The Macau Metro Monitor, October 20th 2010


In the first nine months of 2010, Macau’s total public revenue (not including autonomous agencies) rose by 37.3% to MOP55.82 billion (US$7 billion).  Direct taxes from gaming was up by 60.5% to MOP 46.56 billion.  A fiscal surplus of MOP31.91 billion was recorded in the first nine months of 2010, up by 56.7% as compared with the same period last year.


As we wrote last week, we expect a sizeable Q3 beat out of PENN tomorrow. In preparation for the PENN Q3, we’ve put together the pertinent forward looking commentary from the Q2 earnings release/call and subsequent conferences.


Post Earnings Conference Commentary

  • We’ve got some properties doing exceptionally well, mostly surrounding table games, but other than that, I would say that the consumer is still struggling. And we don’t forecast for next year that, that’s going to change, well at least, we’re going to operate under the assumption that the consumer is going to continue to spend at the current levels of their spending at, and knock on wood, they don’t actually struggle anymore.”
  • “We are very happy with what’s happening with table games in West Virginia, and we know that these percentages will be coming down. So, next year, I don’t believe we’ll have any property north of 20% of our EBITDA.”
  • “Our table games went live in July, it’s been just a staggering success. We’ve been incredibly happy with the results in Charles Town.  Normally, we estimated our table games play to be a function of what our slots revenues were, and candidly, our best property before this was Lawrenceburg and Charles Town. I think Lawrenceburg was in the 15% range, and Charles Town has been averaging somewhere around 25%.”
  • “Penn National’s results have been very good.”
  • “We now own two of the racetracks in Ohio. It’s a bit of a hedge. We’re not exactly sure what’s going to happen with VLTs in Ohio. At this point, it doesn’t look like anything is going to happen before the election. And quite candidly, we think it’s going to be obviously a more focused discussion post-election time”
  • “Our view on Texas is, it is, we believe, very likely that gaming will come to Texas – I don’t know if it’s very likely, certainly north of 50%. And we want to be a part of it. And we wanted to be a part of it from -- in a way that gave us standing to participate in the process.”
  • “If gaming does come to Texas, it’s our belief that it will almost undoubtedly – if gaming comes, we’ll undoubtedly include gaming at the racetrack. That doesn’t mean that they won’t have other standalone facilities in the state, but we are convinced that if they do in fact come up with a measure in Texas for gaming, that tracks would be included.”
  • “It also gives us the ability to have standing in terms of being able to lobby in the State of Texas with credibility; that’s incredibly important.”
  • [Perryville] “Our margins are clearly going to be challenged somewhere in the low-to-mid-teens perhaps potentially we can do a little better for a while. But I think that’s probably closer to where we’re thinking.”
  • “Relative to guidance, nothing has changed.”


Q2 Conference Call:

  • “I guess I could characterize our business as, well, not wonderful but it’s stable and there are some bright spots that we will highlight further through our presentation.”
  • “We’re still seeing the same kind of consumer trends that we saw in prior quarters. It hasn’t gotten any better; it hasn’t gotten any worse. As you look at the unemployment levels around the markets we operate in and you look at the housing prices, I mean we’re still seeing softness on both of those macroeconomic fronts and it’s reflective in our consumer.”

Li-Ning: Picking up the Pace


“Discovering the enemy's dispositions and remaining invisible ourselves, we can keep our forces concentrated, while the enemy's must be divided.” – Sun Tzu



If U.S. based athletic footwear and apparel branded companies aren’t familiar with the ancient Chinese military general and author of The Art of War quoted above, we suggest they pick up a copy – perhaps then Li-Ning’s strategy wouldn’t be such a mystery. Since opening its design office in Nike’s back yard back in January 2008, China’s largest athletic footwear company has taken a methodical and understated approach to entering the U.S. athletic footwear/apparel market – this week’s launch of the company’s first lightweight running shoe is no different. Likely positive for retailers like FL, FINL, DKS and HIBB in the intermediate-term, potentially more competitive for NKE and UA long-term.


Given Li-Ning’s more public efforts over the past 2-months, we’ve taken a step back to put its development in context – consider the following:

  • Consistent with prior launches, partnerships, and corporate developments, Li-Ning officially launched the lightweight Freemont running shoe yesterday unbeknownst to just about everyone. While not the first foray into running (the F2 Runner launched in August), the Freemont confirms Li-Ning is both serious about entering the category and a legitimate innovator of technical footwear. The Freemont weighs ~7 ounces (nearly 15% lighter than Nike’s Free) and the F2 Runner features molded foam construction (think Crocs-like material, not look). We expect future launches to be similarly covert.
  • Li-Ning is no longer just a foreign-based basketball brand. With the addition of running, the company is quickly building out its product portfolio. There is talk of a lifestyle collaboration with NBA’er Baron Davis and along with other ‘off-the-court’ offerings.  Recall that Baron Davis is one of the higher profile endorsers of the brand beginning this season, along with rookie Evan Turner.  Similar to its approach in basketball, we anticipate additional high profile athlete endorsements in the coming months to promote new category extensions – stay tuned.
  • With an inherent low-cost structural advantage stemming from manufacturing assets and a low cost of capital, Li-Ning may actually have cost advantage on its domestic competition.  So far, product has been introduced at low-to-moderate price points. With basketball shoes selling from $65-$100 and the F2 Runner at $59.99, we wonder what happens if the company ups the ante with premium/technical offering at prices well below the current $100-$160 premium price point norms?  This point becomes more relevant as the brand does.
  • Few appreciate the size of Li-Ning and therefore, the backing behind these initiatives – the company reported sales of $1.3Bn USD in FY09 growing at a 2-year CAGR of ~40%. With roughly a 50/50 split between footwear and apparel revenues, the company’s footwear business is nearly 5x that of Under Armour by comparison. More importantly, besides having an R&D budget likely exceeding UA’s, the brand’s footwear heritage, team, and existing China infrastructure should enable it to test and adjust to underperforming initiatives rapidly.
  • Lastly, new product extensions are positive for domestic athletic footwear retailers. Given its existing exclusive relationship with FL’s Champ’s division in basketball (the Baron Davis line is exclusive), we expect Foot Locker to be a primary beneficiary of future develpments. It’s important to note, that the company is currently targeting specialty run shops for its new lightweight shoe. The key here remains how the brand ultimately decides to tier product by channel, with a clear differentiation between price points, technical features, and design. With it’s first foray into the market at sub-premium price points, we suspect price is being used a way to entice consumer trials.  Over time however, the jury is still out as to where the brand may sit on the shoe wall at any given retailer.

After studying its competition for more than 2-years now, Li-Ning is taking precise steps to enter select markets, which so far include basketball, running footwear, and compression apparel (they just acquired a high-end UA like compression company based in Australia) – for now. While the company has done a commendable job in staying largely ‘invisible’ to its competition, the accelerating product/event timeline below suggests the competitive threat on domestic soil is mounting.



Li-Ning: Freemont

Li-Ning: Picking up the Pace - LiNing Running 2 10 19 10


Li-Ning: F2 Runner

Li-Ning: Picking up the Pace - LiNing Running 1 10 19 10


Li-Ning: Picking up the Pace - LiNing USTimeline 10 19 10


Casey Flavin


Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.


Conclusion: Although DPZ posted strong results for 3Q10, the sustainability of the current trends and the company’s ability to better leverage top line growth are key issues going forward.


DPZ is trading well today, outperforming the restaurant space on the back of good earnings results from this morning.  While the results were strong, particularly on the top line, some questions arise going forward regarding the sustainability of their margin growth.   Recurring, diluted EPS growth for the quarter was 59% versus the third quarter of 2009.  Driving this growth was domestic company same-store sales growth of 11.8% and domestic franchise same-store sales growth of 11.7%.  On the negative side, gross margins declined by about 40 bps year over year.  This was the first compression in gross margins since 3Q08. 


The 10-Q provides some detail on the underlying dynamics of the margin compression.  In the section titled, “Domestic Company-Owned Stores Operating Margin”, it is stated that “as a percentage of store revenues, food costs increased 3.2 percentage points to 28% in the third quarter of 2010…due primarily to higher cheese and meat prices, a slight increase in the product costs for our improved pizza” and lower mix.   Insurance costs increased 1.9 percentage points to 5.4% as a percentage of store revenues.  On the conference call this morning, management mentioned insurance costs “as well as higher overall commodity cost” as being largely the cause of the margin decrease. 


While a minor point, by the way this was communicated; it seemed that management was implying that insurance costs were more of a factor than food.  In reality, food costs have increased far more on a year-over-year basis.   To that end, food costs have increased as a percentage of sales each quarter to date in 2010 where as the company had been able to leverage its insurance costs prior to 3Q10.  Management likely highlighted the higher insurance costs as they were less expected and potentially one-time in nature.  Higher commodity costs, however, were expected; though the YOY increase in food costs as a percentage of sales accelerated during the quarter to 320 bps from 190 bps and 150 bps in 1Q10 and 2Q10, respectively.  Although the company continued to get leverage on its labor and occupancy cost lines, it was disconcerting to see margins decline with comparable sales growth up 11.8%, particularly knowing that same-store sales growth will not be up double-digits forever.  Going forward, it will be interesting to see if DPZ can more successfully leverage its top line growth.  This will become especially important in 2011 when facing difficult same-store sales comps and facing commodity cost headwinds. 


DPZ will lap its first quarter of positive domestic company-owned same-store sales growth in 4Q10 (after eight quarters of declines).  The YOY impact on margin from higher cheese prices should decelerate in 4Q10, however, as cheese prices had already started to climb in 4Q09 with the average cheese block price per pound up about 24% from the 3Q09 level.  During 3Q10, the average cheese price increased nearly 29% YOY to $1.53 per pound, but if you assume prices hold relatively stable in 4Q10, cheese prices would only increase about 3% YOY, which should relieve some pressure on margins.  That being said, management also pointed to higher meat costs as an issue during the third quarter.






Howard Penney

Managing Director

China Raises Rates... Setting Off a Chain Reaction That's Bad for Reflation

Conclusion: Fed-sponsored global inflation has led to China raising interest rates, which may lead to incremental monetary policy hawkishness by other central banks as nations from Asia to Latin America struggle to balance combating inflation with curbing currency gains. We could potentially see global interest rates chase China higher, effectively setting up for an end to the current cycle of dollar-debased reflation.


For the first time since 2007, China raised its benchmark lending and deposit rates: +25bps each to 5.56% and 2.5%, respectively. The move, which came as a surprise to many investors (who may have been preoccupied with the busy day of U.S. corporate earnings – BAC, JNJ, GS, etc.), should not be taken as a shock considering the inflationary data out of China of late: 

  • Property prices rose +50bps MoM in September – the first MoM gain since May
  • CPI accelerated to a 22-month high to +3.5% YoY in August – 125bps greater than China’s one-year benchmark deposit rate prior to today’s rate hike
  • The Shanghai Composite has rallied +27% from its July lows – overnight JPMorgan Chase & Co. and Citigroup raised Chinese stocks to “neutral” from “underweight” after the rally 

Today’s rate hike was both a direct response to the aforementioned inflation data and a proactive attempt at addressing the likely inflationary economic data to be released tomorrow. In an ironic twist, however, the rate hike could spur accelerated capital inflows into the country, which contributed to a record $194 billion increase in China’s foreign exchange reserves last quarter.


For the time being, China has chosen to aggressively combat inflation, given that ~36% of its citizenry lives on less that $2 per day (PPP), according to Asia Development Bank. To drain the excess liquidity that is bound to grow with additional capital inflows, the People’s Bank of China is prepared to step up its selling of bills, having already sold a net 209.7 billion yuan YTD after redeeming a net 579.5 billion yuan in 2009.


Elsewhere around the globe, we are seeing a directional shift towards hawkish commentary out of Asian and Latin American central bank presidents, many of whom are in similar predicaments as China: curb currency appreciation to remain export competitive or fight inflation to remain in power. Should this latest tone gain momentum internationally, we could see more central banks abandon the “currency war” and take a firmer stance on the inflation that has proliferated globally due to Fed-sponsored dollar weakness. A few of the notable quotes over the previous 24 hours are listed below: 

  • Australia’s central bank, led by Glenn Stevens, on setting the tone for another rate hike by year end: “The case to wait before making a tightening move was that… the rise in the exchange rate would, if it continued, effectively be tightening financial conditions on the margin.” With China raising rates, the long-Aussie trade may come under pressure, effectively heightening the probability of a subsequent Australian rate hike.  The Australian dollar is down around (-2.1%) today – the largest decline of all major currencies.
  • Thailand’s Finance Minister Korn Chatikavanij on being comfortable with a strong Thai baht: “We became manufacturers of goods to the rest of the world using our relatively cheap currency. That era is over and it’s over rather quickly, so very quick restructuring and rethinking needs to take place.”
  • South Korea said today that it is preparing additional measures to counter the inflows of capital that have been triggered by low rates overseas.
  • Brazilian Finance Minister Guido Mantega after raising taxes on foreign inflows for a second time to 6% from 4% said: “The currency war needs to be deactivated. We have to reach some kind of currency agreement.” 

In addition to inflation across various asset classes, the prospect of QE2 is creating chaos globally. Fortunately for the sake of sanity, central bankers the world over are starting to declare, “enough is enough”. The line in the sand is being drawn on Fed-sponsored dollar debasement. As we have warned over the last several weeks, don’t be on the wrong side when the reflation trade stops working – IF it already hasn’t begun to unwind.


Darius Dale



China Raises Rates... Setting Off a Chain Reaction That's Bad for Reflation - 1

Quantitative Guessing

This note was originally published at 8am this morning, October 19, 2010. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“Time and persecution brings many wonderful things to pass.”

-George Washington


One of my thought partners here at Hedgeye is our head of everything compliance, Moshe Silver. In our final days of being paid by the establishment, we worked closely together at Carlyle. I’d manage daily P&L risk and he’d manage the risk surrounding how our hedge fund teams were driving that P&L.


Moshe writes a must-read Weekly Compliance Screed that we publish on Mondays to our exclusive network of clients. Yesterday’s was titled, “Qualitative Easing” and it was one of Moshe’s best. He provided the historical context for America’s present season of discontent by citing Ron Chernow’s new biography of George Washington.


This is as much a point about leadership than anything else. America’s markets are turning into the sort of soft and qualitative excuse making zones where losers find comfort and coddling. If you aren’t raising children you may not see this as clearly as the rest of us parents do, but this “no one loses” and “my little Johnny just wants to be happy” stuff is becoming pervasive in American culture.


What happens when little Johnny runs into a Chinese kid who crushes him like a bug? Should we call for a time-out and some quantitative easing? If Apple doesn’t beat on iPad sales, should we invoke the deflation Gods for QE3?


Moshe suggests that “today, the underlying issue is a total abdication of responsibility on the part of those invested with the Public Trust. The reason that it has become compelling as an ongoing policy matter to debauch the once-proud Dollar is that our society has established a pattern of behavior.”


“The rest of the world recognized US indebtedness as a nascent problem as far back as the early 1980s. Is it realistic for Washington (the DC kind) to push back on generations of excess? We search in vain for anyone in a position of Public Trust to take a stand against this madness.”


How about the Manic Media? Could its core competency in taking the sell-side’s word for missing virtually every crash until after it has occurred proactively protect Americans and their hard earned savings? Or does the financial media stand in awe of revisionist Big Broker analysts whose tongues lick the Greenspan grounds of taking academic dogma’s word for it?


This morning even one of the most admirable American media platforms fell into the trap of time and persecution. Bloomberg’s Ian Katz opened his review of Timmy Geithner’s currency remarks by suggesting that “a weak dollar may now be in the national interest.” Are you kidding me, man?


If you dig into the financial editorials this morning, Dartmouth’s David Blanchflower recaps his Groupthink Inc. sessions with the finger pointers of America. I couldn’t paraphrase this if I tried:


“I was at the Fed last week in Washington for one of its occasional meetings with academics. Half a dozen labor economists, including myself, met with Fed Board members to discuss the labor market. Of particular importance was a paper by John Haltiwanger, a professor of economics at the University of Maryland, who showed there has been a big decline in the job-creation rate over the past decade. The current obstacle is the lack of credit for small firms.”


Right, right guys. The “current obstacle”  couldn’t be staring you right in the mirror could it? It must be that banks aren’t lending. Right, right… back to debauching the currency then.


Who is going to stand against Quantitative Guessing during this political season? Who is going to stand up and lead? I think it might just be the Chinese. They are proactively RAISING interest rates this morning. Why? Take a wild and crazy guess. You got it Pontiac – QE2 is stoking the bonfires of global inflation.


Don’t ask Fed Chairman Bernanke to stand up for 43 MILLION Americans (the # of Americans on the Food Stamp program) have to put gas in their cars and, God forbid, eat. On Friday, Bernanke said that “we are still learning about the efficacy and appropriate management of non-standard policy tools that do not rely on interest rate deductions.”


In plain English, Americans need to know what that means. Like his predecessor at the Fed, Arthur Burns, who perpetuated Jobless Stagflation in the 1970’s by monetizing US Treasury Debt, Ben Bernanke has no idea how this is going to play out and he’s not allowed to say it could play out Japanese.


Ask a man you can trust – Moshe: “Bernanke is effectively saying we haven’t quite gotten the knack of handling your money, but we are making progress. Another few TRILLION and we should really have it down to a science.” Like journeymen stock brokers and money managers who learn this craft by losing large quantities of other people’s money, those charged with managing the economy have resorted to Quantitatively Guessing…


As George Washington observed, if people are persecuted long enough by their government, they will change their behavior. And change is not a “crisis” until someone gets fed up with it all and punches your little Johnny’s qualitative whining in the face.


My immediate term support and resistance levels for the SP500 are now 1170 and 1186, respectively. On September 19th the cash position in the Hedgeye Asset Allocation model was 46%. A month later, on this fine day of defending ourselves (October 19th), we’ve raised that cash position to 64%.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Quantitative Guessing - QG

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