The Slaughterhouse Four

If you are a shareholder of either TSN, HRL, SAFM or PPC this chart is disturbing. Collectively, the gross margins for this industry are below 7%. With gross margins that low how is it possible that they can make any money at all? Clearly, the only way to improve profitability below the gross margin line, is to manage your labor costs efficiently. Apparently some companies are! Yesterday, CNN ran a story about a slaughterhouse being charged with violating child labor laws.

According to CNN, the owner and managers of the nation's largest kosher meatpacking plant were charged Tuesday with more than 9,000 misdemeanors alleging child labor law violations. The company is accused of hiring minors and, in some cases, having children younger than 16 handle dangerous equipment such as circular saws, meat grinders and power shears.

I’m confident that the slaughterhouse 4 would not risk their business on such stupidity, but it highlights the fact that gross margins hold the key to the future of these stocks.

The Entitlement is Gone

Howard Penney shares his perspective as to why a prestigious business card means little these days, and how it’s all about owning the intellectual debate.

Wall Street is a small place. Living and working in the New York metropolitan area I’m constantly running into people that have worked at various bulge bracket Wall Street firms over the years. After talking with them, the reaction is always the same “I’m so glad I don’t work there anymore,” or “I can’t believe what has happened to XYZ Company.” To digress… the thought of some sovereign fund running one of these companies might be good news in the short run, but disastrous long term. I’m probably not going out on a limb in saying that most Wall Street executives don’t want to work for the government of ….. Nor does a U.S. issuer want to be advised by the government of ….!

Yesterday evening, I had such an encounter with an ex-Lehman salesman. We spent 90 minutes on the sidelines of our daughters’ high school soccer game talking shop, but more importantly watching the girls crush Mountain Lakes 6-0 and yes, my daughter Caroline scored the winning goal – the first one. We both concluded that being ex-bulge bracket employees has its rewards – it has freed us up to sell our stock, which in the case of some fine people I know, is worthless now.

When I first started at Morgan Stanly in the late 1980’s, it was a big benefit to have the Morgan name on my business card. The doors that would open just because I worked at “Morgan Stanley” were amazing. I always joked that a janitor could say he worked at Morgan and people would be impressed. I have not worked there for the past eight years, but I don’t get the feeling that the same entitlement is there today. Of course, the company du jour is Lehman. Previously it was Bear Stearns. In a perverse way, I could argue that some Bear employees were lucky; their Firm was the first to fail. The employees of the second to fail will not be so lucky. Where are they going to go? Goldman/Morgan/Merrill? Not likely! B of A/Wachovia? Maybe some of them… Where are the empty seats?

This is all leading to an investable theme – Wall Street unemployment. Not a new theme, but one that is not going away nor has it completely played itself out (Brian has been talking about the impact here on key players in retail). Profiting from other people’s agony is not pleasant, but we are in the business of generating ideas for our clients. Yesterday in our morning meeting we talked about companies like Tiffany, and others exposed to major Wall Street and international tourism markets (which should take a hit as the dollar strengthens). From where I sit, the whole world can do nothing but afford to eat at McDonald’s – Those same-store sales numbers are so good it can’t be true!

Everything we do at Research Edge is about making clients money – everything! In this environment, without that we don’t have a jobs. No one can rely on the implied entitlement awarded by a Morgan/Goldman/Merrill business card. We need to be right!

We are all experienced, successful analyst/PMs that are coming together to form a business model, that will hopefully improve our collective investment process. Nobody in this world is ever done learning, and if we can make you think – about a company, industry, or macro theme -- then we have both won. More importantly, we don’t have a sense of entitlement, we take nothing for granted.

Function in disaster and finish in style!

Howard Penney
Managing Director

Credit Where It’s Due

You’ve gotta check out this performance chart. The only thing that impresses me more than these results is the investment process that drives them.

Ok, McGough is breaking rank here. I’m going to completely ignore anything having to do with retail fundamentals for a minute. You’ve gotta take a look at the chart below. It outlines the key market calls my Partner Keith McCullough has made since May, when we opened the doors at Research Edge here outside Yale University. No, I’m not making up these numbers and dates. The results are simply astounding. Check it out for yourself at

I’ve known Keith for a while, and have always known that his results and accomplishments over the past 10 years are tough to argue with. But even way back when Keith, Michael Blum (our COO) and I white-boarded the plans for this business, I did not have any clue as to the sheer depth of his investment process, breadth of intellectual leadership, and ability to balance risk and maximize alpha.

Yes, the day will come when he, and we, will be wrong. And trust me, even though there are plenty of people waiting for that to happen, we will be our own harshest critics – by far.

The investment team here at Research Team is – by the longest of long shots – the best I have ever had the pleasure of working with in my 15 years on Wall Street. And yes, the team is adopting the same process that has driven Keith’s results thus far.

For those of you that have not yet seen it, check out the results of the “Hedgeye Portfolio,” and you’ll see similar results at the individual stock level.
I'm not making this up folks. Check for insight on Keith's calls.

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The fact that IGT has lost market share is not new news. Those share losses have been concentrated on the video side. The hottest new industry product in the stepper segment has been the 5-reel spinner. We spoke to a number of slot managers and other industry participants, including our consultant, and IGT does not appear to be faring well competitively here either. BYI and Konami 5-reel steppers seem to be getting better play. Konami is probably the biggest surprise. 5-reel steppers will not make or break IGT’s future, but IGT’s performance in yet another key new game category is discouraging. As I’ve written about before, IGT needs to rationalize its R&D. Too much was spent on server based gaming systems and not enough on new game development. Look for an R&D shake up as part of a larger corporate reorganization.

Konami 5-reels generating higher play levels than IGT in many casinos


SHFL reports its Q3 after the close today. The stock is acting like a major miss is imminent. SHFL priced its secondary offering on July 25th, right at the end of its fiscal quarter. After missing most of its quarters over the past couple of years, the company has a credibility issue. I find it hard to believe that management would punt on its first quarter out of gate following the secondary as they attempt to restore faith. With 16% of the float short, any number close to the $0.10 consensus estimate should result in some nice upside action. As I’ve written about, I have some serious longer term concerns but there are times to differentiate between a trade and trend.

SHFL management needs to restore credibility

Industry Gravity: Hedge Funds Cutting Fees...

Finally, the Wall Street Journal quantified what we have been talking about for the last 9 months in Jenny Strasburg's article this morning titled "Hedge Funds' Capital Idea: Cutting Fees."

I'll let you read the article, but this was inevitable. I have never seen an industry that is oversupplied NOT lose pricing power. At the end of the day, I learned a while ago when I built my own hedge fund, that the art of managing money, is having money to manage!

Winners and Losers continue to emerge. That's free market capitalism, and I'm all for it.

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