WRC: A Tough Shot…But I’m Taking It

There are few events more volatile in this space than a Warnaco EPS report. Several people asked me what I’d do in advance of the numbers. Here’s my 2 cents…
This is a tough shot, but I’m going to take it. I remain quite negative on the 2-year margin outlook, but have burned myself on more than one occasion in being early on this call. But why negative now? A few considerations…

1. My model has revenue growth going from a 20%+ growth rate to a single digit rate – something I think it will be tough to beat organically with its current portfolio.

2. I maintain my view that WRC has passed too much of its incremental FX benefit to the EPS line over 5 years instead of reinvesting back into the business. With margins going from 2% to 10% over that time period, I’m confident that we’ll see a big swing the other way next year when an Obama administration inevitably takes up interest rates, and the dollar along with it. I can’t find another company with poorer positioning that WRC.

3. Aside from a sharp deceleration in revenue and margins, WRC is about to comp against 4 quarters of the biggest improvement in the company’s cash conversion cycle in its history.

4. 12% of the float is short, which concerns me – but we’re seeing it at 20-30% for better quality companies.

5. WRC beat every one of the past 9 quarters by an average of 42%. Do you think that just MAYBE the street is expecting another one? I can’t rule out a beat – though anything near recent magnitude is not gonna happen. Better yet, a guide down is increasingly likely.

6. Why should this name trade at 6x EBITDA – at the peaky end of retail today?

7. No covenant issues right now as first tranche of debt is not due until 2012. But cut margins in half (which is entirely possible) and we’re talking a very different story…


The benefit of the loss limit removal is pretty apparent for PNK’s Lumiere Place and the stock is acting well following the news. However, Pinnacle’s Admiral President may be a stealth beneficiary of the referendum that passed yesterday. We could see a new President upriver in St. Louis. In our June post, “ADMIRALING PNK’S PRESIDENT OPPORTUNITY”, we wrote about the option to move the President near the Chain of Rocks Bridge and farther away from Lumiere Place. I believe this option is more likely after yesterday.

As previously calculated, the total investment for a “new” President would likely be in the $50 million range. The President would draw from a new geographic area while Lumiere Place would certainly capture some or most of the President’s customers with no additional capacity. Assuming a combined $25m in additional EBITDA from the move, the incremental value of the President would be worth around 6x EBITDA less the investment, or a net of $100m.

A $1.67 in incremental value per share is not small change now with PNK trading at just $6.50 per share. Another potentially attractive option could also be pursued. A gaming license in a limited license jurisdiction like Missouri’s with no loss limit in place is surely worth $100 million. I don’t foresee any liquidity issues for PNK, but the sale of the license could alleviate any deteriorating financial condition.

PNK suddenly has some operating options in St. Louis and its financial situation is probably more flexible than it appears to the Street. Look for an in-depth discussion of this flexibility on the call tomorrow.
I personally own shares of PNK

Eye On The New Reality: Free Market Capitalism Defined...

As I have been pointing out over the course of the last few weeks, we are starting to get credible academic support for our view that we have a deficiency in the American financial system's leadership. Earlier this week, Israeli Game Theorist and Nobel Prize winner, Robert Aumann, took aim at Hank Paulson and Ben Bernanke, calling them "not smart." Below I have attached the intro to the Ayn Rand Institute's note from today, by Alex Epstein and Yaron Brook, titled "The Maestro vs. the Market":

"Alan Greenspan claims that the free market failed to prevent the financial crisis, and that he is "shocked" that his professed "free-market ideology" turned out to contain a "flaw." But why should we take him seriously? Greenspan, while once associated with laissez-faire philosopher Ayn Rand, hasn't advocated genuinely free markets for decades. Remember, this is a man who for two decades reveled in being, as the New York Times put it, "the infallible maestro of the financial system."

Free markets don't have "infallible maestros"; they liberate us from such "maestros"--the central planners who have time and again falsely claimed the ability and the right to orchestrate millions of economic lives. Free markets enable each of us to be our own maestro, conducting our own affairs, producing and trading as we judge best, and taking responsibility for the consequences when we fail."

(For the full article see Ayn Rand Center Op-Ed ).

If we collaborate best ideas, quantify fact, and exploit fiction… we’re going to find that “The New Reality” is much more positive than the pervasive bearishness expects.

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October Sales - Updating the Macro View of the Consumer

Retail sales day is here again. While while Wall Street stews over how bad numbers will be, we thought this would be a good time to take another look at the state of the consumer over the last 2 years.

In early October, we analyzed the changing state of the consumer over the last 40-plus years (please refer to Brian McGough’s two posts dated October 12 for more details). Specifically, we wanted to see how consumers were faring in the year-ago period to gauge what type of consumer environment retailers are comparing against in their upcoming reported October results.

Since January 2007, personal consumption expenditures hit their YOY peak in growth in November 2007 and have since grown at a moderated to declining rate. Nondurable goods spending has helped to support total PCE growth as gasoline, fuel oil and other energy spending picked up in September 2007 and began to really accelerate in October followed by four months of 30%-plus YOY increases. Energy spending continued to grow at double-digit rates since that period through July as gasoline prices hit historical highs.
At the same time energy costs took a larger share of wallet, consumers were hit with overall inflationary pressures as CPI reflected these higher energy costs and began its steady YOY increase in August 2007.

The unemployment rate, which has been on an upward trend since January 2007, also began to increase at a more significant pace during this October to November 2007 timeframe. Not surprising, disposable personal income growth decelerated in October as well as it coincided with the uptick in unemployment rates. Since then, disposable income growth has continued to moderate until it turned relatively flat in March 2008. The government’s rebate checks helped to boost numbers in May (also provided a lift to May, June, July retail sales numbers), but this government intervention only provided a short-term fix and disposable income growth has since abated.

In fact, the narrative is quite frightening. Last fall, as inflation and unemployment headed up, what did Americans do? We took our personal savings rate below 0% in November 2007. Then the government came in with rebate checks, but that was a 2-month fix. Now we're looking at unemployment rate a full point above least year, and there's no more tax shelter. Unfortunately, now we comp against a negative personal savings rate in November. That's a tough one heading into holiday and into 2009 -- especially if Brian is right in his October 12 analysis that discretionary spending could finally turn negative in 1Q09 and be down about $170 billion in FY09.

Kerry Bauman
Senior Analyst

Charting Why They'll Cut Again Tomorrow: UK Industrial Production

The winner of this morning's worst economic report goes once again to our British friends. Industrial Production growth for the month of September showed another y/y decline of -2.2% (see chart). While this is 10 basis points better than august, it remains bad... bad enough for the Bank of England to start cutting interest rates more aggressively.



We have collected some trench data from the current the promotion of the Jr. Bacon Cheeseburger, Crispy Chicken sandwich and the Doublestack, all for $.99. Operators were asked to comment on the impacted to their restaurant. A complete assessment from on sales, food cost, labor, service, etc and what has changed, if anything, since the end of the promotion.

Two key themes emerge from the survey……..

  • It helped drive same-store sales........

  • But not profitability…..

The value trio promotion had the following effect on my overall sales:
The value trio promotion improved the profitability of my restaurant:

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