DF – November Milk Prices Continue to Decline YOY

The USDA just released the advanced Class 1 milk price for November of $17.33 per hundredweight. This price reflects a 19.2% decline year-over-year, but an 11.6% sequential increase from October’s level. As I have pointed out once before, there is an inverse relationship between the change in milk prices and DF’s gross margins so the fact that the average milk price for the first two months of the company’s 4Q08 have declined nearly 24% should benefit DF’s quarterly gross margins.

VFC: Written in the Cosmos

VFC has been one of our top short ideas for the past several months. No matter how well-managed a company is, when 3-years of acquisition/FX-fueled growth ends in conjunction with a consumer downturn and lapping its best cash conversion cycle in history, then that spells trouble at a 20% valuation premium to the group.
Growth rolled over in every one of VFC’s businesses – which is a first. It also represents the biggest sequential slowdown we’ve seen in the outdoor division in years. With 12.5% growth in that division (which is responsible for almost all of VFC’s multiple premium), my sense is that after stripping out FX benefit, it was a mid-high single digit increase – with several points of that coming from company-owned retail stores (not what I want to see). As I noted in a note last month – this company needs a deal.

The biggest saving grace here is that the company upped its dividend by $0.04 annually, which will presumably push its yield from 3.9% to something north of 4% when the stock opens in negative territory. That’s fine. If it were any more I’d be even more concerned about this story. I don’t want to see a company with 28% debt to total cap and 20% of its debt due over the next 2.5 years up its dividend at the expense of the balance sheet.

I’m not interested in owning this stock until it has a 4-handle.

There's No Crying In Investing!

``There's a crying need for capital, and now there's a chance that the government will invest alongside''
-David Rubenstein, The Carlyle Group (Bloomberg article by Jason Kelly this morning)

The man they call “Ruby” definitely has that right. I am not sure how that fits within the parameters of free market capitalism, but there is indeed a lot of crying going on these days. You can hear it across the oceans from “Private Equity Inc’s” Super Return Middle East Conference! C’mon guys, there’s no crying in investing.

David Rubenstein is one of the hardest working men in America. He has built a wonderful firm, and hires wonderful people. Moshe Silver and Tanya Clark were two of the finest who I had the opportunity to work with while I was with Carlyle’s hedge fund. Now Mo and Tanya work here, alongside me at Research Edge.

I support Carlyle’s cash flow every day that I check into Dunkin’ Donuts (they own it). This morning I was down there on Whitney Avenue in New Haven with my buddy “Joe The Plumber”. He and I had a quick chat about how great this week has been. If yesterday’s gains hold, this will be the best week in the US stock market since 2003. This is fantastic news for those of us in no need of government assistance. This is a great week for American capitalists with net cash who don’t need “gearing” schemes in order to earn a return.

If the Red Sox can come back from 7-0 last night and stay in the game, so can “Private Equity Inc.”. Never say never folks. As long as “Hank the Tank” is operating the bazookas, you never know how much free money that he and the old boys can endow you with. Once we get through this election, and the Democrats start putting some fire in the zero-transparency holes, things may get uglier however. It will be interesting to see how Blackstone, KKR, and Carlyle deal with non-trivial critters like the “Employee Free Choice Act” (unionization), and a turn in the Queen Mary 25 year-chart of cost of capital (long rates rising). They better hope that the “government invests alongside”. That might be their only way out.

Hope is not part of our investment process. We’re interested in investing the way that people did in the 1970’s. We’re looking for great balance sheets, not levered ones. We’re looking for disciplined capital allocators, not reckless ones. We’re looking for unlevered dividend yields, not manufactured ones. This, of course, is the antithesis of what private equity does. Joe and I are cool with that.

Yesterday we gave some Obamerica “knucks” to another investment great, Jack Bogle, and bought some of his low fee wares via the Vanguard High Dividend Yield fund. The dividend yield we bought into was 4.6%. That’s certainly better than anything called US Treasuries, and importantly, it’s more predictable. The only thing that I can predict about US Treasuries and the man who runs the US Treasury show, is continued reactivity and volatility. There never was a proactive plan. Don’t bank on one now.

From a ‘Hedgeye Portfolio’ perspective (see for positions), we bought low on market weakness yesterday, and it paid off handsomely. This morning, Warren Buffett is even signing off on Americans buying stocks in their personal accounts. Upward and onward? While we have bought a few bottoms this week, we’re not going to rush out and call it “THE Bottom” – that’s what entertainers do. Be patient and be sure to buyem when they are down, not when they are up. I know, another ingenious strategy from Joe’s buddy from Thunder Bay. Our current ‘Hedgeye Portfolio Allocation’ is: Cash 72%, Stocks 25%, and Commodities 3%.

I don’t like bonds here. I don’t like debt, period. Debt is a disease that needs repeated treatment and de-leveraging therapy before I get interested. Everything has a price.

In fact, oil finally found our price yesterday. We bought it at $69/barrel for two reasons: price and a catalyst. That was the lowest price we have seen in 13 months, and since Goldman is now saying it can go to $50 (which is weird because I could have sworn that they said $140 this year as well), and page 1 of the Wall Street Journal has an article dedicated to it “plummeting”, I BUY. The catalyst, of course, is that “Hank the Tank” and “Heli-Ben” will drop moneys from the heavens again, and cut rates to negative (on a real basis) on October 29th. Creating more free moneys for the monkeys will only re-ignite the bubble bath that so many in this market have come to enjoy since Greenspan prepared the lather and hot tubs from 2001-2003.

Staying in hot tubs for extended periods of time is bad for you. Keep your discipline, and stay away from government supports. Be your own process and stand on its principles. Having to depend on the governments of this world to “invest alongside” will only end in more regionalism, regulation, and a host of ugly and unintended consequences.

Have a great weekend,

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Few jurisdictions are less attractive than Illinois from a casino investment standpoint. Yet there were no shortage of bidders for the State’s 10th and last license. Bids ranged from $60 million (dumb) to $435 million (and dumber). And that’s just for the right to operate a casino in this socialist state. Never mind land and construction costs.

Assuming the $435 million bid wins (loses), the all in investment cost will certainly approach $1 billion. I don’t think there is one existing Illinois casino property that will generate more than $55 million in EBITDA this year, and likely less next year. Even if the new casino can drive $100 million in the face of the most onerous tax structure, a 100% smoking ban, and an uncertain consumer environment, a 10% ROI is not very appealing.

The only encouraging take away is that no public gaming entity even bothered to enter a bid. BYD, PENN, and WYNN are the only companies with the actual resources to even face that decision. They all made the right one.


In this environment, one would expect a stock that is down 85% YTD to be an overleveraged, covenant busting, illiquid, and free cash flow negative company lacking hard assets. While many of these adjectives apply to many companies within the gaming sector, none accurately describes Boyd Gaming. Oh and by the way, BYD should generate $2 per share in free cash flow next year for a 40% yield. That’s 40% after all capex and is based on reasonable numbers, not the Street’s.

No one is making the case that BYD’s fundamentals are rock solid right now or their upcoming quarter will be good. Quite the opposite. However, I don’t need to whip out my calculator to know that even if my discounted estimates are cut in half, the FCF yield would still be a whopping 20%.

From a liquidity standpoint, BYD has no significant maturities until 2013. Covenants shouldn’t be an issue either as leverage is coming down at the same time the leverage restriction rises. Please see the chart. EBITDA would have to fall over 25% below my estimate in Q4 to bust a covenant. Not likely.

Something is going on here. BYD dropped 13% today when the DOW rocketed up 400 points. Even HOT was up today. Somebody is blowing up.

Even in Q4 BYD maintains significant leeway before busing the leverage covenant

Explosion: Why We Bought/Covered This Morning...

The VIX hits an all time high

Market pundits are using the term “unprecedented” to describe the levels we are seeing in the options market -for once they are right, there is no real historical corollary for the current volatility environment. The VIX spiked to all time high levels today as equity investors across the entire duration spectrum struggle to find their footing. As you can see from the attached chart this is a global options market phenomenon as every short gamma trader on the planet is scrambling to buy and cover because their models no longer work.

Anyone with a pronounced directional bias for a particular name or names should take note: The volatility curve is very steep sloping downward from the front months -there are a lot of very attractive calendar spread opportunities right now.

On a personal Note: based on the tone of today’s coverage, our friend’s at Bloomberg have apparently decided that it is now time to panic. As you will recall I was miffed when a smirking Bryan Keogh dismissed our thesis that the VXO would reach levels that it hadn’t seen since 1987 as a crescendo signaling a short term bottom for equities. On the 14th, after we were proven correct, volatility levels subsided and Bloomberg’s senior volatility correspondent Jeff Kearns reported that smart money expected that a measure of calm was returning to the options markets –exactly when we made the call that the VIX would test 70 again. It would be tempting now to make a call based on the shrill tone of their latest dispatches as a contrarian indicator but going into expiration at an all time high we might as well try to nail Jello to a tree as call the VIX.

Andrew Barber

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