MGM’s leverage and cash flow troubles are well-known in the credit community.  However, it’s not really an imminent issue if MGM can sell its stake in Borgata and IPO a piece of MGM Macau.



Actual free cash flow is negative.  Even when MGM’s EBITDA improves over the coming years, much of the increased income will go towards catch up maintenance spend (see 8/22/2010 note, "MGM: MAINTAINING LOW CAPEX").


Since 2006, MGM’s FCF (Consolidated EBITDA pre-ESO less gross interest expense (reported interest expense + capitalized interest)) has been on a rapid decline.  In 2006, MGM’s FCF before debt service peaked at $973MM, before declining to $594MM and $410MM respectively in 2007 and 2008. To be fair, the drop is exaggerated by a period of elevated capital expenditure spending.   In 2009, despite meager capex spending, FCF before debt service continued to plummet to just $65MM. 




For the next several years, we’re projecting that FCF before debt service turns negative, especially as maintenance capex returns to more normalized levels.  Over the next 3 years, MGM could burn through about $730MM of cash before debt service.  When you layer in $1.25BN of debt maturities through 2012, MGM's cash burn jumps up to approximately $2BN.  However, this in of itself may not be an immiment problem if MGM is successful in selling its 50% stake in Borgata and IPOing part of their stake in MGM Macau in 2011 (including getting back that ~100MM receivable).  Although by 2012, even after generating a combined $900 million from these two transactions, we estimate that cash balances fall to uncomfortably low levels of roughly $400 million.  In addition, after $1.2BN of MGM's bank debt matures in Oct 2011, they will only have a $3.6BN facility, which we estimate will be fully drawn.  Therefore another debt issuance or equity offering seems like a certainty.




Here's a chart from a insight created for RISK MANAGER subscribers (originally posted on August 18, 2010).




The Week Ahead

The Economic Data calendar for the week of the 23rd of August through the 27th 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

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DKS & HIBB; A Bit Flat-Footed


In looking over the results out of both Dick’s and Hibbett’s it would be disingenuous to say that we weren’t a bit disappointed. Both came in light on the top-line, each have their respective margin considerations, however, they both raised outlook for the full-year. Rather than looking through the quarter and chalking up favorable guidance adjustments to positive trend momentum and hopeful execution we’ve highlighted the key deltas both in the quarter and 2H as we look forward. For DKS our ‘we’re not against owning it’ positioning remains unchanged, though for HIBB, a lack of upside in margins in the quarter and marginally higher costs curb our expectation for further upside at least in the near-term. As always, our view changes as prices do, but the key is we’ll need to see an improvement in footwear trends as we enter the 2H and as the product cycle starts to pick up meaningfully before these names move up in our queue.


Thematic Call Outs:

Store Expansion: Both players remarked that 2011 will be a year of considerably more aggressive growth relative to 2010. Dick’s expects 30% store growth next year resulting in a reacceleration of square footage growth to a HSD rate up from low-to-mid single digit over the last two years. HIBB also sees opportunity primarily rooted in existing real estate opportunities at Movie Gallery and Blockbuster locations as well as adjacent states. Interestingly, while HIBB maintained its goal of closing 10-15 underperforming stores by year-end, DKS announced that it will be closing 12 Golf Galaxy locations in 3Q – an incremental and positive change that will be immediately accretive to profitability and earnings albeit small. Most importantly, while some will call for Dicks increasing focus on expanding into smaller format stores as a direct threat to the Hibbetts model, the reality is that just isn’t the case. While the new format is similar in size to new Sports Authority stores at ~35,000 sq. ft., it remains well above the average 5,000 sq. ft. Hibbett store and will still be targeted for considerably larger markets.


Category Trends: The bottom-line here is that while all three categories (footwear, apparel, and hardlines) comped positively for both companies, footwear came in softer and is clearly not materializing at the rate we have been expecting. Comps across three key retailers over the last 2-days (DKS, FL, HIBB) have all come in lighter than our expectation particularly those with greater exposure to footwear. While much of the new product that we’ve been highlighting during the year isn’t expected to start hitting floors until now, without commensurate demand sales could be softer yet again in the 2H.


Product: The outlook for basketball appears mixed with DKS far more upbeat reflecting strong momentum with Nike collaborations while HIBB was more cautious on the category citing weak launches as the cause for a challenging 2Q and modest participation in 2H launches. In addition to Nike product, the new Under Amour shoe and Reebok’s Zig remain key launches in basketball. Running continues to be the standout category with both retailers optimistic on toning, particularly in Q4 driven by accelerated marketing initiatives.


In apparel, Columbia’s OmniHeat commands all the buzz. DKS has significantly more exposure to the brand and is positioned to benefit more significantly if consumers believe the technology is as evolutionary as Columbia suggests. Importantly, Hibbetts committed to Columbia earlier this year and expects to have the brand in ~50 stores by year end as compared to some 350 stores in which North Face is carried. This is the most significant apparel launch to note for sporting goods retialers heading into the 2H hands down. 


Inventories:  As seen in the SIGMA chart below both company’s sales/inventory spread remains positive and little changed from last quarter suggesting that inventories remain relatively clean. While management systems are playing a key role in driving comps with considerably less inventory than in years past, HIBB is further into the process leaving DKS with an opportunity for additional and more meaningful margin gains over the next 12-months.


Company Specific Call Outs:


  • Mgmt is getting more aggressive on the long-term outlook for the business announcing that after another review, there is an opportunity for 900 DKS stores (up from their original view of 800).
  • Will be looking toward smaller format stores to get there (~25% of the incremental 100 oppty).
  • Decided to take the pain and shutter 12 of the 91 Golf Galaxy stores that were underperforming in Q3 (too costly, bad local or both) – lots of questions on this, but good call for profitability both near and long-term.
  • Chick’s renovation will take another 2-years to complete (longer than expected) to get profitability up to corp. avg.
  • Like FL and FINL, DKS also working on concept shops with NKE (Fieldhouse – more premium and Evolution) and initial steps are going very well. Nike recently commented that it’s the best and most complete representation of the brands worldwide. Already have 5 Fieldhouse prototypes operational.



  • Comps came in +11.9% with a significant deceleration in July despite easier compares (May up +12.8%, June up +13.3%, and July up +9.5%). However, the first 19 days of August suggest a robust start to Q3 up low double-digits. With August accounting for 40% of the quarter and BTS largely complete management’s expectation of a HSD/LDD comp is better than we were expecting heading into the quarter and an incremental positive.
  • While both traffic and transactions were up, average ticket was down.
  • Product margins up +60bps in Q2 were ahead of the company’s internal plans though less than we expected given the level of clearance activity during the same time last year. Given the benign promotional environment this is reflective of either an overall shift towards lower priced product, or is evidence that retailers are absorbing higher costs – our gut tells us it’s the later.
  • Georgia’s non-participation in the tax holiday season impacted comps by 80-100 bps in Q2.
  • Management expects to once again raise its outlook for the full-year again next quarter maintaining that year-end guidance is "very attainable." With Q2 coming in lighter than expectations, our confidence in the 2H is incrementally lower. That said, August trends have been strong out of the gate and account for a disproportionate portion of the quarter.  

So where does this leave us – a bit flat-footed actually. We’re adjusting our models for the full year with DKS shaking out at $1.52 and HIBB at $1.51 down from our prior estimates of $1.58 and $1.60 respectively. While both companies raised the outlook for the full-year, confirmation of trends through August from our trend data over the next several week will be critical before these names move up in our queue.


- Casey Flavin, Director


DKS & HIBB; A Bit Flat-Footed - DKS HIBB Q2 S 8 10



FL: Chipping Away

Foot Locker continues to deliver on its strategic turnaround initiatives as evidenced by another quarter of sequential and year over year improvement on both the top and bottom lines.  For the bears out there, we are all well aware that same store sales of +2.5% fell short of the Street’s and our expectations (we were at 4.5%).  We’re not shying away from the fact that the topline is and will remain a key component of this turnaround.  However, the underlying message from the company’s conference call is “profitable growth”.  Gone are the days of chasing sales with aggressive promotions, selling commodity apparel at a loss, and building aged inventory over multi-year periods.  2Q results confirm that progress is well on its way towards higher sales and profits, a course which has really only been set in motion for three quarters now.  For the bulls, there is plenty to chew on. 


  • Even at a 2.5% comp increase (in which most regions and divisions hovered around the mean), 2Q marked the first time since 2005 that Foot Locker reported a consecutive increase in comp store sales.  It may not be a 5% increase, but consistency is building and the trend is clearly something to note.  Importantly, a pickup towards the end of the quarter and in early August gives management confidence to raise the same store sales outlook to a low to mid single digit increase for Q3.
  • Basketball not the culprit here.  Much speculation was made that the basketball category was extremely weak during the quarter, causing a drag on sales.  We didn’t hear anything on the call to confirm this.  Management did confirm our belief that on a go forward basis, there is much to be excited about from a product standpoint in the category.  The “Big Three” in Miami, Under Armour’s basketball launch, and perhaps even a resurgence from Reebok (ZigTech x John Wall) are all opportunities to drive improvement.
  • Elimination of unprofitable and aggressive promotions impacts the P&L in three ways.  First, transactions were down mid single digits. Second, ASP’s were up low double digits.  Third, merchandise margins improved 210 bps.  Part of the margin expansion reflects apparel’s sequential improvement, but the majority is due to lower markdowns, clearance, and promos.  This formula is expected to remain in place as higher priced technical running, fewer promos, and a substantial upgrade in apparel (technical and private label) drive profitable sales.
  • Many questions from those focused on the past are quick to point out that recent margin gains put overall gross margin rates near peak levels.  While factually accurate, we continue to believe there is opportunity to surpass peak for a number of reasons.  Most importantly, the apparel category as a whole is currently producing margins BELOW the company average and footwear.  Apparel for almost every other retailer on the planet carries a higher margin structure than footwear.  This is a huge opportunity for FL and one that is in the early stages of showing signs of life.  Apparel comps for the quarter increased by low single digits, a sequential improvement from being down low singles in Q1 and down high single digits in Q409.  According to management, the apparel assortment is about 50% towards being upgraded.
  • Inventories remain well controlled, down 5.1% against an essentially flat topline (positive comps offset by shirking store base).  We believe this is the one of the keys to the turnaround as the company continues to reduce inventories and increase turns.  Recall that in a 10 year history prior to 2009, FL grew sales at a rate higher than inventories every single year. 
  • Some slight tweaks to the company’s store opening/closing plans.  Management is now expected to open an incremental 5 units this year although the capex budget of $110 million remains unchanged.  On the flipside, closings may not reach the original goal of 150 units for two reasons.  First, some stores slated for closure are showing meaningful improvements in profitability as a result of the product and inventory initiatives put in place.  Second, as stores were slated to close landlords appear to be willing to strike longer-term lease concessions at favorable terms.  Recall that we have never been in the camp that major store closures were the key to this turnaround.  Getting the product, marketing, and sub-brand positioning in our view supersedes the decision to close meaningful amounts of stores. 
  • Lots of questions as expected on toning.  While the category has been a contributor, management was quick to point out that category growth is likely to slow in the back half as the industry anniversaries the hyper-growth of last Fall.  Second and more interestingly, FL appears to be more focused on capturing the sales opportunity with the female customer beyond a simple toning purchase.  This is particularly relevant for Lady Footlocker, which is the largest female athletic shoe and apparel chain in the U.S.  We continue to believe FL is working to build a sustainable women’s business for the long-term and as such, is not over indexing to the toning trend at the current time.

Net, net this was an essentially inline quarter driven by an impressive gross margin performance offset by a slightly weaker than expected topline.  There is nothing that we see in the 2Q results that change our view on the opportunity for the company’s turnaround or our above-expectation earnings over the next 12-18 months.  We’re tweaking our model a bit to reflect the lower earnings in 2Q relative our expectations, but still stand above the Street at $0.92 for the year.  We continue to believe that the opportunities to improve assortment, right size inventory levels, and profitably maximize FL’s market share dominance will unfold over the next 4-6 quarters. 


FL: Chipping Away - fl


Eric Levine


The Brazilian Consumer: Capital Chases Yield

Conclusion: Don’t mistake yesterday and today’s weakness in the Bovespa for anything more than a global selloff due to weak U.S. economic data. At a point, U.S.-centric investors will be forced to look to places other than U.S. Treasuries and equities for a rate of return. We feel the emerging market consumer in places like China, SE Asia and Brazil will see the bulk of that investment.


Position: Long Brazilian equities (EWZ).


Today we sold our exposure to Indonesian equities for a modest 2.7% gain because we didn’t want to overstay our welcome, particularly as it relates to trade exposure to an increasingly weak U.S. consumer (10.5% of all Indonesian exports in 2009). Furthermore, we’d be remiss to suggest that exporting nations like those of SE Asia, China and Brazil will flourish if our estimate that U.S. GDP growth in 2H10 and 2011 comes in at about half of current consensus estimates. With that said, however, everything that matters in Macro happens on the margin. And in an environment where growth and trade are slowing globally, the marginal direction of domestic consumption will be paramount as it relates to where capital will likely flow.


We know what direction U.S. consumption growth is headed – down. Contrast that with the direction Brazilian consumption looks to be headed – up. As a result of favorable employment, inflation, and credit conditions, the Brazilian consumer is strengthening. Unemployment is 20bps off all-time lows, inflation has improved on the margin for the past three months (down to 4.6% in July vs. 4.84% in June), and, as a result of benign inflation, interest rate hikes have come to a halt (recent reports suggest the central bank expects 3Q inflation to come in below forecast, further reducing the risk of a Selic Rate hike).


The confluence of these three factors creates a bullish setup for the Brazilian consumer, which has been supported by recent data: 

  • Shopping Spree: Brazil’s June retail sales came in yesterday at +11.3% Y/Y, up from 10.2% Y/Y in May and the 1% M/M increase far exceeded consensus expectations of a 0.3% gain. The 11.5% gain in 1H10 was the largest gain ever on a six-month basis.
  • Taking on Debt: According to Brazil’s National Chamber of Commerce, the number of Brazilian families in debt rose from 57.7% in July, to 59.1% in August.
  • And Paying It Off: Credit reporting agency Experian reported a 1.74% delinquency rate among Brazilian checks in July – the lowest reading since 2004!
  • With High Hopes for the Future: For the fourth consecutive month, Brazilian families intend to consume more than the prior month. The consumer index of the National Chamber of Commerce rose 0.7% in August, to a reading of 134.4. Brazilians also expressed increasing satisfaction with their current employment and optimism about their professional opportunities, up 2% and 1.2% respectively. 

Globally, P.E.M.A.C. (private equity, M&A and capital markets) has been investing in this trend, and with the economic situation slowing in the U.S., we should see even more of this activity. According to KPMG Brazil, the number of Brazilian companies acquired by foreigners has more than doubled Q/Q in the second quarter. The 56 acquisitions (vs. 21 in 1Q10) was the highest second quarter number since the data started being tracked in 1994. Of the 77 total acquisitions in 1H10, more than one third were by American firms. It seems all that cash on U.S. corporate balance sheets that many bulls are hoping to fuel a cycle of investment domestically is leaving the country in search of higher growth and higher rates of return. Capital Chases Yield… globally. To affirm, international investors bought a net $1.35 billion of Brazilian domestic bonds in June, boosting their holdings to $13.5 billion in 1H10 – the most in three years.


The Brazilian Consumer: Capital Chases Yield - 1


Managing Risk


As always, our style of investing requires a prudent risk management approach that is duration agnostic. Given, we will continue to analyze and interpret the near-term risks to our long position in Brazilian equities. We don’t have to be bullish on the Brazilian consumer in perpetuity or at every price, so we’ll manage risk around market reaction to the Petrobras saga and the upcoming Presidential election.


Regarding Petrobras, recent reports suggest the company and the government remain split over the price of the oil reserves which will determine the size of the company’s upcoming share offering. As a refresher, the higher the price the government slaps on the oil, the more equity Petrobras will have to issue, creating further dilution of the share base. Market sources believe the government’s consultant priced the barrels at $10-12 per barrel vs. Petrobras’ consultant’s estimate of $5-6 per barrel. ANP, Brazil’s oil regulator sees a “reasonable” price for the oil somewhere in between, around $8 per barrel. The pricing disconnect has some investors worried that the share sale, which has a Sept. 30 target (three days before the election), could be delayed as far as 2011 on speculation that the elections and earnings season will force the issuing to take a back seat. Further uncertainty and speculation from here will continue to weigh on Petrobras’ stock price and, as a result, the Bovespa (Petrobras is Brazil’s second largest company by market cap).


With regard to the elections, it appears Lula endorsee Dilma Rousseff has taken a commanding lead. The latest IG poll shows Rousseff doubling her lead to 16 percentage points over opposition candidate Jose Serra. Support for Rousseff rose to 45% from 41% in the previous poll taken during July 17-20. Serra’s support fell to 29% from 33%, while Green Party candidate Marina Silva’s support was unchanged at 8%. A candidate needs more than 50% of the vote, excluding blank or invalid ballots, to win in the first round and the trajectory of Rousseff’s support suggest a victory for her in early October. The key takeaway here as it relates to the Brazilian economy is that former cabinet chief Rousseff is widely believed to be in support of big government spending, particularly when compared to the more austere Serra. Critics agree that her support is likely a function of her affiliation with current President Lula, whose social welfare programs and increased spending earlier in the year made him a very popular man amongst Brazilian voters. Investors fear that a Rousseff-led administration would bring about inflationary government spending and central government balance sheet deterioration, as her vow to cut taxes will likely force the government to fund any increases in spending via more debt issuance. This is all negative for the Brazilian private sector (and equities), as the need for higher interest rates to fight inflation and attract capital to public debt will keep a lid on private investment and credit expansion. Time will tell whether these fears are warranted.


For now, we are comfortable with our long position in Brazilian equities.


Darius Dale



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