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The resignation of CFO Chuck Sonsteby was surprising to me but it does not spell disaster for Brinker.


Last night, news of Sonsteby’s departure hit the tape.  While I expected him to stay at the company for a few more years, his leaving for Michaels Stores probably offers him some significant monetary upside – particularly if he gets cheap equity and leads the charge on an initial public offering of the private company.  Furthermore, the Bar & Grill industry is a difficult area in this current environment, and while the operational initiatives at Chili’s will generate rewards for the company, Michaels Stores may have provided a more appealing experience (with a possible big IPO payday).


While I am yet to speak with anyone at the company, I do not think this implies any major issues within Brinker.  If anything, it may shorten the odds of a take-out – something I did not think was likely prior to Sonsteby’s resignation.  I will follow up with further details shortly.


EAT: UNEXPECTED DEPARTURE - chuck share price


Howard Penney

Managing Director


Here are our brief thoughts heading into Tuesday along with some recent management commentary.



WMS will hold an Analyst Day on Tuesday of next week and while we don’t expect a ton of new information to be divulged, the tone should be positive.  Management should provide an upbeat assessment of the long term potential of worldwide slot demand while also remaining cautious regarding the near-term replacement environment.  We also expect management to successfully address cash flow issues including the ramp up in capital spend related to Italy among other things, and the accelerated R&D. 


For FQ1, we are pretty much in-line with the Street.  Some additional thoughts:

  • The quarter should follow normal seasonality patterns.  North American (NA) replacements are expected to be weaker sequentially - we’re estimating about 10,000 total replacement units for the industry
  • New units to NA should be flattish with last quarter
    • WMS's shipment to Sugarhouse was accounted for in the June quarter
    • Big shipments for the September quarter include:
      • Cosmo – 23% of the floor
      • Penn Cecil County – 29% of the floor
      • Some expansion units into California tribes
    • EPS of $0.37 is in-line with the Street while our $2.02 FY2011 estimate is slightly below the Street.  However, replacement demand could accelerate at any time, particularly if casinos respond to upcoming Government tax incentives.



  • “The early performance from the initial xDs and the overall feedback from operators across a diverse spectrum of casinos in various geographic markets is exceptional. The initial demand for xD is both gratifying and highly encouraging for our long-term success. In spite of the overall restrained capital spending environment, the strong initial backlog for Bluebird xDs is providing solid visibility just out of 2011 and supports WMS’s expectation of continued ship share gains and revenue growth in coming quarters.”
  • “We did fall a bit short of our target for launching this product at a comparable gross margin to the Bluebird2, our team is squarely focused on the various improvements we need to make to close the gap.”
  • “While we have modest expectations for unit volumes for Helios, it does open up certain markets where WMS did not previously have a presence and also offers opportunities to gain a foothold in these untapped markets and begin to build incremental growth”
  • “I think LORD OF THE RINGS has had an extraordinary start, I think we’ve got about 150 of them out in the field so far and we expect to have several hundred more this quarter. But the comments thus far have been very positive, that the win per day that we’re getting from our operator partners is indicating that it’s not quite WIZARD OF OZ type numbers but not far off either.”
  • xD premium to Bluebird pricing: “A little higher than that, probably 25%.”
  • “Penn National’s New Hollywood Casino in Cecil County, Maryland, we achieved a 29% floor share”
    • This amounts to 435 units shipping in the September quarter
  • “In fiscal 2011, we expect to spend an incremental $9 to $11 million or an equivalent to about 0.10 to $0.12 per diluted share on internal R&D activities over and above a normal annual increase in such as expenditures. We also plan to deploy about $40 million of incremental capital to expand our high return gaming operations business to address the growth opportunities in the Italy VLT sector, the pursuit of attractive operating leasing arrangements from customers globally and the ongoing conversion of our installed base participation games to the Bluebird2 platform.”
  • “WMS has specific product initiatives and operating strategies that provide the basis behind our revenue targets for fiscal 2011:
    • 3 to 7% growth in unit volume
    • 1 to 4% increase in average selling price in our product sales business
    • 4 to 6% growth in our installed participation base
    • 1 to 3% increase in average daily revenues in our gaming operations business”
  • “We expect that replacement sales in the U.S. and Canada will only improve modestly in calendar 2011 over calendar 2010, similar to the low single digit growth we’ve seen in calendar 2010 over calendar 2009.”
  • “Key revenue growth drivers are:
    • Ongoing share penetration and new unit shipment growth for new markets…
    • Modest improvement in Class II and central determinant jurisdictions, which today are primarily tribal casinos in Washington State and around the U.S…
    • Continue the ongoing ramp up in Mexico and Australia due to the strong player appeal and high earnings performance from the initial sales in fiscal 2010
    • We estimate that these three markets -- Washington, Mexico, and New South Wales, Australia -- in aggregate have an addressable market of over 250,000 units longer term.”
  • “In mid fiscal 2010, we also expect to deploy capital for our first VLT units to be leased in Italy.  We are close to concluding our discussions related to our first agreement with one of the concessionaires for VLT licenses in Italy and are presently in negotiations with additional concessionaires. These units will be leased gaming machines that earn WMS a daily revenue rate over a nine-year lease term. Revenues from these placements will be included in other gaming operations revenues. These lease units will not be included in the average installed participation base nor in the calculation of the average revenue per day per participation machine as they are not participation games.”
  • “In fiscal 2011, we also expect to earn initial revenues from both the launch of network gaming applications and our online casino site in the United Kingdom. We have three of the nine beta test sites of our WAGE-NET system and the Jackpot Explosion portal application running at this time. we continue to expect that these tests will conclude in the December quarter and that we would begin to earn our first network gaming application revenues at that time.
    • That adding our Jackpot Explosion portal application increased coin in by over 20% over the same game themes at those sites that do not have the portal application running.
    • We expect to launch our Jackpot Party online gaming site in the December quarter for U.K. residents. This site will contain a variety of familiar WMS games including THE WIZARD OF OZ and Star Trek, along with some traditional casino games and unique play features not seen before in the online gaming world.
    • We expect revenue contributions from both of these businesses will be very modest in fiscal 2011 but in both cases they will represent incremental revenues over fiscal 2010.”
  • “FY2011 …our expectation of 8-11% revenue growth …translates into annual revenue range of 830 million to 850 million"
  • “Our first quarter revenue guidance of 174 to 179 million represents five to 8% growth over the September 2009 quarter”
  • “In fiscal 2011, we anticipate …further improvement in operating margin, which we anticipate in the 22.5 to 23% range for the full year.”
  • “In fiscal 2011, we expect the product sales gross margin to range from 52 to 55% as our continuous improvement programs and benefits from higher volumes are expected to offset lower initial start-up margins on some new products and some new distribution channels. However I would note that in the fiscal first quarter, due to the low seasonality of revenues and the initial impact from the start-up and full commercial launch of the Bluebird xD with its new complex supply chain, we expect a sequential and year-over-year decline in the product sales margin, which when coupled with our higher R&D spend will lead to a year-over-year decline in our operating margin to 17.5 to 18% for the first quarter.”
  • “In our gaming operations business, we expect to sustain our gross margin during the year within a range of 79 to 81% while continuing to reflect the variability of jackpot expense experience and a mild dampening effect of having a higher percentage of WAP units in our installed base.”
  • “We expect R&D expenses to increase to around 15% of revenue in fiscal 2011.”
  • “While the dollar amount of spending on these initiatives will continue to increase, we expect the increase to be less than the rate of growth in revenue and thus expect that selling and administrative expenses will be lower as a percentage of revenues in fiscal 2011 than in fiscal 2010.”
  • “With the anticipated increase in gaming operations capital spend in fiscal 2011 and launching into new businesses, we do expect depreciation expense to begin to increase this year.”
  • “Absent legislative action to restore the R&D tax credit, we believe our effective tax rate will be in the range of 36 to 37% for fiscal 2011”
  • “Of our North American units this year we could ship as many as 25 to 30% of our unit shipments for the year could be XD.”
  • “Typically we sell a third of our products internationally from box sales. Q4 was a little bit of an uptick, we got to 40%, which is a record….I think it’s more in line of the 33 to 35% range is what I would suggest for modeling purposes this year.”
  • “As it relates to Illinois, I would view that to be a second half of the year event for WMS. I would think probably sometime in the probably February, March timeframe, you’ll see some initial placements and then you will see Q4 probably ramp up from there. We don’t see it as a significant opportunity in our fiscal ‘11, it’s probably going to be more so in fiscal ‘12, but we will have a few units in there, and that’s baked into the guidance that we gave today.”

CHART: US Dollar Index vs. Food Stamp...

According to the US Census Bureau, there were 43.6 MILLION Americans living in poverty in 2009 and the latest reading on Americans who live off of food stamps is about that same number (which is at a 15 year high).



CHART: US Dollar Index vs. Food Stamp... - chart1



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Deeply Disturbing

"It is not the function of our government to keep the citizen from falling into error; it is the function of the citizen to keep the government from falling into error."
– United States Supreme Court decision in American Communications Association v. Douds 

Before I start getting into one of the most critical long term TAIL risks that I am currently seeing develop in my interconnected global macro model (analytically incompetent Congressmen starting an economic war with China), allow me to paint a few mathematical lines around the core of the issue – unawareness.

  1. US Dollar: for the week-to-date = DOWN -1.8% (just another week of the same debauchery)
  2. Chinese Yuan: for the week-to-date = UP +0.90% (its best week in 28 months)

Now President Obama has been crystal clear in rhetoric on making decisions “based on facts” so we, as citizens, should hold him accountable to that in order “to keep the government from falling into error.”


To be fair, maybe our immediate term TRADE duration (3-weeks or less) is too short term for the economic sophisticates managing America’s currency risk from Washington, DC. So let’s look at currency “manipulation” on our intermediate term TREND duration:

  1. US Dollar: has declined in 13 of the last 16 weeks, and has lost over -8% of its value since early June when CNBC started begging Bernanke for QE2.
  2. Chinese Yuan: has been stable, not losing more than 0.5% of its value in any given week for the last 3 months.

If the intermediate term TREND of US Dollar devaluation and Chinese Yuan appreciation doesn’t fit your partisan politicking, let’s blow the charts out to the longest of long term so that your local politician who is gasping for the over-compensation air of re-election at the mid-terms can get “smart” on the math.

  1. US Dollar: after Nixon abandoned the gold standard (1971) and endowed both the Fed and Congress with the inalienable right to manipulate the world’s reserve currency via the US Federal Reserve Fund Rate, the US Dollar has only made a series of lower-highs and lower-lows.
  2. Chinese Yuan: since China de-pegged its currency in 2005, the Chinese Yuan has only appreciated in value. This morning’s price is the highest price ever for the Chinese Yuan. By our math, ever is a long time.

For the mathematically challenged, we’ve provided a picture of the long-term US Dollar chart so that you can forward it to Chuck Schumer (Democrat – New York) and Sander Levin (Democrat – Michigan). Before we YouTube what these professional politicians had to say on this matter, here’s what the Chinese said overnight:

  1. “Large fluctuations in the US Dollar’s exchange rate may impede the global economic recovery.” –Chinese Central Bank
  2. “The appreciation of the renminbi cannot solve the trade deficit with China and can’t fix the US unemployment problem.” –Jiang Yu
  3. “Pressure cannot solve the issue, rather it may lead to the contrary.” -Jiang Yu (spokesperson for the Foreign Ministry in Beijing)

Back to America’s conflicted, compromised, and confused:

  1. “We have to figure out ways to change behavior” –Tim Geithner
  2. “The U.S. economy is trying to pick itself up off the ground, China’s currency manipulation is like a boot to the throat of our recovery.” –Chuck Schumer
  3. “Chinese practices have led to a staggering US Trade Deficit… and it’s deeply disturbing.”  - Sander Levin

You got that right Colonel Sander Levin – the comments coming out of your mouth are Deeply Disturbing on so many levels that are obvious to any educated American on global risk matters right now that I can end with that. If your objective is to fear-monger uneducated Americans into going anti-China, shame on you.


Chuck Schumer became a member of the New York State Assembly in 1975. Sander Levin assumed office in Michigan’s 12th district in 1983. If these two characters want to point fingers at China for US government spending, deficit building, and debt incursion rather than hold themselves accountable to zero US private payroll adds in the last decade, they can go ahead and try – maybe that gets the next lemming in line to vote for them again, but in the age of the internet, I don’t think Americans are that stupid. Gentlemen, you have been YouTubed.


What do the alleged “non-partisan” people in Washington have to say about all this? Eswar Prasad, Senior Fellow at the Brookings Institute, concluded that “as the US mid-term election nears, the temptation of grandstanding on China will be irresistible to most Congressman.”


Thank you, Mr. Prasad.


The fact of the matter is that US Dollar depreciation is aided and abetted by stock market cheerleading to keep the US Federal Funds rate at ZERO percent anytime this country has an economic problem. That horse has been beaten to a dead pulp and has only equated to a high/low society whereby guys like me get paid to trade the volatility of commodity prices born out of that Dollar Depreciation as America’s poor get jammed with higher prices.


Mr. President, you tell me who is lying here, because it certainly isn’t market prices. The price of oats are up +24% in the last month alone (I eat oatmeal for breakfast). On our immediate term TRADE duration here are the highest inverse correlations to the USD Dollar:

  1. Sugar = 0.90
  2. Oats = 0.88
  3. Cotton = 0.86
  4. Corn = 0.85
  5. Oil = 0.79

*note to Chuck – these are very high inverse correlations.


According to the US Census Bureau, there were 43.6 MILLION Americans living in poverty in 2009 and the latest reading on Americans who live off of food stamps is about that same number (which is at a 15 year high). Professional politicians who are pointing fingers at the Chinese this morning get one big fat middle one from me – their fear-mongering is Deeply Disturbing. It’s US monetary policy, stupid.


My immediate term support and resistance lines for the SP500 are now 1111 and 1134, respectively. With the US stock market being immediate term TRADE bullish, I have upped my asset allocation to US Equities to 6% this week and taken my position in cash down to 46%. With US Congress imposing this kind of systemic risk to our financial system however, I’ll be a net seller all day today.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Deeply Disturbing - usd

CHART: Sticking with our Yen Short


The chart was extracted from a note dubbed "Sticking With Our Yen Short" issued to Risk Manager Subscribers on  September 15, 2010 at 3:35pm ET.





We aren’t short the yen purely based upon the catalyst provided by the current batch of Fiat Fools leading Japan. We think the top in the yen is around yesterday’s pre-intervention level of 82-83 per dollar and we see downside on a 3-6 month go-forward basis around 6-9%.


The reasons for our bearish stance are: the potential for both waning upward Chinese pressure on the yen and U.S. dollar stability.



CHART: Sticking with our Yen Short - chart1




Subscribers and Free-trialers have access this and other Macro Select notes in their entirety, including access to Hedgeye's real-time portfolio positions. 


Loved by the street, management may have set the bar high for 4Q.


The sell-side analyst community loves PNRA with 65% of analysts recommending the stock as a buy (there are no sell ratings).  It is easy to figure out why with the company posting +10% comparable sales growth and north of 200 bps of YOY operating margin growth in the first half of the year.  The comparisons get more difficult from here, however, with the company lapping sequentially better same-store sales growth in the back half of the year - particularly in 4Q10.  Additionally, PNRA is facing its toughest YOY margin comparison during 3Q10. 


This is not new news as the company guided to lower, yet still impressive, comp growth of +5-6% growth in 3Q10 and +4-6% growth in 4Q10 with flat to 50 bps of margin expansion in the back half of the year.  Based on recent top-line trends, the +5-6% same-store sales guidance for the third quarter seems achievable as the high end of the range only implies a 20 bp acceleration in two-year average trends from the prior quarter.  The fourth quarter comp guidance is more concerning, however, as it implies a 125 to 225 bp acceleration in two-year average trends from the reported level in 2Q10.  Based on management’s guidance, this sequential improvement in trends is expected to be driven by a sharp increase in 4Q10 transaction growth on a two-year average basis while average check growth is expected to decelerate slightly. 


Transaction growth ran positive for PNRA during the first half of the year but average check growth has accounted for about 7% of the 9.8% comp growth.  Average check growth held steady on a two-year average basis during the second quarter whereas transaction growth decelerated 70 bps.


This recent level of average check growth is impressive but is likely unsustainable.  We have seen other restaurant companies in the past use pricing and average check growth to support same-store sales growth, but this often takes a toll on traffic growth (please refer to the charts below that highlight the similarity in trends between the relationship of average check growth and transaction growth for Panera and Chipotle).  Ultimately, restaurant operators need to get more people in their restaurants. 


Panera management attributed the 2Q10 average check growth to the strength of the company’s summer salads, its meal upgrade program (offers the customer the opportunity to get a baked good for $0.99 with the purchase of an entree and a beverage) and to its growing catering sales, which carry higher average check per transaction.  PNRA will begin to lap the increase in catering sales during 3Q10 as catering sales first turned positive in 3Q09 (+3.0%) and quickly accelerated from there (+14% in 4Q09, +20% in 1Q10 and +24% in 2Q10). 


This, combined with the fact that the company is lapping 4.2% average check growth from 4Q09, will put increased pressure on average check growth during the fourth quarter.  Management guided to 3.0% average check growth in 4Q10 relative to its expectation for 5-6% growth in 3Q10 and the reported 6.5% and 7.7% growth in 1Q10 and 2Q10, respectively.  The company expects to offset this lower level of average check growth with +1-3% transaction growth, which I said earlier assumes a significant increase in two-year average trends.  I am not convinced management will be successful in achieving this targeted transaction growth so I am currently modeling +3.0% comparable sales growth for 4Q10 (relative to management’s guidance of +4-6%).  My estimate still implies a 75 bp acceleration in two-year average same-store sales trends and a 110 bp improvement in two-year average transaction growth trends from 2Q10 levels. 


New MyPanera Loyalty Program:


Panera is rolling out its new loyalty program system-wide during the fourth quarter and expects the program to lift comp sales by +1-2% during the quarter.  Management’s comp and transaction growth guidance assumes this sales lift.  The company is confident in the success of this program after testing it in 23 markets where results have shown that it strengthens customer relationships and has a meaningful impact on frequency of visits.  I do not doubt that over time, this program will drive frequency, but a +1-2% lift in the first quarter it is rolled out seems like a stretch.  Like I said, I am assuming transaction growth will get better during the fourth quarter, but based on the deceleration in trends during the second quarter, getting to +1-3% growth in 4Q10 seems aggressive.  Time will tell.    






Howard Penney

Managing Director



Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

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