One on Ones

One on Ones - asset allocation011509

“It is a capital mistake to theorize before one has data. Insensibly one begins to twist fact to suit theories, instead of theories to suit facts.”
-Sherlock Holmes

For those of you who have not had the “privilege” of sitting across the table from one of America’s corporate executives in a Wall Street organized “one on one”, you aren’t missing anything. Although “access” to these “one on ones” are effectively one of the few things that the Street still overcharges the investment community for, like most of the wares that the sell side shops them, they eventually become overvalued.

The sell side’s job, after all, is to sell you stuff. The promise of “one on ones”, I think, is to break the barrier of Regulation FD, and really cozy up to what the CEO or CFO of a public company’s body language looks like. These are helpful, particularly if you fancy yourself as the Sherlock Holmes of the investment business. Make no mistake, most of us who were overcompensated in this business over the last decade actually did think, at some point, that we were worth every penny of our “expert” interrogation tactics… but at what point in the last 6-9 months did investors with this vaunted “access” realize that they were overpaying for a company exec to give them erroneous macroeconomic outlooks? At what point did all the “smart” money in the room start acting on facts that were based on false premises?

As my partner, Tom Tobin, who runs our Healthcare team likes to say, “Wall Street is mostly about storytelling”… and at the end of the day, that’s the truth. People are always “twisting fact to suit theories”, and/or their books. Consider this contrasting narrative fallacy: A) at this time last year the likes of Dick Fuld and Jaime Dimon started to talk about the “worst being behind us” versus B) this week’s Wall Street conferences from New York to California where my team is enlightening me with the following corporate executive outlook – “the worst of the economic crisis is to come.” You seriously cannot make this stuff up.

It “is a capital mistake to theorize before one has data.” If there is one lesson I continuously have to relearn in this business – that’s it. Every mistake that I make in terms of an entry or exit price in an investment can always be traced back to either 1) not maintaining the discipline of data dependence or 2) depending on someone who has bad data! Capital markets and the prices born out of them don’t lie, people do. So be very careful in believing everything you hear in those “one on ones.”

I had a “one on one” with my alarm clock this morning and then went through the Asian data. It was terrible. Japanese machine orders tanked to the lowest level recorded, well… since they started keeping records in 1987. At down -16%, that is one more piece of toxic backward looking macro data. On the forward looking front, Japanese stock prices got hammered again for another -4.9% down move. Yes, stocks are leading indicators, and those facts have deteriorated in Asia from the day that the Crisis of Credibility went global in India with Satyam Computer’s multi-billion dollar fraud.

Frauds are problematic for those investing based on what said “authority” is telling them is going on with their business. Is there corruption, crime, and crisis to consider in Asian equities? You bet your Madoff there is! We continue to be short South Korea via the EWY exchange traded fund – I’d love to have a “one on one” with one of them 2007 “its global this time” bullish investors and hear their views on how trustworthy those South Korean numbers are. The KOSPI index got crushed last night, adding to Asia’s bearish immediate term momentum, closing down -6%.

Despite Thailand cutting interest rates by 75 basis points yesterday, and injecting 116B in Thai Baht of a stimulus package overnight, stocks in Thailand closed down another -3%. India’s stock market, which we continue to be short via the IFN etf, continues to act horribly. It closed down another -3.5%. Don’t forget that “being long India” was one of Vikram Pandit’s “best ideas” before his hedge fund, Old Lane, blew up. God help us all if he was building that investment thesis on the back of “one on ones” with CEOs like that of Satyam Computer.

Frauds and plunging stock markets aren’t good, so don’t expect me to wake up to this data and tell you that it is. Neither are crashing currencies. The Russian Ruble was devalued again by their government this week – now its lost -27% of its value since oil prices peaked last summer. The Russian stock market is starting to collapse again. It is flashing a negative divergence versus the rest of Europe as we await the ECB’s decision, trading down another -3.2%. The RTSI Index is now only 4% away from its 2008 capitulation low – this is the first of the large economy stock markets to test making lower lows. Keep it front center on your risk management screens.

Managing risk is what I do. That’s why I am still carrying a 54% position in Cash in our Asset Allocation Model. When the global data gets this bad, you want to have some powder dry. Part of managing risk, is not getting short squeezed -  a lot of people don’t get that. The levered long community is still busy trying figure out to not be perpetually net long, never mind attempt to understand a proactive process by which they don’t sell the freak-out lows and buy the euphoric highs.

With all that is going on globally, and the lack of transparency implied with foreign stock markets having a Crisis in Credibility of their own, I think the best risk management move you can make right now is to buy American. As always, be very patient on price. I put up a note on the portal yesterday issuing a downside support level for the SP500 at 836. At that level or below it, at least start covering your short positions. If the US market makes lower lows coming out of the Obama inauguration next week, I’ll be the first to admit that I started buying too early. Until then, I am data dependent.

Best of luck out there today,

One on Ones - etfs011409


Full details are not in yet but apparently there was a serious fire at the residence tower at the Four Seasons Macau. The fire has spread from the 20th floor and higher. The tower was expected to contain 1 million square feet of luxury apartment hotel units and open in Q3 2009.

On the one hand, the fire could be perceived as a negative since this will likely delay cash flow from the sale of those units. On the other hand, it is unclear whether they have the regulatory approvals to sell residential units anyway. Further, to the extent they can collect insurance proceeds quickly, any cash would help this liquidity strapped company.

We will have more details as we get ‘em.


Is it me, or are ‘breakout sessions’ at conferences becoming even more of a commodity as each day passes. Yes, a great way to meet new management teams and engage in Q&A – that is if you can get within earshot of a CEO. Check out the photo below. Try having a coherent Q&A session when 60 random people are trying to squeeze in a question. Here’s a smattering of our notes from Day 1 of ICR. I’ve got a ton more. If there is any company you are particularly interested in, please let me know.

Major Theme: 90% of the companies I met with sand the same song…”We’re slowing square footage growth, cutting capex, pulling back sg&a, and are closely managing inventories.” Thanks, but it’s a little reactive, don’t you think? Shouldn’t they have said this a year ago? I want to find a company that can confidently articulate a growth strategy and vision that includes something other than getting smaller. There were two companies that did so today. Lululemon and VF Corp. One I believe and the other I do not.

LULU: To say that I was impressed was an understatement. This company absolutely has a plan, and they are in control of their own destiny. Two things were abundantly clear to me; 1) They are moving ahead aggressively with their rollout – likely ahead of initial plan, and 2) LULU is sticking to its guns in lowering its average lease duration by shifting to 5-year leases from whatI calculate as a current weighted avg portfolio age in the mid teens. The thing I still need to flush out is how the company can lower terms while also cutting rent/ft so meaningfully (which it claims to be doing). That’s tough to achieve. I’m not doubting it, but need to vet it more before I completely buy in. Lastly, it sounds like the company is going heavy into women’s running apparel (shorts, especially) with an eye on Nike’s market share).

VF Corp: As we expected, VFC negatively preannounced into this event (see our ICR Preannouncement Considerations note from Sunday). But what knocked my socks off was management’s view that earnings in ’09 will exceed the long-term growth target of 10-11%. I don’t see how this is possible. First, they excluded higher pension expense and negative FX impact. Sorry folks….you simply can’t do that. Second, compares in 1H09 are super tough, and my sense is that they come out on the 4Q call and make earnings back-end loaded (ie take down 1Q and 2Q). Then They’ll hope that either a) an acquisition will come along to goose numbers, or b) the business environment will improve. Is this really worth paying a 30% premium to the group??? Apparently the market thinks so – the stock was down 6%.
More VFC Notables…
• Jeanswear mass channel was one of first impacted, will provide more detail in Feb
• Slower store growth in 2009 comp to 2008 below 5yr growth plan - fine with that (plan to most likely open less than 75, 5-yr plan is 75-100)
• Inflationary costs have come down, now flattish expectation for next year vs. orig expectation of 3% increase
• More marginal suppliers have gone out of business - not necessarily VF suppliers - not planning to use the balance sheet to help suppliers survive through 2009 - haven't changed terms (i.e. 30 days to 45) with suppliers, holding firm
• Markdown dollars - mostly at dept store level (3% of revs) - Nautica has been impacted, by markdowns, but not a major issue on the whole
• Had a very good qtr in TNF (will touch on in Feb)
• They are re-evaluating, making adjustments to internal compensation structure
• Under constant pressure to expand the distribution (footwear is <20% of TNF)

Quote of the Day – J Crew
“And I personally don't really pay much attention to history, but we try to figure out where the world is going.” – Mickey Drexler, CEO JCG

I’d juxtapose this vs one of our favorite quotes here at Research Edge from noted US/Spanish aphorist George Santayana. “Those who cannot learn from history are doomed to repeat it.”

No offense Mickey, but I side with Mr. Santayana on this one. If you followed his advice, you’d have seen that jamming the channel with more product when business starts to turn down simply is not a winning strategy. It did not work at Gap, and it does not work at JCP.

The irony is that I’m tempted by this story down here. But I need to up the management trust factor before I get more greedy in betting on the timing of the bottom.

Decker’s: Someone asked a very fair question… “What levers do you have to proactively manages through a potential protracted downturn or incremental hit to product momentum in 2009?” In the wise words of one of my Research Edge colleagues, “management sounded like they were throwing pancakes against a wall and hoping one would stick.”

• Still have significant excess inventory that will take at least 6-9 months to clear
• The decision on whether their long awaited distribution facility will be passed takes place this week.

The facility will be immediately accretive. They currently have 5 buildings that they operate from and they will be able to consolidate into 1. Will have short term duplicative facilities, but their buildings currently have very short leases all of which will expire by February. Big deal as they will be able to potentially reduce their headcount from ~1500 to ~500 with the benefit of significant automation. Fred claimed that if they could do that, they might be able to keep SG&A flat. They will be able to cut ~$7M along in transportation costs between the facilities.
• Have committed to 20-25 new stores in 2009, but not all are built and will not pursue additional locations if these aren't completed.
• Commented several times how inefficient their operations are currently
• 35% of sales through department stores – very weak channel

$100M that the company needs to have on hand (through June 2009) is all ARs
Have to get rid of more inventory, won't have good idea of what lies ahead until BTS 2009 after bankruptcies shakeout

Have lost ~500 doors from bankruptcies from 15-20k
• Wrote off $1M on Mervyns and Goodies, less than $100k for GOTT, but they have inventory that will have to be reallocated
• KSS family footwear was a bit stronger relatively
• Expect China to be in the black by end of F09/early 2010 to get to a point where they can leverage infrastructure and headcount

Big 5 Sports
• Look to take advantage of retail store environment in 2009 to grow locations and build inventories
• Only focused on states currently in, not new opportunities to expand
• Average store costs / sq ft is less than $30, are seeing retail prices like some others coming down by as much as 25-30%
• Mentioned that they can open stores very fast if the opportunity presents itself - in a matter of a few months vs. much longer for competitors
• "We believe we are advantaged in our growth and that we are very flexible in the type of real estate that works for us. Our stores average 11,000 square feet in size. This, we believe, allows us to fill the role of being a convenient neighborhood store. We provide a comfortable shopping experience for our customers. We don't need nor operate what's often referred to as cookie-cutter stores. We are successful in freestanding locations, small strip centers, major power centers. We have a small number of mall stores that perform very well."

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PNRA – Implications of Management Comments

Bloomberg reported that PNRA’s CEO Ron Shaich said in a phone interview today that 2008 comparable store sales growth was “north of 3 percent.” Based on the company’s prior 3 quarters of company-owned same-store sales growth of 3.3%, 6.5% and 3.0%, respectively, this would imply that 4Q same-store sales were down about 1% to get to 3% for the full year. Based on the CEO’s comment that full-year same-store sales growth came in north of 3%, however, there could be some upside to that -1% number. For reference, a 1% increase in 4Q same-store sales would yield 3.5% growth for the full year, also north of 3%. That being said, a 1% decline represents a slowdown from 3Q and is below the company’s 4Q comparable sales guidance of up 1%-3%. The company was guiding to a 5.0% YOY increase in retail checks in the fourth quarter, including a 1% negative impact from mix, so a 1% decline in same-store sales would also imply that transactions declined 6% (also a falloff from 3Q’s 3.2% transaction decline).

Eye On China: Keeping The Money At Home

Keeping money at home

China's total foreign currency reserve increased by 418 billion USD in 2008, 44.1 Billion less than the increase in 2007 -with an increase of just 45 billion in Q4. Make no mistake - the stack of chips in front of China may be growing at a slower rate, but they are still the big money at the poker table and can still splash the pot at will.

As the pace of the stimulus measures picks up pace however, they may become more selective in the places they choose to hold their capital –with yesterday’s M2 figures released by PBOC saw broad money supply increased by 17.8% year-over-year with a 62% increase in new Yuan denominated loans and no signs of slowing pace, FX reserve growth rates could go negative in the coming quarters.

For now, China is still financing two separate stimulus packages, one at home and one in the US. As the “new normal” takes effect, the question of who calls the shots in international economic policy may well change. Creditors have a nasty habit of expecting to get their way.

Andrew Barber

Eye on Europe: Grinding To The November Halt

Eurozone Industrial Production continues to decline

November Eurozone Industrial Production came in lower than expected today at -7.7% Y/Y versus consensus of -6.1%. We’re cognizant that a November number is stale, but the slowdown trend is clearly showing no signs of bottoming yet. The impact of the slowdown is being felt harder in some places than others, Italy reported a -12.32% Y/Y production number today for instance, and that divergence creates the possibility of discord among the EU member countries as they plot a course for recovery.

The big factors to watch remain the same:

1. The outcome of Europe’s €200 BN joint stimulus package to jump-start the economy (€50 BN of which Germany committed this week): We’ve written much about Obama’s US stimulus package over the past several weeks. The risk that Europe’s package (along with tax cuts and fiscal policy changes) will fail to increase consumer spending and create jobs sufficiently and require a second round of heavy spending. Back in October Germany and France issued bank rescue packages to the tune of €500 BN and €360 billion respectively, yet today Deutsche Bank made headlines that its Q4 ’08 loss totaled €4.8 BN and HSBC is expected to require an additional $30 BN cash infusion. Another trip to the well will be painful (particularly for EU members that have a higher cost of funding like Greece, which will likely see it’s relatively high cost of borrowing increase further in the wake of today’s ratings cut by S&P).

2. Rate Cut Impact: Tomorrow the ECB will all but certainly cut interest rates, with consensus estimating a -50bps cut, yet will this be enough to accomplish anything? Additionally as ECB interest rates change we’ll be watching its affect on the Euro-USD currency exchange. Should the Euro continue to rise against the dollar, it will put further pressure on European exports. If this should be the case you’ll see exports decline along with PPI and CPI numbers on deflationary pressures.

For all of 2009, we have been short the UK via the EWU exchange traded fund. We covered that position today. Booking gains on the short side continues to be what we do. We will look to re-short EWU on an up day.

Matthew Hedrick

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