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WMS ANALYST DAY NOTES

Here are some notes from the WMS Analyst Day

 

 

General:

  • Harrah's is looking to have a facility in Vegas with all the newest products
  • Speed to market is a key advantage for WMS - makes it easier to do business with WMS.  Bluebird 1 + 2 have a 2 week lead time for delivery; xD has a 6 week lead time.
  • Their sales people cover fewer accounts which allows them to cover clients more thoroughly. Recently increased salesforce by 50%.
  • In the past, customers didn't have to justify ROI of new machines; now they do. Two weeks ago, Ho-Chunk was visiting - haven't bought machines for 2.5 yrs and just ordered machines from WMS.
  • xD took 18 months from conception to market.  They are spending a lot of time to continuously improve their supply chain. Goal is to reach 60% gross margin and 30% operating margin.  60/40 product sales vs participation - once replacement ramps - running at 30% capacity for manufacturing.  Combine that with continued product improvements.
  • xD should get to BB2 gross margins or better by 4Q2011.  xD margins were weaker at launch - multiple new suppliers and new product (not BB1 evolution) - so there is some ramp time. Beginning to see some improvement already in the Sept quarter; should continue through 4Q. Will show QoQ improvement. They shipped a decent # of units this Q.

Strategy & Development:

  • Lean Sigma: started in manufacturing and now headed into product development
  • Strategy Deployment:- focusing efforts and priorities on a critical few. 3-5 year strategic initiatives.

Supply Chain & why speed is so important:

  • Now that they are a bigger supplier, there are a lot more suppliers that will deal with them.
  • 85% of their inventory is replenished based on consumption; replenished within 2 hrs
  • They closed 3 outside warehouses because they consolidated their inventory so well.  Midwest is a hotbed of supplier activity. 65% of their suppliers are located within a 100 mile radius.
  • Inventory was 30% of revenues 5 yrs ago - now 4.5%
  • Goal is to get to $25mm of inventory balance - spent $18mm on chips for their BB2s recently - which they will work through.
  • Have a little bit of finished goods from Barcelona, in Waukegan, and some in Vegas (where they keep the product that comes back (participation) and repurposed).
  • Working on putting USB technology into the cabinets - i.e. simplifying what goes in the box.
  • 90% of their games are built out with only 10% to be customized
  • They doubled their manufacturing capacity without additional money or people; have industry leading supply times
  • Feel like they still have lots of room for improvement

Factory tour:

  • BB2 just looks slimmer. Can make 100 games per day per line. Track production goals hourly. Can build reels and videos on same lines now - 80 reels per hour. Have constant employee cross training.
  • xD not cannibalizing their other products.  Lots of the margin improvement will come from training their workers, redesigning, negotiating, working better with suppliers. xD also has a different finish.

Participation refurbishment:

  • Strip them down, clean them up and then repurpose them.  Will remove a lot of components for testing and cleaning (bill validator/cpu)

Supplies/receiving:

  • 5 yrs ago, it used to take days to get supplies from the dock to the factory - now it's 5 hours - goal is 2hrs
  • Cut inventory space needed in half
  • Everything is barcoded now
  • Takes them 2 days to do a physical inventory count

Inventory mgmt:

  • Inventory reduced from $72mm in June 05 to just $31mm last quarter
  • Scan out empty bin - and they get replenished
  • Super core : 90% complete - can be turned into video or reel.  80% of their customers take games that are pretty plain vanilla.  Margin on the custom games are even better. Only impacts lead times (so 4-5 weeks).

INSIDE THE NOTEBOOK SEPT. 21, 2010

INSIDE THE NOTEBOOK SEPT. 21, 2010 - Notebook Image Hedgeye

 

 

 

Another day, another grind of new DATA and PRICES. Here are the bullish and bearish bullets in my notebook from the last 48 hours:
 
BULLISH
1.      SP500 remains immediate term bullish with TRADE line support = 1124

2.      All 9 sectors in our SP500 Sector Risk Mgt model remain bullish from an immediate term TRADE perspective

3.      SP500 return from the AUG26 low = +9.1%; that 1047 low was a higher-low than the YTD closing low of 1022

4.      Thailand Exports accelerated sequentially (AUG vs JUL) from 20.6% to 23.9%

5.      Taiwan Exports accelerated sequentially (AUG vs JUL) from 18.2% to 23.3%

6.      India’s stock market continues to make higher-highs post last week’s rate hike (5th of 2010, citing inflation pressures)

7.      Chinese Yuan continues to rally early this week as Malaysia was a noteworthy buyer of Yuan denominated bonds for reserves

8.      Chinese Bank Regulation looks tougher than Basel3; reducing one of the larger global macro risks (China having a US style credit blowup)

9.      RAB’s Glen Stevens considering a rate hike rather than pandering to the Bernanke/Japan QE turbo prop helicopters

10.  European equities continue to A) diverge from a performance standpoint and B) see Germany win and Greece lose performance

11.  FTSE and DAX remain bullish TRADE and TREND with both outperforming SP500 YTD

12.  Brazil and Canada remain bullish TRADE and TREND from an equity market perspective

13.  Commodities remain on a tear with the CRB Index +9.8% since beginning of July; seeing very high inverse correlation to US Dollar now

14.  Gold prices hit higher-all-time-highs that we sold into yesterday but we’ll buy back on a pullback to 1261 (maybe)

15.  Euro and British Pound continue to flash bullish TRADE and TREND as the Yen and US Dollar wallow in the Fiat Republic strategies

 


BEARISH
1.      SP500 remains bearish from an intermediate term TREND perspective; our Bear Market Macro line of resistance remains 1144

2.      Our immediate term SP500 RISK/REWARD model is flashing a 10:1 downside (RISK) vs upside (REWARD) signal = rare

3.      Volatility (VIX) is oversold again in the 21-22 range; the inverse relationship b/t VIX and SPY is critical to acknowledge

4.      Hearing very negative Q3 hedge fund performance numbers (real as opposed to rumor); perpetuating the September squeeze

5.      Obama praising his economic team on the TV Game Show thing that CNBC was embarrassing for America

6.      Chinese stocks are down for 4 of the last 5 days; bearish immediate term TRADE and threatening a TREND line breakdown of 2578 on the SSEC

7.      Japanese Yen has had no legitimate bid since intervention day; re-assuring us that there is legitimate TAIL risk mounting that Japan implodes

8.      China/Japan political relations broke down this week on the Chinese fisherman issue = rising tensions that we don’t see priced into oil

9.      Greek equities continue to get hammered on both an absolute and relative basis (-32% YTD) despite Greek politicians doing their road-shows

10.  Sweden re-elects Reinfeldt as PM but he takes a minority government as anti-immigration votes (Swedish Democrats) build momentum

11.  Portugal’s budget gap for AUG was worse than expected  - big miss on the revenue lines (like Greece) as they focus on the spending line

12.  Oil prices have broken their intermediate term TREND line of $76.12 again = bearish US demand signal

13.  Natural gas prices are broken across all 3 of our core risk management durations (TRADE, TREND and TAIL) = bearish US demand signal

14.  Copper prices continue to make lower-highs, much like the SP500, versus April levels

15.  2yr US Treasury yields continue to flag bearish from an immediate term TRADE perspective = bearish US demand signal

16.  Yield Spread (10s minus 2s) has compressed small for the week-to-date, less bullish than last week’s expanding spread was for Financials

17.  US Dollar continues to look God awful; bearish TRADE, TREND and TAIL (down now for the 14th week out of the last 17)

18.  Inflation readings across all of our Hedgeye models are signaling a sequential rise in September versus August

19.  IL’s pension fund “time bomb” potential finally broke as news from Bloomberg this week

20.  Japan’s Pension Fund (largest on the planet) is considering investing in emerging markets as they chase yield

21.  Russia and Costa Rica issuing sovereign debt now as the list of those piling debt upon debt upon debt grows like bark on a bonfire

 
Altogether, I started leaning more bearish than bullish in the last 24 hours. I expressed this by taking up the CASH position in the Hedgeye Asset Allocation Model up from 46% at Friday’s close to 61% this morning. I’ve also gone from net long to net short (longs vs shorts) in the Hedgeye Portfolio which has 10 LONGS and 11 SHORTS as of 11AM EST.
 
KM


The Grind: What's In My Notebook?

Another day, another grind of new DATA and PRICES. Here are the bullish and bearish bullets in my notebook from the last 48 hours:

 

BULLISH:

  1. SP500 remains immediate term bullish with TRADE line support = 1124
  2. All 9 sectors in our SP500 Sector Risk Mgt model remain bullish from an immediate term TRADE perspective
  3. SP500 return from the AUG26 low = +9.1%; that 1047 low was a higher-low than the YTD closing low of 1022
  4. Thailand Exports accelerated sequentially (AUG vs JUL) from 20.6% to 23.9%
  5. Taiwan Exports accelerated sequentially (AUG vs JUL) from 18.2% to 23.3%
  6. India’s stock market continues to make higher-highs post last week’s rate hike (5th of 2010, citing inflation pressures)
  7. Chinese Yuan continues to rally early this week as Malaysia was a noteworthy buyer of Yuan denominated bonds for reserves
  8. Chinese Bank Regulation looks tougher than Basel3; reducing one of the larger global macro risks (China having a US style credit blowup)
  9. RAB’s Glen Stevens considering a rate hike rather than pandering to the Bernanke/Japan QE turbo prop helicopters
  10. European equities continue to A) diverge from a performance standpoint and B) see Germany win and Greece lose performance
  11. FTSE and DAX remain bullish TRADE and TREND with both outperforming SP500 YTD
  12. Brazil and Canada remain bullish TRADE and TREND from an equity market perspective
  13. Commodities remain on a tear with the CRB Index +9.8% since beginning of July; seeing very high inverse correlation to US Dollar now
  14. Gold prices hit higher-all-time-highs that we sold into yesterday but we’ll buy back on a pullback to 1261 (maybe)
  15. Euro and British Pound continue to flash bullish TRADE and TREND as the Yen and US Dollar wallow in the Fiat Republic strategies 

BEARISH

  1. SP500 remains bearish from an intermediate term TREND perspective; our Bear Market Macro line of resistance remains 1144
  2. Our immediate term SP500 RISK/REWARD model is flashing a 10:1 downside (RISK) vs upside (REWARD) signal = rare
  3. Volatility (VIX) is oversold again in the 21-22 range; the inverse relationship b/t VIX and SPY is critical to acknowledge
  4. Hearing very negative Q3 hedge fund performance numbers (real as opposed to rumor); perpetuating the September squeeze
  5. Obama praising his economic team on the TV Game Show thing that CNBC was embarrassing for America
  6. Chinese stocks are down for 4 of the last 5 days; bearish immediate term TRADE and threatening a TREND line breakdown of 2578 on the SSEC
  7. Japanese Yen has had no legitimate bid since intervention day; re-assuring us that there is legitimate TAIL risk mounting that Japan implodes
  8. China/Japan political relations broke down this week on the Chinese fisherman issue = rising tensions that we don’t see priced into oil
  9. Greek equities continue to get hammered on both an absolute and relative basis (-32% YTD) despite Greek politicians doing their road-shows
  10. Sweden re-elects Reinfeldt as PM but he takes a minority government as anti-immigration votes (Swedish Democrats) build momentum
  11. Portugal’s budget gap for AUG was worse than expected  - big miss on the revenue lines (like Greece) as they focus on the spending line
  12. Oil prices have broken their intermediate term TREND line of $76.12 again = bearish US demand signal
  13. Natural gas prices are broken across all 3 of our core risk management durations (TRADE, TREND and TAIL) = bearish US demand signal
  14. Copper prices continue to make lower-highs, much like the SP500, versus April levels
  15. 2yr US Treasury yields continue to flash bearish from an immediate term TRADE perspective = bearish US demand signal
  16. Yield Spread (10s minus 2s) has compressed small for the week-to-date, less bullish than last week’s expanding spread was for Financials
  17. US Dollar continues to look God awful; bearish TRADE, TREND and TAIL (down now for the 14th week out of the last 17)
  18. Inflation readings across all of our Hedgeye models are signaling a sequential rise in September versus August
  19. IL’s pension fund “time bomb” potential finally broke as news from Bloomberg this week
  20. Japan’s Pension Fund (largest on the planet) is considering investing in emerging markets as they chase yield
  21. Russia and Costa Rica issuing sovereign debt now as the list of those piling debt upon debt upon debt grows like bark on a bonfire 

Altogether, I started leaning more bearish than bullish in the last 24 hours. I expressed this by taking up the CASH position in the Hedgeye Asset Allocation Model up from 46% at Friday’s close to 61% this morning. I’ve also gone from net long to net short (longs vs shorts) in the Hedgeye Portfolio which has 10 LONGS and 11 SHORTS as of 11AM EST.

 

KM

 

Keith R. McCullough
Chief Executive Officer

 

The Grind: What's In My Notebook? - The Grind


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THE DAILY OUTLOOK

TODAY’S S&P 500 SET-UP - September 21, 2010

As we look at today’s set up for the S&P 500, the range is 25 points or -2.07% downside to 1119 and 0.11% upside to 1144. Equity futures trading mixed as the market continues to closely watch the bond auctions in Europe and ahead of the FOMC meeting later today. Today's macro highlights include: August Housing Starts, August Building Permits and FOMC rate decision.

  • Commonwealth REIT (CWH) said it will sell 5m shares
  • Cypress Sharpridge Investments (CYS) plans to offer 10m shares
  • Hatteras Financial (HTS) said it will sell 5m shares
  • Health Care REIT (HCN) will offer 7m shares
  • Invesco Mortgage Capital (IVR) 3Q dividend $1-shr vs est. 83c
  • TeleNav (TNAV) extended deal Sprint Nextel to end of 2012

PERFORMANCE

  • One day performance: Dow +1.37%, S&P +1.52%, Nasdaq +1.74%, Russell +2.83%
  • Month-to-date: Dow +7.37%, S&P +8.88%, Nasdaq +11.39%, Russell +11.22%
  • Quarter-to-date: Dow +10.01%, S&P +10.85%, Nasdaq +11.64%, Russell +9.86%
  • Year-to-date: Dow +3.11%, S&P +2.46%, Nasdaq +3.77%, Russell +7.07%

EQUITY SENTIMENT:

  • ADVANCE/DECLINE LINE: +1928 (+1374)
  • VOLUME: NYSE - 955.36 (-48.51%)  
  • SECTOR PERFORMANCE: Every sector was positive yesterday- Several companies reported better than expected earnings (DFS +3.8% and LEN +8.2%) and M&A activity continues to provide an upward bias (IBM +1.2% for NZ +14.9%). The XLB was the laggard….  
  • MARKET LEADING/LAGGING STOCKS YESTERDAY: Office Depot +10.20%, Lennar +8.22% and Teradata +7.53%/Intl Paper --6.35%, Weyerhaeuser -2.32% and US Steel -1.60%
  • VIX: 21.50 +2.32% - YTD PERFORMANCE: (-0.83%)            
  • SPX PUT/CALL RATIO: 2.16 from 2.40 -9.85%

CREDIT/ECONOMIC MARKET LOOK:

  • TED SPREAD: 13.92 -0.102 (-0.726%)
  •  3-MONTH T-BILL YIELD: 0.17% +0.01%
  • YIELD CURVE: 2.25 from 2.27

COMMODITY/GROWTH EXPECTATION:

  • CRB: 279.64 flat
  • Oil: 74.86 +1.63% 
  • COPPER: 350.45 -0.50%  
  • GOLD: 1,279 +0.23%

CURRENCIES:

  • EURO: 1.3073 +0.17%
  • DOLLAR: 81.335 -0.08% 

OVERSEAS MARKETS:

Europe

  • European Markets: FTSE 100: +0.36%; DAX: +0.43%; CAC 40: +0.48% - European markets opened higher in a continuation of yesterday's strong performance with Financial, Oil & Gas and Construction & Material leading the way.  Volume remains light ahead of FOMC rate decision.
  • Nokia trades lower after announcing further delays to its N8 smart phone.
  • BNP-Paribas trades higher after CEO Baudouin Prot rules out need to raise additional capital.

Asia

  • Nikkei (0.25%); Shanghai Composite +0.11%.  Japan’s markets were open again after yesterday’s holiday and declined while most Asian markets posted small gains today.
  • Property developers kept Hong Kong positive.
  • Australia gave up early gains and turned slightly negative. BHP Billiton edged down on extending its offer for Potash.
  • Japan started up but lost its gains in the early afternoon.
  • South Korea is closed through 23-Sep for Chusok.
  • The yen is trading at 85.53 to the US dollar.
Howard Penney
Managing Director

THE DAILY OUTLOOK - levels and trends

 

THE DAILY OUTLOOK - S P

 

THE DAILY OUTLOOK - VIX

 

THE DAILY OUTLOOK - DOLLAR

 

THE DAILY OUTLOOK - OIL

 

THE DAILY OUTLOOK - GOLD

 

THE DAILY OUTLOOK - COPPER


R3: Adi, Ebay, WMT, Wedges, & India

R3: REQUIRED RETAIL READING

September 21, 2010

 

E-commerce continues to fill the headlines with the launch of Marcjacobs.com and a robust holiday outlook for online sales overall.  At the same time, keep an eye on WMT’s efforts which link the retailer with FedEx to offer greater convenience on delivery options.

 

 

RESEARCH ANECDOTES

 

- Blog activity and increased speculation continues to circle around an apparent shortage of Louis Vuitton monogram bags.  Supposedly demand picked up, leaving the iconic bags in short supply on a worldwide basis over the past month.  While most stories point to demand being better, there is also speculation that supply have been cut too far.  Given the handmade nature of the bags, there is little hope either way that production is ramped up meaningfully over the short-term. 

 

- On the heels of its first concept store launch in Santa Monica in August, Nike’s second offering has come to Roosevelt Field in Long Island perhaps best known for shutting down last year in conjunction with a Justin Bieber appearance. The 14,000 sq. ft. store’s key feature is Nike’s NIKEiD technology complete with four Mac computers in the middle of the store in what is becoming the democratization of what has historically been an exclusive by appointment only service.

 

- Driven by the loss of $250Bn a year in lost revenues and 750,000 jobs annually from counterfeit product, Congress is making an effort to combat counterfeit merchandise sold online by rouge web sites through a bill introduced Monday.  While this won't move the needle anytime soon, if ever, it’s a step in the right direction that could eventually harness more sales for luxury brands like Ralph, Coach, Gucci, LVMH, etc.

 

  

OUR TAKE ON OVERNIGHT NEWS 

 

Adidas Sees 2011 Growth on China Rebound, Russian Demand - Adidas AG , the world’s second- largest sporting-goods maker, will increase sales and profit in 2011 as China rebounds and Russia becomes the company’s top European market,CEO Herbert Hainer said . Sales of new products such as Reebok ZigTech trainers will also help boost sales next year, Hainer said in an interview yesterday at Adidas’s headquarters in Herzogenaurach, Germany. That will help compensate for the lack of a sporting event the size of this year’s World Cup. Hainer, referring to both revenue and earnings, claimed “I don’t see anything, honestly, that should hinder us from growing in 2011 and the years ahead.” The company’s biggest challenge next year will be to secure sufficient manufacturing capacity to accommodate growth, Hainer said. He’s increasing production sites in Laos, Vietnam and Cambodia, adding to those in China. <bloomberg.com>

Hedgeye Retail’s Take: It won’t be easy by any means, but comping 2010 can be done. Keep in mind that China and Emerging European markets now account for only ~20% of Adidas’ revs and the progression of the brand’s ZigTech line has been impressively well received. Anecdotally, in speaking with management at Finish Line, the two most anticipated footwear styles for the 2H are UA’s basketball shoe and the Zig (Reebok) basketball product.

 

Walmart.com Tests Free Shipping to FedEx Locations - Retailer’s twist on its Site to Store service targets consumers in Boston and Los Angeles. Walmart.com is offering free delivery of online orders to FedEx Corp. locations in Los Angeles and Boston, where Wal-mart Stores Inc. operates few stores. It’s a variant of Walmart.com’s Site to Store service that lets shoppers buy online and pick up in a nearby Wal-Mart store. The new service lets customers in the two test cities pick up orders at selected FedEx Office facilities. <internetretailer.com>

Hedgeye Retail’s Take: This strategy might speak more to reviving Kinko’s than anything else.  The ability to leverage both its own stores in addition to Fedex Office locations adds a level of convenience that no pure play online retailer can touch. 

 

Ebay Launches Look Book - EBay launched a look book Monday that takes its content from consumers on the streets. Consumers can upload photos of themselves in their favorite fall styles onto the eBay Fashion LookBook, tag three of the items they’re wearing to explain the style and label, and then eBay links the items to similar looks live on eBay Fashion for purchase. EBay expects thousands of submissions and says it’s not necessary that consumers wear items purchased from or up for sale on eBay to submit a photo. <wwd.com/retail-news>

Hedgeye Retail’s Take: While some pop culture magazines include features like this whereby celebrity outfits are translated into affordable look-a-like options, this concept takes it to the next step highlighting product for purchase. Depending on participation, retailers and designers alike are likely to frequent the Look Book as a source of inspiration.

 

Marc Jacobs E-Commerce Launches - The much-anticipated e-commerce site for Marc Jacobs is finally launching — at press time, it was set to go up Monday night — and, like the brand, it will be playful and unique. Most unusually, the site mixes illustration with photography and video. Illustrations of actual sales people dressed in Marc Jacobs clothes appear on the site, and their outfits and identities will change over time. Shoppers can click on illustrated items to buy. The home­page shows an illustration of a store entrance with actual runway video from both of the brand’s collections playing in the windows. <wwd.com/retail-news>

Hedgeye Retail’s Take: The use of multi-media to sell fashion product makes a ton of sense, but it’s tough to execute which is why we haven’t seen more of it. Since it’s often difficult to gauge the fit and look from stills, we expect other luxury designers to follow suit in adding multimedia content to sites if Jacobs’ launch is a success.

As a point of reference, these are the top ten most followed fashion labels on twitter that will likely be following Jacobs launch closely:

1. Lacoste: @lacoste, 204,061 followers
2. Christian Siriano: @csiriano, 185,458 followers
3. DKNY: @dkny, 178,798 followers
4. Victoria Beckham: @vbfashionweek, 163,078 followers
5. Diane von Furstenberg: @insidedvf, 107,028 followers
6. Nicole Miller: @nicolemillernyc, 89,954 followers
7. Betsey Johnson: @xobetseyjohnson, 51,977 followers
8. Marc Jacobs: @marcjacobsint, 42,749 followers
9. Tory Burch: @toryburch, 36,823 followers
10. Jeremy Scott: @itsjeremyscott, 36,568 followers

 

Happy Online Holidays - Direct-to-consumer holiday sales will rise 15% according to consulting and accounting firm Deloitte. But total retail sales will increase only 2%. The reason non-store shopping continues to rise is its convenience. And since consumers are shopping online, as well as on their mobile phones, there’s a prime opportunity for retailers to build brand awareness. <internetretailer.com>

Hedgeye Retail’s Take: No surprise as online sales continue to be the preferred method for consumers driven by the combination of free shipping and convenience.

 

Swiss Watch Exports Maintain Momentum from Hong Kong and France, Slows in USA and China - Swiss watch exports retained their momentum in August, rising 24.1%. “With two thirds of the year now behind us, the branch is 20.1 percent higher and has grown at a sustained pace since last January,” the Federation of the Swiss Watch Industry said in a statement. Sales in Hong Kong, the largest market for Swiss timepieces, rose 51.7%, while France’s business grew 54.7%. However, sales growth totaled just 7.6% in the United States, well below the world average, and China saw its sales progression slow to 4.4% after leading the pack for the first part of the year. <wwd.com/business-news>

Hedgeye Retail’s Take: With the Swiss Franc appreciating 14% against the Yuan since June the slowdown in demand is to be expected – more notably is demand in Hong Kong, which despite a similar currency devaluation continues to exhibit robust demand.

 

New Wedge Rules Boost Golf Sales - A new regulation governing the production of certain types of golf clubs is leading to a spike in sales of certain wedges, according to Golfsmith. The clubs will soon become scarce because of a recent "groove rule" change from the United States Golf Association (USGA). Golfsmith has seen an increase in year-to-date wedge sales of more than 20% over the same period a year ago. <sportsonesource.com>

Hedgeye Retail’s Take: Nothing drives demand for clubs like minute rule changes – this time is no different. Despite the increased interest in soon to be banned clubs, golf sales remain lackluster.

 

India Launches New Program to Attract Women Textile Workers - India’s textile industry of Punjab has recently launched a new program to encourage women to work in textile factories in a hope to solve the shortage of workers. <fashionnetasia.com>

Hedgeye Retail’s Take: Despite common perception, a large percent of women work in India. Case in point, over 50% of farm production is from women. While we don’t have the exact participation rate of women in the textile industry, we don’t expect this to be a substantial enough source to fully offset the current shortage.

 

India Concerned Over Image Relating to Child Labor Laws - For countries and industries who land on government watch lists detailing alleged use of child and forced labor, the consequences are as much about public perceptions as they are about the economic fallout. This summer, the Indian apparel industry expressed concerns about being named by the U.S. Labor Department on one of its watch lists for child labor. Indian manufacturers were particularly concerned their presence on the list would impact the image the world had and would ultimately damage operations. Under Indian law, children under the age of 14 are prohibited from working in “hazardous” industries and in homes, hotels and restaurants. But the law is rarely enforced and convictions have been few. The Indian government estimates that more than 12 mm children under the age of 14 are employed, while nongovernmental organizations estimate there are twice that many. <wwd.com/business-news>

Hedgeye Retail’s Take: This is concerning to say the least, particularly in light of the previous headline. With increased pressure to resolve shortages, expect the U.S. Labor Department to keep a close eye on who fills in at the line.

 

 


TIME TO FEED THE GORILLA

A steady diet of market share losses has IGT looking more like a chimp than the 500 pound Gorilla it once was. Have sentiment and market share both reach a trough?

 

 

We’re pretty sure IGT’s market share is close to bottoming.  With the latest downgrade, we think sentiment may be as well.  Sure there are still some buy ratings out there but no one seems to be pounding the table on the stock.  Why?  A perceived lack of catalysts, a perceived lack of earnings visibility, and a perceived 25% market share in perpetuity.  Well, in this case, perception is not reality.

 

The Elusive Replacement Market

The biggest catalyst out there is the normalization of replacement demand.  It will happen, only the timing is uncertain.  If we knew when, IGT would be a $25 stock.  We don’t but we’re not going to rely on the sell side consensus that replacements will stay under pressure for the next 18 months.  We think an analysis of the major potential drivers yields an acceleration sooner than that and potentially V-shaped in magnitude.  Here are the major drivers:

  1. Accelerated depreciation initiatives working through Congress.  President Obama proposed 100% expensing of capital equipment purchases.
  2. Floors are not old yet but they will be soon – end of TITO was 6 years ago
  3. IGT’s footprint is older than average
  4. Operator balance sheets are in much better shape
  5. More certainty in the casino business – revenues are stagnant but at least the world isn’t ending
  6. More competition from new markets

While accelerated replacement demand would benefit all suppliers, IGT’s stock could have the most upside to that catalyst.  Given the liquidity of the stock, name recognition, and its reliance on box sale, investors would likely flock to IGT.

 

Again, the problem is timing.  However, near term earnings visibility may be a little better than what the bears are chirping.  Despite the recent downturn in sentiment, we don’t believe anything has really changed since IGT last gave guidance in July.  Our $0.18 estimate looks safe and while we are a little below the Street for FY2011, we have not modeled significant replacement growth (yet), share buyback, or the convertible takeout. 

 

25% Ship Share Not Sustainable

IGT has rung up two consecutive quarters of mid 20s ship share.  The share deterioration is nothing short of stunning.  After all, IGT was at 50% as recent as Q3 2006 and at 40% in Q2 2008.  However, we think IGT’s recent share is unsustainably low.  The dearth of new casino openings has not helped since IGT usually garners a bigger share of slot orders from new and expanding casinos.  Second, IGT’s existing footprint is older than the average North American slot machine.  IGT’s content has undergone a significant upgrade as resources have moved from systems to development to game development.  Finally, server based gaming is finally gaining some traction.  Ship share in the 35% range is probably a good run rate and while we don’t see a lot of improvement occurring in the next few quarters, calendar 2011 should show gradual improvement throughout the year.  Ship share gains off the current bottom should be a catalyst.

 

Core Earnings

Given the trough level of replacement demand and the dearth of new markets, we believe earnings are also at a trough.  Starting at a baseline of $0.90, we get to $1.20 in core earnings just from normalizing industry wide replacement demand at 76,000 (adds $0.17), adding $0.08 from taking out the convertible, and $0.05 from using free cash flow to buy back stock.  Beyond the $1.20, IGT should be able to grow earnings 20%+ annually over the next 3-5 years with the addition of new markets (MD, OH, IL, Italy, etc.) and continued share repurchases. 

 

With cash earnings tracking very close to EPS, it seems reasonable to assume at least an 18x multiple for that kind of growth and cash flow generation.  So if IGT is worth at least $21-22 per the analysis, what will it take to get there?  It probably starts with making the FQ4 which we think IGT will do.  Market share stabilization and improvement will certainly help but the real catalyst will be replacement demand.  While we wait for the inevitable, downside appears limited, owing to awful sentiment.


Hedgeye Statistics

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

  • LONG SIGNALS 80.65%
  • SHORT SIGNALS 78.64%
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