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GALAXY 1H 2010 CONF CALL NOTES

Galaxy reports record results and announces additional HK $0.8 BN investment in Galaxy Macau.

 

 

“Once again GEG outperformed the market, with excellent gaming growth and strong results from all our divisions. StarWorld continues to lead the market, delivering exceptional returns and achieving some of the highest volumes of any casino in Macau. StarWorld also boasts one of the highest hotel occupancy rates in Macau, recording a very healthy 96% in the second quarter of the year. In Cotai, we are entering the final fit-out stages, in preparation for the opening of Galaxy Macau™. In early 2011 we will be unveiling the most innovative and uniquely Asian destination resort in the world. This, the first phase in our Cotai development, represents the culmination of six years of careful and detailed planning. We are hugely excited about the opening of Galaxy Macau™ and are confident that it will transform the Macau market just as it is now transforming the Cotai skyline. As a result of our confidence, we are seizing the opportunity to increase our investment and exploit surging market demand.”

 

--Dr. Lui Che Woo, Chairman of Galaxy Entertainment Group

 

 

MANAGEMENT COMMENTARY

  • Slightly lower ADR at Starworld's hotel  is driven by desire to increase occupancy

Q&A

  • Starworld EBITDA margin: economics of scale and cost structure contributed to higher margins; hold did not impact margins.
    • Different mix of profit-sharing rooms from Q1 to Q2 may also have played a factor in higher margins.
  • Taking advantage of limited supply coming online in Cotai to expand Galaxy Macau rooms to 1,400 from 900.
    • will open 800 rooms in the next 6 months.
  • Galaxy Macau scheduled for end of Q1 2011; 2/3 mass tables, 1/3 VIP tables--but mix may change as they move closer to opening.
  • HK$5.4 BN project capex invested YTD. Will spend much of the HK$14.9 BN capex budget in 4Q 2010.

PSS: …Or Get Off The Pot

PSS reports this Wednesday. They're gonna miss. I know it. You know it. Anyone else that's bothering to look at the retail tape this week knows it. I'd love to end this little intro with "...and Mr. Market knows it too." But that would be a JV mistake I simply won't get sucked into.

 

There's only one time in the many years I have tracked PSS that I have seen sentiment worse -- and that's just after PSS levered up to do a dilutive deal about a week before the credit crisis began.  Fast forward a couple of years, and the deal has proven to be the right move. The acquired business has more than doubled, debt to EBITDA is down to nearly 1x,  and the cash flow in the business today (even with the core struggling) is ample enough to buy back 15% of the stock.

 

So let's step back a minute and drill down on what's really wrong. I could argue all day about valuation, and that the sum-of-parts math suggests that the market is only paying 2-3x EBITDA for the base business. But the reality is that the bear case that has frustrated so many people over so many years finally has some teeth. There's finally the 'I told you so' factor. And that, of course, is that the core business can't comp, the business is overexposed to Asia from a  sourcing perspective, and at face value it is tougher to model the earnings upside that used to exist in the models of many.

 

Let's look at the facts…

  1)  Not only did PSS undercomp its peer set by about 500bps over the past three quarters, but in the latest quarter, the  trajectory of the comp diverged meaningfully (to the negative side).

  2)  A perplexing trend has emerged. When consumers trade up (and we see higher-end retailers do well), PSS has not benefitted in its mix or price. But as consumers trade down (and Dollar Stores and Discount Stores score) we’re not seeing Payless participate.

 

PSS: …Or Get Off The Pot - PSS CompTrends 8 10 1

 

PSS: …Or Get Off The Pot - PSS CompTrends 8 10 2

 

 

Now…there are some offsetting factors over the past year that need to be considered.

  A)  At this time last year, PSS’ back-to-school push was aggressive – big time. The company went in with a $7-$8 intro price point at the same time Wal-Mart started to get out of footwear. PSS upped its SG&A and went on full offense. Unfortunately, it didn’t work. The reality is that the consumer was in a spot where they weren’t going to show up – regardless of price. So PSS either ‘over-SG&A’d’ or under-priced.  I’d argue the latter.

  B)  As it to relates to trends, keep in mind that the PSS model differs from most peers in that its proprietary brands very rarely – if ever – catch a fashion trend when they are on the upswing. PSS will usually benefit when the trends explode into the mass market and crush ‘em on price. Last fall and winter, it was short on boots. Early this year it was late on Toning. Same thing with Sandals a couple years back. There’s a couple of sub-themes here…

      -  Expect broader distribution of boots at PSS this fall. It’s about 6%-8% of the PSS mix, and carries about 2-3x the average price point.

      -  Same for Toning. It will go from 1% of business early this year to 5-6% by 4Q at a $29.99 price point. Our sense is that this business is already above plan.

  C)  Why A Late ‘Trend-Catcher’? It’s perfectly fair to question why PSS should be late in catching trends. One reason is that the company took the percent of proprietary brands up by 3x over 5 years to almost 75%.  With in-house R&D teams instead of third-party sourcing, the lead time requirements grow, short-term flexibility declines, and the risk factor in being wrong on product goes up materially. I think that this is why PSS has been so tight with inventory (and Gross Margins have steadily been heading higher) as having increased product risk AND inventory risk layered on top of that is a risky game that no retailer in their right mind wants to play.

 

We can debate the facts, but one thing that’s unquestionable is that PSS is at a key point in its decision tree.  Management needs to think outside the box on this one.

  1)  Does this mean that Payless increases its outside brand exposure – in effect reversing what has been part of the bull case on margins for 3+ years?

  2)  Does it start to produce ‘take-down’ versions of Saucony and Sperry to sell at Payless stores (kind of like how Nike and Polo both design and sell certain product into Kohl’s)?

  3)  Does PSS need to step back and really ask itself if it needs 4,800 stores? If the answer is Yes, are they in the right locations?

  4)  Does the low-income consumer really care one way or another about trading up to better brands at a place like PSS?

 

I don’t like to say this often, but I’m not certain what the right answer is -- yet.  The only thing I am certain of is that something meaningful must change. That makes this one of those ‘trust management to do the right thing’ stories.  Everyone will have their own opinion there, but again, let’s look at some facts.  Just 3 years ago, the big question was around Saucony and Sperry. Check out the following.

 

  A)  At the September 2008 analyst meeting, Saucony and Sperry had combined revenue of about $250, and Matt Rubel said that they should be $500mm combined by 2010. Today, they exceed $500mm (my math is $550ish). Over this time period, the business went from 7% of revenue to 15% today.

  B)  As it relates to profitability, the leverage is clear when the revenue doubles on the fixed-cost portion of the business. Translation = Saucony and Sperry went from 5.5% of EBIT then, and is around 20.5% today (based on our math).

  C)  Recent trends have been solid, to say the least. Saucony continues to gain share aggressively, with growth coming specifically from the Specialty Running channel.  As it relates to Sperry, trade shows are showing more strength in boat shoes for Spring. But more importantly, at the recent Atlanta Shoe Market in mid-August, buyers noted frustration that the brand was only accepting ‘futures’ due to ‘overwhelming demand.’

 

PSS: …Or Get Off The Pot - PSS BrandTrends 8 10

 

 

I’m not highlighting this to justify that there’s another part of the business that’s doing so well and that we should ignore the other 80% of cash flow. But in what I outlined as a ‘trust me’ story, these guys rank pretty high on my ‘give them the benefit of the doubt’ list. They’ve earned it.

 

We’ll hear Matt Rubel give his take on this at the Analyst Meeting in October. Until then, we have a sloppy print next week, extremely poor sentiment, what’s likely to be a downward earnings revision, and pretty much nothing else for people to get excited about on this name. Furthermore, there’s no doubt in my mind that we’re about 3-4 months into a major shareholder rotation, which will probably take us through year-end.

 

Do I think that Saucony and Sperry alone are worth $10 per share today? Yep. That suggests that the 4,800 chain, licensing business, and potential growth if the team gets this right are all worth about $3.50 per share, or $625mm if we give all the net debt to the stub. This thing is cheap on almost valuation metric possible. But I realize that that’s not enough if you’re looking at the next month.

 

But I think that by year-end, we’ll have a better mix AND pricing on the base business, continued growth success in PLG, a more clear strategy that the newer shareholder base can sink its teeth into, and most importantly – a roadmap that $2.50 in EPS is a reality.

 

 

PSS: …Or Get Off The Pot - PSS CompTable 8 10

 

 

 


JULY SHOULDN'T TELL US MUCH

NV will release July revenues in 2 weeks and we expect another mid-single digit drop.

 

 

With McCarran Airport traffic declining 1.1% YoY in July - the same as June - we project Strip gaming revenue will again decline in the mid-single digits.  Helping July is an extra Saturday in July of this year and a fairly easy comparison.  Total gaming revenue declined 11% last year despite above average slot and table hold percentage.  Hurting the performance will be the month end falling on the weekend.

 

Slots should be the laggard this month.  Since the month ended on a Saturday, the weekend's winnings won't be factored in until August.  Thus, we are projecting Strip slot revenue to fall 12% and total gaming revenue to decline 5%.  If we assume the same high 7.4% slot hold percentage experienced last year, total revenue would be flat.  However, due to the timing of month end, we are projecting only 6.6% hold.  Normal slot hold is around 7%.

 

Here are the details of our projections:

 

JULY SHOULDN'T TELL US MUCH - vegas1


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MACRO: 3Q GDP GROWTH

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We have not published our official estimate for 3Q10 GDP growth yet, but suffice to say it will be substantially below the current 1.7% number and substantially below the 2.5% consensus for 3Q10.   
 
Today’s made-up numbers from the commerce department suggest that the economy is in fairly bad shape.

 

 

MACRO: 3Q GDP GROWTH - chart1

 

 


Dr. Copper… Leading the Way Again?

Conclusion: We believe the recent strength in copper may be a leading indicator for China easing its tightening policies. This is bullish for Chinese Equities and may serve to keep a floor under copper prices going forward.

 

Position: Long Chinese equities (CAF); Short Copper (JJC)

 

As the facts change, we do. While we’d like to help our subscribers make money on 100% of our positions, the reality is we’re wrong on about 15% of them (14.4% on longs and 16.1% on shorts to be exact). Most importantly, however, rather than stay dogmatic about our losers, we accept the fact that markets don’t always trade in the direction our research suggests. 

 

In the spirit of this process, we went back to the drawing board on our short on Dr. Copper. After having put out a note early last week affirming our conviction in this position in light of the disastrous setup for growth and housing in the U.S., we revaluated the risks and have come to conclude that they are starting to outweigh the reward. Those risks include: Chinese demand accelerating, accelerating dollar debasement, and supply constraints.

 

We know growth is slowing globally. U.S. 2Q10 GDP came in at 1.6% (10bps below our estimate) and looks to continue rolling over sequentially driven largely by a weakening consumer (we are revising down our 3Q and 4Q GDP estimates to be released soon). As it relates to China, roughly one-fifth of all Chinese exports are to the U.S. so there will be negative knock-on effects in the Chinese economy as a result of slowing growth domestically. Understandably so, the likelihood that China reverses its tightening policies or accelerates the creation of policies designed to support domestic consumption increases with every incremental negative economic data point out of the U.S. and W. Europe – of which there will be plenty of going forward.  For instance, this morning the China Times reported that China’s State Administration of Taxation is considering “large” tax cuts to small and medium-sized businesses to support their growth and development. If enacted, this is incrementally bullish for Chinese employment and consumption.

 

Dr. Copper… Leading the Way Again? - 1

 

As it relates to the potential for dollar debasement, the Fed will have plenty of opportunities to quantitatively ease going forward given the negative economic backdrop domestically. If Bernanke and Co. give in to market pressure (which it appears he will based on his commentary out of Jackson Hole), we expect the dollar to resume its decline after closing up on a weekly basis for the previous two weeks. Further dollar debasement from here is positive for copper prices (r-squared = 0.69 on a two-month basis).

 

Dr. Copper… Leading the Way Again? - 2

 

With regard to supply, copper inventories stocks on the London Metals Exchange continue to trend down and are at a nine-month low. We initially thought that those inventories would start to grow as growth slows globally, but the potential for accelerating demand out of China could serve to keep inventories in check at low levels.  While the global growth story may be in question, the domestic consumption growth story in China continues to accelerate.

 

Dr. Copper… Leading the Way Again? - 3 

 

In addition, some experts are predicting that there may be a deficit in copper next year as demand outstrips supply for the first time in four years.  The impact of a volatile few years of pricing is that there has been limited investment in mines and therefore there will be limited new supply coming on in the next few years.  According to Pan Pacific Copper, “With few new large-scale mines on the horizon and stagnation at existing facilities, in our view, price direction will be upwards given the approach of multiyear deficits.” So as demand naturally continues to grind higher, supply may actually take a few years to catch up.

 

In the end, Dr. Copper has a Ph.D. in being a leading indicator, particularly as it relates to China and global growth. We think the potential for policy easing and accelerated demand out of China is growing and that is a major factor we will continue to monitor as it relates to our long position in Chinese equities and short exposure to copper. As we’ve seen throughout the year, any easing of policy or rumors of easing is bullish for Chinese equities and will likely serve to keep a floor under copper in spite of the negative backdrop for real estate in the U.S.

 

Darius Dale

Analyst


3Q GDP GROWTH

We have not published our official estimate for 3Q10 GDP growth yet, but suffice to say it will be substantially below the current 1.7% number and substantially below the 2.5% consensus for 3Q10.   

 

Today’s made-up numbers from the commerce department suggest that the economy is in fairly bad shape. 

 

The headlines read that “consumer spending in the U.S. rose more than forecast in July.”  Personal spending rose 0.4% (the most since March, up from 0% last month) and Personal Incomes rose 0.2% (slightly less that the Bloomberg consensus).  Despite the low level of in consumer confidence in the United States, the government is telling us that consumers are so confident they feel compelled to spend their savings (the savings rate dropped to 5.9% from 6.2% last month).  Importantly, disposable incomes (the real measure of the sustainability to consumer spending trends) dropped for the first time since January. 

 

Despite government CPI figures, key costs on the consumer’s income statement are inflating.  Food and energy costs, especially, are currently at elevated levels.  This is putting pressure on disposable income!

 

Without the consumer carrying the torch of GDP growth, there might not be any growth in 2H10.  To revisit last week’s GDP figures, the revision to 2Q GDP (dropping from 2.4% to 1.6%), 80% of the downside revision came from June’s reported trade deficit deterioration.  The rest was a negative revision in reported inventory build-up.  The only upside revision was reported in personal consumption. 

 

Despite the consumer spending more, the reaction of today's market is rational.  The reason for this is simple: increasing consumer spending is not sustainable given the current dynamics on the macro front.  Specifically, disposable income is contracting and this will place pressure on consumer spending.  Tracking the trend in consumer confidence presently indicates that this pressure should manifest itself sooner rather than later.

 

In turn, this will cause increased volatility in the trade data when it is released and any changes inventory trends.  To that end, today’s news from the Federal Reserve Bank of Dallas suggests that Texas manufacturing activity remains sluggish at best.  According to the Dallas FED “the new orders and growth rate of orders indexes pushed deeper into negative territory, indicating a further contraction of demand.”  Sluggish demand suggests no need to build inventories!      

 

Sequentially, the inventory contribution to the 2Q10 GDP figure dropped 2% quarter-to-quarter.  For the next two quarters, we are lapping against a 1.1% and 2.8% build in inventories in 3Q09 and 4Q09, respectively.  The current trends suggest that inventory adjustment could be a drag on GDP in 2H10.  The drag is not likely to be as substantial as what we saw during the economic collapse, when inventory adjustments lowered the published GDP growth rate by as much as 2.3% during the fourth quarter of 2008. It is clear from the 2% drop between 1Q10 and 2Q10 that the current cycle of inventory building has collapsed.

 

Given the current trade data, inventory trends and skittish consumer behavior, how is it possible that the USA will see 2.5% GDP growth in 3Q or 2.6% growth in 4Q10? 

 

While government spending has played a significant role in propping up the market, one externality of such grand-scale intervention is an added degree of uncertainty in the market place.  A lack of visibility is impeding companies from making decisions such as hiring new employees; Steve Wynn is one CEO that has been particularly vocal about the unpredictability of present-day Washington.   

 

The leveraging of America’s balance sheet has not created new wealth; rather, in creating a zero-yield environment, it has repelled capital and resources from her economy. 

 

Howard Penney

Managing Director

 

3Q GDP GROWTH - GDP inventory chart


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