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Ugly Chart of the day, the month and Century, to Date...

When we held our preparing for the "Bankruptcy Cycle" conference call on July 16th, 2008, I took plenty of heat from those who couldnt afford for us to be right. Facts are stubborn little critters, in the end.

Here is our US Bank Failure Chart (1), updated for Wamu...

This bank failure chart includes Washington Mutual transaction. The JPM purchase was "facilitated" by the FDIC, which acted as receiver after the bank was closed by the Office of Thrift Supervision yesterday. The FDIC press release explicitly states “FDIC Facilitates Transaction that Protects All Depositors and Comes at No Cost to the Deposit Insurance Fund” in its headline.

By comparison, the last similar purchases brokered by the FDIC were the acquisitions of First National bank of Nevada and First Heritage Bank by Mutual of Omaha in late July. In those transactions Mutual of Omaha assumed all deposits –both insured and uninsured, and purchased the majority of the two failed bank’s assets. The FDIC did commit capital in those instances however, purchasing $862 million of the combined $3.6 billion held by the acquired banks outright, whereas the entire purchase cost of Washington Mutual fell on JP Morgan. As such, the WAMU may not end up officially listed by the FDIC in their closing and assistance transaction list, the list that all other data points on this chart were drawn from -but it’s inclusion here still serves to illustrate the scope of the crises facing the US banking system currently.

Keith McCullough and Andrew Barber
Research Edge LLC

FINL: This One’s A Keeper

This story is definitely looking good to me. Earlier this week I noted my inclination to swap out of FL and into FINL after Nike’s FY1Q09 report. I was concerned about the stocks into the numbers, which turned out to be a bad bet on my part. Good tone from Nike on a good market day sent the group up big. Keith subsequently added FINL to the Hedgeye portfolio after the Nike report. Anyone else who followed him had a good day. As much as I am in tune with (and appreciate) a day’s worth of alpha, I think hindsight 12 months out will show that a buck move here or there will prove to have been a rounding error with this story.

With the numbers I’m seeing out of FINL, my conviction continues to grow in the margin levers as the product cycle turns in favor of the athletic specialty retailers – despite stress in the global footwear supply chain. For the quarter, comps accelerated on a 1, 2 and 3-year basis (+4.7, 0.0%, -2.2%), while gross margins were up 230bps, SG&A down in absolute dollars despite a 3% sales increase, and a 12 day improvement in days inventory on hand – despite facing the toughest yy compare in inventories. Check out the quad chart below. Looks golden.

Going forward, the product cycle should start to improve more meaningfully this fall – thanks to Under Armour stimulating the competitive fires at Nike, K Swiss, New Balance, Asics, and Adidas. This industry competes on product – not price. So a product cycle inherently helps retail in its early stages (i.e. 2001/02). Nike’s US footwear futures and ASP growth support this beginning. I think that we’ll see both traffic and ticket pick up at FINL – ending a 3-year slump in comps. With Paiva gone, Man Alive being downsized, and apparel under control, FINL is focusing back on its core. Good timing. Inventories remain bloated relative to history, and SG&A still has room to come down. I think that this company has the potential to get to a 5-6% EBIT margin within 2 years. Not bad given a 2% print in FY08.

Why do I prefer this one over Foot Locker (i.e. a change of tone for me)? First is that FL’s international exposure concerns me with recent moves in the dollar. Second is that with FINL, you actually get a little square footage growth – albeit low single digits. Lastly, this is a management team that I can actually trust – unlike FL.

DRI – EYE on Hedging - an Important DRI footnote

The table at the bottom is footnote 12 – Fair Value Measurements. I’m confident that Joe Lee (DRI’s former CEO) would have never tried to hedge butter, natural gas, executive compensation or interest rates. Is it a sign of the times or a sign of management’s appetite for risk? I know the absolute dollars are small relative to the size of DRI, but the trend is important. Now that they are in the business of hedging, what’s to stop them from getting more aggressive as they try to manage EPS? A scary thought! Something to keep an EYE on!

Full disclosure: since reading the footnote, I reached out to management, but have not heard back. I will post more details as I get them.

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MCD – Strengthening its Cash Flow Bull Case

MCD raised its quarterly dividend 33% to $0.50 per share. This increase follows two prior 50% dividend increases in both 2006 and 2007. Although I have communicated the issues around MCD’s U.S. margins and the company’s ability to launch its specialty coffee beverage platform by mid 2009, I can’t refute MCD’s strong cash flow story, particularly in today’s challenging environment. MCD has consistently achieved a positive net CFFO/net income ratio, which measures the proportion of earnings yielding cash. Additionally, MCD is close to achieving its target of returning $15-$17 billion of cash to shareholders through a combination of both dividends and share repurchases in 2007-2009 (returned nearly $11 billion to date).

As I said earlier this week (“MCD – The Cost of Capital Is Rising and Access to Capital is Tighter), however, I continue to be concerned about the franchise system’s cash flows as they are forced to make a fairly big investment to convert their restaurant for the specialty beverage rollout at the same time costs are rising. And the Dollar Menu can’t be helping either!

  • MCD has consistently achieved a positive net CFFO/net income ratio, which measures the proportion of earnings yielding cash.
  • And the cash keeps growing......

Food @ Research Edge – My Perspective on Keith’s Trading Calls….

Keith: HSY; thanks for coming out Goldman; they're reiteration of their sell rating is driving this higher, $43.11 next.
My perspective: They need to do a deal to remain competitive globally


Keith: RUTH is plain ugly; tested and tried every line that matters; $3.96 immediate term target
My Perspective: The banker are calling the shots – see my recent post

Keith: WEN getting the lift off the lows right where it should have, but volume here isn't convincing yet on the up moves.
My perspective: it’s so bad its good! Trying to solve for duration….

Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.51%
  • SHORT SIGNALS 78.32%