September 2014 for the Macau gambling industry

Yesterday in Macau, the SAR’s Gambling Coordination and Information Bureau (DICJ) released its monthly report of aggregate casino win (the amount gamblers lost in the casinos) for September.

The results were ugly.  The gambling industry as a whole took in MOP 25.6 billion (US$3.2 billion).  That’s an eye-popping amount  …but it’s 11.7% less than the SAR’s take during the same month last year.  September is also the fourth consecutive month of negative year-on-year comparisons.  To top the negative story off, the comparisons are getting progressively weaker.

The reason for the falloffs the in gambling in the SAR is an intensifying anti-corruption crackdown by Beijing, which has had Chinese high-roller gamblers trying to keep low profiles.  Some are doing their gambling in the Philippines, Singapore or Las Vegas; many are just staying home.

Despite this bad news, Macau casino stocks traded in Hong Kong rose by about 5% on the news.  Why?

–Analysts in Hong Kong have recently been falling all over themselves trying to be bearish, with the (typical) result that the actual numbers were better than the consensus had been predicting.

–The stocks are cheap.  They’re 40% – 50% below their peaks, with most now yielding more than 5%.

–The Macau gambling market is transitioning, thanks to the development of Cotai, away from being a destination only for the ultra-wealthy to a venue for the middle class.  Yes, the former gamble make much bigger wagers, but a casino may keep only 1.5% of the amount bet.  For the mass affluent, on the other hand, that percentage may be 15% – 20%.  In addition, middle class gamblers will also shop, eat out and go to shows.

–Comparisons should begin to improve next year.  New capacity catering to middle class gamblers will open; at some point, the renewed anticorruption campaign will have been going on for a year.  Assuming government efforts don’t intensify again, the yoy high-roller comparisons should stop deteriorating.  That would allow the middle class growth to begin to shine through in earnings.

I have no idea whether this is the absolute bottom for the Macau casino stocks or not.  But they look cheap to me.  I continue to think the long-term winners are the American-run casinos, especially Wynn Macau and Sands China.  I’ve been nibbling at both.  (An aside:  For a long while, I couldn’t buy Sands China through either Fidelity or Schwab.  Both had mistakenly classified the stock as a Reg S issue, which couldn’t be sold to Americans. At least with Fidelity, though, the problem has been fixed.)  The biggest loser will likely be the former monopoly operator, SJM.

why the Fed is looking at/for wage gains

This is Jackson Hole week, when the world’s central bankers convene in Grand Teton National Park in Wyoming to compare notes.  From their meetings, we’ll get a better sense of what the architects of the current emergency-easy money policy are thinking and planning.

Conventional wisdom  is that in times of economic stress the central bank should lower interest rates to a point significantly below the rate of inflation–and keep them there until people and companies borrow the “free” money and invest in large enough amounts to launch an economic rebound.

One indicator that the Fed is watching carefully is the rate at which wages are rising.  In theory, employers only raise wages a lot when they’ve run out of available unemployed workers and can expand only by headhunting away people who are already employed elsewhere.  So wage increases at a faster clip than inflation mean it’s high time to tighten money policy;  sub-inflation wage gains–the kind we have now–mean there’s no rush.

Policymakers appear to be giving this rule of thumb a rethink, however.

For one thing, short-term interest rates have been at effectively zero for over half a decade.  You’d think unequivocal signs of economic strength should have been evident long before now.

There’s no sign I can see that central bankers have any sympathy for the plight of savers (read: the Baby Boom and the elderly), whose desire for safe and stable fixed income investments has been the chief casualty of the economic rescue effort.  However, they do seem to be concerned that the search for yield in a zero-interest-rate world has caused savers to buy exotic instruments (hundred-year bonds, contingent convertibles, for instance) that will likely suffer wicked losses as rates begin to eventually rise toward a normal 3.5% or so.  Is the cure worse than the disease, at this point?

Lately, the money authorities seem to be expressing a second worry.  Suppose the emergence of inflation-beating wage gains isn’t the reliable indicator it’s thought to be.  If so, the Fed may be distorting the fixed income market–and buying trouble down the road–for no good reason.

Why would sub-inflation wage gains be the norm, even in an expanding economy?

Maybe in past economic cycles, high wage gains were caused mostly by the tendency of union contracts to index wages for inflation, not by overworking headhunters.  Maybe the psychology of managements penciling in inflation-plus or simply inflation-matching annual wage increases for the workforce has gone by the boards in a world that has experienced two ugly recessions–the more recent one an epic decline–since the turn of the century.  …sort of in the way inflationary expectations have disappeared from the minds of current workers.  Again, if so, maybe interest-rate normalization should happen at a faster pace than currently planned.

We’ll likely hear more on this topic as this week’s meeting gets under way.

the Fed’s QE3: a “reverse Volcker moment”?

The most recent A-list editorial feature in the Financial Timeswritten by Pimco marketer Mohamed El-Erian, asks this question and answers it with a carefully hedged “Yes.”

Several aspects of the editorial are interesting:

–it’s not the usual El-Erian turgid statement of the obvious.  Instead, it’s concise, well-written and makes a point.  To me, this underscores the fact that Mr. El-Erian is writing, not as an individual, but as the voice of the collective wisdom of the largest and most successful bond investment management firm in the US.  As such, the opinion expressed should be taken seriously.

–the original “Volcker moment” was Paul Volcker’s decision as newly-appointed Fed chairman to deal with runaway inflation in the US by raising interest rates to extremely high levels for an extended period of time.

The editorial suggests Mr. Bernanke is currently in the process of deliberately trying to manufacture higher levels of inflation, thus reversing the major thrust of Fed policy over the past thirty years.  Calling the move a “reverse Volcker moment” implies that the decision may have equally momentous implications (more about this next week).

–although the editorial doesn’t say this (Pimco markets bond funds, after all), such a Fed policy reversal would likely have negative consequences for all securities markets, but especially unfavorable ones for bonds.

At present, long Treasuries yield about 3%, which we can break out into a 1% real yield and 2% as compensation for benign, stable annual inflation of around 2%.  If the world began to think that inflation in the US could be 3%–and rising–how would bonds be priced?  …at a 5% yield?  …higher?

That’s a big difference, one which would produce significant losses for current Treasury holders.

Wynn Resorts, Wynn Macau: a surprisingly (to me, at least) bland 3Q11

the results

WYNN reported 3Q11 results after the closing bell for trading in the New York market on Wednesday.  Revenues were $1.3 billion, up 30% from the comparable period of 2010.  EBITDA (a measure I don’t particularly like but which some investors use) was $381.1 million, up 39% year on year.  Eps were $1.05 vs. $.39 in 3Q10.

The report came as a disappointment to Wall Street, which had been expecting a tripling of earnings per share to $1.18.


Wynn Macau

Revenues for Wynn in the SAR were $951.4 million for 3Q11, up 42% year on year.  What disturbed the market, however, was not that eye-popping number, but the fact that the figure was down slightly from the $976.5 million Wynn Macau posted in 2Q11–in a market that was up about 10% quarter on quarter.

Win percentages for various games were within normal ranges, so Wynn being unusually unlucky wasn’t the reason it lagged behind the market.  Rather, it seems that at least some high rollers who might otherwise have visited 1128 were instead checking out the newer casinos that have opened this year.  To some degree, 1128 benefited from this tendency when the Encore opened.  Now the shoe is on the other foot.

Typically gamblers ultimately return to the venues where they feel most comfortable and get the best service–which means Wynn.  The company says it is seeing this happen in October.

Nevertheless, it’s also possible that 1128 is bumping up against the limits of its ability to take in money in Macau with the hotels and casino space it has now.  That amount will gradually rise, with economic growth in China and with inflation.  But if capacity constraints are an issue, comparisons may be pedestrian (+10% or so?) until 1128’s new casino in Cotai opens in 2014-15.

Wynn Las Vegas

On the 2Q11 earnings conference call, WYNN was very enthusiastic about prospects for 3Q11, which in normal times (which these are clearly not) would be a seasonal low point.  Hotel bookings were unusually strong and the company was musing that its table games win percentage might be permanently drifting northward.

I guess non-casino revenues turned out to be pretty much as anticipated, at $266 million.  That was up 11% year on year and down slightly from the 2Q11 figure of $276 million.  From WYNN’s tone three months ago, though, I’d expected a bit more.

Casino revenue for WYNN came in at $126.9 million for the quarter.  The compares with $158.3 million in 2Q11.  It was also slightly less than in the comparable period of 2010.  But the amount bet in the WYNN Las Vegas casinos’ table games was up sharply.

What happened?  The company was simply very unlucky at baccarat last quarter.  The company’s win percentage on table games for 3Q11 was 18.3%.  That’s sharply below the expected level of 21%-24%, and the 27.6% achieved during 2Q11.

If table games win for the quarter had been normal, eps would have been about $.20 higher than actually reported;  win at the 2Q11 rate would have meant eps about $.45 higher.

The company says that win percentages have returned to normal in October.

my thoughts

1128 has lost about a third of its market value on worries about the mainland economy, and on concerns that Wynn and Encore may lose customers to newer casinos.  I still think that 1128 has a shot to make $1.50 a share this year, and (worst probable case) $1.65 next.  Maybe the subsidiary will come in $.10 short for both periods, but not much more than that.  12x earnings seems much too cheap to me.

1128 represents two thirds of WYNN’s market value.  The remaining $5 billion is the Las Vegas operations, which though still anemic are showing progressively stronger results.  Cash flow generation in the US is running at about $400 million, and rising–meaning that domestic operations would be yielding 8% if considered as a stand-alone income vehicle.  The US operations aren’t being run simply to generate cash.  In fact, it sounds as if WYNN would welcome the opportunity to build a casino in Miami, if asked.  But looking at them as a quasi-bond suggests (to me) that they have considerably more value than the market is now awarding them.

All in all, I’m happy to hold the WYNN and 1128 shares I own.  At the moment, however, it’s hard to see where near-term earnings acceleration is going to come from.

In fact, an aggressive trader–which I’m not–might think of switching some money into LVS.  I don’t think LVS is as strong a company as WYNN, but it’s cheaper and it has more potential near-term earnings momentum–coming from Singapore and its soon-to-open new casino in Macau.  But market sentiment can be a funny thing.  It’s tide can quickly reverse.  Even news on possible resolution of EU financial problems might be enough to swing investor attention back toward the Wynn family of companies.  For me, I’m content to be patient with what I consider two undervalued issues.

toe in the water?–two days later: four signs to watch for

back to the drawing board

I had thought that Tuesday’s afternoon rally in the S&P from its 1106 low to its 1172 close was a significant event for the market’s psyche, since it cut with ease above what I thought was significant resistance at 1150.   Apparently not.  Yesterday’s loss of 6% by European stocks was too much for Wall Street to bear.

four signposts to look for

I think there are four signs to watch for that will indicate that the worst of the current market fall is behind us:

1.  The market holds at/above a significant technical level.  For the S&P, the closest is 1100.

2.  No more lower lows.  The most recent intraday low for the S&P is 1106.  It would be encouraging, even if the index declines from yesterday’s close, if it stayed above that level.

3.  No negative reaction to bad news.  A very clear sign that negative events have been already discounted in current stock prices is when further negative news comes to light and the market simply shrugs it off.  That certainly isn’t happening yet, since yesterday’s fall was sparked by rumors that S&P will downgrade France.  If anything, yesterday’s market action shows the opposite.

4.  Individual stocks stop falling in lockstep.  Panic selling is by nature irrational and tends to flatten everything pretty equally.  A sign that investors are reaching for emotional equilibrium again, even in a market that continues to fall, is when the strongest stocks separate themselves from the pack and begin to outperform the others. AAPL is already one example, but we need more.

CSCO will be an interesting test of this idea today.    The company reported better than expected results after the New York close yesterday and is up about 7% in after-market trading as I’m writing this.  I’m not a big CSCO fan, but the stock is only trading at about 10x earnings, and it does yield almost 2%.  It would be a healthy development for the market if the stock can hold onto most of that after-market rise in regular trading today.

a fifth indicator–one nobody wants to see it, but we may be doing so now

At the recession lows for the S&P in 2003 and again in 2009, the dividend yield on the S&P briefly rose above that of the ten-year Treasury.  That wasn’t because companies were raising their payouts; it was because stock prices were being crushed.  But it was a very clear buy signal.

At present, the yield on the ten-year is 2.1%.  The yield on the S&P, as best I can figure it, is a shade over 2%.  It could even be higher than 2.1%.

This indicator isn’t about the market psychology of when emotion-driven selling will stop.  It’s about value.  And it shows how cheap stocks currently are.  I’ve only seen investors consistently ignore this extreme relationship once in my career–in the post-1989 Japanese stock market.  I don’t think we’re in that situation in the US today.

INTC’s new “3-D” tri-gate microprocessor technology

INTC’s May 4th announcement:  tri-gate

During its most recent quarterly earnings conference call, INTC alluded to a “revolutionary” announcement it would be making on May 4th about its next-generation microprocessor-making technology.  We already knew that the company was going to shrink the distance between elements of the patterns it creates on silicon from 32 nanometers (1 billion nanometers = 1 meter) to 22 nm this year.  But it hinted that there was more to come.

The “more” at a press conference on May 4th.  The company intends to manufacture its 22nm chips using a new technology that it has been developing for almost a decade–a 3-D process it calls tri-gate.

what it is

Up until now, INTC–like everyone else–has been placing chip circuits on a flat silicon substrate.  For 22nm, INTC intends to make the substrate three-dimensional by raising a series of fins up from the substrate, on and around which it will wrap the chip circuits.  If the conventional chip design looks like strands of spaghetti laid side by side, the new one looks more like Rice Chex.

what it does

The the new 3-D “tri-gate” chips cost only 2%-3% more to make than conventional ones.  Just by being 22nm (vs. competitors’ 32 mm offerings), they’re smaller, faster and use less power.  That speed and power advantage is about 15% (I’m eyeballing an INTC chart).  However, the new process allows the chips to be tuned, so that they do much, much more:

–they will use less than half the power of competitors’ chips in high speeds, or

–they will run 37% faster in low-power applications, like smartphones and tablets.

Assuming the adoption of the new process goes according to plan and works as INTC expects, tri-gate will put the company several years ahead of other chip makers.  And it will underscore dramatically the value of INTC having ownership of its own fabrication plants.

when it arrives

Volume production is slated for the second half of 2011.  INTC seems to be putting particular emphasis on shifting its Atom chip–targeted at markets ARMH presently dominates–to the new process.

the big question

The big question for tri-gate, as with any new technology, is whether it will work as expected.  INTC has close to ten years’ experience with the process–and does not seem to me to be the kind of company to announce a development without great confidence in it.  The rest of the semiconductor manufacturing industry is planning to adopt some version of the technology, just not right away.  Still, until we actually see INTC churning out large numbers of tri-gate chips, we won’t know for sure.  We also don’t know whether, even if the chips perform as advertised, that INTC will be able to displace ARMH in new smartphones or tablets.

investment implications

INTC shares are about flat since the announcement.  They’re trading at under 10x earnings and yielding over 3%.  To me, no good news, and a lot of bad, is already factored into the stock price.  On the other hand, merely applying a market multiple to the stock would imply a price of over $30 (see my analysis of INTC’s 1Q11 earnings).  So the risk-reward relationship seems very favorable to me. What I also find interesting is that besides the case made for a value investor, there’s one to be made to a growth investor as well.  It’s the prospect of much better earnings growth than the market expects, for longer than the market thinks.

About ARMH: it’s trading at 90+ times earnings, on the idea that it is the virtual monopoly provider for microprocessors to smartphone and tablet manufacturers.  INTC success doesn’t necessarily translate into ARMH failure; a lot depends on how fast the market is growing.  But while the company may do well, to my mind the ultra-high multiple represents a significant risk in the stock.

US corporates lobby for a new tax amnesty

Yesterday’s Financial Times contains three (count ’em, three) articles, one on the front page and prominently above the fold, talking about recent efforts by US corporations in lobbying Washington to allow them to repatriate foreign cash holdings while paying little or no income tax.

This appears to be the start of a public relations campaign by the US Chamber of Commerce aimed at persuading Congress to pass a tax amnesty bill like the Homeland Investment Act (HIA) of 2004.

US tax law, unlike that of many other countries, makes multinationals incorporated in the US pay domestic income tax (less a credit for foreign income taxes paid) on any foreign earnings repatriated here.  This can be a big deal.  For a US company recognizing Asian profits in Hong Kong, for example, the corporate tax is zero.  This means a firm bringing money like this back home would typically have to pay 35% of it to the IRS.  The funds are probably going to be reinvested in growing Asian businesses.  But even if not, unless the funds are crucially needed in the US it would be financially foolish to repatriate it.

HIA allowed firms to pay a maximum of 5.25% tax on any money brought back to the US during a specified period of time.  Companies were required to use the repatriated funds only to hire new workers or to invest in plant and equipment.  The idea was that this would reduce unemployment and spur new investment.  None could be used for stock buybacks, dividend payments or executive compensation.

According to forthcoming research, the reality of the HIA was quite different.  Corporations repatriated around $300 billion from abroad.  Strictly speaking, all the money was used for the purposes intended.  But aggregate employment and capital investment didn’t increase.  The funds simply freed domestically generated profits to be used for dividends etc..  In fact, some firms actually used the repatriated funds to replace domestic profits that they shipped abroad.

Proponents of  HIA II, which the FT says include Cisco, GE and Microsoft, are not making strong claims this time around.  They label the cash, which is estimated at about $1 trillion, as being “trapped” abroad.  They argue that maybe $400 million would be repatriated under HIA II, giving the government $20 billion or so in tax money it wouldn’t otherwise have.  And the repatriated funds would likely slosh around doing something–presumably economically good–in the US.

So far the Obama administration is saying no, seeing that it’s in enough trouble without advocating a big tax break for cash-rich corporations.

investment implications (there actually are some)

1.  I wrote about this topic a bit last April, specifically regarding the large buildup of cash on the balance sheets of technology companies.

2.  To be able to pay it out in dividends, a US-incorporated company has to have the cash available in the US.  But most publicly-traded companies don’t disclose enough about where there cash balances are, or the cash generating/cash using characteristics of their US and foreign businesses for an analyst to see how well a given dividend is covered.  This didn’t make any difference when dividend yields were very low and investors were interested in capital gains.  But it does now.

3.  It takes a US$1.50 earned pretax in the US to give the same lift to the reported earnings of a US company as US$1 earned in Hong Kong.  So a corporation concerned with maximizing eps might well choose to recognize profits in Hong Kong rather than the US, assuming it had a choice.  Similarly, a decision to shift the profit stream to the US in order to may dividends–again, assuming this were possible–would mean a structurally lower level of eps.  I suspect that at some point, investors will ask for earnings estimates that are “normalized,” in the sense of adjusted to what they would be under a standard 35% tax rate, in order to get a more apples-to-apples comparison.

4.  Why lobby for HIA II?  The paper I linked to above argues that it makes very little difference to corporations in the aggregate.  But there may be firms–most likely in the tech area–who will be forced to borrow or to repatriate foreign cash balances (and pay tax on them), either to be able to maintain the current dividend or raise it.  The strongest advocates of a new HIA might well be in this position.