our industry. There is a huge difference between being right on the research and right on your timing, sizing, and positioning. Our industry pays a “star” premium for conviction in best research “ideas”, but pays much less for the risk managed expression of those ideas. This is good. It provides a tremendous opportunity for us to evolve our profession.

 

“No matter where you go” this morning, “there you are.” I have my coffee and my notebook, and markets are trading for and against my positioning. Without a repeatable risk management plan, I’m not sure what you do when you login every morning. Different strokes for different folks, I guess, but when it comes to grinding through the morning’s macro data, my research process has a very low standard deviation.

 

Conversely, as you may have noticed, my decision making process has a very high standard deviation. Sometimes I make too many Hedgeye Virtual Portfolio and Asset Allocation moves, sometimes I make too few. I learned this playing hockey more than anything else, but there is a time to be moving your feet, and there is a time to wait in the weeds – goals get scored when your timing is right.

 

Yesterday the US stock market was down, so I took that as an opportunity to cover some shorts and buy some longs. Because our macro research is bearish on both the US Dollar and the SP500 doesn’t mean I have to be bearish at every time and price on everything USA (we’re long XLU, Utilities).

 

In modern day risk management, it’s critical to contextualize both time and price within the framework of different investment durations. That’s why we have developed the TRADE, TREND, and TAIL process. It helps us communicate our research findings in a way that isn’t Duration Dogmatic.

 

The SP500 has only had 1 up day in the last 6 trading days. That 1 up day was of consequence however, because it took out the immediate term TRADE line of resistance of 1117. Whenever resistance becomes support on any of our 3 core investment durations (TRADE, TREND, and TAIL), I start moving my feet.

 

The setup for this morning is the same as it was as I was changing my positioning into yesterday’s close. Inactive investors dogmatically call this “trading” – I call it proactively managing risk. You trade today in order to set yourself up for tomorrow.

 

We went through this on our Macro Monthly Strategy conference call yesterday (if you’d like the slides and replay, please email ), but it’s worth repeating – the Bear Market Macro lines for the US Dollar Index and SP500 are $84.32 and 1144, respectively. These are my intermediate term TREND lines of resistance. These back-test with the highest success rate of any duration in my model.

 

Bearish TREND doesn’t always mean bearish TRADE. To the contrary, bearish TREND often insulates bullish trading inasmuch as bullish TREND formations can perpetuate bearish immediate term trading. Bull and bear markets get both overbought and oversold.

 

If the US stock market gets banged up today, there are no rules saying that this bullish immediate term TRADE support line of 1117 in the SP500 can’t become resistance again - and quickly, with no downside support to 1089. Don’t get frustrated with how short term that sounds. Embrace it. Managing risk doesn’t occur in a baby blue Tiffany box.

 

The conclusion of all this is always on the tape. Yesterday I invested 6% of the Cash position in our Asset Allocation model, taking Cash down from 79% to 73% by adding a long position in International Equities - Indonesia (IDX) – and adding another 3% to our long position in the Chinese Yuan (CYB).

 

The risk in all of this is that 1117 doesn’t hold, because that means anything I covered or bought yesterday will have likely been executed on too early. In real life investing, being too early means being wrong. Don’t Do Dogma – that’s for marketing presentations about investing.

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Don't Do Dogma - tiff


WMS F4Q 2010 CONF CALL NOTES

Our notes from the earnings call.

 

 

“WMS’ fiscal 2010 fourth quarter operating performance including record top- and bottom-line results, improved margins, and growth in other key performance metrics were achieved despite a still-sluggish replacement market and lower spend-per-visit by casino patrons in many markets."

- Brian R. Gamache, Chairman and Chief Executive Officer

 

HIGHLIGHTS FROM THE RELEASE

  • “Our anticipated fiscal 2011 growth also reflects the benefit of further success in those markets we entered in fiscal 2010; our expected VLT shipments to Maryland and Illinois and a modest expectation for initial VLT placements with concessionaires in Italy; along with the commercialization of our proprietary WAGE-NET networked-enabled applications and the start-up of our online gaming business in the UK.”
  • FY2011 Guidance:
    • Revenue: $830-850MM, +8% to 11% YoY growth
    • New Unit Shipments: 25.8 to 26.6k
    • ASP: $15.7-16.1k
    • Average installed participation base: 10.7-10.9k
    • Daily revenue per machine: $77-79
    • Operating margin: 22.5-23.0%
    • R&D as a % of revenue: 15% or 20% YoY
  • 1Q2011 Guidance:
    • Revenue: $174-179MM, +5% to 8% YoY growth
    • Operating margin: 17.5-18.0% 
  • "Announced plans to increase investments in internal, organic growth initiatives of more than $50 million and a new $300-million, three-year stock repurchase authorization. Under the new authorization, the Company expects share repurchase activity will exceed prior-year annual levels, depending upon market conditions."
    • "An incremental year-over-year increase of approximately $40 million in gaming operations equipment to support what the Company expects will be a leased VLT market in Italy, an expansion of operating lease arrangements with customers globally, and the conversion of a portion of the existing installed participation base from Bluebird to Bluebird2 gaming machines."

CONF CALL NOTES

  • Expect continued ship share gains and growth in FY2011
  • PENN's Cecil County, MD - they had 29% ship share
  • Launched Lord of the Rings on June 30th - and is being met with high praise so far
  • ROI improved to 15% in 2010
  • Expect that replacement sales will only improve modestly in the US, their growth will come from:
    • penetration of new markets for them: Washington and other Class II markets
    • Mexico & New South Whales growth
  • Bluebird xD- initial feedback is very strong, but the initial margins are a bit lower then they expected
  • Backlog remains robust
  • Launched Helios cabinets, which is margin neutral. Allows WMS to enter incremental markets
  • ASP increase due to modest list price increases and xD penetration, offset by growing mix of lower priced units like Helios
  • Players can extend their gaming experience online for Lord of the Rings.  At home account sign ups are exceeding that of Star Trek in its early life cycle.
  • Assume a modest increase in WAP units in FY2011
  • In Italy - they will have leased games over a 9 year term. They are close to announcing their first deal and negotiating a second deal.
  • Wagenet testing should conclude in the Dec Q and begin collecting revenues.  Portal applications have increased win per day by 20%.
  • UK internet gaming will also launch but contribution will be modest
  • Expect roughly flat growth in new units
  • Expect FY 2011 quarterly revenue trends will be consistent with past seasonality
  • Unit guidance doesn't include any new markets like MA/Ohio/AZ/Greece/Brazil etc where there is regulatory uncertainty
  • FY2011 Product gross margins: 52-55%; however, in 1Q2011, margins will have a sequential and YoY decline due to the launch of new platforms and low seasonal volume.
  • FY2011 Game operations margins: 79-81%
  • R&D will have unusually high growth - normally they would expect R&D to be 14% of revenue
  • Opening an R&D center in India
  • For FY2011, they expect to have more leverage on SG&A - lower % of revenues than in 2010
  • D&A will pick up in 2011 with increased spend
  • Tax rate will be in the range of 36-37% for FY2011
  • Provided a great amount of extended payment term sales.  Do not believe that this demand will diminish but shouldn't be a drag on cash flow either.
  • Inventory increase was due to CPU NexGen chips

Q&A

  • Domestic shipshare?
    • Guess it's in the 30% range
  • Lord of the Rings rollout.
    • Have about 150 out in the field and several hundred more coming.  Win per day is not quite Wizard of Oz, but still really good.
  • $40MM capital investment in Italy VLT?
    • Correct. This year they spend $40MM vs. $80MM in FY2011.
  • Impact on Dynamix?
    • No impact on them
  • Some Class II business impacted ASPs a bit in the quarter
  • Replacements are an industry-wide issue, not a WMS issue. They did think that they would see more of an uptick in replacement demand.
  • Extended financing - not seeing as many customers approaching them but still seeing it
  • Average life of a WMS participation game - pre refresh?
    • Depreciate it over 3 years and top box over 1 year
    • Refresh content every 6 months but hope to maintain the floor share for 5-7 years
  • Yield difference between BB2 and BB1?
    • BB1 was launched in 2003
    • Expect to see a 20% performance improvement in BB2.
  • What is xD expected to do for them?
    • Because it's a different niche than BB, they expect that it will help them gain share.  Think that 25-30% of their annual shipments should be xD and pricing is 25% higher.
  • Sold about 1/3 sales from box sales - for international, 33-35% of total sales is normal and this Q (40%) was a bit unusual.
  • IL should be a Feb/March event, with Q4 ramp up. More of a FY2012 opportunity for them. Expect to have similar ship share in that market nationwide. Think that the total market will be ~25k units, even without Chicago.
    • Expect it to be primarily a for sale market for them
  • Number of logins so far for Lord of the Rings are ahead of expectations - trending ahead of Star Trek in the same point of the life cycle.  Star Trek has over 1MM logins now.
  • Online gaming in the US?
    • Think it's when not if, and think it's a huge opportunity for them to distribute their content.  They are entering UK to better understand the business and the opportunity.
  • Investing at double the rate of R&D than their competitors. Think that investing in their business is their best use of cash right now.

JACK: GLANCE AT THE 3Q MENU

Here is a look at guidance ahead of earnings tomorrow

 

SAME STORE SALES

  • To maintain or sequentially improve two-year average company same-store sales, Jack in the Box will need to post -7.2% or better for 3Q
  • Per Factset, the Street is expecting a company same-store sales number of -8%, which would imply a sequential deceleration of 40 bps.  It is worth noting that on four of the past five quarters, the Street’s Factset estimate has been between 0.9% and 1.8% overly-aggressive.

GUIDANCE

  • Same-store sales are expected to decrease by 7-9% for Jack in the Box in 3Q, and decrease by 6.5% to 8.5% for the full-year
  • Same-store sales are expected to increase 2-4% for Qdoba in 3Q, and increase by 1% to 3% for the full-year
  • Diluted EPS full-year guidance is $1.85 to $2.05
  • Commodity outlook for the year is for a decrease in cost of ~1% (Commodity costs are expected to increase by about 2% in 3Q and 3% in 4Q)
  • Beef costs are anticipated to be flat for the full-year with low double digit increases in 3Q and 4Q
  • Sequentially increasing beef costs are expected to be offset by declining chicken and bakery costs of ~6% for the balance of the year
  • Capex is expected to be $125 to $135 million for fiscal 2010
  • “We plan to increase our ad spend in the back half of the year (FY10)”
  • Gains related to franchising activity should be higher for 3Q10 than they were for 3Q09
  • Full year gains in the sale of approximately 200 Jack in the Box restaurants are expected to total between $60 and $70 million with total proceeds of $85 to $90 million

OTHER NOTABLE COMMENTS

  • “44% of our restaurants are located in the 10 states with the highest unemployment, while only 2% are in the states with the lowest unemployment
  • “3 for $3” promotion was launched in late April and it is margin friendly while offering a great “value proposition” for guests
  • Jack in the Box added a raspberry flavor to its smoothie and real ice cream shakes – will be interesting to hear how smoothies are performing with MCD’s big push…
  • California is outperforming the Texas market; both improved in 2Q but Texas remains the more challenged market for JACK.

Howard Penney

Managing Director


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MONTHLY STRATEGY CALL: SHOULD U.S. GOVERNMENT DEBT BE RATED JUNK STATUS?: REPLAY & SLIDES

To access the replay and the slides, please copy and paste the links below into your URL. 

  

Podcast: https://www.hedgeye.com/feed_items/8837

 

 

Slides: http://docs.hedgeye.com/US%20Sovereign%20Debt.pdf

 

*******************************************************************************************

 

The Hedgeye Macro Team, led by CEO Keith McCullough and Managing Director Daryl Jones, hosted our August Macro Theme Call focused on one of the most timely economic questions facing investors:

 

"Should U.S. Government Debt Be Rated Junk Status?"

 

 As a reminder, key topics discussed on the call were:

  • The implications for the U.S. economy of the massive build up of debt
  • Various federal budget scenarios and their key drivers
  • GDP growth implications based on accelerating debt balances
  • Implications to the deficit under different interest rate regimes
  • Comparison of the U.S. to the PIIGS on key ratios
  • Appropriate investment vehicles for this long-term TAIL theme

As always, if you have any questions regarding any of our processes or conclusions, please email . 

  

We kindly thank you for your support. 

  

Best regards, 

 

The Hedgeye Macro Team


MACAU JULY DETAIL

Including slots, the market grew 70%, slightly higher than the 67% we reported yesterday, which was due to stronger slot revenue and Fx rounding in the data we received. 

 

 

VIP hold percentage was very high in July, which helped drive VIP revenue up 87% YoY.  VIP turnover (Rolling Chip) increased “only” 55% while Mass revenue climbed 39%, in-line with the growth rate this year.  Of course, the comp was more difficult than in the prior months but was still easy on an absolute basis.  Mass revenue fell 5% last year and VIP turnover increased 9%, contributing to an overall table revenue increase of 3% in July of 2009.  Slots set a monthly record of HK$701 million in July 2010.

 

We discussed market share in our note yesterday and the shifts were confirmed today.  WYNN and LVS lost a lot of share, 280bps and 260bps, respectively, from June.  The good news is that the decline was not in Mass where both companies increased share sequentially:  LVS to a normal 26.7% and WYNN to a recent high of 11.0%.  Rather, both lost share in VIP turnover and VIP revenue - hold % played a big role.  Both LVS and WYNN have held very well, above the market, but their hold percentages fell sequentially while the market played luckier in July than June.  On a YoY basis, WYNN table revenue increased 74%, slightly higher than the market while LVS grew 51%.  On the Mass side, WYNN and LVS grew 44% and 27%, respectively, versus the market at 39%.  WYNN obviously benefited from the April opening of Encore.

 

In terms of market share, SJM, MPEL, and Galaxy were the big winners.  MPEL was probably the standout relative to expectations.  Total table market share went up 150bps sequentially and Mass revenue increased 91% YoY.  MGM’s table revenue actually declined 5% YoY, due to lower hold, and total table market share slipped 50bps sequentially.

 

MACAU JULY DETAIL - macau1

 

MACAU JULY DETAIL - macau3

 

MACAU JULY DETAIL - MACAU4


RL: Ammo For the Beat

 [Farah On Core Luxury Customers]

  • Q4 dynamics also suggest something of an inflection point of change in the marketplace. Worldwide, we are seeing our core luxury customers returning to the stores with an openness to spend. [In the US] the aspirational customer remains cautious, and has not returned to the stores in any way. While [our customers] are not spending at pre-recession levels, and they can be focused on value, they do recognize that product availability is limited and there is no price resistance on unique or novel items.
  • We also saw things get progressively better every month during Q4, and the rebound has been most pronounced in our women’s products
  • Urban and tourist destinations are outperforming stores that cater to more regional or local customers
  • As we’ve highlighted in the past, our performance in Europe has been spectacular over the last 10 years when we’ve grown revenues 5-fold, and the momentum continues to be with us
  • While aggregate wholesale shipments were down, we experienced progressive improvement from Q3, which reflects a more stable environment among our wholesale customers worldwide

 

[On Asia Expansion]

  • Given our commitment to the Asian expansion, we are studying how and when it makes sense for us to launch e-commerce capabilities there
  • In Asia, our focus and primary concentration will be in 2 countries, Japan and China
  • [China] As you know, we spent much of FY2010 building a world-class organization of over 700 employees and putting in a new infrastructure to support the transformational growth our company expects in the long term.

 

US Wholesale

  • Should be fueled by share gains and new product initiatives, such as Handbags.
  • The Lauren handbag product will initially be available in approximately 150 of the best North America department stores, and select e-commerce sites beginning in August, with additional distribution already being planned for holiday and beyond.
  • Key price points range from 150 to $400 and the introduction will be supported with product specific advertising both at the national level, and in conjunction with our various wholesale partners

 

Retail/Consumer Direct

  • With only 20 directly operated and 8 licensed Ralph Lauren stores and 24 factory stores, there is clearly room to expand our direct to consumer reach throughout Europe
  • And an exciting new evolution on our European growth strategy this year is e-commerce.  Based on the success of ralphlauren.com in the United States, and the growing importance of this channel worldwide, we intend to launch e-commerce capabilities in Europe, beginning with the U.K. this fall
  • While our European e-commerce initiative will be managed in-market, we are leveraging our ralphlauren.com team in the United States and our existing technology and distribution partners to help ensure a successful launch
  • Although the investment we are making will be dilutive in the near term, we are excited about the long term sales and profit potential of international e-commerce

Other Geographic Callouts

  • In Europe, geographic trends at our Ralph Lauren stores remain consistent with those we have articulated over the last several quarters with the U.K. and Scandinavia remaining strong, and some improvement in Italy
  • European factory stores have maintained their broad based strength across regions
  • In Japan, comp trends at our Omotesando flagship store and at our factory stores were quite robust, and clearly outperformed the broader retail market
  • Our concession shop performance was also noteworthy, particularly for our men’s products

 

Headwinds. [NOTE, SINCE RL’S LAST EPS RELEASE, THE FX GAP RL REFERS TO IN THE COMMENTS BELOW HAS NARROWED BY 50%. THEY’LL NEED TO BACK OFF THIS STATEMENT TO AN EXTENT].

  • [FX] Comparing yesterday’s 1.22 euro per dollar rate to the average 1.4 rate we experienced in FY2010, which is a 13% decline, there is obviously a substantial translation impact
  • Based on our geographic sales mix, we currently anticipate approximately 250 to 300BPS of negative currency translation on our sales, a portion of which will flow through to profits for the full year of FY2011 period, with more pronounced pressure related to exchange rates in the back half of the year
  • There is an additional and approximately equivalent amount of unfavorable transaction exchange rate impact on our operating profits in FY2011
  • [Sourcing] Another profit headwind is higher sourcing costs, which we are beginning to experience with rising raw material, freight and labor expenses, as well as tightened factory and freight capacity in our global supply chain
  • Historically, we have generally been successful in our efforts to contain cost of goods inflation, although we appear to be up against the perfect storm in the back half of FY2011, particularly with our spring 2011 merchandise deliveries

 

OFFICIAL GUIDANCE

Financial/Accounting Notes:

  • “Before I begin the segment highlights for the quarter, as you read in this morning’s press release, we are now reporting our Japan concession shop sales and profits, which had previously been captured in our wholesale segment, in our retail segment.”
  • As a reminder, our revenue growth outlook for FY2011 is for a 52 week period and compares with FY2010’s 53 week period

 

Net Revenues

  • For Q1 FY2011, we currently expect consolidated net revenues to increase at a low double digit rate
  • Our expectations are based on low double digit growth in global wholesale shipments with increases across all major regions and high single digit comps, which now include our Japanese concession shop locations on a comparable basis

Operating Margin

  • Our operating margin for Q1 is expected to be modestly above the 11.4% achieved in the prior year period, with gross margin improvement being mostly offset by higher operating expense deleverage related to the continued investment in our various strategic growth initiatives across geographies, distribution channels and emerging product categories

Retail Segment

  • For the full year FY2011 period, we expect consolidated revenues to increase at a mid single digit rate, led by our retail segment, and mitigated by a low double digit decline in licensing revenues, which clearly reflects the impact of our assuming more direct control over certain product categories and geographies
  • We currently expect to achieve a low double digit operating margin rate in FY2011, the net effect of gross margin pressure that is more back half weighted and a modest deleveraging of operating expenses that is more front half weighted, as we are currently forecasting a modest leveraging of our operating expenses in H2
  • Our FY2011 tax rate is expected to be 34%
  • Again as a reminder, our FY2009 and FY2010 tax rates were advantaged by the favorable resolution of certain nonrecurring discrete tax items that we do not expect to have this year.

 

Capital Spending Plan

  • The higher level of investment that is flowing through the P&L is also reflected in our capital spending plans
  • We are planning approximately 280mm in Capex in FY2011 to support our retail, wholesale and infrastructure investments and initiatives that Roger and I have outlined on this call today
  • About half of our capital is allocated for 15 to 20 new stores and shops; including a new 30,000 square foot flagship location to showcase our women’s and home collection merchandise across from the Rhinelander Mansion on 72nd and Madison Avenue in New York City

 


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