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EYE on Putin and Chicken Exports

Russia recently fired a warning shot over the bow of U.S. chicken producers when it said recently that 19 U.S. poultry producers will be barred from exporting their products to Russia. Right now, U.S. chicken producers cannot afford to lose Russia as an export market. U.S. chicken producers supply nearly 75% of the total poultry import quota set by Russia, which stands at 1.2 million tons. Russia represented the largest export market for chicken broilers made by U.S. producers in 1H08. Specifically, Russia accounts for 17% of Tyson’s International chicken sales (TSN’s second largest International market).

The loss of Russia as an export market would only compound the supply issues the U.S. chicken producers face. Further downward pressure on chicken prices and the loss of a key export market is not the solution for an industry that is already bleeding.

GES: Something’s Not Adding Up

GES gave the bulls and the bears each a little to chew on this quarter. After stepping back and objectively reviewing the story, I’m still in the bear camp.

Let’s state the obvious… How could you not like the income statement algorithm? Sales +33%, GM +42bps, SG&A ratio -80bps, and EBIT growth +43%. Inventories were very much in check at face value, with day’s inventory down 12.6 days vs. last year. The balance sheet is clean, the brand is strong relative to competitors, and this company can seemingly do no wrong.

But what concerns me? I have a few nits on the quarter, and then one much more meaningful concern.

1) The quarter included $0.03 per share in revenue that was pulled forward in GES’ European business. On top of an aggregate $0.04ps FX benefit (though I think it was much more) that accounts for most of the $0.08 beat.

2) GES tempered guidance for 2H – largely due to shipment timing. This is perfectly legit, but it is also the same time the company hints at FX risk in a separate part of its call. Management went as far as to say that the 1H09 benefit may need to be removed from FY10 (Jan) estimates.

3) This is also the same time we’re seeing Euro zone retail sales down 2.8% and the region slip into recession. Not immaterial given that Europe accounts for 40% of sales and nearly half of cash flow.

4) Stepping up investment in China? I posted something today on Skechers and Coke discussing the irony of how they are investing capital in China AFTER a 20% run in currency.

5) North American Retail comps looked good at +8%, but margins were down 134bps, and non-EMEA wholesale was down 3 full points. Remember that 80% of its US stores are located in travel markets. What happens when the translation benefit wanes, and Europeans stop coming to the US for ‘shopcations.’

6) The biggest concern I have is in the Exhibit below, which suggests that FX revenue is flowing through the P&L at an unsustainable rate. Yes, the company says that the EBIT impact from FX was just under $6mm, or about 23% of EBIT growth. That’s big enough in my book. But when I take a basket of currencies (Euro, Canada, China) and apply appropriately to GES’ mix it gets me to gross FX revenues of $31mm, or about 800bps of the 33% sales growth in the quarter. When I look at that number vis/vis the incremental EBIT contribution vs. last year of $26mm, it paints a different picture. Yes, there are higher COGS and SG&A costs associated with this revenue. But in the last two quarters alone, the FX revenue contribution was greater than the incremental EBIT. If the FX revenue really is being booked at a high-teens rate as management suggests, then what does this say about the rest of the revenue base?

There are just too many parts of this story that smell to me like they are unwinding. Am I saying that the earnings stream is going to crash and burn? No. But with all ‘Buy’ ratings, expectations for 20% EBITDA growth for the next 2 years, and stress fractures that I think should start to show in what has been viewed as a low risk global retail growth story, I come away in the bear camp at 9x EBITDA.


The analysis and research of the gaming sector keeps bringing me back to a few themes: liquidity, cost of capital, and return on investment. Excess liquidity kept borrowing costs artificially low, allowing most gaming companies to over earn for a long time. Meanwhile, the same excesses allowed these same companies to pursue lower ROI projects and over leverage their balance sheets. As the ROIC chart shows, lower ROI on incremental developments began to push down industry ROIC in Q4 2006. Obviously, this also impacted ROE which began to fall in Q1 2007. The problem for the industry is that ROIC will likely continue to decline with the double whammy of escalating borrowing costs. ROE should fall at a faster rate over the next two years. Not good for equity holders.
  • A bear might counter that falling industry ROIC should have the same impact on PENN. A surface analysis might indeed conclude that. However, PENN has the ability, liquidity, balance sheet, and a buyer’s market to actually improve its economic ROE, even if the negative industry ROIC trend continues. Why would an investor buy any other similarly valued equity when the economic ROE spread between PENN and everyone else is widening, not that it isn’t already wide. See the ROE chart.
  • Why do I keep referring to economic ROE? I’ll have another post on that shortly but for now, accounting ROE is likely to look worse for PENN following the termination of the merger agreement with Fortress and Centerbridge. The $1.25 billion zero coupon preferred equity investment will be treated as equity which is rarely a positive in the ROE calculation. On an economic basis, however, ROE should climb post deployment of those funds, again even in a declining ROIC environment for basically three reasons:

    • Given management’s track record, any acquisition will likely be ROE enhancing
    • It is a buyer’s market for gaming assets/companies and PENN should face limited competition
    • Additional debt will lever returns

  • PENN holds all the cards in a very trying time for the gaming industry. The environment appears ripe for management to do what it has always done: create shareholder value.

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Timberland (TBL): Tick-ah-teee Booo!

Boot to the head if you're short McGough's bullish call here. I've never been accused of not celebrating big wins, and this was our biggest one today; TBL closed +11% on the day on takeout rumors. See Brian McGough's research for more. At 7x trailing cash float, with net cash on the balance sheet, and 9% short interest, this stock's run isn't over.
  • Breaking out of a big base, TBL's next stop is $19.18, before the shorts get some relief.
chart courtesy of stockcharts.com

SKX: Misery Loves Company

At least Skechers has good company in announcing announces capital investment in China AFTER a 20% run in the Yuan. The narrative here is scary…

I think Skechers’ announcement that it is expanding its Asian JV with the Onwel Group is another nail in the coffin for this story. Let’s add this to the narrative of its growth slowdown… A) Shift in fashion towards low profile propels margins from 0% to 9%. B) Low profile growth slows after four years. C) Takes next leg of growth overseas. D) SKX becomes more litigious, suing a smaller brand after years of fighting against economic harm from knocking off styles. E) Opens up more company-owned retail stores to get product to consumers despite less interest from retail. F) Broadening wholesale distribution to more marginal channels (Goody’s, Mervyn’s). G) Bids for Heely’s. H) Now it grows more aggressively into Hong Kong and Macao with a goal to triple sales there in 3-years. Maybe they should have thought of this 3-years ago before a 20% run in FX? FX moves are always hindsight 20/20, but this is another example of a poorly managed company in this space deploying capital reactively. Proactive always wins in my book.

The biggest plus is that its partnership could secure it better capacity in an environment where plant space is becoming extremely more difficult to find. But this is not a positive – it simply helps mitigate a potentially massive negative.

Also, it was announced within a day of Coke offering a 195% premium for Huiyuan Juice Group.

Maybe Skechers and Coke borrow each other’s Macro analysis….
Investing in China at the top!

Unemployment Trends In Japan: Where's the next big move going to be?

The glass half full crowd got thrown a bone by a slight downtick in unemployment numbers in Japan this week. To better understand the employment environment in Japan you must factor in the “Haken” – a chronically underemployed class of young people created as the government introduced regulatory changes over the past decade that made it easier for employers to hire through temp agencies and short term contracts.

In 2007, the Ministry of Internal Affairs estimated that there were 3.3 million people aged 25 to 34 working as temps or contract employees – put in context that is over 4% of total working age population (15-64).

As major domestic employers like Toyota start to reduce capacity these workers will be the first to go, and even those lucky enough to stay employed will feel rising inflation faster and harder than the fully employed.

Andrew Barber

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