Morgan Stanley (MS): Are the Evil Doers Back?

So now that the short sellers are back, I am sure the finger pointing will find its ground. Losers point fingers. Winners understand the concept of accountability. Morgan Stanley is on the tape at the close here "reclassifying $3.9B in debt to level 3 from level 2"... Huh?... We held a dinner the other night with Yale students who had free reign in the Q&A. One of the questions was un-answerable - "what exactly is a level 3 asset worth?"
  • I have a $9.03/share immediate term target on MS.
chart courtesy of

I’m Finally Liking ANF

For the first time in years, I’m turning positive on ANF. The bear case here is so obvious that it completely hides an emerging bull story. Under $30, you can’t not look at this stock. Here’s why…

ANF’s business trends stink something fierce, as core concepts and growth engines alike have stalled (and crashed). Furthermore, margins are at peak, inventories are at trough levels, and demographic trends remain abysmal in a category that will lose share of wallet in an environment where real consumer spending is likely to go negative for the first time in 64 quarters. That mattered to me six months ago. But after losing 74% of its enterprise value ($5bn flat) over the past year, I’m officially at a point where the stock has overshot the brand value, as well as the strategic and financial call options available to the company. Consider the following…

1) Let’s assume that the consensus EBITDA estimate is 20% too high next year. A $28 stock is getting me to about 2.8x EBITDA.

2) ANF’s brands actually have tremendous value – not unlike Ralph Lauren, Nike and Coach. Kids/young adults wear the apparel bc they want to show off the brand – while a customer at American Eagle, Aeropostale, Gap, etc… could care less if the logo is visible (and in instances, they want to hide it). That customer just wants to wear the look – not the emblem. As a retailer, when you don’t own the customer relationship, you have big fashion risk. But when you are an aspirational destination (like ANF) then fashion risk and gross margin volatility both diminish materially. ANF is one of the few brand families that the consumer will pay up to wear. I think gross margins still come down over time, but they won’t collapse. Similarly, these are the ONLY brands that will maintain some level of ‘take-out’ value. The $7.5EV from a year-ago was glaringly high at the time. But $1.9bn today? This is getting tough to ignore.

3) I think that we’ll see several of these mid-tier brands and retailers go flat-out bankrupt over the next 2 years. ANF will gain share in the mall. Of that, I am near certain.

4) Did you check out General Growth’s stock (GGP)? From $41 to $4 in six months. Yes, this is one of the key mall owners that need companies like Abercrombie to drive traffic. Clearly, as evidenced by ANF’s abysmal comp numbers, it is clear that they are not pulling their weight. But as bankruptcies pick up in the mall, the lease terms will become more flexible for ANF as it gains leverage. I’ve been concerned for a while about the aggressive terms associated with ANF’s leases. The impending turn of events is likely to alleviate my concern to a degree.

5) ANF is yielding a 2.5% dividend – one of the highest in retail. The risk of cutting this is exceptionally low in my opinion. Healthy dividend yield is an important theme right now at Research Edge. ANF fits fight in.

6) CEO Mike Jeffries is a 63 year old control-freak who is involved with virtually decision at the company – to a frightening degree. That’s why he can’t hang on to a CFO. I can’t say with any degree of confidence that sound financial management is a key focus at this company. What I can say is that this team can trade its stock better than just about anyone out there. Check out the sheer volume of shares sold during 1Q and 2Q of this year – almost 1.5mm shares (1.6% of the float) over 3,000 transactions. 10b5-1 sales or not – tough to ignore that the selling pressure stopped when ANF cracked $50 (from $82). At $28, ANF has $600mm in cash to gobble up the stock. My bet is that the management team starts buying first. Either way, I’ll take it.

SP500 Levels: Hedgeye's Strategy Into this meltdown close...

Since we had the call that eliminating the short selling ban would create a stock market crash (the SP500 is down -24% from our call on 9/19/08), we think it’s fair game for us to own the debate as to the levels where we mop this mess up. It is time to buy stocks, patiently, as the levered longs get hammered with redemptions and sell low. They weren’t proactively prepared. Now you’re seeing them manage their books reactively.

I see 3% downside right now, and 16% immediate term upside. Here are our levels for the SP500:

BUY STOCKS = 922.53
Sell the “Trade” = 1070.33

With the SP500 at 948 at the time of this note, we’re going to be deploying more of our 79% cash position. I have never understood why people love buying everything on sale, other than stocks… but I guess that’s their problem here, not ours. Crisis creates opportunity.

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CHUX, RUTH – RT Implications

Yesterday, RT reported 1Q09 same-store sales down 10.8%. Although this seems like a horrific number, for RT, it is really just more of the same as it follows three quarters of 10%-plus declines in comparable sales. That being said, trends continued to worsen on both a 2-year and 3-year average basis.

Management attributed much of this continued weakness to challenging trends in the South, where more than half of RT’s restaurants are located. According to management, the rate of decline at these locations was about 50% higher than the restaurants in the north (and this trend has continued into September). Management stated that the challenges stem largely from increased supply, saying, “I think one, over the last five years, I’d say yeah, we’ve built a lot of restaurants in the Southeast when everybody was building restaurants and we only had the South and the Northeast to build in, and I think that’s hurt us somewhat. The South has been easier to develop in for everybody, so I think you’ve had increased competition there but I do think that they’ve been hurt more in the South, that includes Florida, more from a real estate standpoint, from an oil impact standpoint, and probably from -- I’m guessing, I’m not sure on this but I’m guessing from unemployment. But I’ve talked to some other businesses too and the South is just -- it’s a bit weaker.” Management also said that recent gas shortages in the South magnified an already difficult environment.
  • I think it is safe to bet that these macro issues, related to increased competition, real estate, gas shortages and unemployment, in the southeastern region of the country are impacting other restaurants as well. CHUX, which has already been experiencing negative same-store sales growth for some time now, particularly at its O’Charley’s concept, is also highly exposed to this challenging region with nearly 25% of its restaurants located in Florida and the South Atlantic states. In its most recent quarter, CHUX’s operating margins fell to 1%, which led to a net loss of $0.38 per share. The company is not expected to make money again in its upcoming quarter, which leaves little margin for error.
  • Thirty-four percent of RUTH’s Ruth’s Chris Steak House concept is located in this region of the country as well. As I have said before relative to RUTH’s recently completed sale lease-back transaction, the banks are already driving the process at RUTH (please refer to my post from September 24). Although the company stated that its motives for doing the sale lease-back were to “ensure maximum operating flexibility,” sale lease-backs do the opposite. I think Wells Fargo wanted its money back and forced the company to use the cash proceeds from the transaction to reduce its outstanding debt balance. RUTH is already in a tight position and the potential for decelerating top-line trends at over one-third of its restaurants will not help matters.
  • RT’s CEO simply stated yesterday in response to a question about the company’s cushion relative to current debt covenants that there are two ways to provide a deeper cushion in this environment. They include paying down more debt and increasing profits. RT, CHUX and RUTH all need to do one of these two things and their significant exposure to the challenges in the South are going to make it increasingly more difficult for them to turnaround their sales trends and increase profits.

Hank “The Tank” Paulson . . . Shame on You

As Sigmund Freud famously said, “Sometimes a cigar is a just cigar.” Indeed. And sometimes an investment bank is just an investment bank. In this case, sometimes the Secretary of the Treasury is just an investment banker.

We have major issues with Secretary Paulson, the former CEO of investment banking firm Goldman Sachs, appointing Goldman alum, Neel T. Kashari, to head the $700BN bailout effort. We had previously suggested that former Federal Reserve Chairman Volcker would be the ideal person for this role, but Paulson clearly has a different view of the importance of this function and by inserting a “Yes man”, he is indicating to the market that this role is of little importance or value.

Paulson’s new “Yes man”, Neel T. Kashari, is likely a good guy and no doubt smart, but is he qualified to lead the $700 billion bailout of the U.S. financial system? He has a total of six years experience in business and government. His four years of experience in business were in San Francisco where he worked as a junior investment banker for technology companies. According to the New York Times this morning, Bradford Koenig, who ran Goldman’s technology bank group while Kashari was employed there, said, “they had relatively little contact because Mr. Kashkari was a junior banker.”

We have no doubt Kashari’s powerpoint and excel skills are second to none after four years preparing presentations for the senior bankers at Goldman, but we are not sure how that translates into the experience and management skills that will be required to lead this bailout. If Hank needs qualified candidates, we would recommend that he contact our good friend Hank Higdon over at Higdon Partners, one of the top executive search firms in the world. Mr. Higdon was also a standout Ivy League Football player and is man who can find the right person for a job.

As for our new nickname for Secretary Paulson, “Hank the Tank”, it actually has nothing to do with his football prowess at Dartmouth. This new moniker is actually based on the reaction from the market whenever he speaks publicly. As we outline in our intraday chart from yesterday pasted below, it tanks.

Tomorrow at 6:45pm eastern “Hank the Tank” will speaking on the global credit crisis. Thankfully, the market will be closed on Saturday morning.

Daryl G. Jones
Managing Director

Jobless "Trend" Remains UP - Are "They" Bearish Enough yet, remains The Question...

Finally we had a positive surprise in some weekly economic data this morning. The sell siders will haggle as to what was in/out of the data all inclusive of the hurricane analysis, but at the end of the day, the most important reality here is that the “Trend” in this chart is higher, making higher lows at every rollover.

This week’s jobless # fell down to 478,000 vs. 498,000 last week (which was a the peak in the chart, see below). All in, this print takes the 4 week moving average UP to 483,000 which is the point on the “Trend” being up, not down.

Our forecast for 6-7% unemployment by year end was considered “too bearish” for most of Q1-Q3 of 2008. Since this is just math, our critics don’t day much about this topic anymore. Revisionist historians are reactive by nature. We will continue to deliver on the promise of highlighting risks to consensus, proactively.


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