US Jobless Claims Continue their alarming "Trend"...

Weekly jobless claims shot back up to 444,000 this week from 425,000 last. The unemployment cycle in the USA remains a concern.

The 4 week moving average moves to 438,000, and this elevated level of claims does not augur well for tomorrow's monthly employment report. This is not new, but rather a reminded of what I have been explaining.

My year end target rate for US unemployment remains +6-7%.

Pit Bull vs. Knuckles

Knuckles Obama vs. Pit Bull Palin. This is getting good! Both of these young guns can give a speech cant they? They better – we could be facing the largest cross currents of global economic and geopolitical hurricanes since 1930.

The US market’s short term “Trade” correlation remains in the Republican corner of the ring. As Palin’s pre-speech ratings fell, so did the US market. If her bouncing off the ropes last night finds Obama’s jaw in the polls today, the US market could very well stop going down. Last night’s speech was good enough to have me cover my S&P Futures short position in the ‘Hedgeye Portfolio’ at 5:30AM this morning. Top to bottom, the S&P 500 has dropped 35 points in the last 48 hours of trading. This remains a market to be rented, not owned.

Card carrying Republicans and Democrats alike are now officially amped up for an old fashioned partisan hockey brawl. In the end, there will undoubtedly be a winner and a loser. All the while, those of us surveying the world are going to be dancing with a growling Bear – the Global Economy. Unfortunately, neither of these American political brain-trusts get that, yet. My hope is that someone with a spine steps up and goes after Wall Street the way that both parties are rhetorically going after “Washington”. Hope however, is not an investment process.

Economic reality versus political rhetoric is an important distinction to make, so let’s slap our lipstick and fact finding pants on and take a walk down that global path this morning. Asian stock markets continue to get pummeled, and European markets continue to trade lower. Global cost of capital continues to rise, while access to it continues to tighten. In Europe, the Riksbank in Sweden is raising rates to 4.75% this morning, and in Asia, the central bank of Indonesia raised rates to +9.25%. Both the European Central Bank and the Bank of England refused an American call to arms to cut interest rates. As the US Fed and Treasury keep the Japanese style government bailout pails in place, the rest of the world is starting to take on water. Emerging market currencies are drowning, and their import costs are inflating.

Condi Rice might want to slap some lipstick on that other VP, Dick Cheney, this morning. He’s going to be in Georgia, assuring their conquered population that the Bush administration has their back. Ole Dick isn’t big on the transparency thing, so maybe he should wear one of them CNN hurricane reporter rain jackets so the Russian know he’s there. Russia’s currency epitomizes the aforementioned point concerning economic flooding. The Russian Ruble lost -7.5 of its value in August alone, and is currently having its biggest down day since 2005. The Russians are taking on inflation water-gate style, on two 1970’s like US fronts: prices and wages. Their stock market is getting crushed as a result. The Russian Index has lost -28% of its value since mid-July, in the face of an up +9% move in the US Dollar, and +6% move in the S&P500. America is winning. The Russians are losing.

Japan is losing too. Economic stagflation would be too kind of a description of their current domestic situation. There is no Botox or hair spray that we can put on this economic piggly wiggly to disguise it. Japan is the world’s 2nd largest economy, so this matters. The Nikkei lost another -1% last night, closing at 12,557, taking its loss since the mid July rally in the US began to -7.7%. Across Asia, the de-leveraging “Trend” remains. Hong Kong hit new year to date lows last night, and has lost -11.9% since its dead cat bounce in early July. The Asian contagion associated with growth slowing continues to spread.

This morning’s American hope is as rightly placed as it was last week when we heard a great speech. My Mom is a small town hockey mom too, but John McCain isn’t, and he’ll take the stage tonight. The bipartisan economic call here is to get rid of all of the tired old veterans on this hockey bench. Biden, Bush, Clinton, and McCain – none of these career politicians have proactively prepared this economy for the global economic tsunami that weighs in the balance. We need wholesale changes to this hockey club. No more Hanson Brothers – it’s time to rebuild the country. Let’s start by giving the young guns, Knuckles and Pit Bull, some time on the power play.

Best of luck out there today,

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.

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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.

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.
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