February Skepticism Returns

That deep skepticism I felt in February over the recovery bill, TARP, TALF, et al. has wooshed back with a vengeance this week.

Not that this is a surprise to me, but it seems like too many powerful interests have their hands in the cookie jar - the cookie jar that you and I pay into and will be paying into a lot more in the future.

The debacle with AIG and with what seems like taxpayers making AIG's counterparties (read Goldman Sachs and the like) whole on its varied Credit Default Swaps (CDS) is an outrage.

Meanwhile, that cheek clencher is being obfuscated by Barney and the blowhards dressing down AIG's CEO, Edward Liddy (a former Board member of Goldman by the way), over $165 million in retention bonuses.

Bare in mind that these bonuses were being contractually paid to people like this: http://www.nytimes.com/2009/03/25/opinion/25desantis.html?_r=1 The witch hunt is a complete joke.

I was criticized earlier for saying the involved parties needed to be forced to the table and work something out. Even if the counterparties settled for five cents on the dollar and some went out of business, that would be fine. The government could have just facilitated the orderly workout of AIG's other assets and liabilities, and sounder entities should have taken over custody of said assets and liabilities.

The notion that an orderly end to AIG would create financial Armageddon needs explaining to me. For example, if I have a life policy at AIG and AIG is going to fail, why couldn't the associated asset and liability on AIG's balance sheet for that policy be moved to another insurer that wants it? We could go policy by policy through AIG's book protecting the taxpayer and unsuspecting customer. Granted, the consumer may not be made completely whole, but wouldn't this be better than the mound of debt and reward for bad behavior that is being created currently?

Then there is this: http://online.wsj.com/article/SB123776518094909023.html

Spending layered on top of permanent spending increases is not the way we want to go. It just becomes increasingly clearer that government cannot seem to establish targeted programs in a time of economic crisis, instead it is using the crisis to put its programs (for better or worse) into place without a way to pay for it.

On top of that, it seems like we may just skirt the usual democratic process and use something called Reconciliation to pass everything that the administration wants: http://news.yahoo.com/s/bloomberg/20090318/pl_bloomberg/ai5mx_2yfz7s_1 I cannot make this up.

I know the ranting about spending and the like gets old (I'm the one pounding my head into the desk), but at this point of potential pivotal change, we need real work done to solve these problems - not just try to appease as many political agendas as possible because in the end it just weakens our position in the globabl market place. I am still looking for the person or entity that can provide the assist!

-2outof4

Nutter Likes to Read, but Doesn't Seem Very Innovative

Back in February I proposed this solution http://2outof4.blogspot.com/2009/02/hey-mayor-nutter-likes-libraries-too.html to Philadelphia Mayor, Michael Nutter's, problem of keeping the cities' libraries open.

It turns out he blew an opportunity to innovatively save money, jobs, and libraries while not further burdening citizens and potentially moving more residents out to the 'burbs:

http://online.wsj.com/article/SB123747958958985749.html

Is there any thinking outside the box in big government?

-2outof4

New Book Recommendation

The following book is a must read in my opinion, and I urge you all to sit down with it.

'Hot, Flat and Crowded' by Thomas L. Friedman is a book about the lack of a global sustainable energy system, the impediments and possibilities for developing one, the economic benefits of doing so, and how America can lead a revolution of intelligent design and revolution - once again asserting itself as a technological and manufacturing global leader. More than that though, it is a vision for our children's' future - which at its root exposes the inadequacy of our government's policy and action status quo.

From the book: "We are living at a hinge of history that is going to determine just which way this Energy-Climate Era will swing. If we are going to manage what is already unavoidable and avoid what will be truly unmanageable, we need to make sure everything we do from here on helps to build a real, sustainable, scalable solution. The clear and easy paths are closed. All that matters now is how we walk through the fire."

http://www.abebooks.com/servlet/BookDetailsPL?bi=1290189772&searchurl=an%3Dthomas%2Bfriedman%26kn%3Dflat%2Bhot%2Band%2Bcrowded%26x%3D0%26y%3D0

-2outof4

Tackle from the Blind Side

One of my favorite authors is Michael Lewis. Besides his great books he publishes a number of articles at places like Vanity Fair and Bloomberg News. I've been advised to read his VF article on Iceland's collapse over the weekend.

But for now, I'll give you this gem:
http://www.bloomberg.com/apps/news?pid=20601039&refer=columnist_lewis&sid=atlHxXH7FweQ

It superbly covers the misplaced blame that politicians like to assign without delving into and fixing the problems at hand. It also emphasizes something that I try and emphasize here - the correct framing of numbers as support to an argument.

Happy Friday!

-2outof4

Technical Blog Question

Hi. You were very helpful on my last question. If I have a draft in the Edit Posts section of Blogger, how do I move it up so it becomes the most recently published post once I post it? Right now, I have had to post some old drafts that then get lost in the previously dated posts.

Thanks!

-2outof4

Optimism Around Ingenuity?

This is dated from 2/10/09, and although I do not agree with everything and have to consider the source, I love the tone and help ourselves attitude. There are a lot of great ideas as well.

Fred Smith, President and CEO of FedEx:

http://news.van.fedex.com/node/12752/print

-2outof4

Interesting Charts and Questions

I get a lot of stuff sent to me throughout the week. Here was an interesting economic graph and table from this week. They give an interesting global framing of the numbers we often hear in the news. Is the US in a position of relative strength or just less worse than everyone else?

-2outof4

Stock Interest List Update

MW - reported 4Q08 results last week and surprised analysts on the back of margin strength from cost containment and more stable than expected sales declines. It appears the promotions that MW is running (2-for-1 suits) are driving traffic more than expected. So although the product margin is low, the volume and the general cost reductions are supporting earnings. It is not surprising to have a huge stock reaction in a company's share price that was as beaten down as MW. The shares are up 51% from the time I left for vacation on 3/6. That is the problem with shorting very "cheap" stocks - little margin for error especially if the Company is doing "less worse" than expected. However, at today's valuation and in the current environment, I would still keep it on the Short interest list.

WFMI - Whole Foods Market, Inc. is a name which a lot of readers probably know. Based on the recent run back up in share price following 1Q09 earnings, FTC clarification on the Wild Oats litigation, and Yucaipa (an investment company) increasing its stake, I think the risk/reward of a WFMI short makes sense. I tweaked two Wall Street firms' earnings models a bit, essentially extrapolating SSS and Identical Store Sales trends as well as 1Q09 gross margin, and pretty easily calculate 62-63c for FY09 compared to consensus of 70c.

The key issue in my mind is Same Store Sales (SSS). SSS deteriorated at WFMI for the first time in history during 1Q09. The cadence got a bit better in January, but then trailed off again the first four weeks of 2Q09 at (4.5%) and ID sales at (5.4%), including currency. The numbers for 2Q08 were 6.7% and 5.1%, the numbers for 3Q08 were 2.6% and 1.9%, and the numbers for 4Q08 were 0.4% and (0.5%). The Street seems to tout the idea of slowing growth leading to increasing profitability, but in that case I don’t understand the growth multiple the Company receives.

In conclusion, it seems as though besides the general market run-up, there has been a lot of positive news that has recently been baked into WFMI’s share price. Given the environment and the desire of the consumer to trade down, I view this as an attractive entry point for a short. However, I do note that WFMI has traded at crazy multiples in the recent past – including 55x earnings and 28x EV/EBITDA, which must be taken into account in order to have real interest in the name.

HBI - Hanesbrands Inc is another name almost all readers will know. The Company makes the eponymous t-shirts, as well as many other wearable products. The reason this Company is on the Long interest list is because the management assures it will generate $300 million in Free Cash Flow (FCF) this year and continue to drive down its debt load, while maintaining enviable market position in categories that are almost consumer staple rather than consumer discretionary.

The catch though is that investors have driven down the share price because HBI still has a ton of historic debt from when it was spun out of Sara Lee in 2006. In fact its net debt level is almost 3x its stock market capitalization. But HBI was recently able to push out one of its debt covenant changes for two years, therefore getting rid of some of the risk surrounding the Company's debt covenants.

If HBI can battle through its recent sales declines and keep its price increases, which have been taken in February, and benefit from supplier cost structure improving, there is a chance that HBI can meet Wall Street estimates for the year. If the Company also delivers on its net debt reduction target of $300 million and keeps up that level of FCF generation, this is a clear Buy.

If the stock price drops down to between $6 and $7/share like it did recently, it should really be interesting. There was quite a bit of insider buying at these levels and certain management members were very proud of such well timed purchases.

SHOO - As a follow-up to a prior post, SHOO still looks of interest on the Long side. The Company posted free cash flow (FCF) in its 10K filing with the SEC of $33.5 million. Even though there was a 13% uptick in inventory levels (on a days sales basis), that kind of free cash generation is at least supportive of the current stock valuation, even if FCF declines meaningfully over the next couple of years (i.e. there seems to be a decent built in margin of safety).

-2outof4

Another Wild Week

It has taken me a while to get back into the swing of things this week after vacation. What seems pretty clear is that the government is hell bent on inflating the economy out of the current mess.

The Fed announced yesterday that rates would remain flat but that it was going to buy up a few hundred billion more of treasury bonds. It also announced that it was going to expand the type of collateral that could be used under the TALF program.

What does all the gubalty goop mean? Well here's an article in plain English explaining the former:
http://online.wsj.com/article/SB123749350368087807.html
Essentially the Fed wants to lower interest rates on mortgages, which is working because anecdotely a coworker just refied over the phone at 4.6%. The Fed accomplishes this by going into the market and buying the bonds, whose price and interest rate has an inverse relation. So, as prices rise (because the government is demand/buying so many), interest rates end up dropping.

The latter is somewhat explained here:
http://online.wsj.com/article/SB123748950250187103.html?mod=rss_topics_obama
TALF is what the government has decided to use to get lending going again. Previously, someone like a Carmax had sold a bunch of cars on credit and then sold those loans to an entity that would in turn create a security out of a bunch of pooled loans making an Asset Backed Security (ABS). This was done with all kinds of loans from car to school to home. The creator of the ABS would then sell them on as investments to other people. Part of the reason that most of our fine financial institutions are currently near insolvency is that although they moved a bunch of the ABS on to other people, a lot of the worst/lowest rated (and I use that term loosely) was left on their books - and now its gone bad or looks like it will not be paid down.

So where does this leave us? It is hard to argue that some sort of stimulation to the economy would not be welcome. As you probably know by now, I'm just not in favor of trying to do that by having a Part II of the last six years. (I think there is a lot of really creative stuff that could be done with sustainable energy sources to create jobs and reestablish America's strength in the world economy, but that's another topic.) Inflation is an obvious concern too. At some point rates will have to go up in order to control what is almost unavoidable inflation. This is the primary reason I advise not to lock yourself into any kind of interest rate on an investment product for more than 12 months at a time today. In 18 months rates could be 8% and I wouldn't want you in a 60 month 5% product.

One vehicle to play a rise in rates is the ETF, ticker TBT. It is the inverse of the Lehman Brothers 20+ Year Treasury Index. So, its price goes up when the Lehman Brothers 20+ Year Treasury Index goes down (or interest rates go up b/c remember bond prices move inversely to interest rates). That's a lot of inverses! This is one of the few stock tips I would go on record with friends and family. At some point I guarantee that it is going to go up - a lot! I just don't know when. I bought a little in my IRA in mid December and sold on the above news this week. I will get back into it at some point. Please note, this is one of those leveraged ETF's so it trades at two times the inverse of teh Lehman Brothers 20+ Year Treasury Index.

As for the TALF, I suppose I understand the need to get high grade debt paper circulating in order to lend more money, etc., but I also want to stick to the fact that I think America just needs to deleverage and that the process will be painful. This kind of program to me delays that deleveraging as much as anything. For example, the numbers for a company like Carmax were explained to me like this earlier in the week:
Carmax used to make a loan with a 10% interest rate, their loss rate would be 2%, they would sell the loan off at a 4 percentage point cut to the buyer of the loan and Carmax would end up with 4 percentage points of the interest on the loan, and supposedly this interest income accounted for a large percentage of earnings. (All numbers used are examples only.) This explains why Carmax's stock was crushed last Fall when the ABS markets, or ability to sell on ones' loans completely seized up. The problem is that the above numbers today look more like this:
Carmax makes a loan with 10% interest rate, their loss rate is now 6%, they sell the loan off at a 4 percentage point cut to the buyer and Carmax ends up with no profit on the loan business. Therefore, it kind of makes Carmax (ticker: KMX) of interest on the short side because a huge portion of its earnings will likely not repeat in this environment.

The point is that the TALF is being implemented and will likely be used to securitize loans from places like Carmax, but ultimately these loans are not profitable to the Company, and could be a negative to earnings in an inflationary environment where they have to offer the buyer a higher rate because rates in general are higher. In a sense, in this example, TALF just allows the consumer to buy that car at an artificially low rate and allows the car sellers to move volume. Does anyone see the need for the government to prop up volumes in that and similar markets?

It doesn't really get us on any stronger financial ground as a country in the long run. It just perpetuates business as usual, which I thought we just voted to change.

-2outof4

Carolina Blues

It looks like the Prez and I have the same NCAA tournament winner:
http://games.espn.go.com/tcmen/entry?entryID=2813746
It doesn't look like he has any major upsets, but I think his body man may have a little too much influence. But hey, what's wrong with a little ACC bias.

-2outof4